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For over 35 years, Hotchkiss Associates has been managing client portfolios as separate accounts with investment strategies tailored to the clients’ unique goals and tolerance for risk. The management of domestic equity and fixed income assets represents the firm’s traditional core competency – these allocations are comprised of individual securities and are managed by the firm’s investment committee.
For international equity and fixed income, market neutral, commodity, and real estate allocations, the firm uses a combination of outside managers selected by the United Capital investment committee through a rigorous due diligence process.
Hotchkiss Investment Strategy
Hotchkiss Associates employs a top down investment approach based on the development of investment themes. The firm identifies business sectors which are likely to grow faster than the overall economy over a five year period due to economic, demographic, or other reasons. The firm identifies industry leaders based on market share, the quality of management, return on equity, and a solid balance sheet.
The firm believes that overvaluation and undervaluation of securities stems largely from investor misconception regarding growth prospects and competitive forces within a sector, industry, or product area. Our holistic worldview incorporating macroeconomic analysis and industry specific metrics provides the most efficient platform from which to identify and exploit these misconceptions.
Hotchkiss Associates investment team is responsible for securities selection. The team divides the equities universe into sectors and each sector is assigned to a member of the investment team. To analyze a new security, a team member will perform extensive research and due diligence and will report findings to the full investment team. The investment team members will share their thoughts regarding key growth drivers, competitive advantages, and investment risks. Following the analysis and discussion, the investment team will vote on whether to purchase a security. The industry analyst responsible for the sector will break a tie.
Portfolio Construction Methodology
Having identified a stable of companies across diversified industries, a portfolio manager works with the client to construct an appropriate portfolio responsive to the client's objectives and constraints containing between 25 - 35 equities, representing approximately 10 industries. Cash reserves are a function of investment opportunities and client needs; at most times, portfolios will be fully invested. Portfolio managers regularly review and re-balance portfolios based on the conclusions of the investment team and changes in client objectives.
The team uses valuation models including the dividend discount model and compares pertinent financial ratios. In the end, the firm's discipline emphasizes investing in profitable businesses at prices that are justified by the growth potential. The firm has identified criteria in which a material change would cause the sale of an investment. Those are:
- The appraisal of the quality of the company's management
- The market for the company's products
- The competitive landscape
- Negative changes in the outlook for the industry
In addition, the investment committee will review and re-vote on any stock where:
- The PEG ratio is greater than 1.5x industry peers
- The stock has declined by more than 10% from the prior month's investment committee meeting
Hotchkiss Investment Strategy – An Example
Investment Strategy
An Example
Identification of high growth sectors that have been
under-researched by other investment managers
In early 2007 we analyzed the alternative energy space because we believed that traditional energy prices would rise due to the combination of industrialization in the developing world, global population growth, inelastic demand, and a dearth of new discoveries and that the growing global consensus on the need for stricter emissions controls would further increase the cost of traditional energy sources. Moreover, we concluded that the alternative energy space was not well understood by either the buy side or sell side community because there had historically been very few publicly held companies whose primary business was in an area of alternative energy.
Industry Analysis
We divided the alternative energy universe into three sectors, biofuels, wind, and solar, and produced a study of each sector using research from government agencies, industry trade groups, the academic community, and securities filings from the small universe of publicly-held companies in each sector.
Investment Strategy
An Example
Sub-Sector Identification
We concluded that the market had significantly underestimated the rate of growth in the solar sector broadly and in particular had underestimated the competitive advantages of the low cost producers.
Company Discovery
We focused our analysis on the lowest cost solar producer because we believed that its proprietary manufacturing process provided a competitive advantage with high barriers to entry, allowing the company to expand margins and gain share over the long term.
Investment Strategy
An Example
Company Analysis
At the time we began our analysis in the spring of 2007, the company was generating de minimis earnings with the result that multiples of forward earnings and EBITDA were ineffective as valuation metrics. Therefore, we built a discounted cash flow model that took price and cost per watt of modules produced, volume of modules sold, and other industry and company specific metrics as inputs. Using these metrics, we estimated a three year revenue CAGR and a five year EBITDA margin expansion supported by our primary research.
Conclusion
Our primary research, comprised of an extensive review of documents from a variety of sources, allowed us to segment the sector, identify the drivers of growth and competitive advantage in the space, determine how each company was positioned with respect to these drivers of growth and competitive advantage, and recognize a company that was trading at a discount to its intrinsic value.
Portfolio Diversification Strategies
Portfolio Diversification
Strategies
Through United Capital, Hotchkiss has access to best in class outside managers across a broad range of asset classes including equity and fixed income investments in international developed and emerging markets, market neutral strategies, commodities, non publicly traded REIT’s, and structured products. United Capital’s investment committee includes CFA’s, CFP’s, and other advanced degree professionals with over 100 years of combined industry experience. This team uses an extensive due diligence process to select, monitor, and replace outside managers.
