WHY INVEST IN THE SMALL-CAP VALUE ASSET CLASS?

GREATER INEFFICIENCIES IN THE SMALL-CAP MARKET LEAD TO GREATER POTENTIAL OPPORTUNITIES.

“Small stocks tend to have higher average returns than big stocks and value stocks tend to have higher average returns than growth stocks.”

– Kenneth R. French

 

1) Log scale. SOURCE: Eugene F. Fama and Kenneth R. French, The Anatomy of Value and Growth Stock Returns, August, 2007. Ongoing updates to data by Kenneth R. French Data Library, Tuck School of Business at University of Dartmouth. Break point between small and big is median market equity (ME). Break point for valuation is 70th book equity/market equity (BE/ME) percentile and 30th book equity/market equity (BE/ME) percentile.

TWO LONG-ONLY, SMALL-CAP VALUE STRATEGIES:

Sterling Small-Cap Value Diversified and Sterling Small-Cap Value Focus

PHILOSOPHY

Both strategies seek to deliver total returns higher than the Russell 2000 Value Index on a risk-adjusted basis within a diversified and concentrated portfolio. To achieve this, we apply a consistent and repeatable process developed through decades of investment management experience. We conduct in-depth, fundamental research that we believe yields proprietary knowledge, particularly among smaller, underfollowed companies. Our focus on identifying unlocked value is what allows us to seek excess returns and above benchmark performance. We invest with a long-term time horizon at significant discount to our estimate of intrinsic value or “true worth,” and then carefully monitor our holdings as we wait for the gap between market price and “true worth” to close.

INVESTMENT DECISION-MAKING PROCESS

Our investment decision-making process for both strategies is built around a research-driven, fundamentals-based effort to estimate the intrinsic value or “true worth” of companies in our universe, which is primarily those companies within the market-capitalization range of the Russell 2000 Value Index. We invest in companies that we believe offer the best total return on a risk-adjusted basis where we can identify a catalyst to realize the underlying value. We construct extensive financial models of our candidates for purchase, review public filings and conference call transcripts, and analyze competitors, suppliers and customers in order to make our best estimate of intrinsic value and expected return. We sell a holding once it no longer offers an attractive total return.

FOUR CORE INVESTMENT PRINCIPLES

  1. 1 We adhere to a disciplined, repeatable investment process
  2. 2 We remove emotion and trust conviction
  3. 3 We attempt to invest at a significant discount to “true worth”
  4. 4 We exercise the patience necessary to allow the thesis to be fully realized

RESEARCH AND INVESTMENT PROCESS

  • Search for Underfollowed, Misunderstood, Misperceived and thus MISPRICED Securities with a Viable Catalyst for Value Realization
  • High-Level Valuation Screens to Assess Valuation and Quality
  • Qualitatively Evaluate the Best Candidates from Quantitative Screens to Determine if a Stock is Mispriced
  • Make the Best Possible Estimate of “Intrinsic Value” to Determine the “Expected Return Estimate”
  • Portfolios are Built with Stocks that We Believe Offer the Highest Expected Return

BUY

SELL

  • Significant Discount to True Worth
  • Valuation Potential Realized
  • >20% Annual Expected Return
  • <20% Annual Expected Return
  • Reliable Thesis Intact
  • Broken Thesis
  • Catalysts Unfolding
  • Impaired Catalysts

RISK MANAGEMENT

  • Provide margin of safety against permanent loss of capital
  • Discount to Sterling Partners Equity Advisors estimate of
    intrinsic value (>40%)
  • Continuous evaluation of thesis and company fundamentals
  • Ongoing risk/return analysis
  • Specific limits on position sizes

RESOURCE CENTER