Active ETF Manager on Why He Loves Berkshire, Apple

David Rolfe is a seasoned investor but a new name to the mutual fund world. At St. Louis-based Wedgewood, Rolfe has helped to manage low-turnover, large-growth portfolios for 18 years. He's built a strong track record there and now runs recently launched RiverPark Wedgewood Fund (RWGFX) in that same style. The fund is available in both open-end and exchange-traded fund formats. The ETF is named RP Focused Large Cap Growth .

A low-turnover, large-growth strategy makes sense for an active ETF because there's enough liquidity for managers to finish a trade during the day before they have to post the portfolio at day's end. It does make for an interesting view of an actively managed fund, as you can see in daily portfolios here.

Q. What kind of companies are you looking for?

A. We endeavor to own the best of America. Such companies are best-in-class business franchise--double-digit growers, market-share takers, industry leaders, and cash-flow generating machines.

Q. How important is management?

A. Critical. True growth companies must have passionate, entrepreneurial management at the helm. A true long-term vision--and reinvesting capital for long-term growth--is sacrosanct.

Q. How do you go about assessing management?

A. We must answer the following questions affirmatively: Is management a good steward of shareholder capital? Does management exhibit entrepreneurial tendencies and attributes? Does management manage the business to please Wall Street first or to please patient "owner-shareholders" first? Does management admit mistakes early and forthrightly? Does management provide and communicate enough financial information in order for an investor to make an informed analysis of the company?

Q. How do you manage risk with a portfolio of just 20 stocks?

A. Risk mitigation permeates all elements of our philosophy, process, research, and portfolio management. We reduce company-specific risk by investing in seasoned businesses with the highest-quality balance sheets. We reduce management risk by investing in businesses with seasoned, deep management teams. We reduce macroeconomic risk by relying on management to navigate the economic trade winds of their respective industries. We reduce company-specific valuation risk by adhering to a disciplined, contrarian valuation construct. We reduce portfolio risk by both minimizing company business-model overlap, as well as not allowing any holding to represent more than 10% of our portfolio. We reduce client-portfolio risk by focusing on reducing the permanent loss of capital, rather than short-term quotational loss of capital. We reduce risk by muting the "institutional imperatives" that permeate active investment management: We are independently owned. Our jobs are secure. We have the rare luxury to think, act, and behave in a contrarian manner.

Q. Do you have limits on sector weightings?

A. Maximum 35% broad industry weighting. Maximum narrow industry weighting. Maximum 10% individual stock weighting.

Q. What is your competitive advantage?

A. Our competitive advantage is our singularly focused investment philosophy. Investing in large-cap growth companies is a rather efficient endeavor--but is not perfectly efficient. Furthermore, we gain a competitive advantage by analyzing businesses with a longer time frame than others. We focus on where a business will be three to five years from now, while other investors/traders focus on where the business will be next week, month, or quarter. We believe that by limiting our portfolio to just 20 to 22 intensely researched companies, concomitantly valued at compelling valuations, we capture the best elements of both growth investing and value investing. Relatedly, our focused philosophy as a growth investor, coupled with the discipline of a value investor, provides the foundation to potentially outperform in both up markets and down markets. Our 18-year audited track record of outperforming in both up and down markets continues to validate our differentiated, repeatable investment philosophy and investment process.

Q. With the benefit of daily portfolios we can see that you recently added Berkshire Hathaway. Why?

A. Short answer:  Berkshire Hathaway (BRK.A) (at current prices) is a terrific growth company at a compelling valuation.

Long answer: We have a long history as shareholders of Berkshire Hathaway from 1998 through 2010 (and a nearly 30-year history as students of Buffett and Munger). Since we first invested alongside Buffett, Buffett has proved to be a master capital allocator and master CEO along with his decades-long record as master investor. We sold our Berkshire holdings in early 2010 into the price spike when Berkshire was added to the S&P 500 Index and the Russell Indices. While our timing may have been "right" to sell, we were "wrong" in our assumption of how strong the earnings of the Berkshire Hathaway conglomerate would rebound out of the Great Recession. Buffett's $50 billion investments during the Great Recession are paying huge dividends (literally). In addition, we have come to the view that Buffett's acquisition of Burlington Northern was a masterstroke. Berkshire's unheralded status as a top-flight growth company continues apace. Net-net, one rarely gets the chance to buy Berkshire Hathaway so cheap.

Q. In the fourth quarter, you sold  Expeditors International of Washington  (EXPD). Why?

A. We sold, in our view, a poor risk/reward holding to buy an exceptional risk/reward in  Intuitive Surgical (ISRG). We had owned Expeditors continuously since early 2007. The company requires little fixed overhead and exhibits tremendous scale. Expeditors has a unique business model. Its net margin during 2009 was its highest in the last decade, yet they did not engage in any headcount reduction or reengineering. How many companies can say that, much less anything positive, about their respective 2009? That said, our philosophy imparts us to not overpay for businesses, regardless of how wonderful they might be. Valuation is one of the main tools we have to reduce risk in our focused portfolio. EXPD ended the year trading at over 35 times its enterprise value to free cash flow. While that is not the highest it has traded, it is certainly lofty on an absolute and relative basis. What actually drove the final decision to sell the stock was the fact that we identified another opportunity with a better long-term growth rate and cheaper historical, absolute, and relative valuations. Even though we only need one reason to sell, in reality, two components of our sell discipline were triggered with EXPD: 1) a superior opportunity and 2) lofty valuation.

Q. How do you add value with a name like  Apple (AAPL) that is so widely followed it would be difficult to find information not priced into the stock?

A. In our view, while Apple is certainly well known and well followed by the Street and the greater investment community, we still wholeheartedly believe that Apple is misunderstood. Let's remember that, in the latest quarter, Apple beat earnings expectations by over 20% (its 33rd-consecutive earnings beat), and as widely followed as Apple is, the sell-side analyst community, in the aggregate, were off by a margin of 9% of Apple's reported earnings. Specifically, we believe that the company's depth, breadth, scale, and scope of the company's competitive-moat, halo-effect, ecosystems, and platforms are both misunderstood and underappreciated as a once-in-a-generation driver of outsized profits and cash-flow generation. Apple is a generational technology-media-digital-consumer-enterprise-retailing-life-style economic moat of unprecedented proportions. (The company's average earnings growth over the past 16 quarters is an astounding 63%!) Cupertino is something extraordinary that rarely presents itself to the public, consumers ... and investors. Apple's revolutionary and evolutionary products and customer experience and satisfaction is global scope--and utterly transformational for the citizenry and society.

Steve Jobs has joined the pantheon of the great CEOs. Apple Inc. is continuingly defining (and redefining) this era's computing technology, mobile communication, media, entertainment, and retailing in both iconic and landmark terms. Apple continues to be our largest holding due to our strongly held opinion that the company possesses a unique global economic franchise that will allow for the continued execution and growth at a pace that belies its size, as well as consensus expectations. Furthermore, given the fact that the stock's valuation has barely kept pace with the company's underlying corporate growth over the recent past, and if the stock would just track the growth of earnings over the coming year (we expected plus-$24 per share), shareholders will be amply rewarded.

Q. If you reached the point where assets were so large that you couldn't finish a trade in one day, would you have to shut the fund?

A. Yes.

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