Towle Deep Value Fund (TDVFX), May 2015

By David Snowball

Objective and strategy

The fund pursues long-term capital appreciation. They look to invest in a compact portfolio of 30-50 undervalued stocks. The fund is nominally all-cap but the managers have traditionally had the greatest success in identifying and investing in small cap stocks. The fund looks for “well-seasoned companies with strong market positions, identifiable catalysts for earnings improvement and [exceptional] management.” They have strong sector biases based on valuations but will not invest in tobacco, liquor, or gaming companies based on principle. For a small cap value fund, with predominantly domestic based holdings, it has unusually high exposure to international markets. They systematically track macro conditions and have the ability to move largely to cash as a defensive measure but have not done so.

Adviser

Towle & Co. Towle was founded in 1981 and is headquartered in St. Louis. They provide investment advice to institutional and private investors through the fund, partnerships and separately managed accounts. The firm had approximately $560 million in assets under management as of December 31, 2014.

Manager

The Fund’s portfolio is managed by an investment team comprised of J. Ellwood Towle, CEO, Christopher Towle, Peter Lewis, James Shields and Wesley Tibbetts. Together, they share responsibility for all day-to-day management, analytical and research duties. Other than Mr. Shields, the team has been in place since the fund’s inception. The team also manages two partnerships and about 75 separate accounts, all of which use the same strategy.

Strategy capacity and closure

The strategy’s capacity, in all vehicles, is viewed to be approximately $1 billion, but highly dependent on market conditions and opportunities. They have previously closed when they did not feel comfortable taking on new money.

Active share

98.6 “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. An active share of 98.6 reflects a very high level of independence from its benchmark, the Russell 2000 Value index.

Management’s stake in the fund

The elder Mr. Towle has over $1 million in the fund and owns 6.5% of its shares, as of January 2015. The Towle family is the largest investor in the fund and in the strategy. The family has over 90% of their wealth invested in the strategy. All of the managers have invested in the fund. The younger Mr. Towle has between $50,000 and $100,000. Mr. Lewis has between $100,000 and $500,000.  Messr. Tibbetts and the newest manager, Messr. Shield, have modest investments. None of the trustees have invested in the fund, but then they oversee 76 funds and have virtually no investment in any of them.

Opening date

October 31, 2011. The underlying strategy has been in operation since January 1, 1982.

Minimum investment

$5,000, which is reduced to $2,500 for various tax-advantaged accounts.

Expense ratio

1.20% on assets of $75 million, as of May 2015. There’s also a 2% redemption fee on shares held fewer than 90 days.

Comments

There are two persistent investing anomalies worth noting. The first is “the value premium.” Value has persistently outperformed growth over the long-term in every size of stock. One 2013 essay claims that every Russell value index, everywhere in the world, in every sector, has outperformed its growth counterpart since inception. It’s true for the Russell 1000, 2000, 2500, Global 3000 ex-US, EMEA, Global ex-US ex-Japan, Global ex-US Large Cap, Greater China, Microcap, the whole shebang. In many instances, the long-term return from value investing is two or three times greater than in growth investing. Value investing is, in short, a free lunch in a business that swears that there are no free lunches.

The second anomaly is the almost no actively-managed value fund captures the value premium. That is, investors who bill themselves as dyed in the wool value guys have far wimpier performance than the theory says they should. Value funds tend to prevail over long periods but by less than you’d expect. That reflects the fact that very few of these guys invest in the sorts of deeply undervalued stocks that create the value premium. Instead, they’re sort of value-lite investors who liberally hedge their exposure to really cheap stocks with a lot of cheap relative to the rest of the market stocks. The reason’s simple: these stocks are cheap for a reason, they’re often fragile companies in out-of-favor industries and they have the potential to make investors in them look incredibly stupid for a painfully long stretch.

Few investors are willing to risk that sort of pain in pursuit of the full potential of deeply undervalued stocks. Towle & Co. is one of those few. They’ve managed to stick with their convictions because they haven’t had to worry a lot about skittish investors fleeing. In part that’s because they work really hard, mostly with separate account clients, to partner with investors who buy into the strategy. And, in part, it’s because they are their own biggest client: The Towle family has over 90% of their wealth invested in the strategy.  Happily, their convictions have reaped enormous gains for long-term investors.

While Towle assesses a wide variety of valuation metrics, a primary measure is price-to-sales. They focus on sales rather than earnings for two reasons. Topline measures like sales directly measure a firm’s vitality (are they able to sell more stuff at better prices each year?) which is important for a discipline that relies on buying robust growth at value prices. And topline measures like sales are harder to fudge than bottom line measures like earnings; a lot of financial engineering goes into “managing” earnings which makes them a less reliable measure.

Towle’s portfolio sports a price-to-sale ratio of 0.26 while its benchmark is four times pricier: 1.03. The Total Stock Market Index sells at 1.61, a 600% higher price. By that measure, only one other stock fund (out of 2300 domestic equity funds) has such a deeply undervalued portfolio. By measures such as price-to-book, Towle’s stocks sell at a 30% discount (0.91 versus 1.45) to its benchmark and a 65% discount (0.91 versus 2.52) to the broader stock market.

In the long term, this strategy has performed well. There are about two dozen small cap value funds with 20 year track records. Precisely one of those, the long-closed Bridgeway Ultra-Small Company Fund (BRUSX), has managed to outperform the Towle strategy. In the very long term, Towle has performed astonishingly well. Here are the stats for performance since the strategy’s inception in 1982:

 

Annualized return

$10,000 invested in ’82 would now be worth:

Towle Deep Value (net of fees)

16.0%

$2,400,000

Russell 2000 Value

12.4

590,000

S&P 500

11.7

470,000

That said, a free lunch is still not a free ride. Over shorter periods, and sometimes over quite lengthy periods, deep value stocks can remain stubbornly undervalued and unrewarding. While the strategy has a three decade track record, the mutual fund has been in operation for about four years and has married substantially above average returns with even more substantially above average volatility.

 

APR

Max
Drawdown,
%

Standard Deviation,
%/yr

Downside
Deviation,
%/yr

Ulcer
index

Sharpe
Ratio

Sortino
Ratio

Martin
Ratio

Towle Deep Value Fund

17.6

-14.6

18.1

11.5

5.1

0.97

0.53

0.50

Small Cap Value Group

15.9

-9.8

12.9

7.5

3.3

1.24

2.17

5.58

The fund’s sector concentration – lots of consumer cyclicals, energy and industrials but very little tech, pharma or utilities – contributes to the potential for short-term volatility. In addition, the managers occasionally make mistakes. Joe Bradley, one of the folks at Towle, says of the strategy’s 2011 performance, “we made some bad choices and we stunk it up.” Indeed the strategy posted three disastrous years this century in which they trailed their benchmark by double digits: 2000 (-1 versus +22.8), 2008 (-49.9 versus -28.9) and 2011 (-17.4 versus -5.5). Two of those three lagging years was then followed by phenomenal outperformance: 2001 (42.8% vs 14.0) and 2009 (101% vs 20.5). The portfolio, Mr. Bradley reports, became like a too-tightly compressed spring; when the rebound occurred, it was incredibly powerful.

Bottom Line

Towle Deep Value positions itself a “an absolute value fund with a strong preference for staying fully invested.” While most absolute value funds often pile up cash, Towle chooses to turn over more rocks – in under covered small caps and international markets alike – in order to find enough deeply undervalued stocks to populate the portfolio. The fund has the potential to play a valuable role in a long-term investor’s portfolio. Its focus is on a volatile and sometimes-despised corner of the market means that it’s not appropriate as a core holding but its distinctive strategy, sensible structure, steady discipline and outstanding long-term record makes it a serious contender for diversifying a portfolio heavily weighted in large cap stocks.

Fund website

Towle Deep Value Fund. It’s a pretty Spartan site. Folks seriously interested in understanding the strategy and its performance over the past 34 years would be better served by checking out the Towle & Co. website.

Fact Sheet

© Mutual Fund Observer, 2015. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.
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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.