New York (HedgeCo.Net) Emancipation Management, LLC is an SEC registered New York based investment manager, formed in June 2003. The company has a 10 year track record of identifying public companies within the technology sector that possess valuable franchises which are mispriced by the market. Emancipation has been successful in effecting board or management change, identifying necessary expense reductions, improving inefficient capital structures, and/or initiating a sale process. We were able to sit down with portfolio manager and founder Charlie Frumberg recently to discuss the company’s ideologies.
HedgeCoVest: Welcome Charlie. Thanks for taking the time to sit down with us.
Charlie Frumberg: You’re welcome, happy to do it.
HCV: Looking at the overview for the Emancipation Long/Short Equity model on the HedgeCoVest platform, the first thing that jumped out at me was the fact that you are focused on the tech sector. If you would, describe the investment philosophy you use to invest in the tech sector.
CF: We believe that there are inefficiencies inherent in the tech sector where investors overlook certain stocks. We look for businesses that stay within strict parameters. The things we are looking for are enterprise value, recurring revenues and EBITDA or cash flow. Stocks go through phases where they are sought after because they are considered a growth stock and then eventually the money flowing in and out of the stock, not the company, starts to change. Perhaps it is being reclassified into a value stock. When these shifts occur, the valuations change and they create pricing inefficiencies.
HCV: It sounds like you see the investors changing as the stock moves out of the growth phase and in to a value phase which changes how investors perceive the stock.
CF: That is exactly right. As the company matures and moves out of the growth stock classification, there seems to be a period where they don’t attract growth investors or value investors.
HCV: I would think as a stock gets reclassified like this, it would create a lot of institutional trading. A growth oriented mutual fund isn’t interested in the stock anymore and it isn’t on the radar of the value oriented mutual funds yet either. Doesn’t that wreak havoc on the valuations and money flows from institutions?
CF: It does and that is why we tend to shy away from the turmoil. We want to wait until the dust settles and then evaluate the company using the items we talked about before- enterprise value, recurring revenue and cash flow.
HCV: Can you give me an example of a stock that has gone through the phases?
CF: Microsoft is a great example. It was considered a growth stock in the late 90s and it had returns to fit. Then from 2001 until 2007, the stock moved sideways for the most part. It dipped with the overall market in 2008. It was now classified more as a value stock, but from the bottom in 2009 until recently, the stock tripled in value. The company is a mature business now and it attracts a different group of investors.
HCV: I would think Apple would fit this scenario as well.
CF: Absolutely. We have invested in Apple several times over the years and taken gains each time. The stock was languishing for the first four years of this century as it was considered a value stock, but then with the iPods, iPhones and iPads being so successful, the stock went back in to the growth stock classification and it has gone up 10-fold in the last six or seven years. And that reclassification is something we look for. We asked ourselves, can the stock get reclassified?
HCV: It sounds like almost all of your analysis is based on fundamental analysis, is that accurate?
CF: We look at everything, but the core of what we do is definitely centered around fundamental analysis.
HCV: It sounds like you are using the fundamentals to decide what to buy and then using technical analysis as a way to determine WHEN to buy. Am I interpreting that right?
CF: That’s a fair way of putting it. We try to be market agnostic in an informed way. We are driven mainly by the number of candidates that appear on our screens. That in turn forms our overall market opinion. If we see a huge list of stocks that meet our criteria which are pretty strict, it usually is a sign that the market is undervalued. Conversely, if we see very few names on our screens, it is likely that we are hitting a top or that a rally is losing its steam.
HCV: So in March 2009, I assume you were seeing lots of names on your bullish screens whereas right now, after six years of a bull market, I am guessing you aren’t seeing as many names on the list.
CF: That’s a great point. 2009 is a great example for us. We made it through 2008 alive, and in the early part of 2009, it reminded me of the shift in 2002-2003 when there were so many stocks on our bullish list that it seemed like it was raining stocks. We re-ordered the entire book in early 2009 and became very long biased. It turned out to be our best year ever. Your example is a very good one and a very relevant one to us. Now, in markets that are rising, the average can sometimes mask a lot of damage underneath. But what we have found in the last run here is that there has been a lot of injected capital and liquidity looking for a home. There are still lots of names that meet our criteria, they just aren’t the best performing names at this time. The indices are a little top heavy right now. But there are value opportunities out there.
HCV: Is there a market environment that you feel the strategy is less effective or will underperform the overall market?
CF: Purely go-go markets where investors will pay anything for growth. Multiples don’t matter, cash flows don’t matter. The late 90s is the type of market where we are most likely to lag or the most difficult type of market for us. This year, where the averages are up modestly, as is volatility, we are having an excellent year, up low double digits year-to-date. We have gotten excellent performance from our long book, especially our core. While the market direction is up, there is an incredible amount of churn underneath it, and it is generating a lot of prospective names for us to invest in.
HCV: What does the typical construction of the portfolio look like?
CF: We are generally looking at 20-25 names in the long book. In the long portfolio we will have a higher concentration in our top five ideas or our core holdings and the rest would divided out pretty evenly among the other 15-20 names. And we do limit the exposure to one stock or idea to 15%. In the short book we typically carry 12-15 names in there with the average allocation being 1-3% on average.
HCV: If your screens are showing few names are meeting your criteria for going long, or the potential for a bearish swing in the market, would you increase the allocations to the bearish names?
CF: No, we would keep them in the 1-3% range, we would just add more names to increase the short exposure as a whole.
HCV: What do you see as the strengths of the strategy?
CF: It is non-correlated to the overall market because we tend to invest in lower beta stocks. These lower beta stocks tend to hold up better in a down market. I think another strength is that we are unique in the way we invest in the tech sector. Most tech funds are looking for growth stocks where we are looking for value stocks within the sector and that makes for a very unique portfolio.
HCV: What do you see as the weaknesses?
CF: Like I said before, we aren’t going to perform as well in a real go-go market. Lower beta stocks are not going to move up as much as high beta or growth-type stocks.
HCV: Are you more heavily invested in large cap names as the result of looking for stocks that have matured from the growth phase to the value phase?
CF: Originally we found most of our opportunities in the small-cap area. Over time, we were finding as many opportunities in the mid-cap and large-cap realms. Today the holdings could be from any of the three categories, but the majority are still in the small and mid-cap areas.
HCV: How often is the portfolio rolled over?
CF: On an annual basis it is probably right around 100%, but the breakdowns are very different. We roll over the short book far more frequently than the long book. Within the long book we have the core holdings and then we have the non-core holdings. The non-core holdings are rolled over more than the core holdings, but not as often as the short positions. So if you ordered them from most actively traded to least actively traded, it would be short book, non-core holdings then core holdings.
HCV: Charlie, we thank you for your time.