“Our equity strategies continue to be driven by our core belief that competitively advantaged companies will outperform their peers through economic cycles and market cycles.” --Mark Hillman
Mark Hillman (Trades, Portfolio) goes through a series of quantitative and qualitative screens to identify strong companies with sustainable competitive advantages and a price that offers a margin of safety.
It is a strategy that served Hillman and his mutual fund very well in the first five years, from 1999 through 2004. Since then, the performance road has been bumpier.
In this article, we examine Hillman and his investing strategy more closely, as well as reasons for the fund’s previous success and current challenges.
Who is Hillman?
Hillman is the principal owner, president and chief investment officer of Hillman Capital Management.
He graduated from Tufts University with a Bachelor of Arts degree in economics in 1986. Hillman Capital was his third financial startup in the 1990s.
In addition, he launched Hillman Capital Management Investment Trust in 2000 after setting up two mutual funds, Hillman Focused Advantage (HCMAX) and Hillman Advantage (HCMTX).
Hillman has been a professional investment manager for more than two decades and has a history of making his own way in a crowded industry.
What is Hillman Capital Management?
In its Form ADV Part 2A, the firm describes itself as providing discretionary and non-discretionary investment advisory services to separately managed accounts, a mutual fund and a private fund. It is based in Bethesda, Maryland.
The Hillman Focused Advantage Fund is now known simply as the Hillman Fund, while continuing to use the symbol HCMAX. This is the only fund available to non-client investors.
The firm offers other funds, including the Hillman Advantage, through separate accounts and the private fund.
In its 13F form for the first quarter of 2017, Hillman reported the firm had 106 clients, made up mainly of high net worth individuals and other individuals. It also reported having $88.352 million under management.
Hillman operates a relatively small firm, one made up of various components, as he serves individuals and high net worth individuals as well as some institutional clients.
The Hillman investing strategy
Hillman Capital Management's slogan is: Uncommon foresight.
It is an approach to investing the firm develops in more detail on its website. More specifically, for individual investors, it promises four benefits:
- The comfort of investing in strong companies.
- An easily understood investment process.
- Protection through powerful risk mitigation.
- Expanding investors' portfolio strategy beyond what it calls "conventional wisdom."
For the firm's sole mutual fund, the prospectus states the fund invests mainly in common stocks of American companies that have both qualitative and quantitative competitive advantages. These stocks have "fallen out of favor" temporarily, for non-recurring or short-term reasons. Alternatively, they might be companies whose value is not widely known or recognized by the public.
The first step in finding these companies involves a quantitative screening for:
- Industry dominance or niche market.
- The style and adaptability of management.
- Pricing and purchasing power.
- Barriers to industry competition.
- Strength of brand/franchise and brand loyalty.
- The quality of its products and services.
With this smaller universe of candidates, Hillman next determines which of them show superior growth prospects. And, these short-listed stocks then undergo qualitative screening for measures that include:
- Price-book ratio.
- Present value of discounted project cash flows.
- Strength of the balance sheet.
- Price-sales ratio.
- Price-earnings ratio.
Each stock purchased receives a target allocation in the fund.
As for sectors, the rule of thumb is to have no more than 25% in any one sector, but in some circumstances they will go beyond that limit.
Hillman sells an individual stock when he believes it is overvalued or when he needs to rebalance it to get it back to its targeted allocation.
In addition to buying and selling stocks, the fund sometimes sells call options on those stocks, and sometimes sells cash-covered put options. Each of these tactics can generate additional income for the fund and help reduce risk. In its semi-annual report for the six months ended March 31, the fund reports a net realized gain from options of $448,670 (compare with dividend income of $319,075).
On his website, Hillman says he believes their analysis discovers companies that are well positioned and whose stock is undervalued by the market. He adds, “Although no one can predict the future, we feel this approach has proven to be remarkably prescient over time."
Hillman has developed a robust screening process that helps him find strong companies with competitive advantages and a price that provides a margin of safety. The screening process has two levels: quantitative, to identify the competitively advantaged companies; and qualitative, to assess these companies according to key fundamental measures.
Current holdings
As this Morningstar chart shows, consumer cyclical stocks predominate, at just over 25%, in the Hillman Fund:
The firm reports the following as its top 10 holdings as of June 30; note the first listing is cash parked in a money market fund:
After the money market fund, the next largest holding is an interesting one. The ProShares Short 20+ Year Treasury (TBF, Financial) is described by its managers as “The investment seeks daily investment results, before fees and expenses, that correspond to the inverse (-1x) of the daily performance of the ICE U.S. Treasury 20+ Year Bond Index.”
In other words, the ProShares Short is a vehicle for shorting (inverse) this bond index; while holding this position, Hillman is betting bond yields will decline. These daily funds are tricky to hold; assuming Hillman has met his goals with the ProShares, he has been an effective manager.
After getting past the first two holdings, three of the remaining eight are financial stocks, which puts Hillman in an advantageous position if financial stocks do thrive under a looser interest rate regime. With Bristol-Myers Squibb Co. (BMY, Financial), a pharmaceutical and nutritional company, it is well positioned to profit from aging populations in much of the developed world.
Hillman’s performance
The Focus Fund has had a back and forth relationship with the S&P 500 over the past decade, sometimes leading and sometimes lagging:
In earlier years of the Fund’s history, though, it stayed solidly ahead of the S&P:
Particularly noteworthy is Hillman’s performance in 1999 and 2003, posting returns of more than 50% in each of those years. His fund fell well behind the S&P in 2007 and 2008, however. The following GuruFocus chart shows the fund’s history only through 2014, but that is enough to reveal assets under management dropped off dramatically, from a high of $1.223 billion at the end of 2007 (according to the 13F filed in February 2008):
Despite the big, early lead, Hillman today trails the S&P, as shown in this Morningstar chart to the end of the first quarter of 2017 (Hillman on the dark blue line, the Large Cap Value category in orange and the S&P in the green):
While the Hillman Fund fell behind the S&P, it has generally kept up with its category average (Large Cap Value funds).
As with many other gurus, it seems to pay to get in while a fund is young and to stay away from value funds when the market gets and stays bullish. Certainly, investors who put their money into the fund (or its predecessors) in its early days were well rewarded.
Conclusion
Hillman has a well articulated strategy for value investing. As seen, that strategy worked very well for the first five years of the fund’s existence. Since 2005, the fund has had trouble consistently staying ahead of the S&P 500, the broad benchmark for most fund managers.
Although there is no annual commentary which might help us understand this shift, we can make some educated guesses. First, 1999 is the year before the dot-com crash. It seems likely he avoided the tech stocks that took significant beatings in the crash. As the market recovered from the crash, value stock pickers had innumerable opportunities to get into strong companies at favorable prices.
Hillman was not so fortunate when the housing bubble popped. His fund lost more than the S&P 500; and while his performance afterward was good, it lagged the S&P by an average of more than 1.3% per year. Presumably, he, like many other value stock pickers, has fought a rising tide of higher valuations. Market-wide higher valuations make success more challenging for value investors.
Still, despite all that, no one who invested with Hillman for the long-term has lost money. Even on five- and 10-year cumulatives, Hillman has provided returns that beat inflation by a good margin.
Disclosure: I do not own stock in any of the companies listed in this article, and I do not expect to buy any in the next 72 hours.
