Seeking Value in Temporary Setbacks
Nuance Mid Cap Value Fund
Author: Ticker Magazine
Last Update: Sep 29, 10:14 AM EDT
|Investors are not always patient when companies are riding along the ups and downs of business cycles. However, a disciplined approach to investing in out-of-favor companies undergoing temporary issues can be quite rewarding. Chad Baumler, portfolio manager of the Nuance Mid Cap Value Fund, relies on a five-step process in identifying companies with favorable risk/reward profiles.
“We aim to invest in what we believe to be leading businesses that are temporarily or transitorily underearning their long-term potential and because of that under-earnings display an attractive risk-reward ratio from a valuation perspective.”
Over the course of 2016, the company’s transitory issues were resolved and earnings rebounded to $3.00. The price went up from the low $30.00s to the low $50.00s where it is today.
Q: How is your portfolio constructed? Is diversification part of your portfolio construction process?
Our target range is between 50 and 90 names in the portfolio, but it generally averages between 50 and 60. Diversification is not the major driver in our portfolio strategy. Instead, the process is based on our fundamental research into each security and an assessment of their fair market value and downside price target.
In evaluating each of our potential securities, we also assign a peak weight that reflects our certainty of the company’s degree of future visibility. We are willing to take larger positions in companies that we view as having higher levels of certainty. So, generally speaking, the max position of any one name in the portfolio is 7.5% and the minimum is 0.5%.
Our portfolio construction is driven by an assessment of risk and reward at the security level. But we also do have sector, industry, and diversification constraints that we overlay on top of our risk-reward and peak weights when we configure the portfolio.
Q: How do you define and control risk?
We define risk in terms of the standard deviation of returns, so we view the world from the perspective of a Sharpe ratio. In an attempt to control our overall portfolio risk, we aim to control the risk associated with each of our stocks. Every day, we calculate how much downside potential exists in each one of our stocks and in our portfolio.
We make sure that each company has a sound competitive position and we monitor their balance sheets to make sure they haven’t taken on additional financial risk. We also dig into their capital allocation priorities to make sure they are not diluting our price targets. This detailed monitoring gives us confidence that our downside price estimates are still on target.
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