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ValueSearch Equity Strategy – Introduction to the Strategy
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Since 1987, ValueSearch managed separately managed accounts and limited partnerships relying successfully on the ValueSearch Equity Strategy which is based on a Growth-at-Reasonable-Price (“GARP”) long-term investing approach. ValueSearch Equity Strategy is based on the premise that outstanding long-term results can be achieved by investing in a small number of extremely well run companies, while timing these investments so that they are long-term by nature.
It is further based on a premise that when investors are buying and selling their positions in a company there is the ever present judgmental mistake of the majority of investors to equate an excellent company with an excellent investment. VCM exploits this systematic judgmental error.
ValueSearch Equity Strategy (“Equity Strategy”) is still one of the strategies VCM relies on when managing its funds. This description of ValueSearch Equity Strategy is intended to illustrate the evolution of VCM investment strategies and is intended to help the reader to understand the performance results achieved by VCM when using the Equity Strategy.
The documents referred to below and describing the Equity Strategy are essentially in the form they were when the Equity Strategy was used as the foundation for the partnerships managed until 2007.
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ValueSearch Equity Strategy – Summary of the Framework
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VCM manages its funds based on ValueSearch Equity Strategy (“Equity Strategy”) with a long-term perspective on investing. The investments are made in common stock of publicly traded companies with the expectation of holding them for several years or longer. Our goal is to achieve a return superior to that of the market while paying utmost attention to the preservation of capital.
Our Equity Strategy is based on the premise that outstanding long-term results can be achieved by investing in a small number of extremely well run companies, while timing these investments so that they are long-term by nature. It is further based on a premise that when investors are buying and selling their positions in a company there is the ever present judgmental mistake of the majority of investors to equate an excellent company with an excellent investment. We exploit this systematic judgmental error.
Of course, the underlying premise of our entire approach is that the stock market is unavoidably inefficient. This inefficiency is at the very core of the market, and an astute and disciplined investor can rely on this inefficiency.
We can predictably rely on the behavioral tendency of many investors to extrapolate the past course of a company too far into the future. They often continue to attach a label of high quality to a company while ignoring its changing financial condition, or the company’s changing standing in its industry, or the changing standing of its industry in the economy as a whole.
At the same time, because we aware of these behavioral biases, we have developed a proprietary investment model that is intended to control our own similar biases. This model forces strict numerical representation of our investment parameters as well as parameters that describe the future characteristics of a company. Our investment system is based on this model and is designed to control and minimize our own judgmental biases.
We further control both our own bias and the general inherent risk of investing by monitoring exposure of our portfolios to a given industry, sector of an industry, and an individual company.
To further exploit behavioral weaknesses of most investors, we use our own classification system of industries. This system assigns companies to industries with results often far different from the standard classification systems, which are frequently based on superficial associations or continuation of trends.
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ValueSearch Equity Strategy – Contents of the 'Framework Document'
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A detailed description of ValueSearch Equity Strategy can be found in Equity Strategy - Framework.
This document requires significant access privileges and covers the following areas:
1. Disclaimers and Cautionary Notes
2. Margin of Safety
3. Value and Growth; Growth at Reasonable Price
4. Investing in High-Technology
5. Investment Risk
6. Dividends
7. Investing in Established Companies
8. Investing in Early Stage Companies
9. Investing in Ground-floor Opportunities and Unusual Opportunities
10. Investing in Bonds, Notes, Fixed-Income Funds
11. Investing in Equity Funds; the Role of Cash
12. Market Predictions and their Role
13. Use of Debt, Retirement Accounts, Tax Considerations
14. Evolution of our Investment Framework
15. Summary: Patience and Knowledge of Values
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ValueSearch Equity Strategy – Summary of the Implementation
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Here and below, ValueSearch Equity Strategy is referred to as either “Investment Framework”, “Framework” or “Equity Strategy”.
While the premise on which the Framework is built is sound indeed, it is the ability of the investment manager to implement the Framework and to use it that makes all the difference.
Equity Strategy - Framework described the investment philosophy and major premises the Framework is based on. Here, in the Implementation of the ValueSearch Equity Strategy, we describe the evolution of the Framework, the actual process of implementing and using the Framework, and the results of twenty years of its use.
The philosophical underpinnings of our Framework have slowly changed over the last 20 years. Its implementation has undergone several revisions with the purpose of honing the investment process and separating the essential and long-term tenets of the Framework from the temporal and unessential. These revisions are always undertaken with the goal of simplifying the resulting investment process.
The investment process as implemented at VCM forces a constant comparison of holdings in our portfolios with other companies which we monitor. This successfully diminishes the tendency, present in all investors, to hold on to a portfolio company independently of its current investment merits as compared to another monitored company.
On the other hand, the goals of tax efficiency and of minimizing the risk of introducing a lesser known company into a portfolio have to be balanced against this tendency of an investment manager to hold on to a winner in the hope of extending a winning streak, and to hold on to a loser in order to avoid facing the acknowledgement of a mistake or bad luck.
When a particular stock market is near an inversion point, i.e., is either significantly overvalued or undervalued, we may invest substantially all assets of our portfolios in those bond and equity funds (including exchange traded, index, mutual and closed funds) which we believe will yield the highest return for our clients when the market corrects the overvaluation or undervaluation. Occasionally, we move a significant portion of portfolios into cash for a long period of time.
Our investment framework combines the analytical discipline of determining fair value with a practical understanding of markets. We do not believe that buy-and-hold-forever approach is the most efficient but we also do not believe that week-to-week market timing can be consistently made successful. We study the overall market level and rarely but decisively leave (or enter) the market if the preponderance of indicators and our judgment call for such move.
We believe that an investment approach that emphasizes intrinsic value and rejects being fully invested independently of the market levels will achieve consistent absolute investment returns and safeguard capital regardless of market conditions.
Tuning this process, with the contradictory requirements imposed on it and with possible biases introduced by the investment manager, takes the ultimate investing experience. The ability to tune this process successfully is the mark of a good investment manager.
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ValueSearch Equity Strategy – Contents of the 'Implementation Document'
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A detailed description of the Implementation of the ValueSearch Equity Strategy can be found in Equity Strategy - Implementation and provides a comprehensive review of most aspects of the accounts we manage.
This document requires significant access privileges and covers the following areas:
1. Disclaimers and Cautionary Notes
2. Past Returns
3. Returns in the Context of Taxes
4. Repeatability of Returns
5. Investment Process
6. Concentration
7. Investing in High-Technology
8. Strategy on Long and Short positions
9. Methods of Analysis
10. Volatility; Leveraged and Non-leveraged Accounts; Debt and Volatility
11. Independence of Decision Making
12. Significant Manager’s Investment using the same Framework
13. Positioning and Performance compared to Hedge and Private Equity Funds
14. Positioning and Performance compared to Mutual Funds
15. Positioning and Performance compared to Managers of Separate Accounts
16. Summary
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ValueSearch Equity Strategy – Summary of the 'Returns Document'
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Past returns, described in detail in Equity Strategy - Returns put VCM at the very top of investment managers for the twenty years starting with 1987. Thus, both VCM Investment Framework and our implementation of this Framework have proven to be solid, and have yielded outstanding results.
ValueSearch Equity Strategy investments managed by VCM have outperformed the US stock market significantly in the 20 years starting 1987. The compounded annual return of these investments was 15.3% from 1987 to 2007 while S&P 500 had a return of 10.5%, with VCM outperforming S&P 500 by 4.8% compounded. (VCM returns are shown before fees and expenses, and S&P 500 returns are after reinvestment of dividends.) Moderate leverage was employed at certain periods of time.
In this comparison, ValueSearch Equity Strategy's advantage for the 20 years starting 1987, after all fees and expenses, was 4.3% compounded.
The Equity Strategy - Returns document contains detailed performance tables and requires significant access privileges.
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ValueSearch Equity Strategy – Not used in 2008
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In October 2007 VCM made the decision to wind down the partnerships based on ValueSearch Equity Strategy, and in December of 2007, after consultations with our limited partners and tax accountants, began the orderly process of retiring the limited partners.
We took our limited partners out of the market and into cash long before the worst declines of the US stock market during the financial crisis of 2008 - 2009. The decision to leave the market in 2007 was based on our observations of the US stock market parameters and preliminary conclusions that the US stock market was heading toward a steep decline.
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Michael Schwartzman, President - ValueSearch Capital Management - Marblehead, MA
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