Arcataur Large Capitalization Equity Portfolio
Investment Strategy
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Our strategy for the Arcataur Large Capitalization Equity Portfolio is to maximize expected return while reducing risk by constructing diversified portfolios with exposure to most major industry sectors. We invest in high quality companies that have sustainable growth to compound returns over long periods of time. Most companies will have market capitalization in excess of $10 billion.
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Our equity investment process begins with a top-down approach, where we start with a macroeconomic analysis, including a focus on all sectors and industries, to emphasize areas that we expect to benefit from the current and prospective economic environment. We then perform fundamental equity analysis on individual companies, emphasizing their competitive positions within their respective industries. We focus on leaders or emerging leaders in these industries to lever the portfolio for out-performance versus broader market benchmarks. Dominant market share, strong financial position, unique products or services, low cost operations, significant free cash flow and appropriate stock valuations are critical variables we look for in the companies in which we invest. Financial and operating quality are then considered to provide a greater margin of safety and stability to the portfolio. Valuation is evaluated to avoid overpaying for the company. Once we reach our investment conclusion, technical analysis is used for optimal timing and pricing decisions.
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Our strategy then looks at ways to maximize expected return through constructing diversified portfolios utilizing the “65/15” principle. On average, this portfolio could hold 65 stocks; however, the largest 15 could account for as much as 45% of the portfolio’s market value. The direct stock portfolios may be augmented with large capitalization index based equity exchange traded funds (ETFs) for liquidity or for lower dollar value accounts to achieve proper diversification when needed.
Investment Process
Step 1 Macro Assessment of the Economy
Our research starts with a top-down strategy to assess the current economic environment and stage of the business cycle. Based on this analysis, sectors will be over-weighted, equal-weighed or under-weighted to achieve optimal sector exposure. We will have representation in nearly all eleven sectors that make up the universe of the economy and the stock market to diversify risk. To further minimize risk, we constrain sector weights to no more than 2.5 times the benchmark weight. Macroeconomic data and specific industry data are monitored regularly to keep sector weights positioned correctly.
Step 2 Fundamental Analysis of Companies
The heart of Arcataur’s fundamental equity analysis focuses on the competitive position of the company within its industry. We search for companies that have demonstrated franchise value that will provide compound returns over multiple years, as we are long term investors and don’t trade in and out for short-term returns. The franchise value might arise from a technological edge relative to competitors, high barriers to entry for new companies, or products with very few substitutes. We then dive deeper to focus on key factors of financial strength such as revenue diversity and growth, cost structures and margins, profitability, capital intensity and cash flow generation, financial strength, debt leverage and cash reserves, as well as management execution. This research identifies the leaders or emerging leaders in each industry to lever the portfolio for out-performance versus broad market benchmarks. We then evaluate absolute and relative valuation levels. In short, high market share, robust financial position, unique products/services, low cost operations, significant free cash flow and appropriate stock valuations are critical variables we look for.
Step 3 Portfolio Construction
After deciding on sector weights and performing individual company analysis, we build our portfolios utilizing the “65/15” principle. On average, we will hold 65 stocks (55 to 75); however, the largest 15 could account for as much as 45% of the portfolio’s market value.
As we are long-term investors, new investment ideas and changes in the relative size of an individual stock held account for the majority of the trading within the portfolio. Key investment factors are monitored closely and re-evaluated constantly to optimize the portfolio structure.
The Arcataur Large Capitalization Equity Portfolio can be augmented by exposure to small & mid capitalization domestic and international stocks with Exchange Traded Funds (ETFs) to gain diversification. Small/Mid capitalization domestic and international stocks offer higher returns over time, but higher volatility.