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Former Baron Manager Shares Buys and Sells

Mitch Rubin tells us what he has changed and what is the same from his Baron days.

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We recently interviewed Mitch Rubin and Conrad van Tienhoven, who run RiverPark Small Cap Growth (RPSFX). Rubin also runs RiverPark Large Growth (RPXFX) and the exchange-traded fund version of it--RP Growth (RPX). You may recall Rubin from his days at Baron, where he ran Baron iOpportunity and comanaged  Baron Growth (BGRFX). He established a strong track record there, so you've got a little more to go on than with most new funds. Van Tienhoven is also a Baron alumnus, as he served as an analyst there.

Q. You have a fairly small team to run the funds. Why is that?

A. At RiverPark, we firmly believe that portfolio managers must also be the lead analysts on the stocks they own. At Baron, we believed our best years of performance were when we had a small team that constantly debated and visited our companies together. We have watched as many firms have grown large staffs of midlevel analysts and, in many cases, the portfolio managers have become managers of analysts instead of portfolio positions.

To enhance our research, we have created two new positions: one specifically around financial modeling and one for qualitative due diligence. We have a rigorous modeling process, and it is an imperative that we build our own models to study the companies we own as well as their customers and competitors to gain a full understanding of a company within an industry. We also believe that understanding the backgrounds of the key executives at our companies as well as how they and their firms are perceived by their customers, competitors, and communities is key to understanding the direction in which the firm is heading.

In addition, because RiverPark has three other portfolio-management teams that are subadvisors to our other funds--namely the Wedgewood team (that has a 19-plus-year record of researching and investing in a focused portfolio of large-cap growth stocks); the Cohanzick team (that has a 15-plus-year record of fixed-income/high-yield credit research); and the Gravity team (a value-focused investment firm whose principal worked as an analyst for us at Baron several years ago and then became a comanager at Davis Funds)--we believe that we have the infrastructure and support of a large, integrated firm while retaining the passion and attention to detail of a small, focused team.

Q. You have limited the small-cap fund to stocks with market caps below $2.5 billion. At what point does a stock's market cap become so large that you will sell it?

A. Our small-cap fund will always be a small-cap fund, and you will always find it in Morningstar's small-cap growth style box. We will only allow up to 10% of the portfolio to be invested in stocks with market caps above $2.5 billion, and stocks whose market cap appreciates to in excess of $5 billion will be sold, thus insuring that the fund will remain within the small-cap category regardless of market appreciation. We firmly believe that small-cap funds should own small-cap stocks, even if we believe that a stock whose market cap has grown beyond our range still represents a compelling investment. This is precisely why we have launched the RiverPark Large Growth Fund to be able to continue to invest in graduates of the small-cap fund.

Q. Are there other ways that your strategy today diverges from how you invested at Baron?

A. Our research process and investment strategy at RiverPark is, in many ways, a continuation of the process and strategy that Baron, with our assistance, developed in the 1990s. We continue to believe that Baron paved the way for an exciting new way to invest in small-cap growth stocks. We are, first and foremost, bottoms-up stock-pickers with a focus on companies with substantial, long-term growth opportunities. We pride ourselves on being long-term investors in these secular growth businesses and not short-term traders of stocks. As we did at Baron, we believe that one of our core strategic differences with other investors is that we study businesses with a time frame that is substantially longer than other investors as we focus on the company's prospects over the next three to five years rather than the company's stock's prospects over the next three to five days or weeks or months.

That being said, our strategy diverges from Baron in a number of key ways. First, we embrace technology companies and do not seek to limit our technology exposure only to the users and beneficiaries of technology as we did at Baron. As an emerging firm (albeit with an experienced portfolio-management team), we do not have the burden of investing many billions of dollars in small-cap stocks and therefore we have the luxury of : (a) committing to keep our fund within the small-cap style box as we will not allow the fund to experience market-cap creep; (b) limiting our ownership stake to under 5% of a firm's enterprise value, thus insuring ample liquidity to execute a rigid sell discipline; and (c) to closing our funds in order to preserve our ability to continue to invest in smaller market-cap firms (under $500 million of market cap).

Q. Your most recent portfolio showed about 15% of assets were in cash. Is that just a reflection of starting up and getting invested or is that likely to be a more common feature?

A. The 15% cash position was an anomaly, as the cash included a sizable investment in the fund but did not include (because of T+1 accounting) the investment of the new cash on the same day or the purchases that the fund made in the following days. As a general rule, we intend for the fund to hold frictional cash positions of 0-7% at most times. We believe having a slightly higher than normal cash balance gives us the flexibility to make opportunistic purchases in volatile market environments. On only rare occasions would we expect our cash position to be in excess of 10% of the fund.

Q. What trends are you investing in today?

A. We generally direct our company-specific research toward a handful of high-conviction secular trends and themes that the companies we are researching can take advantage of. For those of you that remember us from our Baron days, these are our sunrise industries. These trends are powerful and ongoing, and they encompass such concepts, among others, as an increasingly mobile society; the explosive growth of Internet usage for media, commerce, and communication; the globalization of financial markets; the growth of electronic payments; alternative energy; health-care information technology and advanced devices; cloud computing; and the aging of the Baby Boomers.

 

Q. Small caps have had a long run of outperformance versus large. Do you think the run is over?

A. While we recognize the outperformance of small caps versus larger companies of late, we do not believe that the run is over. We believe that many small companies have had substantially greater organic revenue growth than larger companies. Smaller companies have also been able to more nimbly navigate the financial and global crises of the last several years. In addition, we believe that the wave of mergers-and-acquisition activity of smaller firms will continue in an environment of low interest rates and cash-rich larger companies in search of growth and product expansion.

More importantly, however, we note that in a market that consists of thousands of small-cap stocks, we run a relatively concentrated portfolio of 40-60 positions. Therefore, we need only identify a small subset of the small-cap universe as attractive holdings for our fund. Whether small caps continue their run or not, we are able to focus our research on those companies that meet our criteria of substantial, organic revenue growth; high returns on capital; strong balance sheets; committed and entrepreneurial management teams; competitive barriers to entry; and large market opportunities. We have a working list of several hundred small-cap stocks being considered for investment and believe that valuations for many of these firms remain extremely compelling despite the recent outperformance of small-cap stocks in general.

Q. Could you provide a name of a stock in the portfolio and why you bought it?

A. One of our larger holdings is The Home Shopping Network (HSNI), or HSN. This is not the investment that most people think about as they reflect on the TV show of 20 years ago. HSN is now a hybrid business that presents products to consumers through TV shows, catalogs, and websites. We believe this combination of sales channels along with an energized and highly competent management team makes HSN well-positioned to take advantage of shifting consumer buying patterns as media, commerce, and communication continue to converge.

HSN essentially created the television retail industry more than 30 years ago and currently reaches more than 90 million homes. In addition, a quarter million unique users visit the company's website, HSN.com, every day--making it a top-10 most trafficked e-commerce website and a top-30 Internet retailer by sales. The company also owns and operates popular catalog-based businesses including Frontgate, Ballard Design, and Garnet Hill (among others).

After going through multiple leadership changes over the years and long underperforming industry leader QVC, HSN has had a rebirth and a reinvigoration of growth since being spun out from Barry Diller's IAC under new CEO Mindy Grossman. Ms. Grossman joined HSN in late 2006 and has been focused on turning around the business with a greater emphasis on fashion and programming to capture the motivated female shopper. Ms. Grossman formerly ran Nike's apparel business and is credited with turning their operations around and delivering robust growth.

Since joining the company, she and her new management team have revamped marketing, constructed new TV sets, refreshed their website, and completely overhauled the company's merchant lineup. In addition, they have turned the company's catalog division around from a drag on profits and growth to a strong contributor to both. With the catalog business now on a profitable growth path and HSN's sales results now outpacing the retail industry (with improving margins), we believe that HSN is poised for very strong performance in the years to come.

Q. What about a name you sold and why?

A. We have had three significant sales, among others, of late. Over the last few weeks we have sold out of two of our long-term holdings in the data-center industry-- Equinix (EQIX) and Terremark (TMRK). We have long been investors in this industry as we believe that the combination of the recurring revenue and asset base of a real estate provider with the long-term growth curve of exploding digital data traffic and cloud computing presented a unique opportunity to invest in a sector that, in our opinion, was misunderstood by both traditional real estate and traditional technology sector investors. Terremark is a smaller and more services-focused firm, while Equinix is larger and more focused on real estate and colocation services.  Verizon (VZ) recently announced an all-cash bid for Terremark, and we took advantage of that move to sell our position, as we do not expect other bidders to emerge at a premium to the Verizon offer. With respect to Equinix, the stock has recovered all of its decline since we were able to opportunistically make purchases following a disappointing 3Q10 earnings report, and it is now trading close to our $5 billion market cap upper limit for holdings in our fund.

In addition, we recently sold our position in online retailing logistics provider  GSI Commerce (GSIC). Although we continue to believe that GSI has substantial growth opportunities in providing online fulfillment services for brands and retailers, our ongoing due diligence has led us to conclude that GSI's technology investment and website development and innovation have not kept pace with the evolution of the industry and that there is, as a result, a risk to the company not fulfilling its potential. Given this conclusion, we prefer to monitor the company as an interested researcher rather than as a shareholder for the time being.

Q. When a holding in your portfolio misses Street estimates, how do you respond?

A. We pride ourselves on being research-intensive and high-conviction investors. In this way, we generally do not expect our investment thesis to be altered by a given quarter's earnings report or by any given analyst's reaction thereto. That being said, our response in situations where a quarterly report is below Street expectations is always dictated by the reason for the "miss" and how the new report impacts our long-term financial model for and our projected valuation of the company.

In many instances, especially with respect to small, high-growth companies, management must choose in any given period between the opportunity to increase an investment in the company's growth (inventory, research and development, new employees, infrastructure) with meeting the market's expectation for earnings. The market has become increasingly focused on short-term expectations, and the near-term stock reaction to an earnings miss can be substantial but, in many cases, can also be short-lived. Our goal is to analyze the data in the context of our long-term expectations for the company. In addition, we will generally look for the opportunity to visit with or, at the least, discuss with the management team the reasons for the miss as soon as possible to gauge the impact on our long-term expectations.

It is often the case that we are both comfortable with the reason for the miss and fully supportive of management's willingness to take advantage of long-term opportunities against short-term stock price disruption. In these cases, we have often used these misses to opportunistically increase our holdings. Recent examples would include Immunocor, Accretive Health (AH), and Equinix that all had quarterly reports that disappointed the Street but gave us the opportunity to add to our holdings at compelling valuations. In other cases, if the report does indicate a breakdown in our long-term thesis for the investment, then it is our goal to exit the position even though our research of the company will inevitably continue.

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Russel Kinnel does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.