Author: Barry Randall, Crabtree Asset Management
Covestor model: Crabtree Technology
At Crabtree Asset Management we’re highly disciplined about our investment process. Roughly 45 of the 50 names in the model come straight from the quantitative screen that we run four times every year. But we reserve the remaining spots in the portfolio for high-quality companies that no quant model will ever find because (for example) they are a recent spin-off from another company, and the spin-off’s financial data has not yet been loaded into the relevant investing databases like FactSet and Bloomberg.
Among our exceptions also are companies that once qualified “by the numbers” through our quant screen, but which no longer pass. Happily, this often occurs because the company has performed well and its stock price and valuation have risen to a level that eliminates it from the model.
IBM (IBM) and SXC Health Solutions (SXCI) are two long-time Crabtree holdings that fit this description and our flexibility has rewarded us in each case.
Of course, that doesn’t always happen. Long-time Crabtree holding TriQuint (TQNT) was an exception which we made because our deep analysis of the semiconductor company led us to believe that short-term under-performance was the result of the company preparing for a massive order from its largest customer, Apple (AAPL). TriQuint has long been a trusted supplier to Apple, even going so far as to decline a slot in Apple’s Verizon iPhone 4S 18 months ago because it didn’t have the requisite manufacturing capacity and simply didn’t want to disappoint Apple by falling short of production goals.
But enough time has elapsed, and TriQuint has landed neither the in-phone content nor the volume we expected it to get from Apple. So it has failed our “execution” parameter. TriQuint is a example of the exception that proves the rule: a company for which we make an exception has to be…exceptional. TriQuint proved it wasn’t, and it was gone on April 26 – a rare intra-quarter liquidation in our fund.
We like to say that our investment process is probabilistic, instead of deterministic. That’s just a fancy way of saying that we invest in companies that have a high probability of outperforming the companies in which we haven’t invested. This, as opposed to analyzing companies to a fare-thee-well in order to attempt to determine conclusively that they will or won’t outperform. We believe the latter process, which is what the Fidelitys and the T. Rowe Prices of the world do, is inherently flawed because it equates more information with more alpha.
If that were true in real-life, Fidelity’s TV ads would trumpet their funds’ outperformance. Instead, their ads tell people to follow a green line on the floor. Make of that what you want. But it probably doesn’t reflect well on their process.
TriQuint had a high probability of outperforming. But that probability wasn’t 100%. It wasn’t the first company to disappoint us and won’t be the last.
Overall, April was a very strong period for the Crabtree Fund. The Technology model rose 1.3% during the month, beating our internal benchmark, the Merrill Lynch Technology 100 (MLO), which fell 4% during the same period. Covestor also compares the Crabtree Model to the Nasdaq 100 Index, which fell -1.2% during April and to the S&P 500, which declined -0.8%. [MW: Confirmed]
April brought with it the start of earnings season, and roughly half our holdings have reported their 1st quarter 2012 financials as of this writing. There were some stellar performances, including those by IBM, Electronics for Imaging, Hexcel, OSI Systems, Teledyne, Stamps.com and Ariba. And there were disappointments including TriQuint, Coherent and MKS Instruments. Fortunately, our May portfolio re-balancing offers us the opportunity to trim our winners and replace the under-performing companies with those that have a high probability of generating alpha.
One last thing. As noted in our last monthly letter, Crabtree holding Tele Norte Leste Participacoes (TNE), was taken over and our holding was converted to shares of OI (OIBR), also a Brazilian phone company. We’ll decide in the forthcoming re-balancing whether to remain OI shareholders longer-term. But in the meantime, OI has already rewarded us with a hefty dividend in early May. So a little bit of Christmas has come early to the Crabtree Fund. But perhaps that makes sense: it’s wintertime in Brazil.
