When Eddy Elfenbein earned his MBA from the University of Connecticut in 1994, he knew he was interested in investing but wasn’t sure he would work as a professional manager. He worked several years in finance before getting into the newsletter business, starting out writing about microcaps. He would go on to author numerous financial newsletters and work as a financial consultant before striking out on his own in 2005 with his “Crossing Wall Street” blog.
In December 2015 he began publishing a “buy” list of 20 stocks he was investing in and would track their performance. The concept was to buy those 20 stocks and hold them for an entire year. He only would replace a stock in the case of a buyout or merger and track it as one portfolio.
“I like very solid companies with long histories of consistent performance as far as earnings, low debt and rising sales,” Elfenbein says. “I like companies with strong positions within their perspective markets.”
It was a way to add value to his blog and newsletter by standing behind his recommendations. He chooses stocks on fundamentals and the portfolio is broadly diversified consisting of mainly large-cap stocks, but will include some mid-cap and small-cap stocks if there is a compelling bargain.
“I really don’t have any hard and fast rules; my theme is to be broadly diversified. [For instance]I am not going to worry [that] right now I don’t have any energy stocks; it is not a macro call on energy. In December I chose five stocks and didn’t see any in energy that jumped out at me.”
He looks for financially sound companies with a consistent operating history, growing sales and earnings with a strong market position. By that he means, a company like retailer Ross Stores (ROST). “They have developed a way to be Amazon proof. They have a good understanding of their market. The people who go to Ross Stores are not likely to go to Amazon,” he says. “They have carved out a specific position within the market that is well-defined and well-defended.”
Each December he replaces only a quarter of the buy list, so these are extremely long-term plays.
“I sell for one of two reasons: The value soared beyond what is a reasonable value or the investment thesis has changed for some reason,” Elfenbein says. “The stock is no longer the one I bought.”
The process is continuous; as soon as the portfolio is set he will look at the best to add for the following year, or he will add a stock mid-year if there is an event that causes him to do so.
“Each stock averages a four-year holding period, so it has a very low turnover. That is one of the best ways to go about investing; get solid companies and stick with them for a long run track record,” he says.
Elfenbein has kept this up basically unchanged for 10 years and has outperformed the S&P 500 during that period (see “Building a record,” below), which has caused some of his readers and some of the subscribers — 2,000 strong — of his weekly newsletter to ask him to go pro.
“A lot of people enjoyed the newsletter and the blog and [followed me on] Twitter. They liked reading about the buy list but said, ‘that’s a lot to invest in 20 stocks, do you have a product?’ And I said, ‘no,’” Elfenbein says, “But I had enough people ask that I realized that maybe this is something worth pursuing.”
He knew some folks at AdvisorShares and earlier this year began informal discussions about building a product from the buy list. “I was really impressed with them. We polled my readers and got a pretty good response, and we said let’s go ahead with this. It’s completely grassroots. I don’t know if this has ever been done through finance like this.”
Elfenbein worked well with AdvisorShares founder and CEO Noah Hamman, who immediately saw value in the buy list and Elfenbein’s loyal followers.
Advisor shares focuses on active managers, large firms and small firms, and in some cases — individuals like Elfenbein, for example — simply stock pickers.
“Eddy is a great example of that,” Hamman says. “Eddy has a unique following, mostly developed on line around his buy list. He is not a typical money manager but has done a good job with a very focused strategy, which we like.”
So much so that they will launch in late September the AdvisorShares Focused Equity ETF (ticker symbol CWS), based on Elfenbein’s buy list.
“He has a lot of flexibility in how he can select stocks. We wrote a prospectus that follows exactly what he has done historically, but it still gives him latitude to do what he [does best], which is pick stocks,” Hamman says. “He has an interesting following where there is a real demand for his strategy in the marketplace so it was a great combination for us to take someone who has demonstrated a good job at active management, and has demand.”
It also is in line with the AdvisorShares mandate. “We have tried to do things differently and be the first on things in the actively managed space,” Hamman says.
Another first for AdvisorShares will be offering an ETF with fulcrum fees, which adjusts the fee structure based on performance. There is a set fee and a range that can move higher or lower based on the ETF’s performance versus its benchmark (see “Fee schedule,” right). AdvisorShares will charge 75 basis points for CWS, but fees can range from 65 to 85 basis points based on performance.
Hamman says that fulcrum fees are widely used in the actively managed mutual fund space but have never been tried in an ETF. “We have been looking for an opportunity to apply this type of fee structure,” Hamman says. “It is appropriate for any actively managed strategy, but, one it is difficult to find a manager that outperforms; and two, if you have someone who can do it, having that incentive from a fee perspective is a great way to keep that portfolio manager motivated. He is motivated by a 15% potential increase in revenue, which depending on the size of the fund is measurable.”
Elfenbein does not look to track the S&P 500 but his buy list has been heavily correlated to it over its 10 years. “A lot of hedge funds don’t want to be correlated at all, they want to do the complete opposite and that can lead to trouble. I am not too worried about being overly correlated to the market in the short term,” Elfenbein says. “After a while, I will get some divergence.”
Hamman expects investors to be split 50/50 between institutional investors and retail unable to implement Elfenbein’s entire buy list on their own. “There are clients that have been following Eddy that we know are going to be using this strategy out of the gate — they can implement it themselves for free. But for those investors that want an easier way to do it, they can just buy the ticker symbol. And the strategy can be managed far more tax efficiently in the fund that in a separate account.”
Hamman understands the tendency for passive investments to outperform active managers but is always looking for that diamond in the rough.
“I am in that camp that if you can find the one out of five who has some talent that outperforms the indexes, you rally around it. That is hard to do and very few people can do that,” Hamman says. “Can he do that? I don’t know; he has had relatively consistent outperformance.”
Elfenbein is satisfied with the simple approach he takes and has not been tempted to try and optimize his strategy over the last decade. “I wanted to tell people, yes you can beat the market, it’s not overly complicated,” he says. “And I wanted to make sure to go out of my way to make a list and not have a million names or look for bizarre small-cap companies; just focus on a list — not a lot just 20. It can be done. It was just a theoretical exercise, but you can beat the market by having a little patience and a little discipline.”
Hamman knows that there is an added cost in creating a structured product, but says, “Ultimately the question of who wants this is the person looking for the manager, the person who wants to invest in a manager who is willing to make those concentrated bets and who also can deliver. He has to deliver or nobody will want it; that is the reality of active management.”