Growth Rooted in Quality
Grandeur Peak International Stalwarts Fund
Randy Pearce, Brad Barth
Author: Ticker Magazine
Last Update: Sep 20, 11:45 AM EDT
|While smaller companies are generally underfollowed domestically, that is even more so when it comes to investing in emerging markets. Randy Pearce, CIO of Grandeur Peak Global Advisors, and Brad Barth, portfolio manager and senior research analyst, explain how the International Stalwarts Fund benefits from the firm’s global reach and extensive research process in search of high quality companies that are still in the early stage of growth.
“We look for steady performers that we believe can continue to deliver returns over the long-term. We focus on the highest quality subset of our huge universe, but are valuation sensitive.”
Q: How has the fund evolved? Could you give us some background information?
Grandeur Peak was set up as a global firm. From the onset, our mission was to establish an industry-based research structure, which would be a critical component of all the firm’s funds. At Grandeur Peak, I don’t think of individual funds, but of the entire research team, because we collectively work on all the strategies.
The Global Reach Fund is our key strategy, run by our five industry teams. Each industry portfolio manager runs a tranche of that long-list portfolio, which serves as an umbrella fund for everything we do. It is a critical part of the Grandeur Peak process and affects all our funds, including the International Stalwarts and Global Stalwarts funds.
The firm started with one global and one international strategy, which were primarily focused on micro and small caps. The next products were the Global Reach and the Emerging Markets strategies. All four strategies closed relatively quickly; meanwhile we had a growing team with desire to take on more responsibilities, as well as clients who were clamoring for more capacity.
We decided to speed up our long-term plans for a SMid cap strategy, which would provide more capacity. We identified the market cap of $1.5 billion as a critical level for major liquidity constraints. The results of the back-testing were positive and that’s how we launched the Global and International Stalwarts Strategies three years ago.
So, we are not just a micro to mid-cap specialist, but a global research team that aims to be world class in what we do. Any time we launch a new strategy, we ask ourselves if we can be in the top decile over a 10-year period. If we can’t answer affirmatively, then we are not willing to launch the strategy.
The Stalwarts strategies are consistent with the other strategies we manage. The only difference is the market cap hurdle of $1.5 billion and above. We are disciplined about closing strategies and the International Stalwarts Strategy is approaching a closing level of AUM.
Q: What core beliefs drive your investment philosophy?
We look for steady performers that we believe can continue to deliver returns over the long-term. We focus on the highest quality subset of our huge universe, but are valuation sensitive.
One of our guiding principles is that we want to own companies for which we have sufficient conviction and confidence to buy more when they are down. Then we can use such opportunities to our advantage. If the stock is down because of a macro factor, an exogenous factor, or a short-term blip and if we believe it will get back on track, then the correction is a blessing. We would be excited about the opportunity to buy more of that company.
Q: What is the significance of the word “Stalwarts” in the name of your strategy?
We view the Stalwarts portfolios as our high-quality portfolios. Across the firm, we focus on three types of companies, which we identify as: best-in-class growth companies, stalwarts and fallen angels. When we talk about stalwarts, we refer to the truly stable, solid, high-quality companies, for which we have conviction and which seek to avoid permanent loss of capital.
In the micro-cap arena for example, quality is less certain as there are younger and smaller companies which may provide bigger payoffs, but with greater risk. In Stalwarts we focus on the high-quality subset of the smid-cap universe to capture solid returns while trying to avoid big mistakes that would detract from the performance.
Q: How do you assess and define quality?
We define quality as companies with good business metrics, management teams, balance sheets and with the ability to continue to grow their business going forward. We spend a lot of time on the trend, the level and the volatility of different factors, but we focus particularly on growth and margins and how they flow through to return on capital.
We believe that the companies which exhibit these characteristics historically are more likely to have sustainable competitive advantages. That’s why our quantitative screening begins with identifying the companies which have had positive characteristics in the past. Then we delve into a more qualitative approach, where we try to understand if the historic numbers can be extrapolated forward and if there is a sustainable competitive advantage.
Q: What are the critical steps in your investment process?
There are roughly 30,000 companies in our global investable universe. We have our own screening methodology utilizing our own version of a DuPont analysis. Essentially, it provides a snapshot of the company’s financial statements over the last 15 years, such as the income statement, the balance sheet, the return on invested capital, the cash flow statement and the different ratios. There is also a valuation section.
On a weekly basis, our quant team sends screens to the industry teams. Then the industry teams look through the sub industries and scan through the numbers looking for interesting levels, trends and volatility. Then, as a team, we analyze and discuss the most interesting companies. Our goal is to focus on one or two really great names from the different screens and to make them first priority. Then we create a separate pool of candidates that we want to watch and monitor. We have done this for years, so we have a healthy set of watch lists.
After the team identifies the most interesting names, we pursue further due diligence, which flows into our decision-making process about quality. Our watch list includes companies of A, B, and C quality, with A being the highest. We continue to review and monitor the quality of each company over time to make sure we stay focused on those of the highest quality.
Our key competitive advantage is setting up a research structure and being extremely disciplined. We’ve visited about 10,000 companies in our universe over the last seven years. Sometimes we arrange conference calls, but most of the visits are on site. We’ve visited the higher-quality companies multiple times. Our industry teams vet this huge universe and monitor the names for opportunities.
Our quant team sits down with each industry team bi-monthly to discuss companies whose numbers are becoming intriguing. I believe that the key to our success is the quantitative approach with the qualitative layer. It is unique that we have a research team of 25 people truly working together, as opposed to three or four individuals running one strategy.
Q: What metrics do you use in your process?
We aim to focus on the companies with attractive business metrics and a bright outlook. We build five-year financial models after examining the companies historically. We try to estimate an expected return given current valuation and our five-year model projections. There are different ways to approach the varying accounting standards globally, but we have built about 5,000 proprietary earnings models in our database. We undertook a huge task several years ago, when we transferred all of our models into a comparable format.
Basically, there are three sets of numbers that we focus on—reported numbers, adjusted numbers, and the Grandeur Peak adjusted numbers. Because companies adjust their numbers differently, we make consistent adjustments to be able to correctly compare the companies, regardless of their industry or geography. The adjustments are a critical element of our process, because they are necessary to achieve a true, comparable, cash-adjusted set of numbers.