Alpha-Based Strategy

Investment Philosophy

Smaller companies have historically provided besthet returns in the equity markets. Smaller companies are also followed less closely by investors, and the pricing of such stocks is more “inefficient”. Through identifying value stocks with superior Risk Adjusted Relative Strength (“RARS”), management can add value to the excellent long-term returns available from investing in smaller companies.

Investment Objective

The Alpha-Based (“A-B”) objective is to provide substantially higher returns than are available from the market averages, with controlled risk. The A-B strategy is intended for the aggressive growth portion of an investor’s portfolio.

Investment Strategy

Modern Portfolio Theory has offered investment professionals numerous insights regarding risk and risk-adjusted rates of return. While much attention has been paid to the sensitivity of stocks to overall movements in the market or in their “style” peer group, a selection of stocks has been consistently overlooked. These are stocks which move independently of the market, exhibiting a characteristic of strong “alpha.” Alpha is a term which identifies excess returns that are unrelated to broader movements in larger groups of stocks.

The Alpha-Based Strategy starts with a quantitatively generated list of equities (ADRs are included) which exhibit high alpha. In general, recent alpha should be 2% per month in positive returns independent of the overall market, and the average portfolio stock offers a much higher alpha. Stocks are further screened for low variance relative to mean prices. Improving fundamental trends which support evident price activity play an important role in further winnowing the group. Preference is given to accelerating sales growth and rising profit margins.

The focus is on undervalued growth: normally the average rate of growth for a portfolio will be about twice the level of its price/earnings ratio. Technical factors are important in timing entry and exit decisions. Low risk from the standpoint of technical analysis goes hand-in-hand with the reduced risk parameters established by fundamental analysis of the companies. It is critical to focus on reducing risk in this area of investing, since by definition these are stocks with greater price change than the ordinary stock. Both growth stocks and value stocks are employed as conditions warrant. Management may raise cash as needed for defensive purposes, or hedge portfolios with options. In addition, utilized may be multi-stock index or sector securities to maintain temporary market exposure, or hedge portfolios with short-oriented funds.

Reward/risk ratios for all holdings are recomputed regularly in response to changes in price and/or fundamentals. Selling decisions result from these recomputations, and comparison with newly emerging investment opportunities. The guiding principle is the maximization of annualized returns.

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