Description

The Small Capitalization Portfolio

Investment Management of Virginia’s Small Capitalization Portfolio is unique for several reasons.

First, we run a concentrated small-cap portfolio, generally holding between 25 and 35 positions. We don’t buy stocks with a market cap larger than $2 billion, but we will hold companies greater than this size. This leeway gives us the ability to hold onto successful positions longer than many other small capitalization managers. Our targeted holding period for a stock is between 2 and 3 years, and our turnover has averaged between 35 and 45% over the past five years. While we do occasionally buy and sell stocks within one year’s time, we aim to generate long-term capital gains. These investment parameters ensure that our clients are truly investing in a concentrated, tax-efficient small-capitalization portfolio.  Exchange traded funds (ETFs) may also be used.

Second, we use a combination of quantitative and qualitative research to pick stocks. We use a proprietary, statistical and qualitative screen to create a list of stocks that meet our investment criteria. We then perform fundamental research on a company-by-company basis to ensure we add only the best ideas to the portfolio.

Third, we are not limited by a simple value or growth bias. We buy stocks that we believe have an attractive risk to reward ratio. Our new purchases will normally be out of favor at our time of purchase, but other investors may characterize them as growth, value or core. We use both income statement (EPS and cash flow multiple analysis) and balance sheet (book value, undervalued assets, break-up analysis) parameters in determining potential risk and reward.

These parameters, in general, give us greater leeway to select and hold onto small capitalization securities. Optimally, we will identify a company for initial investment that is substantially out of favor, and then hold that position as the company progresses into a core and then growth story. We want to exit a position when it becomes a momentum stock. We believe our ability to hold a stock through its full appreciation cycle gives us an advantage over many of our active management peers.

INVESTMENT DECISION-MAKING PROCESS: We are primarily “bottom-up” stock pickers. We seek companies with strong growth prospects that are trading at reasonable or depressed valuations. We also seek out special situations, out of favor sectors or stocks, and companies with catalysts for change. Critical investment attributes include companies with well-developed businesses that have a sustainable competitive advantage, the potential for strong earnings and cash flow growth, a solid financial position, and a superior management. We particularly favor corporations that are generating increasing levels of free cash flow used for stock buy-backs, and companies in which management owns significant equity interest in the business.

Once a company has been identified as a potentially attractive investment, the portfolio managers conduct extensive due diligence. The due diligence process may include:

• On-site visits
• Conference calls with management, competitors, suppliers, and customers
• Research into company filings and public documents
• Examination of relevant sell-side research
• Investigation into any “short story” if there is one
• Determination of investor sentiment toward a company/stock through put/call option ratios, sentiment surveys, and flow of funds data if applicable and available

To manage risk, we invest in a diverse group of companies and sectors. While we run a concentrated portfolio of 25 to 35 stocks, those stocks will be diversified by sector within the small/mid capitalization market.

The portfolio will not dramatically overweight one particular stock. An initial position will normally be 2% to 3% of the account, and positions generally are reduced once they approach 6% of the account.

We formally review stocks that have declined by 20% and have generally sold stocks with a 40% loss, no matter what the circumstances.

The Small Capitalization Portfolio strives to outperform the small and medium capitalization indexes and measures its performance against the Russell 2000 TR.

Download the full description of the Small Capitalization Portfolio in PDF format: 4Q2022 Small Capitalization Portfolio Presentation