Active Equity Approach
We apply a proprietary, multi-factor quantitative security selection model to rank all stocks in the international market relative to a pool of over 80 factors that are categorized into seven broad classifications — Valuation, Capital Management, Earnings Momentum, Earnings Quality, Price Momentum, Fundamental Operations, and Market Sentiment. The stocks which meet our selection criteria are then quantitatively screened on the same metrics but according to region and sector. Our region-specific analysts then apply fundamental business analysis to the resulting 100 to 200 stocks. Stocks which meet our rigorous criteria and which managers believe have the best current risk/return profiles are included in the portfolio of 100 to 175 stocks.
1 Quantitative Screening
Initial Screening of the Approximately 2100 Stocks in the MSCI EAFE Index to Identify Companies With:
- History of Operating Earnings
- Strong Financial Criteria based on Earnings Screens, Valuation Metrics, & Quality Factors
2 Quantitative Ranking
Region- and Sector-Specific Multi-factor Model Ranks Stocks By:
- Earnings Screens
- Valuation Metrics
- Quality Factors
3 Fundamental Research
- Company Business Model
- Competitive Environment
- Earnings Screens
- Valuation Metrics
- Other Quality Factors
4 Portfolio Construction
- Minimize Unintended Portfolio Risk
- Region, Sector, and Market Capitalization Neutral Relative to Benchmark
- Do Not Hedge Currencies
- Continuously Monitor Portfolio
We begin our process by segmenting the world into industries. Of the 7,000 stocks available for investment, we identify those stocks with the best chance of outperformance, relative to global industry peers, by looking for those with a combination of factors included in our multi-factor model. The most important screening factors are listed below:
Earnings Trends
This component encompasses several factors including the earnings growth rate, earnings momentum, historical earnings growth, earnings stability, organic sales growth rates and momentum, and estimate revision trends. The aim is to identify companies with demonstrable earnings growth over time, strong current earnings trends and those with the potential for future earnings acceleration.
Earnings Quality
The investment process focuses on balance sheet and income statement relationships to identify those companies with the highest quality of earnings. The aim is to weed out those companies whose earnings fall short of cash flow since this could signal deterioration in future earnings momentum.
Profitability Momentum
Here we focus on profitability trends of the company, as evidenced by gross margin, operating margin, return on equity and cash flow return on investment. The aim is to identify companies with improving or accelerating profitability trends. Our research indicates these companies tend to receive the greatest price multiple expansion.
This step narrows our universe to 300 companies. We then perform fundamental analysis on each of these companies to determine competitive advantage and the sustainability of this advantage.
Fundamental analysis is a critical element of the stock selection process and it is a key determinant of the sustainability of earnings trends. During our investment process, we seek to understand the growth dynamics of each company through analysis of several key elements:
- Type of business model and key products or services
- Unit and market share growth of company's products or services
- Company's market niche and competitive advantages
- R&D spending levels
- Sales and distribution channels
- Cost and pricing trends
— Business cycle analysis
— Profitability analysis
Analysis of these factors enables the team to identify those companies whose fundamentals are capable of supporting the strongest sustainable earnings trends. This step also serves as a way for the team to confirm the opinion formed after analysis of earnings and profitability.
The team assesses valuation in relation to fundamental trends and earnings growth and evaluates the momentum of those trends. In addition, the historical relationship between valuation, growth and fundamentals is contrasted with current levels. Further, we make an assessment in terms of future growth possibilities based on current valuation and profitability trends. In different sectors, the team looks at different valuation ratios. In Financials, the focus is on P/E, P/B, Dividend Yield, and Dividend Yield Growth. In the Information Technology sector, the focus is on price-to-cash-flow. In all sectors, security selection is based on both Value and Growth characteristics. The balance of growth factors to value factors varies from region to region and from sector to sector.
After our analysts perform their fundamental and valuation analyses, we compose a buy list of 100-150 stocks and choose the most attractive stocks for the portfolio.
The buy ideas from the screens and analysts’ vetting are submitted to the portfolio manager for review during weekly formal meetings, as well as in more frequent casual communication. The portfolio manager evaluates the ideas and either executes a trade or requests further analysis. Equity security selection is a team-based process for Certium’s International Equity Strategy, although the final decision rests with the portfolio manager.
The International Team controls risk and strives for diversification by maintaining a more equally weighted portfolio with targeted, controlled sector weightings relative to the index. The result of the team’s process is a portfolio of highly profitable, attractively valued companies with strong capital structures relative to the benchmark.
Internal portfolio guidelines are as follows:
- The maximum single-stock concentration allowed is 5%
- The maximum allocation to a sector is plus/minus 4 percentage points vs. the benchmark
- The maximum industry allocation is plus/minus 10 percentage points
- Portfolios generally hold between 100-200 stocks
- Cash a residual of customer cash flows. The fund has averaged 0-5% in cash, as the goal is to remain fully invested. The maximum cash position allowed is 10%
The sell decision is the most important investment decision and is the initial discussion of the weekly analyst meeting. There is no minimum time period for holding a position. Certium will sell stocks when any of the following situations occur:
- Business fundamentals peak or begin to change
- Earnings characteristics change. Examples of this include negative estimate revisions, a negative earnings surprise, and slowing earnings and/or revenue momentum
- A stock's ranking deteriorates within the selection universe
- A stock reaches extreme overvaluation