2011 SMA Manager of the Year, Small Cap: The London Company

Small Cap Equity 2011 SMA Manager of the Year
The London Company
Small-Cap Core Strategy

Throughout the month of April, AdvisorOne will focus on separately managed accounts: the money manager options advisors have, the platforms through which they can gain access to those managers, how they can conduct due diligence on those managers, and how advisors are using SMAs in client portfolios.

We begin our coverage by presenting the Investment Advisor-Prima Capital seventh annual Separately Managed Account Managers of the Year. In a feature article in the April 2011 issue of Investment Advisor, seven managers in six different asset classes were chosen as "A Class Apart."

(See the complete calendar of our Special Reportfor past and upcoming coverage.)

In this article, we focus on Richmond-based The London Company’s Small-Cap Core Value strategy, winners in the small-cap equity space.

The philosophy: Viewing equity ownership in the same pragmatic manner in which a conservative, rational businessman would, if he were buying the entire company..

The portfolio: Investing in what the management team considers its best low-beta small-cap ideas, with above-average downside protection. For the portfolio, the team seeks profitable, financially stable companies that consistently generate free cash flow and high returns on unleveraged operating capital, trade at rational valuations, and are run by shareholder-oriented management.

The performance:  2010 performance (company supplied).

Strategy composite return (gross): 24.3%

Strategy composite return (net): 23.7%

Russell 2000: 26.9%

Russell 2000 Value: 24.5%

S&P 500: 15.06%

Return (net) since inception (9/99-12/10): 15.4%

Russell 2000 return since inception: 6.9%

Total firm AUM (12/31/10): $1.94 billion

Total assets in strategy: $1.48 billion (See firm’s Form ADV Part II.)

The people: Investment Advisor Editor John Sullivan spoke in March with Stephen Goddard, CFA, founder, managing director and portfolio manager, and Jonathan Moody, CFA, principal and portfolio manager. Team members include J. Wade Stinnette, Jr., portfolio manager, and J. Brian Campbell, CFA, portfolio manager.

 

Small-Cap Equity Award
The London Company
Small-Cap Core Value Strategy

“We don’t think we’re better than anyone else, we just take a rational approach to investing,” says Stephen Goddard (left), when asked to brag on himself and his firm.

Goddard, managing director and founder of The London Company, based in Richmond, Va., then gets down to basics.The firm takes positions in low beta, conservative companies that are large enough to make an impact to portfolio performance, but with a primary focus on downside protection.

“It’s far easier to determine downside risk than it is to determine the next winner,” Goddard says. “What really hurts the portfolio are the names you’re wrong about.”

The firm was founded as “a very small shop” in 1994, but soon got the attention of

 

industry consultants and today has nearly $2 billion in assets under management.

Jonathan Moody, a principal and portfolio manager with the firm, says he distills the investment process into four pieces. The first is that they go into a new investment with a long-term approach and don’t key in on short-term fluctuations.

“We don’t want to try to outguess the other 1,000 analysts on what the earnings will be for this quarter,” he says.

The second is buying in at attractive valuations, or building the portfolio “on the backs of the companies’ balance sheet.” They look at valuations in the same manner as an owner or private equity investor, and assume zero to little growth because they don’t trust the analysis coming from Wall Street.

“We’re private equity wannabes,” says Goddard. “We look to control what we can. We can’t predict the future, but the balance sheet is something real; something that’s in the here and now.”

The third piece, Moody says, is to find the appropriate investments and then weight them accordingly.

“We hate positions of 1% or less,” he says.
The last piece is ensuring tax efficiency on the part of the portfolio. Moody claims turnover is currently less than 25%.

It all sounds pretty staid and conservative. Is there anything that really sets their philosophy apart?

Yes, according to Prima. The London Company takes a somewhat unusual approach in that it seeks to determine a company’s optimal cost of capital, which it then uses to discount future cash flows. A discount of 40% or greater to the firm’s determination of intrinsic value is sought in potential “buy” candidates, thus, the product’s value bias. The firm conducts intensive research on each company which includes knowing management’s capital allocation strategies. The methodology is similar to evaluations by private buyers (Goddard’s “wannabes” comment), which can benefit returns in an environment in which private equity buyers, and mergers and acquisitions are prevalent.

According to Prima, “The small-cap strategy has been an exceptionally consistent performer on an absolute and risk-adjusted basis since its inception.”