Andrew Parkinson, president and chief operating officer of Vancouver-based Van Arbor Asset Management Ltd., has an unusual strategy for enhancing returns: Identify high quality, low volatility stocks and then leverage the portfolio for extra juice.
Leverage -- which magnifies returns in up markets and enlarges losses in down markets -- is the use of borrowed money to enable investors to gain additional exposure to the underlying holdings. At Van Arbor, Parkinson typically maintains leverage in a range of 25% to as high as 50% of portfolio value. "Leverage is sometimes viewed as risky, but we view it as an advantage, as we expect that high-quality companies will do relatively better in all types of markets," he says.
Parkinson's theory is that because markets have historically gone up over time, leverage should work in investors' favour, particularly when the firm is employing quantitative techniques to identify superior stocks. "We buy boring, stodgy companies and enhance our return through leverage," he says.
Van Arbor introduced two funds in May 2004 --Van Arbor Canadian Advantage andVan Arbor US Advantage. For the five months ended Oct. 31, the $1.3-million Canadian Advantage fund showed a gain of 12%, well above the median return of 5.3% for the Canadian Equity (Pure) category. The slightly larger $1.7-million US Advantage fund hasn't fared so well, losing 13.2%, compared with the median loss of 9.7% for the U.S. Equity category.
The funds are sold by offering memorandum, which means they require higher minimum investments than ordinary mutual funds; it is also what allows them to employ leverage. However, the funds avoid other "alternative strategies" such as short selling.
Parkinson, who was president and compliance manager at Vancouver-based Cundill Investment Research Ltd. from 1998 to 2000, developed and back-tested Van Arbor's stock-picking model for two years before he and his partners launched Van Arbor funds.
For Canadian stocks, he requires a minimum market capitalization of $500 million, and for U.S. stocks the threshold is US$3 billion. Canadian stocks must be priced at $5 or higher at the time of purchase, while U.S. stocks must be trading at US$10 or more. Canadian stocks must have a five-year trading history, while U.S. stocks must have 10 years.
Parkinson examines corporate behaviour over both short and long time periods to make sure that growth in earnings and dividends, as well as stock price appreciation, are achieved consistently rather than in a "whipsaw" fashion.
He keeps a list of the top 100 stocks identified by his model in both the Canadian and U.S. markets, limiting his portfolios to the top 20 stocks in each market. He makes changes as stocks rise or fall on the ratings ladder, but always stays invested in the top 20 stocks.
Stocks start out at about 5% of the portfolio's assets, and are trimmed on a monthly basis if price changes take them to more than 8%. Conversely, more shares are added in any company that drops to less than 5% of fund assets, providing the company has maintained its place on the top 20 list.
Parkinson estimates the Van Arbor's portfolio turnover will be about 25% a year. Since the funds were launched in May, only two companies have been changed in each of the Canadian and U.S. portfolios.
"We stick to our guns and don't let our feelings about a company get in the way," he says. "The worse thing you can do is chop and change and second guess. The concept of liking a company is gone, it's a matter of mathematics and discipline.''
Mathematics has always been Parkinson's strong suit. After graduating from the University of Calgary in 1977 with a bachelor of education, he taught math at the high school level in rural Alberta while playing the options market in his spare time.
He left teaching to do some travelling, ending up in London where he completed an MBA at Cass Business School in 1982. He worked for the London International Futures Exchange and the Hill Samuel merchant bank in the U.K., later transferring to Australia.
He moved to Vancouver in 1988, working for the British Columbia Securities Commission as a policy advisor, later becoming a consultant to the securities industry. He was hired at Cundill in 1998, where he stayed until 2002. After leaving Cundill, he immersed himself in developing the quantitative stock selection model for Van Arbor, believing that human emotion is flawed when it comes to investment decisions.
