The overwhelmingly most common equity investment style across accounts at Scholtz & Company is “All Cap Core.” Due in part to the fact that we have very experienced portfolio managers and in-house analysts, we feel confident filtering through large numbers of stocks to find ones with winning characteristics. However, although most of our assets are managed under an All Cap Core methodology, we do have an investment strategy focused solely on small cap equities.
Scholtz & Company performs in-depth fundamental analysis to determine whether a stock would make a profitable contribution to our clients’ portfolios. This process involves multiple steps such as calling or meeting with a company’s senior management teams, industry experts, and sell-side analysts, deep reviews of financial statements, and internal model building. Before an investment is added to our portfolios, we have typically spent a minimum of over 20 hours reviewing the company and its industry.
In terms of attractive characteristics, we seek companies for investment that display 5 specific characteristics. These 5 characteristics involve companies that are taking market share, in above GDP growth industries, with strong competitive moats, that has excellent financial metrics, and finally a strong management team. We call these companies “5-star” companies. Since these attributes are clearly very appealing, we often find these companies to be expensive (at-least based on near-term metrics). For this reason, we build a list of “5-star” companies and wait until a temporary swoon in the market or the business allows for an appealing entry point.
Technical Analysis is a school of investing which uses prior stock price movements to determine future movements based on the premise that the stock’s movement is a glimpse into the underlying fundamentals and sentiment. We have found technical analysis can be extremely useful in making trading decisions. Thus, Scholtz & Company predominantly uses technical analysis as a means to pick optimal entry and exit points. Often times, our quantitative and fundamental work will suggest that a stock is attractive, but ‘listening’ to the charts allows us to be patient and initiate positions even lower. The most common technical indicators we look at include movements relative to the 50/150/200 DMAs, changes in volume, short interest, and relative strength.
At Scholtz & Company, bonds represent a stable source of income for our conservative balanced and income portfolios. In assessing our performance, we seek to exceed the return of the Bloomberg Barclay’s Gov’t/Corporate Bond Index.
INTEREST RATE OUTLOOK
In order to develop a portfolio of bonds, we begin with an interest rate forecast by assessing various macro-economic factors including GDP outlook, monetary policy, inflation, interest rate spreads, and investor risk appetite. This forecast is vital to the types of bonds we use to optimally structure the portfolio over a multi-year time horizon. For us, determining interest rate risk is paramount because interest rate neutral or laddered portfolios are not utilized. Instead, duration is carefully monitored and varied according to our two year interest rate projections. For example, if we believe that long-term bond rates are going to rise, we would structure the portfolios around low duration bonds to mitigate this headwind and provide ample reinvestment opportunities upon maturities. We may also use putable bonds, variable interest rate bonds, or other structured products as a means to combat this risk.
Credit risk is mitigated because we only invest in investment grade bonds. These are bonds rated BBB- or better by Standard & Poors or a similar rating by Moody’s. If bonds are downgraded below investment grade, they are sold. Furthermore, Scholtz & Company undergoes its own level of credit risk on all purchases with heavy emphasis on any bonds that are on the lower end of the investment grade credit scale. Our internal credit research involves a variety of analysis on cash flow needs and business outlook.
SPECIFIC SECURITY SELECTION
In terms of picking individual bonds, we are highly focused on relative value. This can be determined by several credit or spread metrics so we closely monitor gov’t/corporate bond spreads to quickly identify strong relative values when they present themselves. Further, due to the complicated features associated with certain fixed income securities, we often find bonds that the market appears to have mispriced when these features are taken into account. Similarly, we have found certain sectors to be systematically undervalued by the market despite low probabilities of default. Thus, at times, industry or sector concentration can occur.
Finally, Scholtz & Company engages in several other investment ‘tactics’ including “Riding the Yield Curve” or investing ahead of potential credit re-ratings. Riding the Yield Curve works well in periods of steep yield curves because we are able to create an enhanced return by selling bonds as their yield sharply declines and re-purchasing a similar bond with a long maturity. Yield curve analysis plays a large role in determining optimal points to enter/exit bond positions (especially in a stable rate environment).