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Q&As and Interviews
Kiril Nikolaev Mar 15, 2016
Charlie Smith (C.S.): My “trajectory” has been slow, steady and gradual. I started in the business in 1983 as Ron Muhlenkamp’s (MUHLX) second employee right out of college. He taught me the craft of money management. From there I went on to a regional brokerage firm (Bill Few Associates – BFA) in 1992 to convert a largely commission-based book of business into fee-based, managed money. Seven of us broke away from BFA in 1995 to form Fort Pitt Capital. We’ve been building our business ever since. We started the fund in late 2001…9/11 happened as I was writing the prospectus.
C.S.: It was less inspiration than philosophic and strategic conflict with the ownership at BFA. They saw the business going in a different direction than we did.
C.S.: There is nothing particularly unique about our strategy, per se. A better descriptor is “consistent.” What we do boils down to purchasing well-run businesses at reasonable prices and holding onto them. ROE is our lodestar when it comes to measuring corporate performance, as it gives you the most “well-rounded” picture of corporate results and is easily broken into its component parts via DuPont analysis. We try to be patient enough to buy consistently high-earning companies at opportune times – when they are under a cloud for some reason. Then we hold them for a long time, typically eight to 10 years.
C.S.: Fund performance for 2015 lagged the major indexes. This occurred as the “value” style of investing trailed the “growth” style for the third consecutive year, and the seventh in the past eight.
The fact that growth has outperformed value for nearly the entirety of the current economic recovery speaks volumes about the mindset of investors, the tepid nature of the recovery, and Federal Reserve policy. In a halting economy, investors clamor for companies able to produce predictable earnings growth, with diminishing regard for the price paid for that growth. Up through the end of 2015, this phenomenon explained the steady outperformance of stocks in the booming biotech, cloud-computing, and social media spaces, as well as the monster valuations awarded many private firms (so-called “Unicorns” – Uber USA, LLC, Airbnb, Inc., Snapchat, Inc., etc.) not yet available to the broader public.
This emphasis on growth has been further accentuated by central banks around the world (including the U.S. Federal Reserve) determined to drive interest rates as low as possible. The lower the interest rate within an economy, the higher the price investors have been willing to pay for a stream of expected future cash flows. Seven years of quantitative easing (“QE”) and zero interest rate policy (“ZIRP”) have driven a universal hunt for high “duration” assets – those with a promise of steady growth not only today, but compounded far into the future.
This performance “regime” may be changing, however, as you noted. Our fund has recently begun to outperform market averages. In the future, investors may be less enamored with growth as interest rates begin to rise. Value may begin to outperform as we escape the deflationary funk of the past seven years. The timing is anyone’s guess, but we’re certainly not going to try to change what we’re good at (picking good businesses at reasonable prices) in order to chase returns. We’d end up chasing our tails.
C.S.: Investors who want to earn a reasonable level of equity return (historically about 4 to 6 percentage points per year above inflation) with less volatility than market averages. We certainly won’t outperform the market averages every year (or even every rolling three or five years), but over the long term our returns will be competitive. From inception in January 2002 through February 2016, for example, our fund has outperformed the S&P 500 by more than 100 basis points annually.
C.S.: No. We have neither the systems nor the desire to build an automated investment vehicle. We’re good at helping people solve their investment needs in a manner that lets them sleep at night. ETFs and index-oriented products can be wonderful vehicles for reducing the costs of investing, and work well as far as they go. They work very well as long as the markets never go haywire. Unfortunately, many clients have a tendency to make exactly the wrong moves (buy high – sell low) at market extremes. That’s where we (and human advisors in general) come in.
C.S.: Absolutely. As noted above, human beings will always need sound and calming advice, particularly when the investment world is not working “as advertised.” In many ways, we get paid more for our stomachs than our heads.
C.S.: Impossible to know. There is always volatility and uncertainty ahead, and likely more so now that the Fed has stopped the “morphine drip” of Quantitative Easing. In this sense, we’re getting back to a more “normal” market, and here at Fort Pitt Capital we welcome it!
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