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Screening for Reduced Volatility

November 7, 2011

As the European debt crisis continues to batter investor confidence and portfolios, French President Nicholas Sarkozy and German Chancellor Andrea Merkel had hoped to have a finalized Eurozone bailout package in place at the start of the Cannes G20 summit in November. The announced proposal derailed when the Greek government called for a referendum, now cancelled, not to approve or reject the plan, but to determine Greece’s future status in the EU and 17-nation Eurozone. While efforts at crafting effective policy continue to misfire, a guarantee that private sector investors will not face losses on their debt investments in troubled banks could boost investor confidence and stem the sell-now-and-ask-questions-later sentiment.       

Small-cap stocks have been particularly pummeled by European market volatility. Though generally considered more susceptible to unstable market fluctuations than large caps, Ed Lugo, Portfolio Manager in the small to mid-cap international investing space, says that adhering to a highly disciplined stock-picking strategy has helped keep volatility in check recently and has even revealed some opportunities.  From his October 13 remarks:  

“We focus on companies that trade at attractive prices and are well positioned in the face of continuing uncertainty. The European debt crisis certainly adds a lot of volatility to the international small-cap marketplace. On the upside, this permits us to identify which companies have strong fundamentals that typically shield them from market instability.”    

Acquiring only companies demonstrating strong competitive advantages, solid balance sheets, and good cash flows—in other words, relatively stable companies—is easier said than done, particularly amid a continuous blitz of bad news and negative market reaction. Few small and mid-cap companies in the international marketplace meetLugo’s investment criteria. Those that do are usually better positioned to weather the oscillations endemic to a bumpy economy and have proven to be a buffer to recent volatility: 

“Potential for good performance can be traced directly to great growth companies. Those that do not meet our criteria simply are not considered. This can result in a highly concentrated portfolio, though one that aims to be less volatile based on the stable nature of the companies we buy.”    

Spain, Italy and Ireland are current examples of countries Lugo cites as sources of attractive small and mid-cap growth potential because of the stock price dislocation—a disconnect between what fundamentals suggest a stock price should be versus what the markets suggest it should be—those markets have experienced: 

“We are finding small and mid-cap growth opportunities with good potential the old fashioned way: by running screens and visiting management teams. That’s how we get our ideas and we look everywhere to find high quality companies trading at a good price. These could be great growth companies that we follow for years.” 

Until next time, Beyond Bulls & Bears leaves you with another gem from the late Sir John Templeton: 

“Achieving a good record is a lot harder than most people think.”

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