Q:  What are the most important aspects of your sell discipline?

A: Having a disciplined process to efficiently and effectively identify companies with strong business fundamentals is only half of the equation; the other half is knowing when to sell them. We are very disciplined in monitoring our portfolio for any companies with weakening earnings or business trends for our sell discipline.

There are several potential catalysts that trigger a trim or outright sell decision, the most obvious being a deterioration or negative inflection point in the fundamentals that attracted us to a company in the first place. We constantly monitor our companies for any yellow flags, including but not limited to peaking or slowing momentum in sales, earnings growth, or the profitability trends. Another area of focus is estimate revision trends and earning surprises. Any moderation in these metrics potentially signal street expectations are catching up to a company’s story. Similarly, if a stock’s valuation reaches extreme levels relative to the underlying fundamental trends, then that could trigger a sell decision. And lastly, when a company reaches $3 billion in market cap we begin to implement an exit strategy. The alacrity with which we exit a name depends upon the strength of current fundamental momentum in relation to valuation.

Q:  What are the turnover levels of your fund?

A: Our turnover has been very consistent in the 90% to 110% range over seven years. This consistency is highly attributable to the consistency with which we have executed our process, which is one of the keys to our success. Roughly 75% of our turnover is stock in and stock out of the portfolio, whereas the remaining 25% is trading around existing positions. If the valuation of a company has gotten ahead of itself, but we still like the underlying fundamental trends, we may not want to sell the entire position. Instead, we may cut down the position and look for an opportunity to add back to it at a later date.

Q:  In addition to having a diversified portfolio, what other risk control measures do you have in place and what risks do you perceive?

A: One of our primary objectives is reducing company-specific risk in our portfolio, but we also like to minimize the risk of getting too attached to a company. We are very fond of all our companies and we like to date them, but we don’t want to marry them. It is much easier to part ways if and when the time comes. That means taking an arms-length approach towards communication with company management and towards the potentially biased assessments of sell-side analysts. We try to make our assessment based on the facts and not based on whether we really like a particular CEO.

In monitoring our portfolio risks, we track on a regular basis the Modern Portfolio Theory risk statistics such as standard deviation of the returns, the beta of the portfolio, our tracking error, and our sector weights relative to the benchmark. Even though our sector weightings are generated from our bottom-up stock selection, not only do we make certain that we stay within our sector weight guidelines, but we are always performing a check to make certain that an overweight or an underweight position in a particular sector makes sense from a big picture vantage.

We are not paid to manage market risk or hold cash as a proxy for stocks. Our investors expect us to be managing a small cap growth stock portfolio as a part of an overall asset allocation strategy.

Regarding management risks, our fundamental research includes an evaluation of the management decisions, company history, and capital allocation decisions, all of which is a reflection of the management and their decision-making ability at running the business. For example, we evaluate the impact of capital allocation decisions, such as major acquisitions or share repurchase, on stock price performance. One such study that we read evaluated every company, which has acquired a company that is at least 50% of its size, and found out that 70% of those companies underperformed over the next 12 months. These incremental factors help us to evaluate management decisions and play a role in our overall evaluation of company fundamentals.