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.