TD Epoch U.S. Small Cap Quality Value
At a glance
Our U.S. Small Cap Quality Value strategy pursues long-term capital appreciation by investing in a portfolio of 60-90 small-capitalization U.S. companies. As fundamental investors with a long-term orientation, we select companies based on their ability to generate free cash flow and allocate it intelligently for the benefit of shareholders. Our bottom-up security selection process balances investing in our convictions with diversification and rigorous risk control.
The U.S. Small Cap Quality Value Opportunity
Minimal research coverage of U.S. small-cap companies creates opportunities to discover promising but overlooked companies.
Disciplined process combines the judgment and experience of fundamental investors with the rigor and objectivity of quantitative insights.
Differentiated view on value investing that accounts for intangible assets.
Invests in companies with strong free cash flow and intelligent capital allocation policies; offers low correlations with growth, value, and other accounting-based styles.
Portfolio construction framework designed to minimize unintended risks, reduce volatility, and emphasize security selection risk as the primary source of risk.
Free cash flow approach expected to provide attractive balance of performance and downside protection.
Philosophy and approach
The bedrock of our philosophy is the belief that the best predictors of long-term shareholder return are growth in free cash flow and management's skill in allocating that cash.
We prefer cash flow to earnings for three reasons. First, cash flows are more reliable than reported earnings because they are harder to manipulate under accounting rules. Second, for innovative businesses which derive much of their economic value from intangible assets, reported earnings have become increasingly less relevant as a measure of value generation compared to cash flows. Third, businesses which appear to generate reported earnings but not cash flows are more likely to run into financial distress
Capital allocation matters because decisions on how to allocate cash flows—whether to reinvest in order to grow a company, or to return capital to shareholders—can create or destroy long-term shareholder value.
Our investment process begins by identifying candidates for investment from a universe of common stocks generally consisting of companies in the Russell 2000 Index, although the strategy has the flexibility to invest outside the Index.
From the investable universe, we develop a focused list of investment candidates sourced by our qualitative insights, quantitative tools, and macroeconomic observations. Analysts leverage their deep industry knowledge and experience to identify potential research candidates through meetings with companies, suppliers, customers and peers, as well as conferences and trade shows.
We complement our fundamental insights with the TD Epoch Core Model ("ECM"), a proprietary quantitative tool that expresses and reinforces, in quantitative terms, the economic logic behind our fundamental research, seeking out companies headed by capable managements that are able to consistently generate and grow free cash flow. The ECM evaluates each stock in our investment universe according to five broad investment characteristics—Quality, Valuation, Growth, Capital Allocation, and Investor Behavior—which we believe drive company fundamentals and security prices.
Fundamental research is carried out on potential investments and portfolio holdings by our veteran team of research analysts and portfolio managers. We develop an investment thesis as we assess the sources of the company’s long-term value creation and management’s ability to nurture it. We scrutinize management’s track record of allocating capital, looking for those with the discipline to use free cash flow to maximize return on investment, thereby creating shareholder value. We also evaluate each company's business model and financial statements, as well as its operating environment and valuation. Once a stock has been purchased, we regularly revisit our thesis and typically sell or trim a stock if our price target is reached, our thesis changes, or we see another investment with a better risk reward profile. We will sell a position outright if our investment thesis has been compromised due to a change in the company’s strategy, business conditions, or the competitive environment.
While the portfolio is constructed from the bottom up, we also consider the macro context while making investment decisions. TD Epcoh's Investment Policy Group, composed of senior members of our different strategy groups, provides insight and guidance on the global market environment as well as macroeconomic and industry trends.
Risk management is integrated throughout the portfolio construction process as we seek to produce an efficient portfolio on a risk/return basis. The portfolio is diversified across economic drivers of return, individual position sizes are limited, and the strategy employs a strict sell discipline. We do not have strict sector limits but are aware of our sector and industry exposures through our risk management process. Position sizes are determined by the portfolio managers with input from the analyst and our Quantitative Research and Risk Management Team and are inversely related to the risk presented by each individual security within the context of the overall portfolio.