Q. What are the most significant differences between IMI’s investment strategies and others?

A. Successful investing is based on three principles: the management of return, risk and costs. Just like a three legged stool needs all three legs to stand, we believe all three aspects of the investment process have to be tended to produce good, long-term results.  IMI’s strategies are engineered to enhance the return potential, minimize the costs and manage the risks that are inherent in any investment portfolio.  IMI achieves this feat by designing extremely low turnover, highly cost and tax efficient, long term strategies.

Q. Why do IMI strategies concentrate on both the return and the cost side of the investment equation?

A. A very brief answer to this question is that returns are probabilistic, whereas cost savings are deterministic.  In other words, in the short term, whether or not a particular portfolio is going to be rewarded is unknowable.  So, the best an investment manager can do is to position the portfolio in such a way that it has beneficial attributes.  These are attributes that the market has historically rewarded.  However, the portfolio manager can not control by how much and when these rewards will be realized.  The outcomes are entirely probabilistic. 

On the other hand, any cost savings that can be realized while implementing a portfolio accrue directly to the investor.  At the portfolio level cost savings can be realized at two distinct areas: by reducing transaction costs and by deferring taxes on gains. 

IMI’s investment strategies are developed with the expectation to earn excess return, not only from market inefficiencies, but also from savings realized due to extremely low turnover portfolios.  As far as we are concerned, there is no difference between earning a dollar and saving a dollar.  And being able to do both simultaneously is the key to building wealth.

Q. Why low turnover?

A. Turnover, that is, buying and selling securities from the portfolio, triggers two significant sources of performance drag:

·        Transactions costs: Brokerage commissions capture but a very small percentage of transaction costs.  The full impact of transaction costs include: commissions, bid-ask spreads, market impact and other opportunity costs such as timing costs, lost trades, etc.  In sum, it costs around 1% of principal to trade a large cap, highly liquid position.  The costs are 4-5 times as large for small cap or illiquid positions.  Since these costs are incurred with every trade, the only way to control them is by reducing the frequency of trading.

·        Capital gains taxes: For a taxable portfolio, with every trade one stands to lose either 20% or 40% of the capital gains realized.  The impact is that a manager operating with typical institutional turnover parameters has to earn 2 ˝ -         3 ˝% more than the market in order to match the post tax return of an index portfolio.  On the other hand, unrealized capital gains appreciation is the best tax shelter.  As long as one build assets rather than income there is not tax liability. 

Low turnover portfolios have one other beneficial trait, namely time.  Since the outcomes of a portfolio strategy are realized somewhat randomly, having the luxury of time gives the strategy a higher probability of achieving the expected results.

Q. What are the differences between IMI low-turnover strategies and others?

A. There are very few long only managers who claim to be tax efficient in their investment process.  Turnover awareness is not in the lexicon of long/short managers.  Among the long only managers who are low turnover, one popular technique utilized entails adopting a core and satellite approach to allocating assets.  Under this methodology, the core is comprised of index funds and the satellites are actively managed portfolios.  The manager is able to achieve lower turnover by taking advantage of inherently lower turnover characteristics of index funds, and by paying careful attention to realization of gains and harvesting of losses. 

We see two drawbacks with such a process.  First, under a core and satellite approach, the investor ends up paying active management fees for a process that only actively invests 40-50% of funds.  Second, any tax efficiency achieved is entirely due to back office operations.  Unless the manager utilizes a long term investment strategy that is built from the ground up, postponing gains from a short term strategy might cause these unrealized gains to become realized losses.

Tax efficiency is a fundamental part of the IMI long and short stock selection strategies.  Our investment process takes a long term approach, and the timing of gains and losses, both on the long and short sides of the portfolio, is entirely determined by the portfolio management rules.  Also, because we utilize a tax efficient process, IMI can put 100% of funds into an actively managed portfolio.

Q. Isn’t there a lot of uncertainty in long-term investing?

A. As Warren Buffett has very eloquently expressed, “In the short term the market is a voting machine but in the long run it is a weighing machine.”  We vote with our emotions; therefore, in the short run the market can behave erratically, shooting up one day only to reverse course the next.  Short-term investing can be an emotional roller-coaster, whereas in the long run, the only thing that matters is the weight of the evidence: did we acquire companies with solid fundamental characteristics at reasonable prices and did we sell short companies trading at excessive valuations?  If our answer to this question is “yes” then we can weather the storms of the market with patience and confidence.

 In summary, our claim is the exact opposite of conventional wisdom: in that there is significantly more uncertainty in investing for the short term than investing for the long term.  Time is the investor’s friend, but many choose not to befriend this ally.

Q. Why does IMI use a quantitative approach?

A. IMI is a fundamentally based, quantitative investment manager.  This means our approach relies on financial relationships that are extracted from balance sheet, cash flow and income statement line items.  We also take into account estimates from sell side analysts and historical price behavior. 

Although we share some similarities with purely fundamental investment managers, we have a number of significant differences.  First, we quantify the predictive ability of each factor that is included in our process.  Financial statements offer a multitude of factors to judge a company’s profitability, valuation, efficiency and risk characteristics.  However, only a subset of these relationships is predictive of price behavior.  Since our focus is excess return generation, we concentrate on relationships that have demonstrated a consistent historical ability to predict price behavior.  By using such an approach, we are better able to distinguish between information that could be interesting but useless, and knowledge that is price predictive.

Second, this highly methodical process also brings with it a number of additional benefits.  Consistency and discipline are two of the least developed traits in humans, yet success in investing absolutely requires it.  A quantitative approach allows us to add these extremely crucial qualities into our process.  Another extremely important quality that comes with such an approach is objectivity.  Typically, the CEO’s and presidents of large companies are charismatic and have considerable power in swaying opinions; otherwise, they would not have risen to such a position.  This trait has the potential to bias the opinions of portfolio managers or analysts who visit companies.  Our process allows us to distinguish between speculation and verifiable performance.

Finally, a disciplined quantitative investment process brings with it a considerable amount of transparency.  Just like a plant manager can improve the throughput of a factory by being able to measure, monitor, and change, this transparency gives us the ability to enhance our process.  In addition, a fully described process reduces risk.  Neither the firm nor the clients are reliant on one gifted portfolio manager.

In our opinion, any investment process that is not methodical, consistent and objective embeds randomness.  The markets already incorporate a sufficient amount of randomness; we see no reason to add to that by making the process less than it can be.

Q. Why don’t investment styles play a role in IMI strategies?

A. Creating an investment discipline that has a distinct investment style, such as value, growth or momentum, invariably subjects it to periods of underperformance.  As the preference of investors oscillates between value, growth and momentum, one or more of the stylistic strategies go out of favor.  Each time a strategy goes out of favor the investors risk losing money. 

By creating strategies that do not have a distinct style, but incorporate the best of all styles, we are able to assure that a certain number of strategy components remain in favor the majority of the time.  That way, we are able to minimize the number of periods when our strategy is out of favor and create a much more consistent investment approach.

Q. How does IMI manage risk?

A. All active investment managers, whether quantitative, fundamental or qualitative, make bets.  They further assume that company characteristics that they prefer will be favored and rewarded by the market.  This is how active investment managers hope to earn returns in excess of their benchmark – excess return.  Our strategy is no exception to this fundamental rule of active investing.  Among other attributes, we favor companies that have demonstrated fundamental stability.

Traditional risk management and portfolio construction platforms are designed to reduce bets that they do not understand.  In the process they end up curtailing the exact bets the manager is attempting to make.  Since these bets are the source of excess returns, they end up constraining or eliminating the manager’s ability to earn excess return. 

We believe we have a better method of controlling the risk of our investment process: one that does not make us sacrifice our ability to earn excess return in exchange for risk control.  During the development stage of our investment strategy we try to quantify where our planned and unplanned bets are.  For any bet that is unplanned, we try to build offsetting conditions that would constrain the strategy from venturing in that direction.  In addition, we try to incorporate risk control into our portfolio management rules.  By taking this two-pronged approach we maintain that we are able to control the risk parameters of the strategy without having to sacrifice portions of our returns.




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