Portfolio management is as much about picking the right stocks as it is about realising early when we've lost conviction.
Today we're talking about valuation and sell discipline. On the valuation side, we have a very structured and consistent framework which consists of three different valuation methodologies. First one is DCF (discounted cash flow), the second one is economic value-add and the third one is target multiple, which we apply on each company five years out to ensure again that we are long-term in our approach.
On the discounted cash flow side, we have a very structured, consistent methodology. We use an 8% cost of equity across all companies that we look at. This is to ensure that we are conservative when assessing upside to fair value. This enables us to make sure that the businesses that we look at have got upsides in every environment and don't just rely on upside to fair value purely based on low rates as we have at the moment.
For every company, we run three different scenarios. We have a base case scenario. But we also run the bull case and the bear case to assess upside and downside risk, with probability adjusters to get a good sense of skewed to the upside or the downside when you look at any company.
We also have a 'Blue Sky' and a 'Dark Sky' scenario. This enables us to really stretch our assessments to the limit. On the Dark Sky scenario, which has helped us greatly during this unusual pandemic crisis, we were able to default on the Dark Sky scenario to get a sense of where market levels are compared to that very bleak scenario that we apply across all companies.
The focus is there to ensure that all stocks in the portfolio are high conviction.
We have a very structured sell discipline. If a stock reaches price target and we cannot get more upside, this is pushing us to take the decision to exit the position. Equally, if a stock is getting close to price target and we have on the bench an attractive company, with stronger upside, a more supportive risk profile and a supportive risk impact on the portfolio...we will look at making that switch at that point.
And thirdly, we also focus on conviction across all holdings that we cover. And on that basis we have a proprietary way of assessing our conviction across all holdings. Ultimately we run conviction portfolios. And the focus is therefore to ensure that all stocks in a portfolio are high conviction. By the same token, it means that we have to assess very carefully whenever we are losing conviction in a stock. If we lose conviction in a stock, that stock goes into the urgent research work needed to understand why have we lost conviction...what can we do to rebuild conviction in that name.
And at the end of that process, if we cannot rebuild conviction in a name, we take action and sell out of that holding. Because portfolio management is as much about picking the right stocks as it is about realising early when we've lost conviction in a name and moving on to protect our clients assets from further negative performance.
All in all, this highlights a very structured process we have at the valuation and at the sell discipline level as well as testing our conviction at all times on all the holdings. High-conviction investing is part of that.
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