The Art of Sausage Making

Upton Sinclair wrote his famous novel The Jungle to expose the wretchedly harsh living and working conditions of immigrants in America’s great industrial cities. Sinclair spent seven weeks during 1904 working incognito in Chicago meatpacking plants. His experiences provided him

an unvarnished look at the dark side of urban immigrant life. He hoped his novel published in 1906, would arouse the American public about the plight of immigrant workers and spark reform of working conditions. Instead the fickle American middle class focused on his disgusting descriptions of unsanitary meatpacking practices, stockyards compromised with diseased cattle, and the job accidents causing human flesh to be ground up along with animal parts.

Nothing was done to improve factory working conditions. President Teddy Roosevelt, however, supported passage of the Meat Inspection Act and the Pure Food and Drug Act which established the predecessor of the Food and Drug Administration, the FDA. Sinclair opposed the legislation because taxpayers, not the meatpackers and stockyards, would pay the estimated $30 million of annual inspection costs. He considered the legislation another government concession to Big Business. He later lamented, “I aimed at the public’s heart, and by accident I hit it in the stomach.” His statement supports the observation that hardly anyone really wants to see “how the sausage is made.”

We sometimes think the investment process is a bit like sausage making.

Somebody has to do it, but few people have any interest in knowing the details. Nevertheless, we think clients can benefit from knowing a little something about the process Patton Albertson & Miller uses to grind out investment returns.

First, our fiduciary responsibility to clients is paramount. We are a fee-only Registered Investment Advisor because that better aligns our incentives with client objectives. We have no incentive to push certain products, funds, or securities on clients, unlike the commission-based brokerage and insurance industry business models.

Client needs are the starting point for everything we do. We discuss with clients their goals and resources and that guides us in recommending the specific asset allocation for their unique situation. Once a client agrees to the investment objective by signing an Investment Policy Statement, the process of constructing their investment portfolio can begin.

Unlike some registered investment advisors which allow each portfolio manager to “do his own thing”, we believe that our clients should expect similar investment results, taking into account the investment objective, regardless of which portfolio manager handles their portfolios. How does Patton Albertson & Miller strive to accomplish that feat?

It starts with our Investment Committee which is charged with selecting securities for our Approved List. The committee comprises the three portfolio managers, Bill Miller, Keith Jaworski, and Ricky Supan plus our president, Jimmy Patton.

The committee usually meets monthly to review financial and economic developments and to consider additions or deletions to the Approved List. Our policy restricts investment to the Approved List of stocks, exchange traded funds (ETFs), and mutual funds. We handle individual bonds by requiring that all new purchases be of high credit quality i.e. investment grade. We also maintain a Hold List generally comprised of securities already owned before someone becomes a client or which arise from some form of corporate action, such as a spin-off. These securities may be held but not added to.

In determining which securities to place on the Approved List the portfolio management team uses a variety of research sources. It looks to BlackRock’s strategic analysis for help with overall asset allocation. BlackRock is the largest money manager on Earth and it has world class research capabilities, in our judgement. The team also evaluates the analyses of other major players in the financial sector such as Goldman Sachs, PIMCO, Fidelity, GMO, and JP Morgan.

The selection of individual stocks is the core of the process. As classic value investors Patton Albertson & Miller relies on research that emphasizes valuation and “margin of safety” as bulwarks for sound, conservative portfolio construction. The portfolio management team uses the in-depth research of Applied Financial Group (AFG), Morningstar, and Valuentum. It also taps a range of more specialized research to help in assessing the global equity market environment. Publications such as the High-Tech Strategist for technology, The Dines Letter for precious metals, the Casey Report for energy and materials, Richard Young’s Intelligence Report for quality dividend payers, and Global Monetary Trends for international stocks and currencies are among the many publications that bring insights to security selection. Many of the research sources also help in assessing the attractiveness of mutual funds and ETFs.

Fixed income (bonds) are important for most investment objectives. Patton Albertson & Miller avoids assuming much risk in bond portfolios because of the asymmetry of returns. In general, if events follow expectations, a bond pays a stream of coupon payments over its life and repays the original par amount at maturity. There is no likelihood of making a multiple of the initial investment (as can happen with a stock investment). Since the upside is limited, it seems prudent to avoid taking excessive credit risk. Credit risk is simply the risk that some or all of the principle might fail to be repaid.

The investment team constantly looks for investment opportunities in the stock, bond, and alternatives markets. It holds frequent meetings with mutual fund and ETF portfolio managers or their sales representatives. The investment industry is in a state of flux so it is vitally important that the investment team stays on top of new developments. The team evaluates many more opportunities than it actually selects for placement on the Approved List.

The investment team tries to view securities through the skeptical lens of value investing. Like a well run meatpacking plant, it wants to proudly say only the choicest USDA meat goes into the sausage.

Bill Miller, CFA

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