Our value-based investment philosophy is built on five guiding principles:
Use a Business Approach
As a lender, we believe it is important to research each security on a business basis to ensure we have put the odds in our favor that we are making a good loan. Our research and analysis takes into account both quantitative and qualitative factors. Most importantly, we appraise the entity’s ability to repay our loan.
Our research and analysis takes into account both quantitative and qualitative factors. Through our internal credit analysis, we focus on the quality and strength of the balance sheet, income statement, and statement of cash flows. We also examine the viability and reputation of the entity and, most importantly, appraise the entity's ability to repay our loan.
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Use a Margin of Safety
We strive to create a margin of safety that will help us construct favorable reward-to-risk characteristics for the client’s portfolio. Therefore, we believe in maintaining maximum flexibility with the maturity structure of the portfolio. We also seek to invest in corporate securities that are selling at wide spreads (i.e., discounts) relative to U.S. Treasury securities. Finally, we require a minimum real rate of return for each Treasury security. By using this principle across a diversified basket of fixed income securities, we are able to put the odds in our favor that, over the long-run, our investment portfolios will be a success.
We believe in maintaining maximum flexibility with the maturity structure of the portfolio. This helps to provide clients with protection against capital losses while at the same time provides opportunity for solid returns.
We seek to invest in corporate securities that are selling at wide spreads (i.e. discounts) relative to U.S. Treasury securities.
We require a minimum real rate of return for each Treasury security. Typically, on long maturity government bonds, we are looking to average a minimum 3% to 4% real rate of return.
While the margin of safety guidelines do not guarantee the success of an investment or that the price of a security will not go down temporarily, it does help to protect against the effects of unforeseen events that are out of our control such as higher interest rates and inflation. By using this principle across a diversified basket of fixed income securities, we are able to put the odds in our favor that, over the long-run, our investment portfolios will be a success.
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We believe securities are not always priced to accurately reflect their true intrinsic values. At the extremes, this price distortion can be irrational. Thus, price is not always the same as value. When investors lose sight of fundamentals and instead trade their debt securities based on emotions, they can cause volatility in the market place. It is during these “manic-depressive swings” when we usually see the greatest disparity between price and value, and therefore, have an opportunity to capitalize on attractively priced securities that can provide solid returns.
When investors lose sight of fundamentals and instead trade their debt securities based on emotions, they can cause volatility in the market place. Benjamin Graham referred to this emotional trading and its ensuing volatility as "manic-depressive swings". It is during these "manic-depressive swings" when we usually see the greatest disparity between price and value and therefore have an opportunity to capitalize on attractively priced securities that can provide solid returns.
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Focus on Price
Paying too much for a security of a great company or highly rated government entity can lead to a poor or mediocre return. However, we believe buying the security of a lesser known company, one with a short-term problem, or a company or government entity whose credit profile is temporarily out of favor for a bargain price can lead to a great return. Furthermore, it has been our experience that investing at a bargain price, or as we like to say a “wholesale” price, helps to reduce risk, increase potential reward, and put time on our side..
After the margin of safety, which helps to safeguard the return of capital, we believe price is the most important consideration as it helps to generate our expected return. The following example highlights the importance of price. Assume you were to invest in a 10-year corporate bond at par, or $1,000. Next, assume this bond has a coupon equal to $60 per year, thus yielding 6%. Last, assume at the end of the 10 years the bond matures and you get your original $1,000 investment back. Your 10-year return on this investment will be 6%, as this is the rate of interest that was paid to you each year before getting your original investment back.
Now, instead of paying par, or $1,000, for this same corporate bond, let's assume we were able to buy it at a discount to par, or in this example $900. This could have occurred because bond spreads widened or for any number of other reasons. While this bond is bought at a discounted price, it still pays the coupon payment of $60 per year. However, because our cost basis is $900 instead of $1,000, this $60 coupon now represents a yield of 6.67%. In addition, the bond will appreciate over the next 10 years, maturing at par or $1,000. Therefore, in addition to the annual coupon received, we will receive $100 in capital appreciation over the next 10 years. This adds roughly 1% to the annual yield, which brings our total compounded return to 7.67% over the life of this investment (6.67% coupon + 1% appreciation = 7.67%). This is a good example of how the price you pay will ultimately determine your return.
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Focus on Absolute Returns
While we offer several investment strategies within our separate account practice, the core focus of our fixed income strategy is to invest where we see the best value and opportunity rather than to manage the portfolio allocation to an index or benchmark. Thus, our focus is on absolute, not relative, return.
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