Finding Quality and Growth at a Discount
First Investors Opportunity Fund
Edwin Miska, Steven Hill
Author: Ticker Magazine
Last Update: Aug 28, 10:10 AM ET
|Investing in well-established companies with growth characteristics tends to provide added value when the purchased stocks, or their sectors, are suffering from temporary problems. Steven Hill and Edwin Miska explain how the core strategy behind the First Investors Opportunity Fund blends a bottom-up selection process with a catalyst-driven approach to build a portfolio of quality stocks across a flexible market-cap range.
“We emphasize catalysts, or the discrete events and/or moments in time that will lead to earnings acceleration or enhanced shareholder value. In other words, we look for companies with growth-like components and try to get them at a reasonable price.”
Newell Brands Inc exemplifies this M&A theme. The company, which markets a large portfolio of well-known consumer and commercial brands, successfully completed the merger of Newell Rubbermaid and Jarden Corp, another brand leader in consumer household products. The companies saw an opportunity to come together and take on the changing retail marketplace.
At the time of the merger, we owned positions in both companies, and both had been successful as individual investments. Since the deal closed in April 2016, the stock is up about 22%. Although a number of our holdings have benefited from an M&A strategy, none have quite reached this magnitude. Today, Newell remains one of the larger positions in our portfolio.
Q: How do you go about constructing your portfolio?
We tend to construct our portfolio one stock at a time with a bottom-up focus. After going through multiple financial crises, we adopted a policy of broad diversification across sectors and in the number of holdings in the portfolio – thus meeting the needs of the conservative retail consumers who buy our fund.
At any given time, the fund has approximately 100-120 names. Positions are initiated at around 0.50% to 0.75% with the goal of them reaching 1% through appreciation. Possible additions to the portfolio are names we’ve identified as having the potential for 15% to 20% upside or more in a year.
The S&P MidCap 400 Index is our benchmark, but we also monitor the fund relative to the Russell Midcap Index and pay close attention to our peers in the Lipper Mid-Cap Core category on a daily basis.
We remain aware of overall sector weightings but don’t pay too much attention to relative weighting versus an index or peer set. It’s important to stay mindful of sector weightings, though, and generally we avoid dramatic underweights or overweights since we don’t want the focus to be exclusively on stock selection as it could create a hidden risk force.
We have one-year price targets which are updated daily and constantly monitored. Changes are made based on information flow and any effect that may have on earnings and cash flow. As a name approaches our target, it will be reassessed and we’ll decide if there is potentially more upside.
If we conclude that neither the valuation nor the catalyst for potential upside exists, we typically sell a stock. Sells can also be triggered by both positive events, like mergers, or on bad news as a defensive tool to protect the capital of our shareholders – perhaps there’s been a management change, a strategy shift, or missed earnings that we can’t make sense of because they’re unexplained or poorly explained.
Typically, our holding period is longer than most. The fund’s turnover ranges from 30% to 40% a year, which means we own our stocks for at least two to three years. Some names in the portfolio have been there since Steven and I got involved with the fund in the early 2000s.
Q: What are the different risks you focus on? How do you control risk?
Our tendency is to focus more on risk at the level of the individual company rather than things like equity risk, the liquidity risks of small- and mid-cap companies, or the risk of a sector going out of favor. By relying on our bottom-up approach, we make long-term individual bets based on our ability to analyze companies over multiple years.
We constantly monitor this daily to see if there has been a change in the quality of the company, be it a deviation from a stated strategy, leverage that has increased uncomfortably, or a negative liquidity event which would compromise our ability to successfully trade.
One routine risk management tool we watch closely is position size – especially relative to our price target – to see whether a name has become a large position in the fund. Although we wouldn’t necessarily eliminate the position, we would try to harvest some of its success and reduce the stock-specific risk that having such a large position introduces into the fund.
Managing risk from a macro perspective is something we try to avoid because so much of it is based on things beyond our control. We can’t rely on the popular press to figure out which sectors or subsectors might benefit in a certain environment because almost invariably they are either wrong or simply lack the detail we need.
Take healthcare, for instance, where the risk situation changes every 24 hours. The circumstances are evolving rapidly, so we remain quite deliberate in our approach, because we are not rapid traders. Instead, we constantly assess what the outcomes could be, then make a decision to trade.
Even when we do trade, we tend not to go in and out of stocks but rather gradually accumulate and dispose of names over time to give ourselves leeway should there be volatility in the marketplace.
1 2 More: Mutual Funds Archive