From the March 2014 issue of Investment Advisor • Subscribe!

February 24, 2014

Growth and Value

Whether it's mature firms or growing companies, Charlie Smith and Fort Pitt know what they’re looking for—and where to find them

Photography by Richard Kelly Photography by Richard Kelly

Fort Pitt Capital Group started life as the money management division of a brokerage firm in Pittsburgh. The founding partners, including Charlie Smith, chief investment officer and manager of the firm's Total Return Fund (FPCGX), broke the group off to form Fort Pitt Capital in 1995, launching the fund a few years later.

“The reason we started the fund was because we wanted to be able to provide a vehicle for our clients who didn't have our individual account minimum,” Smith told Investment Advisor. “We started it in 2001, and at that point our minimum was $250,000. We wanted to have a way for people who had small IRAs and college funding accounts, that sort of stuff, to be able to invest in our approach to the market.”

The fund's minimum investment is $2,500, and as of Jan. 31, it had nearly $50 million in assets.

“The objectives are the same as our other separate accounts, which are to maximize total return after taxes over time,” Smith said. “We’ll take returns wherever we can get it, whether it be income or appreciation. We will own businesses that are growth businesses in which we would rather management hold on to the capital and not pay dividends, but we also invest in more mature businesses where there is cash being thrown off and we’re happy to take a dividend as part of our return. We purposely wrote a very broad prospectus so we’d have the ability to own both growing companies and companies that are a little bit more mature.”

So what kind of companies is Smith looking for? Telecom, industrials and aerospace are big parts of the fund's portfolio. In fact, Honeywell and Boeing are the two largest holdings in the fund.

Smith is steering clear of consumer cyclical sectors like housing, autos and big-ticket consumer durables, though. “Just like everyone else, we’re following this steady deleveraging on the part of the consumer. We think it's pretty tough for most households to be able to afford big-ticket items without free-flowing credit, and credit is certainly not free-flowing yet.”

Although energy hasn't been a big play for the fund in the past, that's starting to change, Smith said.

“We believe in the revolution we’re seeing in natural gas production, so we’re starting to participate on that side of the energy realm, mostly in gas transportation and equipment for natural gas production. We believe oil is selling at too high a premium. The arbitrage that exists between the energy value in natural gas and oil will shrink, and oil prices will come down and natural gas prices will begin to move up.”

Smith noted that there are still some unknown variables when investing in natural gas. “One of the questions we haven't been able to answer yet is whether natural gas will be used here domestically in petrochemical plants or for producing electricity through replacement of coal-fired generation,” he said. “We’re not sure whether that's going to be the key trend over the next few years or if it's simply going to be exported. Not only is there an arbitrage between natural gas and oil, there's a geographic arbitrage between the U.S. natural gas markets and foreign markets.”

Although the S&P 500 performed better than expected in 2013, Smith said he expects the big issue in 2014 will be separating genuine improvements from Fed action. “We came in to 2013 with a target around 1,500 to 1,550, and that assumed earnings [per share] of about $105 on the S&P and maybe a 15 multiple,” he said. “Turned out that earnings came in a little better than we thought; it looks like S&P earnings for 2013 will come in around $109. The big factor was multiples expansion. We saw the multiple on the S&P expand by 25% last year, mostly driven by Fed accommodation. The biggest task we have in 2014 is figuring out how much is real and how much is driven by Fed inflationary efforts: teasing out what is real in the economy and what segments of the economy are actually growing due to real activity—people doing real things and selling real things—rather than simply the inflation that's being driven by Fed money creation.”

Smith predicted the S&P will show the same low level of growth in 2014 as it did last year, with earnings per share rising from the $109 range “maybe up to $114. We don't expect multiple expansion this year because the Fed has basically signaled they’re not going to continue shoveling money into the system at the rate they have been. We’re expecting multiples to be flat to maybe even slightly down, and a flat year for the market, maybe up 3% to 4% at the maximum, maybe a target of somewhere between 1,850 and 1,900.”

The real “wild card” for the markets this year will be China, though. “We’ve seen crazy levels of debt growth in China over the last five years. They’ve expanded their financial system the equivalent of the entire U.S. banking system over the past five years,” Smith said. Unfortunately, a lot of the money that was created was “not for profit-making purposes; it was mostly created to generate statistics that you could show to the central party and make your region look good.”

Consequently, “the Chinese central bank has a choice to make as to whether they’re going to continue to flood the system with liquidity and keep this bad credit from failing, or finally a day of reckoning will come and they’re going to have to admit that they’ve got some problems in their system. We think that's probably going to happen this year.”

Whatever happens in China, investors here have to be prepared. “China's still the biggest auto market in the world. They’re the biggest steel manufacturer in the world, the biggest importer of gold, the biggest importer of oil, biggest producer of coal. When fundamentals deteriorate there, it's going to be something we need to pay attention to here,” Smith stressed.

It's not all bad news, though. “The counter to that, and it's something that's not really talked about very much in the press yet, is the significant improvement in the U.S. fiscal situation. Fiscal year 2012 we had a $1.1 trillion deficit. Fiscal ‘13 it sank to about $660 billion. If you prorate what we’ve seen in the first few months of the fiscal year through September, it looks like the deficit could come in under $400 billion, which would be about 2% of GDP, which is a pretty normal level.”

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Correction: The print edition of this article misstated Fort Pitt's initial minimum investment as $250 million. The correct amount is $250,000. This article has been corrected to reflect that change.

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