“Why don’t we get any good snow around here?” That question was recently asked by one of Steve Scruggs’s four daughters. Scruggs, a CFA® is portfolio manager for the Queens Road Small Cap Value Fund and the Queens Road Value Fund. Although Charlotte, North Carolina, where Queens Road is headquartered, does not get much snow, like any determined investor, Steve “dug in” to try to solve the problem. After some trial and error, Steve converted an old pressure washer and an air compressor into a homemade snow-making machine. A few days later there were piles of fresh snow and a line of kids in the yard waiting to go sledding.
Queens Road Small Cap Value Fund
That kind of curiosity about how things work combined with old-fashioned resourcefulness helps to make Scruggs a good investor. The Queens Road Small Value fund has outperformed its benchmark, the Russell 2000 Value Index, over the past 10 years and since inception in 2002, earning an annualized return of 9.59% vs. 8.38% for the Russell 2000 Value Index (as of 9/30/16). Scruggs has served as portfolio manager, using the same value process for that entire 14-year period.
Seth Klarman: Investors Can No Longer Rely On Mean Reversion
"For most of the last century," Seth Klarman noted in his second-quarter letter to Baupost's investors, "a reasonable approach to assessing a company's future prospects was to expect mean reversion." He went on to explain that fluctuations in business performance were largely cyclical, and investors could profit from this buying low and selling high. Also Read More
I spoke with Steve on December 4.
You have two funds, the Queens Road Small Cap Value Fund (QRSVX) and the Queens Road Value Fund (QRVLX). Both have been around since June 2002. What is your background and that of your investment team? What led you to create these funds?
The Queens Road Funds are managed by Bragg Financial, our family owned and run investment firm in Charlotte, NC. We were started over 50 years ago and we manage $1.2 billion for private clients and institutions. By the 1990’s, we had a good investment philosophy and an established investment committee and were picking stocks for clients. We were doing a good job, so in 2002, we decided to launch the mutual funds to continue growing our firm.
I have been the portfolio manager since inception almost 15 years ago and I am supported by our investment committee. Benton Bragg and Matt DeVries are analysts on the Queens Road Small Value fund and all of us are CFA’s. Benton and I went to high school together in Charlotte and we both went to business school at Wake Forest. He is also the chair of our investment committee and is an analyst on the Queens Road Value fund along with Ben Rose.
What are the mandates of the two funds? What is your investment process?
The Queens Road Value Fund is a large cap value fund. The Small Cap Value Fund is focused on small companies that are part of the Russell 2000 Value Index. We use a very fundamental, bottom-up process to find companies that we can buy at discounted prices based on a Graham and Dodd approach. We want to buy with a margin of safety. Both invest only in U.S. companies.
We look at both quantitative and qualitative aspects of a company. On the quantitative side, we look at a variety of things. Primarily we’re looking for solid balance sheets, companies that have strong cash flow and serviceable levels of debt and companies that aren’t reliant on the capital markets. We then look at valuation by normalizing operating margins over a full market cycle to arrive at our estimate of intrinsic value. Instead of looking at just the most recent data, we look at operating margins over a full market cycle. We want to buy good companies with a margin of safety.
On the qualitative side, we’re looking for two things: management and the markets in which the companies compete. We want to see management that can lay out a strategy and execute to that strategy; we want management that is clear and honest and willing to admit mistakes and ones that are willing to take measured risks. We want to make sure that the companies we’re investing in are competing in industries that have favorable economics, are growing and aren’t overly competitive. This helps us avoid value traps.
Your small-cap value fund, the larger of the two funds, has outperformed its benchmark, the Russell 2000 value index, since inception (June 2002) by 121 basis points (9.59% versus 8.38%, as of 9/30/16). To what do you attribute that outperformance?
It’s the discipline and patience that we apply in the portfolio management. We have a very straightforward approach that’s based on fundamental, bottom-up analysis. Sometimes the market seems to focus on fundamentals, and sometimes it doesn’t. But we’re always focused on the fundamentals. Sometimes our investment style will be in favor, and sometimes it won’t be in favor. Our discipline and patience come into play when our investment style is not in favor. We continue to apply it the same way, knowing that in the long run, things always come back to the fundamentals.
I attribute that outperformance to not losing as much in down markets as our competitors. That is the bottom line. It also means we’ll trail a bit when stocks go straight up and investors aren’t paying attention to risk. We’ll lag during those big “momentum runs” when risk is ignored.
But bottom line, when there’s a little volatility in the market, when there’s some worry, some fear, some down markets, we traditionally have not lost as much.
By Robert Huebscher, read the full article here.