CastlePoint’s proprietary investment model, independent-minded portfolio management team, and partnership culture of investing alongside our clients, are each important and differentiating aspects of our proven and historically successful approach to investing. CastlePoint began offering its flagship large cap equity product in 2005.
DONALD L. TUTTLE, CFA
Senior Advisor
CastlePoint’s approach to equity investing is based on the fundamental belief that markets are inefficient and mispriced securities can be systematically identified and opportunistically acquired using a time-tested, rigorous, and highly disciplined investment process. The firm uses the following broad tactics – an outgrowth of the investment philosophy – in the pursuit of this goal.
Limit downside risk by acquiring securities trading at a 40% or greater discount to the estimated intrinsic value of the company. Building a portfolio using this approach frequently requires one to be indifferent to the market consensus (contrarian) and highly opportunistic.
The investment philosophy that serves as the cornerstone of CastlePoint’s investment strategy is based on thoroughly researched and well-established financial theory.
Market participants tend to “overreact” to unexpected and dramatic news events.The natural tendency for many is to give more weight to recent information than prior data, regardless of the data’s significance. Cognitive errors and emotion-driven mistakes of this nature create exceptional investment opportunities for patient, long-term investors.
Investment return volatility, while employing CastlePoint’s disciplined risk controls, is historically comparable to or less than the relevant indices. Further, evidence suggests the benefit of diversification diminishes rapidly beyond 30 portfolio holdings. Therefore, CastlePoint’s concentrated investment strategy focuses its efforts exclusively on fewer securities believed to hold the greatest potential for price appreciation without increased risk.
There’s little evidence anyone can consistently make accurate financial forecasts. And if possible, the forecast would be of little value if it’s consistent with consensus expectations as this is accounted for in the current price. Forecasts must be accurate and differ from the consensus to be valuable. Consequently, CastlePoint relies heavily on rigorous analysis of historical financial statements when calculating our proprietary estimate of a company’s intrinsic value; we rely on neither interally generated nor Wall Street published analyst projections.
As such, CastlePoint limits portfolio holdings to a more manageable level of about 30 securities. This allows us to conduct thorough due diligence and scrutinize each investment while also offering sufficient portfolio diversification.
As shown in the chart below, the largest decrease in portfolio risk occurs where the lines are steepest. Once this inflection point is passed and the curves flatten, the incremental benefit of adding more stocks to the portfolio increase, but at a significantly declining rate.
Owning additional securities in a portfolio solely for the sake of diversification is short-sighted, at best. Furthermore, making purchases of this nature typically increases the risk of a poor investment decision thereby mitigating, at least partially, the benefits of owning a portfolio of truly exceptional companies. Failing to adhere to a proven investment process – and buying securities that do not withstand the scrutiny of that process – is an almost certain recipe for mediocre investment returns at best and more likely a significant loss of capital.
Additionally, there are numerous studies from the academic community and practitioner’s alike that refute the notion one must own 75 securities (or the mutual fund average of 172 holdings) to be adequately diversified
Perhaps Warren Buffett explained it best: “Wide diversification is only required when investors do not understand what they are doing.”
Through extensive and time-intensive investment research and analysis combined with CastlePoint’s intense focus on security selection results in a portfolio of about 30 stocks.
A fund’s investment returns cannot surpass the benchmark if it highly resembles or owns a vast majority of the securities in the index. As such, independent research and analysis is at the core of each investment decision at CastlePoint: thoroughly understanding the reasons for buying and continuing to own a stock provides the insight necessary for understanding when to sell it.
The presence or absence of a company presence in an index is irrelevant in CastlePoint’s decision-making process, which general results in portfolios with a tracking error about 3% to 5%
CastlePoint’s investment philosophy is based on investors’ tendency to commit cognitive such as Representativeness, Availability, and Anchoring as defined below. These mistakes cause the market price of a company to fluctuate far more widely than its underlying fundamentals, which tend to change gradually over time.
Behavioral finance is the study of how the psychology of investors’ behavior and the subsequent impact on the market. In addition to the overreaction hypothesis, it includes how people make judgments under uncertainty. For example:
CastlePoint successfully employs the same time-tested investment approach used for over two decades creating portfolio that outperform the index with less than market risk with relatively high consistency. Over the years after extensive empirical research and analysis, several elements of the investment model used to screen prospective additions were meticulously reevaluated and fine-tuned to insure continued excellent results. Nevertheless. the core investment approach and philosophy remain unchanged. The firm manages investment portfolios from two satellite offices, one in the San Francisco Bay Area and the other in Atlanta, GA. CastlePoint, with fewer than $10 million in assets, is an independent advisor currently exempt from SEC and State regulatory reporting requirements