NPFA's portfolio managers maintain an investment philosophy that is simple: We consider ourselves to be owners of the companies we purchase, not merely buyers and sellers of financial instruments. This philosophy has a few straightforward themes: (1) Stocks should be the cornerstone of any long-term investment plan because of their ability to maintain purchasing power over the long term. (2) Superior earnings and dividend growth play a key role in equity selection. (3) Investing in high quality companies while paying particular attention to diversification are major factors in controlling portfolio risk. While this approach entails a bottom up, company-by-company process, guidelines have been established for asset allocation and sector diversification to ensure that the philosophy is being carried out consistently.
This investment style could be characterized as "quality growth at a reasonable price". As to "quality growth", research conducted is based upon the company's fundamentals: earnings growth and consistency, the health of the company's balance sheet, the quality of management, growth strategy and competitive advantages. Where companies pay a dividend, an above average rate of dividend growth is preferred. Because we invest for the long term, the expected holding period for a company is five years or more. This minimizes portfolio turnover and the taxes such turnover entails.
One of the principles behind this style of management is the conviction that growth stocks are often less susceptible to economic cycles and that stock prices have a high correlation to earnings and dividend growth over the long term. As to "at a reasonable price", current and forecasted price earnings rations are compared to historical absolute and relative price earnings ratio ranges and purchases are considered when a stock looks undervalued using either or both of these measures. In addition, a company's growth rate is compared to its price earnings ratio, as we prefer not to pay an excessive multiple of a company's growth rate.
As company owners, selling is not done for tactical reasons such as taking a profit in the expectation of buying a security again at a lower price. Owners seek out good management that will lead a company out of difficult times. As owners with a long term outlook, our portfolio managers attempt to insulate themselves from the emotions, often fleeting, which can push a stock's price from one extreme to another over a short period of time. A company will be sold if the longer term outlook deteriorates or if a stock's size in the portfolio hampers diversification.
We expect the fixed income allocation of the portfolio to add price stability and current income with a minimum of risk. Therefore, highly rated securities with maturities evenly spaced over a maximum maturity of ten years are used. Non-Treasury securities are employed only when the particular client will be adequately compensated on an after-tax basis for the additional credit risk and lack of liquidity inherent in Federal Agencies, Corporates and Municipals.
As stated above, diversification is crucial to controlling risk. This means investing in asset classes other than domestic stocks and bonds, which are our primary areas of expertise. Mutual funds are employed to diversify into developed international markets, developing international markets, domestic mid cap and small cap stocks as well as international bonds and, where appropriate, limited partnerships and other vehicles for real estate, venture capital, private equity and hedge funds. All such commingled investment vehicles are carefully selected and monitored with an emphasis on cost, the manager's long term record and the fund's investment discipline.
Our portfolio managers engage research partners to assist in the analysis of companies and in the generation of new ideas. Northern Trust Company has a long history of providing research on growth oriented stocks to institutional clients. The company also publishes broad coverage on economics, investment strategy and fixed income. Contravisory Research provides long-term relative price trend analysis which is used in conjunction with fundamental analysis and often acts as an early indicator where differences between the fundamental and technical landscapes occur. William B. Smith & Co. provides fixed income investment counsel. The advice is long-term and value oriented, catering to clients who use bond income for current cash flow. William B. Smith & Co. also assists in day-to-day bond market evaluation as well as execution of bond purchases and sales.
Our portfolio managers report to the Investment Committee, composed of NPFA's investment professionals. The Committee meets monthly for market analysis and discussion as well as for individual account reviews. The Committee also approves additions to and deletions from the Committee's Buy List. The Committee also discusses economic analysis and market strategy. Each month overall asset allocation policy is reviewed and target allocations among all asset classes are considered.
