Our goal in Microcap Growth Equities is to provide superior risk-adjusted returns and to outperform relative benchmarks such as the Russell Microcap Index over a full market cycle.
Transamerica Investment Management, LLC ("TIM") Microcap Growth Equities can be categorized as a fundamental and research driven approach to investing in micro-cap company growth stocks between a market cap of $10 million and $300 million. TIM utilizes a team approach and a philosophy of investing in high quality companies which exhibit rapid growth in earnings and revenue. Significant emphasis is placed on management and their past record of success and superior business models.
We believe that value can be added when we identify at an early stage positive changes affecting a company that the market has yet to discern. This groundswell of change may be a result of long term secular trends such as changes in demographics or technological advances. It may also be positive fundamental changes occurring within a company, an industry or a management-related change.
The entire team also reviews economic indicators and events occurring in each of our analyst's respective sectors. We then synthesize our conclusions into an outlook on the economy, what type of growth is to be expected and what portions of the economy will drive that growth.
TIM fundamental research starts with a universe of approximately 800 investment opportunities. These are small companies with a market capitalization over $10 million but under $250 million (at purchase) which demonstrate the desired growth characteristics (i.e. earning growth in excess of 20%).
We then screen by industry groups using specific criteria unique to each industry such as sales growth, return on equity and assets, and debt to equity ratios. This process brings us to a list of approximately 200-300 companies in which to research.
Original research is the core of our investment process and has added value for over 20 years. Our team-oriented research process emphasizes in-house research and seeks to control or limit non-systematic or business risk. In addition to a dedicated and highly experienced equity research team, our portfolio managers (who are analysts as well) also have the benefit of a large group of credit analysts as a resource.
The generation of "new ideas" starts with an eclectic group of sources including: securities industry contacts, trade shows, industry conferences, trade and general media, quantitative screens and, on a limited basis, Wall Street research. A manager or analyst then identifies a company or group of companies that may be positively impacted by change. Change may be secular, driven by evolving demographics, politics or economics; or it may be fundamental, involving an industry cycle, a product cycle or a management transition. After this initial review, promising "ideas" are presented to the entire management team to determine which concepts merit further investigation.
Companies that warrant further investigation are contacted and a meeting set up with senior management by several members of TIM's research team. Through these meetings and interviews with management, the research team identifies the companies best positioned to benefit disproportionately from change; generally those with superior business models, proven management teams and businesses that are producing substantial free cash flow.
TIM's philosophy is to invest in a concentrated number of companies that offer distinct and sustainable competitive advantages (5-10 years) over their competitors. Many of these companies maintain dominant market share yet have transparency of their operations. We also prefer to invest in companies that demonstrate organic growth instead of growth through acquisitions, recurring revenue models and an operating business that benefits from incremental unit volumes and can bring those incremental unit volumes to the bottom line.
In meeting with management teams, the evaluation includes a determination of their vision, culture, incentive plans, strengths and weaknesses, the company's product lines, distribution capabilities and product pricing. Our goal is to invest in companies that have management teams which are experienced, prudent, and visionary, that have a history of success and that act in the long-term best interest of shareholders - particularly through effective allocation of capital.
Independent sources such as customers, suppliers, and competitors are used to verify or cross-reference facts and information derived from company management interviews. These meetings and discussions can also add a different perspective to the merits of an investment idea.
The financial statement analysis is focused on companies that are experiencing a substantial increase in discretionary cash flow. Through proprietary analysis of financial statements, we look at the sustainability of a company's cash flow and reconcile it back to its earnings. Often these companies exhibit highly predictable revenue and earnings growth, strong balance sheets and demonstrate high returns on equity and assets.
Critical to the investment process is the identification of companies exhibiting the highest growth potential at the most attractive prices/valuations. We want to make sure we do not overpay relative to a company's intrinsic business value and/or projected growth rate or relative to alternative investments within an industry. Proprietary valuation models (DCF-based) are built for every company considered for investment and form the basis for our valuation judgments.
TIM company research includes a "Porter's 5 Forces" analysis which reviews entry barriers and the threat of new entrants, threat of substitutes, bargaining power of buyers and suppliers and rivalry among competitors.
Research documentation will include a business discussion, an earnings model which reflects historical and expected financial performance and a quantitative analysis of the stock's potential risk-reward characteristics.
Companies not eliminated from fundamental research are presented to the equity team for review. These group evaluations ensure that the reasoning and analysis behind each recommendation is solid and defensible and the securities ultimately selected truly fit all criteria and controls.
The final security selection is a result of the compilation of all of the fundamental analysis. All portfolios are well-diversified, and will generally consist of 60 to 90 securities (with an average holding representing 1.5% of the portfolio). A typical individual position size at purchase is 1.0% with an absolute maximum issue size of 5%. No more than 35% of the portfolio can be invested in any one broad Russell sector. All accounts are monitored on an on-going basis by the portfolio manager responsible. The number of portfolios assigned to a portfolio manager varies depending on the size of the portfolios. Client restrictions and guidelines are documented, and if possible, quantified on TIM's portfolio accounting system. Compliance with client guidelines is reviewed on a regular on-going basis by the portfolio manager and Compliance Department.
The sell disciplines we use incorporate several factors, including: identification of a better idea (crowding-out), overvaluation relative to TIM-determined fair value and as compared with other like securities, a deterioration in company fundamentals, or if management is changing strategy in a questionable way or not meeting operating objectives. The research group also formally reviews all holdings which have declined 25% from cost or trailing twelve month high.
TIM's equity trading desk is staffed by six equity traders. Traders and portfolio managers work together to establish trading priorities (e.g., time or price limits) at order entry and if necessary, during the execution process. Portfolio managers review trade tickets at the end of the day and all trade tickets are reviewed the following morning by the investment team. TIM's Best Execution Oversight Committee monitors trade execution costs on a quarterly basis.
TIM's dedicated trading group has developed an extensive network of brokers, and due to our firm size and trading volume is able to leverage negotiations for best execution practices. Trading costs average $0.03 - $0.05 per share. We attempt to keep commissions as low as possible.
While the traders do their best to minimize market impact while executing orders, the ultimate decision on execution lies with the portfolio managers where opportunity costs may outweigh short-term market impact costs.
Our internal research is presented at our weekly research meetings as well as monthly at our equity strategy meetings. Weekly meetings tend to focus on brief updates of news items affecting our holdings while monthly meetings tend to cover more comprehensive reports such as buy or sell recommendations. Internal research is easily accessed by everyone through e-mail and voicemail. TIM has offices in Los Angeles with a daily exchange of information among the entire investment and research staff. TIM's extensive peer review process also incorporates daily internal meetings/conference calls involving the Chief Investment Officer, portfolio managers and analysts of all investment classes.