The Elevate Capital Low-volatility Strategy
Objective: The Elevate Capital Low-Volatility Strategy is designed to generate long-term appreciation.
Goal: The goal of this strategy is to beat/outperform the benchmark (S&P 500) when it is down and capture at least half of the upside return when the benchmark is up, thus achieving lower volatility than the benchmark over the course of a full market cycle.
A full market cycle is measured either from the peak of one bull (up) market to the peak of the next bull market after experiencing a bear (down) market in between. Alternatively, a full market cycle could be measured from the low of one bear market to the low of the next bear market after experiencing a bull market in between. We consider and evaluate our performance using both measurements.
We do not endeavor to make judgements of our performance over any other “man-made” timeframes such as years, year-to-date, quarters, or months.
In pursuit of our objective and goal, we may utilize fundamental analysis, technical analysis, active trading, options, short sales, stocks, bonds, exchange traded funds (ETFs) including inverse and leveraged versions, and rules-based exit/entry signals.
We primarily seek to buy the individual common stock of companies that we can confidently hold forever when they trade at very low prices and multiples relative to their own history, or when they trade below what we fundamentally determine to be the company’s intrinsic value. “Forever” is not to be taken literally. While we expect that we will be able to hold them for a very long time, perhaps multiple generations, even the best businesses with the longest track records have seen experienced periods where we would not have wanted to buy or hold them.
Stocks that we believe that we can hold forever generally have two distinct characteristics. First, they have a durable competitive advantage such as dominant brands, products, networks, or other assets that would be difficult and cost prohibitive, if not impossible, to re-create. Second, they do not require substantial ongoing investment in new property, factories and/or equipment to sustain their competitive advantage(s) which leads to consistently high levels of free cash flow. We often refer to these stocks as being “capital efficient,” as opposed to capital intensive. Furthermore, we prefer to see much, if not all the free cash flow generated by these companies returned to shareholders in the form of dividends and share repurchases.
The Low-Volatility Strategy differs from the flagship Elevate Capital Strategy in that we will also seek to limit the volatility of the overall portfolio in three ways. We will:
Generally select stocks with lower historical volatility.
When selecting higher volatility stocks we will:
Use tighter stops than the historical volatility of those stocks would normally indicate, and/or
Take smaller position sizes.
A durable competitive advantage is something that Warren Buffet has referred to as a wide and long-lasting economic “moat”. There are at least five sources of that economic moat.
Intangible assets like brands, patents, and licenses create a moat. An enduring brand like Coca-Cola, or McDonald’s, is created over decades and cannot be directly valued or easily copied. These assets don’t appear on a company’s balance sheet.
Economies of scale create a moat. Once billions of dollars have been invested in a semiconductor factory it makes little sense for a competitor to make similar investments in hopes of serving the same customer base.
Network effects create a moat. As a network increases in size the more each user benefits and the more difficult it is for a competitor to create a similar network.
Cost advantages create a moat. Finding a way to create something more efficiently or because of access to low-cost raw materials discourages competition.
Switching costs create a moat. Sometimes it costs a great deal of time, effort, and capital to switch from one product or service to another.
Some of the best categories in which to hunt for these types of businesses include Property & Casualty Insurance, Royalties and what we like to call Digital Utilities, Trophy Assets, Elite Brands and World Dominators. Using third party data we constantly monitor these categories.
Since we believe that we can identify when companies that fit our primary criteria and are trading below their intrinsic value, it should follow that we must believe that we can also identify when companies that we own begin to trade significantly above their intrinsic value. When we determine that a company trades significantly above its intrinsic value, and/or through technical analysis, we determine that the stock price is likely to experience a short-term decline; rather than sell our shares outright we generally seek to sell covered call options against all, or a portion, of the shares that we own.
The purchaser of the call option has the right, but not the obligation to buy our shares at the option’s strike price. We, as the seller of the call option, have the obligation, but not the right to sell our shares at the strike price. This arrangement effectively limits our upside by the strike price, but it also generates immediate income for us in the form of the premium paid for the option by the purchaser. Collecting this premium reduces the impact of any drop in share price.
Ultimately, there will be situations in which we do decide to exit a position either because something has changed within the business no longer rendering it a good long-term investment, or because we were wrong in our initial analysis. Additionally, and even though we plan to hold stocks meeting our preferred criteria for as long as possible, we will still follow rules-based sell discipline to protect our capital. When a stock that we want to hold forever drops enough trigger a sell signal and we exit the position, we will immediately set a rules-based buy alert to get back in. Typically, a buy alert would be set using a form of technical analysis suggesting that the stock has stopped falling and is in the early stages of a new up-trend.
We may invest in the debt, bonds, or preferred stock, of a company with the aforementioned characteristics, rather than owning the common stock. These types of securities generally have maturity dates and our preferred holding period of forever means that we are willing (but not obligated) to hold them until their maturity date.
From time-to-time special situations arise that call for investing in “baskets” of stocks instead of just one company. We generally prefer to create our own baskets by directly buying the shares of several companies, but we will also use ETFs to gain the desired exposure. ETFs have the drawback of additional costs and exposure to companies that we wouldn’t otherwise want to own.
When few investment opportunities matching these criteria exist, we will seek to hold cash, and cash equivalents like (short-term) US Treasury securities that pay reasonable interest while we wait for investment opportunities to arise.