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While most investors are familiar with stocks and bonds, Lyon
Capital Management expands the range of asset classes to include:
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Stocks |
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Bonds |
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Cash |
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Real Estate Investment Trusts (R.E.I.T.s) and
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Treasury Inflation Protected Securities
(T.I.P.S.) |
The majority of a client's portfolio is usually invested in
stocks and bonds. But, we add in weightings of R.E.I.T.s and
T.I.P.S. (in non-taxable accounts). We think of R.E.I.T.s as a separate asset class
because they behave differently than (have a low correlation with)
stocks or bonds. This makes them great portfolio diversifiers. We use R.E.I.T.
stocks traded on the major U.S. exchanges. T.I.P.S.
also behave differently than stocks, bonds and R.E.I.T.s. They
are good diversifiers, a great inflation hedge and they tend to
smooth out portfolio volatility. Because of how T.I.P.S. are
taxed we use them in non-taxable accounts.
Click here to read about our Equity
Investing Style
Click
here to read about
our Fixed Income Investing style.
Click here to read about Real Estate
Investment Trust securities (R.E.I.T.s).
Click here to read about Treasury
Inflation Protected Securities (T.I.P.S.).
Equity Investing at Lyon Capital Management
Some of history's greatest investors, people such as Ben Graham, Warren Buffett, Peter
Lynch, John Templeton, and John Neff have all been patient, long-term oriented investors
who purchased securities that were undervalued and out of favor.
Buy Discipline
Our focus is on individual companies. We use a bottom-up approach. While we
are certainly aware of the current economic conditions and economic outlook, this is not
the focus. We strive to purchase companies that will do well in strong as well as
weak economic conditions.
We do not make sector bets. We develop a diversified portfolio, but selecting and
altering sector weightings is not part of the strategy. We also do not make bets
based on market capitalization (i.e. we cannot be categorized as a “small cap”
manager or a “large cap” manager).
We focus on individual companies, substantial businesses, with a proprietary product or
competitive advantage as well as a diversified customer base. We only buy when a
stock is down in price from a recent high and selling at a low relative valuation compared
to other companies in the market and other companies in the industry. This indicates
a stock that is out of favor with most investors. We invest in companies that are
industry leaders, that generate good returns and strong cash flow. We look for
companies with strong or improving balance sheets. We like the company to pay a
dividend.
We evaluate management and look for a streamlined team with a small, independent
board. We like to see significant share ownership by the management and
directors. We like a board size of not more than 11 (any more dilutes
decisiveness). The board members should not be on more than 3 or 4 other
boards. For top officers the value of the stock holdings should be at least equal to
salary. Management should be focused on growth and profitability.
A fully invested equity portfolio at Lyon Capital Management is equally weighted
between 20-25 different issues, divided among 10 to 15 different industries. This
allows for good diversification without nullifying the value added by the stock picking
method described above. Portfolios are built gradually over time as we select stocks
that are currently undervalued and establish positions in them. It may take as
long as six months to a year for a portfolio to become fully invested. Portfolio
turnover is relatively low, therefore minimizing trading costs while maximizing
return. Past volatility of returns has been low and we provide evidence of this on
our performance data sheets. We believe the risk one takes
when investing is just as important as the returns generated.
We purchase securities listed on the major U.S. stock exchanges.
International exposure is gained by selecting companies based in the United States that
have a strong presence in foreign countries. When one invests in a stock like Applied
Materials or McDonald’s, companies who do a large portion of their total business
outside the U.S., one is in effect hiring the best foreign business managers to make
decisions about foreign markets. These managers know the market, in many cases,
live in the market and are familiar with the economic and political situations. We
believe they are better positioned to make smart international investing decisions than we
are or than are most other money managers based in the U.S.
When we do decide to invest in a company we look for that investment to generate a
return of about 50% over a 3-year period. When we buy a stock, we’re not
looking at making a quick profit. We are long-term investors. We are not
market timers. We believe patience and sticking to one’s investment discipline
are the keys to sound long-term results.
Sell Discipline
The sell decision is as important as the buy decision. The parameters of our
“sell discipline,” as it is sometimes called, begins with establishing goals for
what we expect a stock to do. When we first purchase a stock we have a goal for the
up-side of the investment. To put this in more concrete terms: the upside goal
is to achieve a gain of 50% over three years, which is a 15% annual return plus any
dividends. When the stock reaches the up-side goal we often take profits by selling some
or all of the position. If the stock appears to have strong fundamentals and continued
strong growth potential, we will continue to hold a portion.
We also have an idea of how low we think the value of the investment could possibly
go. We recognize that stocks don’t always go up, even when we have done our
best to select investments we think will increase in value. When a stock goes down
more than 20% from the original purchase price then we re-evaluate the investment.
One may ask ,“Why 20%?” Simply put sometimes out-of-favor stocks (the
type of stocks Lyon Capital Management buys) go down before they head back up.
Unlike many other investors we are not buying stocks already on the rise and selling at
the first sign of bad news. Often the companies we buy may go lower because of
recent bad news or market trends. In addition, in today’s more volatile market it is
not unusual to see large swings in the value of a stock. A stock may go down
rapidly 5, 10, even 15% and then quickly rebound. If one has a discipline to always
sell when a stock is down, say 10%, one may miss out on an opportunity and incur an
unnecessary loss.
A decision to sell is based on how the company is performing. We ask questions
such as: Is management following through on their stated initiatives such as cutting
costs, selling off under-performing divisions, or expanding in new markets? Is the
company’s debt level falling? Are margins improving? If the answer to any of
these questions is, “ No,” we re-evaluate whether or not we should
continue to hold the investment and we may sell. It is important to exit a position
when one has lost faith in the investment.
If, however, the reasons we bought the stock in the first place are still in place, a
lowered price is an opportunity to buy more. And often that is what we do. If
we have strong confidence in the stock, even after a 20% drop, we’ll purchase more.
To hedge, when we first start investing, we sometimes buy a small position. The
idea is to begin small and then add to the position as the price goes down. When we
buy we try to do so at what we believe is the lowest price; however, buying at the lowest
possible price is almost impossible and is almost a matter of luck. So when we buy
at what we think is a good price we are fully prepared for the price to go lower, to take
advantage of this and buy some more.
The bane of buying undervalued out-of-favor stocks is that they can become more
out-of-favor (meaning the price goes lower) before the value is realized by the
marketplace and the price goes up. The reward is buying quality companies at bargain
prices, and earning good returns on investments while taking below-average risks. It
is a strategy that may not be as glamorous as buying a stock when it is on the rise, but
it certainly carries less risk. And for conservative, patient, long-term investors
it is a desirable, and often more rewarding strategy.
Fixed income investing at Lyon Capital Management
Our Philosophy: Do
not try to time the market by trying to predict interest rates. We use a buy and hold approach to fixed income
investing.
Rationale: Fixed
income accounts are usually set up to provide secure, regular returns to an investor. Trying to aggressively time interest rate changes
can be risky and is often a losing game.
Our Philosophy: Build
a portfolio with securities maturing at different time intervals. This is known as “laddering.” We buy
securities that have a life (or maturity) of anywhere from 6 months to 30 years. We usually spread the maturities out over time. If the goal for the account dictates a liquidity
schedule that requires timed payouts then we select the appropriate maturities.
Rationale: In a
rising interest rate environment this approach gives us the opportunity to re-invest
maturing securities at the higher interest rates on a regular basis. In a falling interest rate environment this
strategy locks in a portion of the portfolio (those securities maturing at later dates) at
higher rates. The laddering approach also
provides a degree of liquidity for the account holder – securities maturing on a regular
basis in case cash is needed. And, it gives us
the opportunity to select new securities on a regular basis.
Securities we use:
The security is issued by
a large company.
The company has a strong fixed charge coverage ratio.
The company has low debt ratios.
The issuing company’s business is a consistent
cash flow generator.
The security offers an attractive yield-spread
above treasuries.
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Fixed Income Performance:
It is important to remember what the goals of fixed income investing
are:
Price appreciation is not a goal of our fixed income
security investing style – that is the goal of our stock investing style.
You will notice that the prices of fixed income securities go up and
down (depending on how interest rates are changing in the marketplace). But, because we hold fixed income securities for
their stated life, this fluctuation in price is not as important as the income the
securities generate for your account. Keep in
mind that while the price of a security will fluctuate, we will be holding it in your
account (in almost all cases) until it matures at which time you will receive the entire
face value of the security. The face value is stated when the security is issued and stays
the same over the life of the security. (There is one exception to this rule: Treasury Inflation
Protected Securities or T.I.P.S. – in this case the face value increases over time
with inflation.)
In some instances we may sell a fixed income security if we feel it
has become a bad credit risk. This is an
unusual event since we use primarily U.S. agency securities. When we are investing in
corporate bonds or state tax exempt securities we tend to stick to investment grade
securities, and we evaluate their fundamentals carefully before purchase.
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