The Long-Short Equity Strategy seeks to provide equity-like returns with substantially reduced volatility while emphasizing capital protection.
The long portion of the Long-Short Equity Portfolio’s universe targets securities with market capitalizations greater than $750 million.
The short portion of the Long-Short Equity Portfolio’s universe targets securities with market capitalizations greater than $500 million.
The Long-Short Equity Strategy investment process proceeds through four stages:
I. Idea Generation
River Road employs two research methodologies – Systematic and Dynamic.
Systematic Research: Screening of the firm’s three principal databases.
- Our Watch List (including former portfolio holdings)
- Qualitative screening with Value Line: Provides a snapshot of a business and up to 15 years of relevant quantitative historical trends
- Quantitative screening through FactSet: Identifies stocks that best exhibit the Strategies’ critical criteria
Dynamic Research: An active search for attractive candidates among:
- Investment media
- Industry research
- Competitor analysis
- SEC filings (10-K/Qs, 8-Ks, proxy statements, insider trading (Form 4 filings), share repurchases/dividend increases, etc.)
- Various other contacts and resources established by the portfolio management team
II. Security Analysis
The critical criteria for long holdings include:
- Valuation: Target discount ≥ 25% of a company’s valuation
- Attractive business model: Understandable, predictable, and sustainable; high returns on equity and invested capital; and reasonable growth prospects
- Shareholder orientation: Significant insider ownership/insider buying; opportunistic stock buybacks; accretive transactions; debt reduction; and dividend raises/initiations
- Financial strength: Liquidity and leverage; hidden assets; and free cash flow yield
The critical criteria for short holdings include:
- Challenged business model: Low returns on invested capital, companies in secular decline, companies that cannot grow their top line, companies that rarely generate free cash flow
- Financial weakness: Unsustainable capital structures, excessive debt, negative free cash flow
- Poor shareholder orientation: Overly generous compensation plans, significant related party transactions, insider selling
- Priced at a premium to value: Target price ≥ 120% of a company’s valuation
- Low price and earnings momentum: Avoid stocks with strong positive momentum
III. Portfolio Construction
The long portfolio targets 20 to 40 positions representing 50% to 100% of the portfolio value, with the actual number of positions dependent upon market conditions.
The short portfolio targets 20 to 40 positions representing -10% to -90% of the portfolio value, with the actual number of positions dependent upon market conditions.
Expected net market exposure is between 50% and 70% in normal market conditions. In extreme market conditions, net market exposure may range from 10% to 90%.
IV. Sell / Cover Discipline
We believe that the key difference between a losing strategy and a winning strategy is that losers make big mistakes and winners make small mistakes.
- Our sell and cover disciplines help keep the inevitable individual mistakes from causing large, permanent losses of capital in the broader portfolio.
- We do not average down on losing positions.
Long-Short Equity Strategy Inception Date: July 1, 2010