Capital Appreciation through Quality and Diversification
Value Line Capital Appreciation Fund
Cindy Starke, Liane Rosenberg
Author: Ticker Magazine
Last Update: Mar 23, 4:25 PM EDT
|Seeking capital appreciation and income, the Value Line Capital Appreciation Fund is an asset allocation fund that at year end 2017 was 85% invested in equities and 15% in bonds and cash. For equities, the fund mainly looks to own leading growth businesses with secular growth drivers, unique market positioning and competitive advantages. On the fixed-income side, the fund focuses on income, liquidity, and improving credit metrics. For portfolio managers Cindy Starke and Liane Rosenberg, the ultimate goal is to achieve a diversified portfolio that emphasizes the best return-generating ideas.
ďWith equities, our goal is to create superior longer-term capital appreciation for investors through longer-term ownership in a diverse group of leading growth companies. On the fixed income side, it is about relative value and enhancing investment income.Ē
Q: Could you give us some background information on the fund?
In February of 2018, the Value Line Income and Growth Fund was renamed the Value Line Capital Appreciation Fund. It currently has $435 million in net assets. Liane Rosenberg, who has been on the fund since 2011, manages the fixed-income portion of the portfolio. Cindy Starke joined the fund in 2014 and manages the equity portion of the fund. At the end of 2017, the asset allocation of the fund was approximately 85% in equities and 15% in fixed income and cash.
Q: What core beliefs drive your investment philosophy?
With equities, our goal is to create superior longer-term capital appreciation for investors through longer-term ownership in a diverse group of leading growth companies. We believe that sales and earnings growth are the primary drivers of share prices over the longer term. Overall, we target sales growth of 10% and earnings growth of 15% on average for companies in the Fund.
On the fixed-income side, it is primarily about relative value. While we actively manage the duration of the Fund, taking interest rate risk is not our primary way of adding value. Although we take some bets in placement on the yield curve depending on our interest rate forecast, our returns and outperformance of the index come through sector and individual security selection. We had a large corporate overweight relative to our index and a similar underweight in US Treasuries for the last few years. This year had seen a reduction in overall corporate exposure and increases in Treasuries as we dialed back our risk exposure in 2018.
Also, we believe in diversification. Our fixed-income process begins with a top-down approach and an economic overview. We take into account global trends and what are central banks are doing or are likely to do. So, we start with a broad economic conviction and work from there.
Q: What is your investment process on the equity side of the portfolio?
On the equity side, our research process is bottom-up. We look to own high-quality growth companies, that we believe can grow both their sales and earnings at a faster pace than the market and their peers.
As far as finding these great growth companies, we have a multi-step research process that helps us identify and analyze these companies. Our process begins with idea generation, then transitions to fundamental analysis on the companies that have attractive growth businesses and warrant additional research, then ends with our decision making.
The first step is idea generation and there are a variety of ways new ideas come to us. One tool we regularly use is quantitative screening. Every two weeks we look for companies that are consistently beating expectations and are growing faster than the market and their peers. Another tool we use is Value Lineís Timeliness Ranking, which is updated on a weekly basis and ranks approximately 1,700 stocks relative to each other for expected price performance over the next 6-12 months. Stocks are ranked on a scale of 1 to 5, with ones expected to be the strongest relative performers and fives expected to be the weakest.
Importantly, the idea generation process involves us constantly reading, listening and learning about new companies, longer-term industry trends and changes in consumers buying behavior. This includes us going to conferences, speaking to analysts and management teams. We listen to all our companiesí conference calls as well as to those of their competitors. We find it helpful to understand how they are spending and investing their money as this often gives us insights on other industries and companies for us to potentially invest in.
During the fundamental analysis process, we view sustainable sales and earnings growth as the most important factors. In general, we like to see sales growth of at least 10% and earnings growth of 15% over the next few years. We strive to own companies with strong balance sheets, led by visionary management teams, and are not dependent on the economy to succeed. Overall, we are looking for unique growth businesses, preferably dominant global brandsand businesses that operate in industries have high barriers to entry or a product/service with a competitive advantage or differentiation. When we take into account all of these fundamental factors, there arenít too many companies we feel compelled to own.
The final step is decision making. If we believe that we have found an idea that meets our criteria and we want to buy it, then we decide if we should sell or reduce our exposure somewhere else. If we like the company but have some concerns, we may decide to watch it for several quarters. Because we start with the intention of owning these businesses for the long term, we are not concerned about waiting a quarter. We are never forced to buy anything.
Q: Would you describe your process from the standpoint of fixed income?
We also take a long-term view in fixed income, but we ask different questions. We examine how the management has treated the bondholder relative to the shareholder. We want to see if the company is returning cash back to the shareholders and how stable the credit profile has been. It is also important which sectors will do well in the current environment and in the future economic backdrop.
Now we are looking at companies that will do well in the current rising interest rate scenario. Generally, corporates have done very well for us in both investment grade and high yield. Unlike our index, we have a modest high-yield presence that has generally been a source of alpha.
When researching individual companies, we go to conferences and read credit reports from independent credit analysts as well as from Street analysts. Increased M&A activity can be a cause for concern and a close watch is kept on these credits. We donít trade heavily as we try to keep turnover low and costs down. We prefer to we give these credits time to run.
Q: How do you generate ideas on the fixed-income side?
On the bond side, many of the ideas are generated by the technicals in the market. When new bonds and companies come to the market, we start to follow them. Once we become interested in a name, we analyze spreads, relative value, and overall credit metrics. We may like a name but decide not to own it if deemed too expensive. We may look for a more attractive entry point when the bondís relative value improves. Overall, the decision-making process is driven by both fundamental and technical factors.
Q: Could you give us some examples of holdings to illustrate your research process?
A good example of our Equity research process is GrubHub, the leading US online and mobile food-ordering and delivery company. We have owned the company since a pullback in their share price in 2015 and it has been one of the top performers in the Fund over the past few years. Initially, we found the company through our quantitative screening process while we were looking for companies that were projected to grow sales and earnings faster than the market. It was nice to see GrubHub make the list, as we were already frequent users and big fans of their Seamless branded service.
At the time, GrubHub (GRUB) was a small-cap company, and while we own mainly large cap names, we were attracted to their early market leading position in the fast-growing food ordering and delivery market. GrubHub has transformed this market through organic growth and acquisitions and now has over 80,000 restaurant partners in more than 1600 U.S. cities and over 14 million users.
During our fundamental research process on GRUB, it revealed a business that we believed wasnít easy to execute and one in which scale, trust, and a significant first mover advantage were all important competitive advantages. GRUB has already established a brand name that helps restaurants reach more customers and drive more sales and has a simple and trust worthy interface for consumers that made ordering food to go seamless. All of these factors, combined with an impressive revenue and earnings growth outlook, led us to initiate a position.
GrubHub is the kind of company we like to own Ė it has a brand that consumers already know and is the established leader in its space. That in itself creates a barrier. Itís a high-margin business with a large and underpenetrated growth opportunity ahead.
Q: Why do you think the business of GrubHub is sustainable?