Introduction

A sound investment process is the successful execution of the investment philosophy. As stated above, an investment philosophy tells you how you should make investment decisions. Here, we will merely describe the steps taken day to day to ensure that we make sounds investment decisions.

“The Detective and the General”

The Labrusca family manager’s investment process can be divided in two parts, both crucial and important yet intertwined in the production of absolute returns. These two parallel processes are:
1) Bottom-up research and stock picking
2) Overall portfolio risk and management

We call the first part of the investment process for "The Detective". The second part is called "The General". The Labrusca Investment Process executed by ALL portfolio managers is the constant interrelation between these two sets of responsibilities.

The reason why we call the first part of the investment process The Detective is that we feel that the work required to find attractive investment opportunities is somewhat similar to a detective’s work when solving a case. Similarities include some creativity (i.e. the capacity to think “outside the box”), logical and analytical capacity, enthusiasm and chess-like qualities to be able to think two or even three steps ahead in to history and into the future. And like Sherlock Holmes says; "to find what you look for – always follow the cash".

The General has the portfolio management role of taking another perspective on an investment idea than The Detective. He will focus on the systematic aspects of the position, disconfirming evidence and other variables which for various reasons might have escaped The Detective’s attention from an overall portfolio context. This work will present “the whole case & the whole fund” and bring objectivity to the process as well as the fund composition, and make sure that a pair of skeptic eyes is on each position at all times. All portfolio managers will take on both these crucial roles.

Search strategy

It’s not so much where we look for mis-priced securities but how we look for them. Although we use our own proprietary screening tools for securities with certain attributes, screening processes are readily available to everybody through various databases and any advantage is thus quickly arbitraged away. This brings us to how we look for undervalued securities. In a world where the average holding period of a stock is about 7 months, the pockets of opportunity are likely to be further out on the time-scale simply because it is less crowded. As such, the market has a tendency to overly discount near term fundamental prospects and extrapolate it into the future. Major fundamental changes beyond say, 12 months, tend to get much less attention and create opportunity for excess returns. As stated above, we aren’t saying that the markets are always inefficient, but rather that opportunities are more likely to be found where longer term prospects differ materially from shorter term ones.

Valuation – not what you might expect

We have several times stated that valuation is the most important part of our investment process. Within fundamental investing, those who emphasize valuation are often referred to “value investors”, as oppose to growth investors. We find this notion of value vs. growth logically misguided as growth is simply a component of valuation, which can be value-creative or destructive. This depends on whether the business is producing returns above its cost of capital or not. As such, whether the investment offers satisfactory risk/reward doesn’t necessarily depend on whether it’s growing or not. We don’t discriminate against high growth businesses as long as we don’t have to pay full price for them. To us, the only sensible approach to investing is paying less than we get back when we sell the asset - no matter what others choose to label it.

Continuing on the valuation theme, we find that conventional yardsticks such as P/E and P/B have very little to do with robust decision making in investment analysis, as these measures are usually severely distorted by accounting conventions or strategies which disguise economic reality. Some investors seem to spend a lot of time understanding the industry and talking to the management of the company, while in the end basing their investment decision on oversimplified and clumpsy valuation metrics. In failure, investors then refer to their investments as “value traps”. A priori, there’s no such thing as “value traps”, just bad valuation analysis. This is far from saying we ourselves employ more highly sophisticated excel-based “holy grail” valuation metrics in order overcome bad analytical interpretation; What we are trying to say is that we are likely to have securities in our portfolio which on the face of it won’t have the typical attributes of “value stocks”. We will hold stocks trading at P/E 5 and P/E 50 side by side for the same reason: that we believe the market is severely underestimating their intrinsic value.