Amidst rising economic fears and skittish markets, veteran value manager Tim McElvaine is finding new discount opportunities for the concentrated five-star McElvaine Value B mandate.
“The future seems fairly uncertain,” says McElvaine, founder, president and portfolio manager at McElvaine Investment Management Ltd., in Victoria, B.C., “but I have yet to find a time when the future was certain,” he says, based on three decades of hindsight.
Clear to Proceed Carefully
“I sort of put things into the category of red light, yellow light, green light,” says McElvaine, “and we’re touching on the green light now. I’m finding enough interesting things and new ideas to look at, being cautious price-wise, which is a good environment from a value point of view.”
With a portfolio of approximately 15 holdings and a turnover of 27% last year, long-term careful stock selection is characteristic of the fund. And it’s paid off this year, with the fund up 3.08% year-to-date as of June 30th. By comparison, its benchmark Morningstar Canada Small Cap (GR) Index has lost 17.19% so far this year. The investment approach is categorized as a small cap value blend, but McElvaine says he is much more careful now in not holding too many small caps.
McElvaine’s on the lookout for securities that are between $500 million and $10 billion, maybe a little bit below $5 billion. “That’s very liquid from my point of view,” he says, “and usually the businesses are developed enough, and have more resilience, than some of the smaller companies I used to invest in.”
Find the Advantageous Disconnects
Since 1996, the fund’s strategy is to look for a 60% discount on a quality stock but McElvaine says he starts with a different point of view these days, looking for the competitive advantage on a purchase. “I call it dislocation,” says McElvaine, “asking why are people selling? It could be because people are scared, or because something’s gone wrong with the company or the sector, for example.”
Four Principles of Investment Philosophy
McElvaine does have an in-house template but says his detailed model would be embarrassingly straightforward. Everything in his research assessment falls into four categories:
-What’s our competitive advantage?
-Why is the company worth more than is reflected in the stock price?
-Why does the company have staying power?
-What’s the alignment of interest?
In addition, the stock assessment includes ESG factors, cash flow, and debt load.
When considering the mandate, McElvaine has all of his retirement savings invested in the fund. “While I cannot recommend someone else do that,” says McElvaine, I think an investor can take comfort from the fact I am focused on the fund.” As to the time frame, “a bargain takes time to mature,” says McElvaine. “Watching a month-to-month return is not really an exciting pastime. I suggest a three-year plus timeframe.” At the 3 year mark, the fund has handily outperformed its benchmark index with around 13.45% annualized vs. 4.80%, and 11.34% vs. 3.16% at the 5 year mark.
Positioning of the Fund
The weighting of approximately 47% in Canadian equity has been the case for a while and usually spans between a 40% and 60% position. McElvaine says he is very happy to go wherever there are compelling value opportunities but he prefers investing in Canada or North America because there’s a much higher familiarity.
Risk Measures
“This is an important question,” says McElvaine. “I deal with capital loss by being careful in the price we pay and ensuring the companies have staying power.” He also deals with the uncertainty by being in alignment with management teams. As well, the target is 15 to 20 holdings in the fund, so initial position sizes tend to be about 5% of assets.
Value Opportunities
A recent purchase, Bausch & Lomb Corp. (BLCO), illustrates the investment approach. According to McElvaine, a messed-up share structure and an unfortunate initial IPO during poor market timing provided a buying opportunity for a premium company. “Bausch & Lomb, diversified across the eye-care business,” says McElvaine, “is one of the top three players in each category. They’re very cash generative, a very global company, and we don’t often get that investment opportunity. Shareholders are uncertain about the future, and that’s a great setup for me because people aren’t really thinking about the price.” In addition, favouring management incentives, and the existence of activist shareholders on the board ticks all the boxes.
Warner Bros. Discovery Inc. (WBD) is another recent purchase of a quality company. “Warner Bros. has a little too much debt at the moment,” says McElvaine, “and I’m careful about that, and they have a business transformation going on, the fight over becoming a direct distributor, so two big headwinds.” Yet, from his point of view, shareholders were selling during the AT&T transaction, providing a discounted price opportunity and a competitive advantage.
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