What is your average turnover?
Annual turnover for the firm's multi-cap portfolios have averaged approximately 60% to 75% over the last several years. Turnover will vary according to the type of portfolio (small-cap will differ from multi-cap, for example) and whether or not the account is taxable or tax-exempt. In addition, a by-product of the emphasis on private-market value in our investment process is that large companies often acquire companies in which we invest. As a result, even though our clients may benefit in years in which there is a great deal of merger and acquisition activity in our holdings, our turnover will be inflated in those periods. This type of "turnover inflation" occurred in both 1995 and 1999, for example.
What is the most appropriate benchmark to measure your performance?
Because we are a bottom-up manager and do not invest the portfolios with a benchmark in mind, we do not believe any benchmark is ideal. However, if forced to choose, the benchmark varies with the portfolio or the fund. For the KING Small-Cap Equity Portfolio, we suggest the Russell 2000® Index, which is a small-cap index.
For the KING Mid-Cap Equity Portfolio, we suggest the Russell Midcap® Index.
For the KING Multi-Cap Equity and Balanced Portfolios, a suitable market index is more difficult to define. The S&P 500 Index is the most widely known investment benchmark, but it is not accurate for comparison purposes for many managers. For instance, the S&P 500 is a large-cap index. KING's hallmark Multi-Cap Equity Portfolio and Balanced Portfolio are dynamic portfolios which invest in companies of all sizes. Their market cap weightings may change depending on buying opportunities; therefore, it is difficult to identify a permanent benchmark. However, over the past several years, the emphasis for this portfolio has been in the mid-cap arena. For recent comparisons, the Russell 3000, a broader index, or the NYSE or Value Line Index, more indicative of the results of the average stock, would be appropriate measures.
Does your buy discipline emphasize potential takeover candidates?
KING's clients have benefited from merger and acquisition activity since the firm's inception. KING, however, does not explicitly target possible takeover candidates. Instead, M&A is often a by-product of our investment process. In fact, we are rarely surprised when one of our holdings is bought by another company at a premium above the market, because we buy companies valued at "fifty cents on the dollar."
It is only logical that if you buy companies at public prices below their enterprise value, others may eventually recognize this value as well. A corporation whose public stock price is at a significant discount to its private-market value will not remain on the bargain counter forever. Any number of catalysts will cause the stock price to increase, in some cases dramatically.
KING's focus on private-market value has contributed to our success over long periods through different types of markets. It is also what makes us unique among managers.
How does your emphasis on private-market value play out in down markets?
According to MERGERSTAT, studies dating back to 1990 show that the average premium for acquired stocks has consistently ranged between approximately 30% and 45%, regardless of the performance of the market. Although it is difficult to predict specific future corporate acquisitions, companies which are selling at a steep discount to their private-market value (especially those in consolidating industries) are more likely to be acquisition targets.
Investors using the private-market value approach are likely to hold more stocks of acquired companies than are other investors. If just 10% of the stocks in a portfolio are acquired at the historical 40% premium, the overall portfolio return is boosted by 4%. In a lackluster market, this can mean the difference between making and losing money.
Does KING make sector bets?
KING portfolios often have heavy weightings in certain industries but, contrary to popular opinion, these weightings are not representative of sector bets.
KING uses a "bottom-up" stock selection process. Bottom-up analysis means that we examine the fundamental value of a company by looking at its financial statements, products, competitive position, management, and overall inherent value. Our primary concern is not which sectors will do well this year, but which companies are poised to do well, yet have been overlooked by the market. While we do consider macro factors in our broad analysis, these factors do not drive our investment decisions.
By using this approach, we may frequently have some sector overweightings in our client portfolios. When an industry is out of favor, several companies within that particular industry may show up in our screening process. We are interested in buying earnings power, cash flow, and assets for a low price, regardless of industry classification. As a result, several stocks which we believe have significant long-term potential may be purchased from the same sector. Again, the companies are the primary focus of our analysis, not the industry.
Investing in stocks which we believe are trading at a discount to their true intrinsic value, regardless of industry, should produce a risk-adjusted return well above average over the long term.
Do all portfolios with similar objectives own the same stocks?
Not necessarily. Account holdings are largely the same but may differ a bit for a variety of reasons. First, KING does not use "cookie cutter" model portfolios. When a client opens an account, we do not automatically buy the same stocks that another client with the same objective owns. For example, a client who has been with us for several years may own a stock we believe has only 10% or 15% potential upside from current levels. We may choose not to purchase that particular company for a new account. We also may not sell it for the older account as, depending on the tax situation, the realization of a sizable gain and creation of a tax liability may not benefit the first client.
Finally, a client might not have a sufficient amount of cash in his/her account when we are buying a stock. This may be due to withdrawals, special account restrictions, or other circumstances.
What importance does Wall Street research have on your firm's investment decisions?
KING uses a variety of research sources, including Wall Street research. Not only do we scrutinize reports from the large research houses, we also review information from several off-Wall Street firms, Bloomberg, Value Line, and SEC filings. We also meet with company management, attend conferences, and visit with others in the industry. We combine this knowledge with our own internal research to make buy and sell decisions.
Wall Street research certainly does warrant our review; however, we are independent thinkers. We research beyond what is written in the reports and question the "herd mentality."
How long do you take to become fully invested for new clients?
It varies. It may take anywhere from several weeks to several months, depending on opportunities. KING does not run rubber stamp portfolios; thus, we do not necessarily put all the money to work immediately. If we perceive few attractive opportunities, we will be slower to invest a client's assets. On the other hand, if we perceive many available opportunities, we will invest more rapidly.
Do you consider taxes when managing taxable accounts?
Yes, we are very cognizant of each client's tax situation. For example, if we purchase a stock which is acquired in a stock transaction relatively soon after we initiated a position, we may sell that position for a non-taxable account (if we believe the upside is limited in the near term), but hold the same position for a taxable client until he/she will benefit from a lower capital gains rate.
Unlike a mutual fund, KING is able to sell positions at year-end if unrealized losses or gains are present, in order to offset realized capital gains or losses.
These tax-efficient strategies help our clients generate higher after-tax returns.
How do you determine when to sell a stock?
We evaluate securities for sales as fundamentally as we do for purchase. Our primary reasons for selling a security are: price objectives are met, more attractive alternatives are found, fundamentals change. Technical deterioration versus a broad market index is a secondary condition. Our sell discipline is driven by fundamentals, but a technical deterioration will cause a stock to be considered a candidate for sale.
Why do you own relatively few stocks in a given portfolio?
KING generally holds between 25 to 40 stocks in a given portfolio, depending on the investment objective. By having fewer holdings, our investment staff can obtain a thorough understanding of the fundamentals considered to be critical in uncovering a company's true value (i.e., by not trying to monitor 100 different companies). In addition, studies have shown that broadly diversified funds tend to hold portfolios that closely resemble the market, thus not adding value for the client. By offering a more focused portfolio to investors, we believe that we can add value and offer incremental return for our clients over the long term versus the overall market (i.e., we are a positive alpha generating manager).
In addition, recent studies have concluded that more concentrated portfolios tend to outperform those that are broadly diversified. Clemems Sialm, Assistant Professor of Finance at the Michigan Business School, stated the following about the findings of a 2003 University of Michigan study: "Funds with more concentrated portfolios perform better than funds with more diversified portfolios. This performance seems to be generated by a better stock picking ability by managers."
The outcome of the study indicated that funds with an above-median concentration returned an incremental 2.18% per year before expenses and 0.82% per year after taxes over the 1984 through 1999 period. Lu Zheng, Assistant Professor of Finance at the Michigan Business School, states, "Conventional wisdom suggests that funds should widely diversify their holdings across industries to reduce their portfolio's idiosyncratic risk. However, managers might want to hold concentrated portfolios if they believe that some industries will outperform the overall market or if they have superior information to select profitable stocks in specific industries."