Our Beliefs

The Bellmont Consolidated Equities Portfolio is comprised of two separate, but complementary components - the 'Core' and the 'Satellite', with approximately 50% of the portfolio allocated to each.

Core (top 100 universe)

The 'Core' component of the portfolio employs an extensively researched, three step systematic process to identify the highest quality value stocks on the market, from a potential universe of the 100 largest ASX listed companies. This portion of the portfolio draws on decades of academic research into the 'factors' that drive portfolio performance, with each step of the process based on highly regarded peer-reviewed academic papers, the findings of which have been shown to be robust across markets, and through subsequent 'out of sample' performance since their publication. We then conduct our own testing to ensure the persistence of the broad concepts, their relevance in the Australian market, and the ability to profitably implement them in a relatively concentrated portfolio. The three steps in our systematic process involve examining:

1. Accruals - The 'accrual anomaly' was first discovered by University of Michigan Professor Richard Sloan, who identified that investors focus too heavily on reported profits, and don't devote sufficient attention to cash flows. While there can be good reasons why a company's cash flows may differ from reported profit in any one year, persistent differentials may be cause for concern.

We scan the market for the long run differential between reported profits and cashflows, and remove the poorest performing companies on this metric from our investment universe.

2. Value - The 'value effect' is perhaps the most extensively researched anomaly in equity markets, with numerous researchers over more than 40 years having found that stocks that trade on low multiples of their fundamental metrics (eg earnings, cashflow or book value) tend to outperform those that trade at high multiples of the same, and the market as a whole.

Our systematic investment process ranks the investable universe on earnings based valuation metrics (our research suggests that book value based measures are no longer as relevant as they once were), and removes those in the highest quintiles, leaving us only with the 'value' portion of the universe.

3. Quality - It’s intuitive that with value as a constant, higher quality companies (in terms of profitability, earnings growth and stability, balance sheet strength etc) are likely to generate higher future investment returns. Studies by numerous researchers, including Novy Marx (2013) and Asness (2013) have shown that not only is quality predictive of future returns, but that measures of quality are persistent over time.

Our investment process assesses all the remaining companies in our universe (ie those that have passed through the Accruals and Value filters) on multiple quality metrics, the results of which are aggregated to give an overall quality score. The universe is then sorted based on this aggregate quality score, and we invest in the top 15 companies, using an equal weight methodology.

This three step process results in the selection of 15 high quality value stocks, with an equal weighting (of approximately 3.3%) allocated to each on the rebalance date. The equal weight methodology leads to improved sector diversification relative to a market capitalisation weighting process, as used in the ASX200, where extreme sector concentration is often observed. This side of the portfolio is rebalanced annually to ensure the optimum mix of quality and value is maintained, while taking advantage of the tax benefits of concessional CGT.

Satellite (top 300 universe)

The 'Satellite' component of our portfolio is drawn from the 300 largest companies on the ASX, and is a true Buffett style value investing portfolio, more akin to buying businesses than trading stocks. The strategy seeks to identify and invest in 8 to 12 outstanding businesses, run by quality, founder-led management teams with significant skin in the game, where we can be virtually certain that Earnings Per Share (EPS) will be materially higher in 5 and 10 years time. We seek to purchase such companies when they are trading at a reasonable price relative to their future prospects, and then aim to hold them for the long term.

The key elements of our investment process are: Quality & Value

Element 1 - Quality

Numerous studies, including by Novy Marx (2013) and Asness (2013) have shown that companies that have exhibited characteristics in the past that may be considered indicative of being high quality (highly profitable, growing, stable and conservatively financed) are far more likely to exhibit those characteristics in the future, than companies that have not. In line with our strategy of 'buying businesses, not trading stocks', we seek to only invest in such quality businesses, living by Buffett's adage that "If you aren't willing to own a stock for 10 years, don't even think about owning it for 10 minutes".

Having said that, no one ever tells you they are trying to buy low quality businesses! The word quality is subjective in the industry, and we have placed an enormous amount of time in building proprietary infrastructure and processes that allows us to identify what quality really is.

We start with quantitative filters. The first part of our process in identifying quality is actually just ruling out poor performing businesses or higher risk businesses with our filters. These are not complex, however we don’t want to be wasting time researching companies that are over leveraged or have inconsistent or poor profitability. The hurdles include: 

• Minimum Return on Capital requirements

• History of earnings growth

• Stability of earnings growth (the less stable earnings are historically, the less predictable they are to forecast!)

• Appropriate levels of leverage

The second stage of narrowing in on what we define as quality involves our proprietary Quality Assessment Score (QAS). There are two components to this score (quantitative and qualitative) accounting for 50% of the score each. The final score is adjusted to 100, enabling us to rank the companies with as little human bias as possible as to whether any particular business is higher quality than another. This is one of the most crucial components to our process, ensuring that no human bias or price multiple determines what we consider quality. The components we consider in our QAS can be seen below

Quantitative Component (50%)

• Return on Capital: We score on stability, trajectory and the absolute level.

• Sales / Share: We score on growth and stability. Consistent and stable growth gives insights into the competitive nature of the product .

• Earnings / Share: We score on growth and stability. This is an extension of sales / share and how well run the business is.

• Margins: We score on stability, trajectory and absolute level. Lower quality businesses tend to have less stable and or falling margins.

• Earnings Quality Factors: We have our own proprietary models which look for accounting anomalies and irregularities.

• Balance Sheet Quality Factors: We assign a higher score for companies with net cash given the optionality and lower risk. We consider liquidity and other debt metrics in our score.

Whilst the quantitative component is a look into the business’s historical results, the qualitative components are the factors that we believe could enable these strong results to be sustainable in the future. You will see above that two of the five categories are a score on management.

Founder Led Management

Perhaps the most important factor in determining the success or otherwise of a business is the capability, and alignment of the management team. Yet assessing the capability of management, and creating remuneration structures that incentivise long term value creation in the face of often short term turnover of management, is to say the least, a challenge.

However, it's reasonable to assume that the capabilities of the founder of a business, who has grown that business to the point where it can be listed on the ASX, and then subsequently generated the sorts of results since listing that enable it to pass our quantitative screens (ie among the top performing 1% to 2% of all listed companies) - must be considered exceptional. Further, with most founders having the vast majority of their wealth tied up in the business, it's safe to say that their interests are fairly well aligned with ours, as shareholders. Indeed, an emerging body of research by authors such as Fahlenbrach (2009) has found that founder-led companies are (unsurprisingly) far more likely to engage in strategies to maximise long term value creation, and that these types of companies substantially outperform the market as a whole.

By investing in companies that are led by their founders (or where the founder remains actively involved in the business through board or indirect representation) we are able to ensure that management of the companies in our portfolio are highly capable, focused on the long term, and aligned with our interests as long term shareholders.

Element 2 - Value

Once we have applied such a rigorous review of the companies which pass our filters, we have provided ourselves with an unbiased measure of quality. This gives us a framework by which we can then go and assess value. Value is often misconstrued in the market as a “lower PE company” compared to “growth companies”. We view this as an extremely poor measure of value. We are looking for businesses that display a fair to attractive price relative to their prospects, which is often judged by their history and our QAS, coupled with our in-house valuation process. We consider context as a crucial element of the valuation process, and given the large amount of noise and data on offer in the market, we simplify this by automating our infrastructure for speed and efficiency and then centralising our data for context. This enables us to judge stocks according to their price relative to their quality, whilst also considering risks to our investment thesis.

Of course, such high quality, founder-led businesses are often popular with others in the market as well. However, no business is immune to short term setbacks, and we look for opportunities to buy these high quality, founder-led businesses when they are temporarily out of favour with the market, for reasons that we believe to be cyclical not structural.

With the short investment horizon of most in the market, even exceptionally high quality companies can be sold down aggressively if they face significant challenges in the short term (1 to 2 years). In many instances, this can lead to the company's shares trading at a level that significantly undervalues their long term (5 years +) prospects. In such an instance, we will look to take advantage of the market's negativity, and buy shares while they are out of favour with the rest of the market, placing our faith in the company's capable, aligned, founder-led management team to deal with their challenges, and come out stronger on the other side.

Investment Process Diagram