Questions with Katz

QUESTION:

A few months ago, we discussed what gives us confidence in selecting individual stocks over ETFs and mutual funds (multifactor security funds).

What is it that allows us to outperform these multifactor security funds? Are all these other investors right to only depend on ETFs and mutual funds?

ANSWER:

Multifactor funds have come and gone for decades. Clients do not ask for them. While professionals likely back-test multifactor strategies before offering these funds to their clients, their real-world performance often falls short. A study from a few years ago revealed that 84% of the funds available five years prior had closed, and the remaining 16% underperformed by 2.4%.

Why is this of interest to us? After all, we have little interest in funds. We generally have little interest in funds because we haven’t encountered a single fund that outperformed our common stock model while diversifying among small, medium, and large companies, as well as various industries. Perhaps it’s our approach to diversification that gives us an edge.

Perhaps the number of securities in the portfolio also plays a part. We start with the well-established S&P 1500 and work our way down to our portfolio that tends to consist of 15-20 companies. Therefore, we believe we are investing in the top 1%.

Our portfolio falls into the category of High Conviction Funds — funds that feature the analyst’s top buy recommendations. Studies have shown that the benefits of diversification plateau after twenty securities, so we don’t see the need to weaken criteria to increase investments. That is what we call diversification.

Another possibility for our outperformance is the unique structure of our multifactor fund. We use more factors than our competition. For nearly six decades, our five factors — Safety, Quality, Growth, Value, and Confirmation – have consistently delivered strong results.

Finally, each factor is tested in several different ways and prospective securities must pass all tests to be recommended. That is why we work from a 53 — column spreadsheet.

This is how we maintain a high standard of investments and eliminate bias.