From the May 2011 issue of Investment Advisor • Subscribe!

The Value of Experience

Prospector Capital Appreciation Fund Manager Rich Howard counts four decades of working with the biggest names in the business as the secret to his success

Forty years in the business means Rich Howard can tell a lot about a company from a simple phone call.

“I wouldn’t call it intuition,” he says. “I’d just call it experience.”

Which isn’t to say he doesn’t feel hitting the road and kicking the tires is important in due diligence, it’s just not as important as most people think. Howard, lead manager on the Prospector Capital Appreciation Fund, has a reservoir of knowledge developed over decades that includes portfolio management stints at names like Fidelity and T. Rowe Price, where he ran the famed Capital Appreciation Fund. In 1997, he broke away to help start Guilford, Conn.-based Prospector Partners. Along with two partners, Kevin O’Brien and John Gillespie, the firm started as an institutional asset manager (hedge funds and SMAs with about $3.5 billion under management) before opening that expertise and infrastructure to retail investors.

Today, Prospector Capital Appreciation is a five-star, value-focused fund with $60 million in assets and one of the largest cash buyers of convertible securities (arbitrage players dominate the market), which Howard views as an excellent means to manage risk.

“We like the risk/reward characteristics,” he says. “We have all the advantages of an asset allocation fund without having to give up some of the reward potential.”

What sets the fund apart, Howard explains, is that they’re value managers, in the best sense of the word. By that, he means they try to stay well-diversified to get an appropriate margin of safety behind their investments. But a favorite sub-sector focus, he says, is to ask themselves what they believe the private market would pay for a company.

“Let’s say a piece of an oil field sold for X and a company we’re interested in owned a large piece of that same oil field,” he explains. “We would try to apply that to say ‘this part of the company is worth X’ and if that’s a significant portion of the company’s value, then of course that would be an attractive investment for us.”

In addition to this current market value, Howard and his team mainly look to financial statements. But he notes the market typically focuses on income statements first, cash flow statements second and balance sheets third. He reverses the process and mainly focuses on balance sheets, followed by cash flow and income statements.

“We believe it is easier for the management of public companies to inappropriately manipulate the income statement than the balance sheet,” he says. “Therefore it’s a better document, in terms of the quality of information it gives you. So we often use balance sheet changes as a way to measure companies. We look for a catalyst to improve internal performance, e.g. new management, sale of a division. So this balance sheet focus is something that separates us from other managers.”

Where is he currently finding alpha? Blue chips, believe it or not. They’ve underperformed so dramatically that they’re attractive to a value manager like Howard. He mentions Johnson & Johnson as one he was buying on the day of our interview. Its multiples have almost been cut in half in the last decade, and are trading at a very favorable price.

Prospector Capital AppreciationBut his attraction to blue chip, large-cap stocks at the moment doesn’t mean he’s simply a large-cap value manager; quite the contrary. Howard points to his “go anywhere” mandate as one reason for his success.

“We certainly prefer to buy small-cap stocks because they tend to have the most bang for the buck,” he says. “And they are most likely to have a ‘value capture’ event, like a merger or a takeover. Large-caps are our second choice, but at the moment we are adding more large-caps than small-caps.”

Another area of focus recently has been in the gold mining space. While he doesn’t think of himself as a gold bug, over 10% of the fund is currently in gold mine stocks. The metal itself has risen dramatically in price, but the company stocks have risen less; a classic value play, he says.

“One of the reasons why gold mining stocks have not been terribly good is because there are so many more investment vehicles available today to the individual and the small institution, whether it’s an ETF or just a share in gold itself, like GLDs. Gold mining, on the other hand, has really been left behind relative to history because of that competition. I think that makes it more attractive rather than less attractive.”

Prospector Capital Appreciation FundSo with such a good bead on attractive returns, is he looking to grow the fund, and, specifically, is he using consultants to do so? Surprisingly, no; he doesn’t feel it’s a good use of his time. While he says he’d certainly like the fund to be larger, he’s not prepared to share fees with consulting and marketing organizations.

“We feel we would rather plow that money into our own research efforts to make the fund better,” he says. “We feel that if you do a good job running a fund, the money will eventually come. And not unlike most small fund companies, there’s no negative in our small size because we have so many assets from our private account business.”

It might seem odd that a top fund manager and Harvard Business School grad would choose Gilford, Conn. to manage money, but its convenience is in its centralized proximity to eastern seaboard financial hubs.

“It takes 15 minutes to get to the New Haven Train Station. In one hour and 45 minutes you can be in Manhattan. You can also get to Boston easily. You can get to several airports, so it’s been a wonderful location. We have a very good staff. We have eight excellent senior analysts and they have a very good support staff.”

Which brings us back to the issue of hitting the road and proper due diligence. While Howard likes to say he “gives good phone,” he still makes sure to attend conferences and routinely meet with the managers of the fund’s top holdings. It comes back to his experience. While at Fidelity and T. Rowe, he met with so many managers and so many investment research staff members that he knows what he wants and what to ask for in a relatively short period of time.

“If you’ve been doing this for 40 years like I have, you’ve met an awful lot of people and you’ve talked to a lot of analysts,” he says. “I have a reservoir of knowledge and certainly have benefited very much from working at Fidelity and T. Rowe Price. It is a wonderful advantage having worked at those places.”

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