The investment management process is geared to generating favorable long term returns by investing in companies whose current prices fall significantly short of their intrinsic values. The following account summarises the key elements of this process, which varies slightly from fund to fund (see the respective fund sections for further information) - one common factor being a focus on value creation and a bias towards developing (small and mid-cap) companies.
Our portfolio construction recommendation process is not index cognizant; it is rather based on rigorous bottom-up research with a top-down/macro overlay. Our recommendations reflect our highest conviction picks; the portfolios are concentrated, with each containing around 30-40 stocks, carefully selected to achieve an optimal balance between focus and diversification.
We have built a track record in identifying undervalued companies. We scan across mainstream and non-mainstream/under-researched stocks within the resources universe, where poor research coverage and information often result in greater pricing inefficiencies. Our rigorous research process and industry-wide network enable us to better understand many of these lesser researched resources companies and, over time, raise their profile in the market. In short, we aim to exploit the market’s inadequate understanding of small to mid-sized resources companies.
Generating ideas; narrowing down the field – getting to the sharp end
The universe in which the funds operate is global and extensive. Several methods are used to narrow this field down to a manageable size from which the top ideas are distilled.
Ideas are generated through a variety of channels: monitoring industry news feeds, in-house searches, interaction with analysts, company executives and industry experts. These ideas are subject to initial quantitative screening to achieve consistency with the top-down views of the team and/or the specific requirements of the fund. Companies passing these preliminary screens are then subjected to rigorous bottom-up analysis using detailed mining and financial models, management interviews, and discussions with industry experts and analysts. A ranking system flags securities as potential new investment ideas or points to existing holdings which have become overvalued.
The team operates in an environment where all new ideas are openly voiced and discussed. Stock evaluation is undertaken by the team, but the final recommendation to buy or sell shares lies with the responsible manager (while the ultimate decision to implement or not lies with the manager).
Portfolio construction – putting it all together
The portfolio construction recommendation process combines our top-down and bottom-up analyses. Liquidity management is a key component of the portfolio construction process. No positions are taken in unlisted entities, and stocks are required to meet liquidity parameters.
The Precious Metals Fund seeks to invest in precious metal companies which are expected to show growth even in a static gold price environment. Accordingly, the bias is towards emerging producers and companies equipped to grow their reserve and resource base well into the future. Exposure to the exploration sector is limited, with a preference for companies in, or close to, production.
The Global Resources Fund focuses on the most compelling resources sub-sectors and seeks to exploit the greatest opportunities they offer.
We do not recommend construction of the portfolios on the basis of benchmarking. We are primarily driven by two factors: the merits and intrinsic value of the stocks meeting our selection criteria, and the top-down view which has been formulated by the team. Factors taken into account in evaluating stocks include quality of assets, management, profitability (ability to reinvest earnings above WACC), cost efficiency and competitiveness, liquidity and valuation.
We are domicile cognisant and recommend investing in countries where we do not have concerns about political or economic conditions - which can mean anything from potential for nationalisation to unfavourable taxation changes.
In making recommendations to add or switch stocks in the portfolio, the impact of that stock on the fund is assessed. This entails looking at the exposure of the fund to specific sectors (or segments), countries, regions and development stage. The stock’s impact on the fund’s overall liquidity and risk profile (operational, financial and market related) is also considered, using (where appropriate) simulation models to measure any changes.
Decision discipline – buy, sell or hold?
‘Buy’ recommendations follow the process outlined above. ‘Sell’ recommendations result from a stock reaching or approaching our target level and/or dropping in the ranking table (which also considers relative value). A decline in the ranking can also result from a revision to the valuation arising from a change in the expected return or in the company’s risk profile.
Risk management – looking after the money
As UCITS V entities, the funds comply with the regulations on position concentration, leverage and investment type. Further details may be found in the prospectus of the funds, but broadly, the UCITS V regulations are directly comparable with those governing public unit trusts/mutual funds operations in most developed markets, and are designed to protect the interests of investors. Daily reports covering these aspects are produced by the funds' administrator and are combined with our internally generated reports to aid risk management.
Liquidity risk is monitored and managed in three ways: by ensuring that portfolios can be liquidated quickly if necessary; by limiting exposure to illiquid stocks and not investing in unlisted ones; and by ensuring that any withdrawal request can be met without disrupting the structure of the portfolio.
Although currency exposure is monitored, we do not recommend the use of hedging to manage foreign exchange risk, since many of the investments benefit from a high level of inherent currency hedge due to their revenues being US$ denominated; declines in the value of the US$ often result in higher commodity prices.
Investment Management Approach – the team at work
Craton Capital subscribes to a team-based investment management approach, with the investment process not being reliant on any single individual. Every team member holds responsibilities which reflect his or her core competencies and skills. Analysts are responsible for bottom up company research, while the responsibility for investment recommendations lies with the respective fund managers. Both lead and co-portfolio managers have significant investment experience and expertise in bottom-up company analysis.
The portfolio recommendation function is not strictly separated from the research function. The team works in a transparent environment with portfolio recommendation and research functions working together in a symbiotic relationship. This approach generates healthy debate and the free flow of ideas from which value opportunities can be identified and exploited.