Manager Monday: Stockbridge Partners
Stockbridge Partners has made a record investing in undervalued companies, and their performance has been something few have achieved.
Stockbridge Partners is unique in its own way. It’s a subsidiary of Berkshire Partners, which has been a leader in the Private Equity space since 1984. Back in 2007, when Berkshire Partners decided to open up a Hedge Fund, it seemed to be a wise decision. They entered the business with an aim to maximize their clients’ returns by investing in undervalued companies. The experience that Robert J. Small and his team bring is very core to this strategy. Small has been investing in Private Equity with Berkshire Partners since 1992, and the majority of the team has had experience working with Bain, Mckinsey and Co, and Goldman Sachs, indicating they understand the fundamentals of the business. Now that we know more about the team’s background and that their expertise is congruent with the philosophy of Stockbridge, let’s see what the data shows.
A Note on Our Data
As with all our Manager Mondays, everything mentioned in this post is sourced exclusively from public data, including the manager’s profile, simulated performance and all other analysis. The data used here omits the short side, non-equity securities, many non-US securities and all non-public information such as actual fund performance. Regardless, this data can be incredibly insightful if viewed with the right prism.
Since the beginning of our data, Stockbridge’s simulated returns have outperformed S&P 500 TR and MSCI World NR by 18.9% and 43.7% respectively.
Stockbridge is primarily driven by investments in undervalued companies on the long side. This suggests a great deal of accuracy surrounding their public data. Partly due to strong performance, they have increased their Market Value from $178 Million to $1.7 Billion, peaking at a little over 2 Billion in July, 2015.
From our research on several thousand managers, we’ve discovered that it’s often difficult to produce this level of return when a manager significantly increases their value. As mentioned in our previous research posts, there are three levers that a manager can pull to compensate an increase in Market Value: 1) Investing in new ideas, 2) Do nothing and let the liquidity slide, 3) Move up the Market Cap spectrum.
While Stockbridge did not budge on first two, they did go significantly up the Market Cap spectrum over time, though that has declined a bit recently.
We can validate this increase by looking at the Market Cap exposures. It’s evident that Stockbridge has increased Large Cap exposure at the cost of Small-Cap and Mid-Cap buckets.
Market Cap Analysis
If this trend were to continue, it is likely that they might continue their move up the market cap spectrum. In order to understand what that means for a manager, we ran a market-cap attribution analysis to isolate skill from market forces.
All buckets have generated positive security selection Alpha except Small Cap names. An important thing to note here is that of the total 10,731 bps of Portfolio Contribution, roughly 80% has been generated from investing in the Market and choosing the right Market Cap buckets, whereas Security Selection Alpha accounted for remaining 20%. Furthermore, we can see that while Large and Mega have been positive contributors to Alpha, the largest Alpha (selection) contributor has been the Mid Caps. They’ve decreased Mid Cap allocation since 2010, but kept it stable since 2014.
For managers like Stockbridge, it is crucial to understand the returns from their high conviction names. Especially with Stockbridge, as they claim to be the experts of recognizing true valuation of businesses and hence make mostly conviction bets. All positions in the portfolio are greater than 3.5% as of March, 2016.
Looking at returns by position sizing bucket, we see a clear relationship between performance and conviction. This bar chart shows that the more confident they are in a name, the higher the likelihood of outsized returns.
Apart from demonstrating great position skill, we see that Stockbridge has the ability to allocate capital and generate outsized returns from their winning names.
Looking at attribution using the Novus lens, one key take-away from the below chart is the high Win/Loss ratio of 12.7x (average contribution by a winner / average contribution by a loser). This means that although they posted a Batting Average (% of Securities that outperformed their sector level benchmarks) of 51.3%, they were able to generate a positive contribution of 10,731 bps over the total time-frame of analysis.
We know that Stockbridge prides itself in taking value-oriented and fundamental approach towards investing, but many of the names represent high levels of crowding. As we’ve previously mentioned, crowdedness is a function of # HF Owners and HF % ADV. We see that the names they’re invested in are not only held by several other Hedge Funds, but also represent a high percentage of ADV. They have an overall crowdedness of 0.9, which is greater than the average 0.78. Below are the top 5 names with highest crowdedness ratios, which need to be taken into account from a risk management perspective.
Stockbridge has dramatically increased its market value over the last five years, followed by an increase in the market cap spectrum, which seems to have worked well for them. While recent market turmoil caught them off-guard, as it did many others, they seem to be recovering when looking at their recent months’ performance. Stockbridge’s record speaks for itself. While past performance is not indicative of future performance, past skill sets can be. As we have shown in this Manager Monday, Stockbridge’s team has demonstrated an incredible amount of skill in security selection and position sizing. These two skills will be the determining factors in their future outperformance.
One of the most hotly debated questions in asset management is whether smaller managers outperform their larger counterparts. There have been many studies to test the theory that significant AUM growth undermines performance and we have published on the topic and collated a number of the studies as well. Although there is some dissension, most studies we found determined this theory to be true.
The reasons seem intuitive. Smaller managers are be more nimble and can opportunistically take advantage of developing trends in the markets as well as invest in smaller capitalization securities that are off limits to their larger peers. They might also be hungrier for performance gains, motivated by the performance fee more so than the management fee, which is small at lower asset levels.
Given this reasoning along with the findings of industry studies, some of our institutional clients continue to show an appetite for skilled managers running smaller amounts of assets. To help them with their search, we set out to create a “best of” list focusing on smaller managers. We ranked managers on consistency with which they demonstrate these skills. For each year the managers landed in the top quartile for each skill they were assigned a point. What we were left with were the 18 best performing emerging funds from 2010-2015.
Download our latest report to discover our list of these high-performing funds.