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business newsSmall Caps For Your Portfolio
By
Josh Lipton Nov 05, 2010 4:00 pm
Husam Nazer talks about his investment process and stock picks.
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“I have to gather the current facts and not make any heroic guesses about what the future will look like,” Nazer says. “I need to come up with the worst, base and best case cash flow assumptions as best as I know how with my research process.”
The 39-year-old Nazer took over the TCW Small Cap Growth Fund (TGSCX) in early 2005 and has since proven a capable captain over the long haul. Through November 4, the fund’s 5-year annualized return of 9.81% handily beats its benchmark, the Russell 2000 Growth index, and bests its Morningstar rivals by 6.59 percentage points, landing in the top 1% of its “Small Growth” category.
TGSCX, with $800 million in assets, has an expense ratio of 1.20%, and requires a minimum investment of $2,000.
Recently, we caught up with Nazer at his Los Angeles office to talk about his strategy and top picks. For more, please read on.
Minyanville: How do you find your stock picks?
Nazer: At the end of the day, we believe that stock prices follow after-tax free cash flows. So we spend as much time as we can figuring out what those cash flows will be, which we do using a three-step research process: talking to as many experts as we can; interviewing the management teams; and then taking all that information and putting it into financial models.
Once we develop cash flow estimates then we have what we call the worst case, base case, and best case cash flow scenarios. From that, we can develop price targets and compare them to where the stocks are trading at today. If the risk/reward is favorable then we purchase the name.
Minyanville: You took over the fund five years ago. How did you change its investment approach, if at all?
Nazer: This used to the typical 1990-style growth portfolio i.e. it was sector concentrated and had lots of names. The managers concentrated the portfolio in those sectors of the economy that they thought were growing the fastest. Our philosophy is sector diversification and name concentration. We took the number of names from 120 to about 60.
Minyanville: Over the past 5 years, you have bested 99% of your Morningstar rivals. What explains that outperformance?
Nazer: You need to separate emotion from stock picking. Our buy and sell discipline keeps us honest. Let’s say the stock goes to our “worst case” scenario. Then we have to admit that we made a mistake and move on. As it hits our “base case” scenario then we tend to trim. As it hits our “best case” scenario then we sell the name outright.
Minyanville: You’re having a tougher time this past year. What’s the reason for the struggle?
Nazer: We have made some mistakes particularly in Healthcare. That’s been a rough sector in terms of the regulatory environment, the FDA and Obamacare. But that’s no excuse. I don’t like to make excuses with bad stock picks.
Minyanville: With the caveat that you’re a bottom-up stock picker, what is your macroeconomic outlook?
Nazer: We do incorporate macroeconomic issues in our “worst case” scenario. For instance, if the cash flows are highly sensitive to inflationary pressures i.e. increasing interest rates then we will incorporate that into the models.
Minyanville: You think we’re in for a slow recovery?
Nazer: Yes, I’m looking at employment and housing stabilization and those two just aren’t panning out as fast as people expected. This will be a slow recovery. I’m also very concerned about this quantitative easing because it is extremely inflationary. There are reasons why commodity prices are now where they are. The market is predicting lots of inflation in the future and that is worrisome.
Minyanville: In terms of sector diversification, you clearly do see a lot to like in Healthcare with top ten positions in Human Genome Sciences (HGSI), Volcano (VOLC), and Masimo (MASI). Why the enthusiasm?
Nazer: We look for companies that have clear differentiated products. In Healthcare, there is a lot of innovation in that sector satisfying that criteria. The issue has been the FDA, which has been very stringent. For example, we own a company called DexCom (DXCM), which is having a rough time because they make a glucose monitoring device that they wanted to integrate with a pump. We thought this integrated device would happen in 2011. But now the FDA is requesting more trials.
No positions in stocks mentioned.
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