Blue Tower Asset Management annual letter for the year ended December 31, 2014.
Stay tuned for more from the letter.
I am pleased to report that in its first year of operation the Blue Tower Global Value strategy has achieved a gross composite return of 15.92% for 2014. This year has been a difficult one for many investment managers, so I am glad I was able to grow the wealth of Blue Tower’s investors and reward the trust that they placed in me.
In this letter, I’d like to review the philosophy of Blue Tower and give the rationale behind two investments which were made in 2014 as a demonstration of that philosophy. Future letters will be on a quarterly basis and shorter in length.
Blue Tower Asset Management endeavors to provide above average capital appreciation over the long term while attempting to avoid large permanent impairments of capital. The two dominant approaches used on Wall Street today are quantitative investing and value investing. The philosophy of Blue Tower is to bridge the best practices of these two approaches by using recommendations generated by algorithms to create short lists of companies. These companies are then evaluated using classic value investing due diligence methods. This combined approach of machine intelligence and human understanding allows us to find hidden opportunities that most people would overlook while at the same time avoiding value traps to which a purely quantitative strategy may fall victim.
This strategy was formerly known as the Allometric Fundamental Value strategy when it was part of Allometric Research and Management LLC, a multi-strategy RIA. I found that being part of a multistrategy firm was confusing potential investors, so I created an independent RIA (Blue Tower) for the strategy. There was no change in the investment policy, management, or client base of the strategy during this transition, and the performance was linked in accordance with the GIPS portability rule.
In the attached monthly performance numbers, I compare the performance of the strategy to the CRSP Total Market index and the Russell 2000. The CRSP Total Market index is composed of nearly 100% of the public US equity market. The Russell 2000 is one of the most widely recognized small cap indexes and is composed of the 1001st to 3000th largest stocks by market capitalization. The Blue Tower Global Value strategy is a concentrated strategy that is not managed to any particular benchmark.
Despite the CRSP Total Market being the official benchmark for the strategy, the Global Value strategy is more correlated on a daily basis to the performance of the Russell 2000. The reason for the firm’s performance being more correlated to the performance of a small-cap market index rather than the market as a whole is that the firm’s holdings are currently mostly in small-cap stocks with 75.5% of the holdings in the Global Value strategy at year’s end being invested in companies with a market capitalization below $1 billion. This doesn’t reflect a directional view that small caps as a whole are currently a significantly better investment opportunity than larger companies, but rather due to lower market efficiency in regards to smaller companies. Small companies are the focus of far less attention from investors and sell side analysts and as a result small companies are more likely to be significantly mispriced and offer compelling valuations. I manage the portfolio in a bottom-up fashion and will continue to allow the valuations and merits of individual businesses to direct where capital is invested.
Blue Tower Asset Management – The Strategy
Blue Tower’s investment philosophy is a blend of two of the most dominant strategies used on Wall Street today; quantitative analysis and value investing. Screening algorithms, that I developed by adapting and combining the best elements of quantitative investment management strategies, will identify companies which score high on a number of accounting tests and which are trading at a low valuation. These companies are then vetted for investment using the best practices of classic value investing and industry analysis.
Factors that we look for in determining if a company is high quality are high returns on tangible assets, geographic and product diversification, improving industry structure, low cyclicality, high profit margins, conservative use of debt, and a high likelihood of continued organic growth in their main product categories. The strength of a company’s competitive position (their “moat”) is an important aspect of investing that many other value managers overlook.
Evaluating the management of a company is an important part of the qualitative portion of the research process that Blue Tower uses for determining investment quality. We want to invest in companies with highly motivated management who are of the highest integrity and put shareholder interests at the forefront. Management should be a good steward of the capital of the business. We first determine where management is using investor capital. A company’s management has four options when it comes to allocating capital: 1. Reinvest in the Business 2. Make acquisitions 3. Return capital to investors through share repurchase or paying dividends 4. Build up cash reserves/Pay down debt. Once we have determined where capital is being spent, we can evaluate the wisdom of these decisions.
Part II shortly – stay tuned