Poplar Forest Partners Fund (PFPFX), April 2014

By David Snowball

Objective and strategy

The Fund seeks to deliver superior, risk-adjusted returns over full market cycles by investing primarily in a compact portfolio of domestic mid- to large-cap stocks. They invest in between 25-35 stocks. They’re fundamental investors who assess the quality of the underlying business and then its valuation. Factors they consider in that assessment include expected future profits, sustainable revenue or asset growth, and capital requirements of the business which allows them to estimate normalized free cash flow and generate valuation estimates. Typical characteristics of the portfolio:

  • 85% of the portfolio to be invested in investment grade companies
  • 85% of the portfolio to be invested in dividend paying companies
  • 85% of the portfolio to be invested in the 1,000 largest companies in the U.S.

Adviser

Poplar Forest Capital. Poplar Forest was founded in 2007. They launched a small hedge fund, Poplar Forest Fund LP, in October 2007 and their mutual fund in 2009. The firm has just over $1 billion in assets under management, as of March 2014, most of which is in separate accounts for high net worth individuals.

Manager

J. Dale Harvey. Mr. Harvey founded Poplar Forest and serves as their CEO, CIO and Investment Committee Chair. Before that, he spent 16 years at the Capital Group, the advisor to the American Funds. He was portfolio counselor for five different American Funds, accounting for over $20 billion of client funds. He started his career in the Mergers & Acquisitions department of Morgan Stanley. He’s a graduate of the University of Virginia and the business school at Harvard University. He’s been actively engaged in his community, with a special focus on issues surrounding children and families.

Management’s stake in the fund

Over $1 million. “Substantially all” of his personal investment portfolio and the assets of his family’s charitable foundation, along with part of his mom’s portfolio, are invested in the fund. One of the four independent members of his board of directors has an investment (between $50,000 – 100,000) in the fund. In addition, Mr. Harvey owns 82% of the advisor, his analysts own 14% and everyone at the firm is invested in the fund. While individuals can invest their own money elsewhere, “there’s damned little of it” since the firm’s credo is “If you’ve got a great idea, we should own it for our clients.”

Strategy capacity and closure

$6 billion, which is reasonable given his focus on larger stocks. He has approximately $1 billion invested in the strategy (as of March 2014). Given his decision to leave Capital Group out of frustration with their funds’ burgeoning size, it’s reasonable to believe he’ll be cautious about asset growth.

Active share

90.2. “Active share” measures the degree to which a fund’s portfolio differs from the holdings of its benchmark portfolio.  High active share indicates management which is providing a portfolio that is substantially different from, and independent of, the index. An active share of zero indicates perfect overlap with the index, 100 indicates perfect independence. The active share for Poplar Forest is 90.2, which reflects a very high level of independence from its benchmark, the S&P 500 index.

Opening date

12/31/2009

Minimum investment

$25,000, reduced to $5,000 for tax-advantaged accounts. Morningstar incorrectly reports a waiver of the minimum for accounts with automatic investment provisions.

Expense ratio

1.25% on about $400 million in assets. The “A” shares carry a 5% sales load but it is available without a load through Schwab, Vanguard and a few others. The institutional share class (IPFPX) has a 1.0% expense ratio and $1 million minimum.

Comments

Dale Harvey is looking for a few good investors. Sensible people. Not the hot money crowd. Folks who take the time to understand what they’ve invested in, and why. He’s willing to work to find them and to keep them.

That explains a lot.

It explains why he left American Funds, where he had a secure and well-paid position managing funds that were swelling to unmanageable, or perhaps poorly manageable, size. “I wanted to hold 30 names but had to hold 80. We don’t want to be big. We’re not looking for hot money. I still remember the thank-you notes from investors we got when I was young man. Those meant a lot.”

It explains why he chose to have a sales load and a high minimum. He really believes that good advisors add immense value and he wants to support and encourage them. Part of that encouragement is through the availability of a load, part through carefully-crafted quarterly letters that try to be as transparent as possible.  His hope is that he’ll develop “investor-partners” who will stay around long enough for Poplar Forest to make a real difference in their lives.

So far he’s been very pleased with the folks drawn to his fund. He notes that the shareholder turnover rate, industry-wide, is something like 25% a year while Poplar Forest’s rate is in the high teens. That implies a six or seven year holding period. Even during an early rough patch (“we were a year too early buying the banks and our results deviated from the benchmark negatively but we still didn’t see big redemptions”), folks have hung on. 

And, in truth, Mr. Harvey has given them reason to. The fund’s 17.1% annualized return places it in the top 1% of its peer group over the past three years, through March 2014. It has substantially outperformed its peers in three of its first four years; because of his purchase of financial stocks he was, he says, “out of sync in one of four years. Investing is inherently cyclical. It’s worked well for 17 years but that doesn’t mean it works well every year.”

So, what’s he do?  He tries to figure out whether a firm is something he’d be willing to buy 100% of and hold for the next 30 years. If he wouldn’t want to own all of it, he’s unlikely to want to own part of it. There are three parts to the process:

Idea generation: they run screens, read, talk to people, ponder. In particular, “we look for distressed areas. There are places people have lost confidence, so we go in to look for the prospect of babies being tossed with the bathwater.” Energy and materials illustrate the process. A couple years ago he owned none of them, today they’re 20% of the portfolio. Why? “They tend to be highly capital intensive but as the bloom started coming off the rose in China and the emerging markets, we started looking at companies there. A lot are crappy, commodity businesses, but along the way we found interesting possibilities including U.S. natural gas and Alcoa after it got bounced from the Dow.” 

Modeling:  their “big focus is normalized earnings power for the business and its units.” They focus on sustainable earnings growth, a low degree of capital intensity – that is, businesses which don’t demand huge, repeated capital investments to stay competitive – and healthy margins.  They build the portfolio security by security. Because “bond surrogates” were so badly bid up, they own no utilities, no telecom, and only one consumer staple (Avon, which they bought after it cut its dividend).

Reality checks: Mr. Harvey believes that “thesis drift is one of the biggest problems people have.”  An investor buys a stock for a particular reason, the reasoning doesn’t pan out and then they invent a new reason to keep from needing to sell the stock. To prevent that, Poplar Forest conducts a “clean piece of paper review every six months” for every holding. The review starts with their original purchase thesis, the date and price they bought it, and price of the S&P.”  The strategy is designed to force them to admit to their errors and eliminate them.   

Bottom Line

So why might he continue to win?  Two factors stand out. The first is experience: “Pattern recognition is helpful, you know if you’ve seen this story before. It’s like the movies: you recognize a lot of plotlines if you watch a lot of movies.”  The second is independence. Mr. Harvey is one of several independent managers we’ve spoken with who believe that being away from the money centers and their insular culture is a powerful advantage. “There’s a great advantage in being outside the flow that people swim in, in the northeast. They all go to the same meetings, hear the same stuff. If you want to be better than average, you’ve got to see things they don’t.” Beyond that, he doesn’t need to worry about getting fired. 

One of the biggest travesties in the industry today is that everyone is so afraid of being fired that they never differentiate from their benchmarks …  Our business is profitable, guys are getting paid, doing it because I get to do it and not because I’ve got to do it. It’s about great investment results, not some payday.

Fund website

Poplar Forest Partners Fund. While the fund’s website is Spartan, it contains links to some really thoughtful analysis in Mr. Harvey’s quarterly commentaries.  The advisor’s main website is more visually appealing but contains less accessible information.  

Fact Sheet

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About David Snowball

David Snowball, PhD (Massachusetts). Cofounder, lead writer. David is a Professor of Communication Studies at Augustana College, Rock Island, Illinois, a nationally-recognized college of the liberal arts and sciences, founded in 1860. For a quarter century, David competed in academic debate and coached college debate teams to over 1500 individual victories and 50 tournament championships. When he retired from that research-intensive endeavor, his interest turned to researching fund investing and fund communication strategies. He served as the closing moderator of Brill’s Mutual Funds Interactive (a Forbes “Best of the Web” site), was the Senior Fund Analyst at FundAlarm and author of over 120 fund profiles. David lives in Davenport, Iowa, and spends an amazing amount of time ferrying his son, Will, to baseball tryouts, baseball lessons, baseball practices, baseball games … and social gatherings with young ladies who seem unnervingly interested in him.