How Parsec Monitors Investment Securities

Parsec invests in a variety of securities for its clients. These may include mutual funds, exchange traded funds (ETFs), and individual stocks, among others. All of these investments can and do experience significant price pullbacks from time to time. While Parsec’s research committee focuses on investments it can hold for the long-term and performs significant due diligence before adding any new positions, price declines still happen. In this article we will discuss how we monitor investment securities and our process when a stock or fund does not perform as expected.

Returns of investment securities are driven by several factors.

For individual stocks, earnings growth, the competitive environment, and exogenous events can significantly affect price performance. For mutual funds and ETFs, the general capital market environment as well as portfolio management departures or changes at the parent company (for actively managed funds) can influence both fund flows and price changes. At Parsec, in addition to reviewing all covered securities at regularly scheduled meetings, the research committee continually monitors client investments for these types of factors in between our ongoing investment reviews.

We do this by keeping up-to-date on news and price movements regarding our portfolio companies, as well as reading sell-side research reports, company government filings and earnings reports.

Our challenge is on the side of too much data rather than not enough, so we use a number of tools in our process to leverage technology in our monitoring process.

Two such tools are our master comparison framework and our quantitative ranking system:

  • The master comparison extracts a number of company fundamentals and ratios on each company, as well as how each has performed relative to the overall market since our last review. We exclude market movement (since we view that as the natural ebb and flow of prices) and focus our special off-cycle reviews on companies that have moved up or down in price by more than a certain percentage ex-market.
  • Another tool we use is our proprietary quantitative scoring system, which distills several key fundamental data points and rankings into a single score. We can then use this to rank companies, either within a sector or across our overall coverage universe. We examine both the overall level of the score as well as whether it is improving or deteriorating and the reasons driving a change.

For mutual funds and ETFs, we have another proprietary scoring system that we have used for many years based on data from Morningstar. Like our process with individual stocks, we focus on the level, trend and changes in our fund scores. In addition, we incorporate data and scoring from another outside provider into our decision-making process.

At the same time, the financial software we use alerts us to any new developments on our covered securities and helps us manage the large volume of news flow to focus on the most important stories of the day. When a significant event does happen that negatively affects a security, we research the development by reviewing published research, listening to a company’s conference call or reading the transcript, reading industry reports, and conducting our own due diligence. We review our thesis on the fund or stock and determine if and how the latest events could affect the security’s long-term prospects going forward. To gauge an investment’s upside potential, we adjust our growth assumptions to reflect the new information and evaluate the security’s risk/reward profile in light of its new price and valuation level.

How do we handle breaking news?

Oftentimes when a major story surfaces, there is minimal new financial information on which to make a decision. At the same time, the market often tends to overreact to news events. For these reasons, Parsec’s research committee may intentionally wait before taking action when a stock or fund experiences a significant negative development. Although it may appear that we are not responding to the event in question, we are in fact working diligently behind the scenes to gather as much data as possible while reviewing our thesis and assumptions. This can be a frustrating time for clients who might prefer us to take immediate action. However, we have found that taking a wait-and-see approach allows us to collect more information and answer important questions rather than making an uninformed or premature decision.

Waiting for the dust to settle while collecting additional information also allows us to better understand how a development could affect a stock or fund’s long-term prospects. If we believe that a company or fund can recover from an adverse event and the security has fallen significantly in price, it is often an attractive buying opportunity.

However, on other occasions it may be clear that it is time to sell a position. This can happen when an investigation surrounding a security is new but affects multiple divisions or aspects of the underlying company’s or fund’s operations. Other examples include an environmental disaster or a significant product recall that could take years to resolve. In these situations the best action may involve taking a modest loss now in order to avoid a much larger loss in the months or years to follow.

While our bias towards higher-quality stocks and funds may mean we are more likely to hold a security or even add to positions following a negative news event, we are closely monitoring client investments on an ongoing basis and performing in-depth due diligence as new developments arise. Our intention is to make objective and thoughtful decisions that will benefit clients and their portfolios over the long-term.

For more, read my related article, “Does the Stock Price Fully Reflect the News?

Bill Hansen, CFA
President, Chief Investment Officer

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