Essential Investment Partners, LLC

Essential Investment Partners uses open end mutual funds in most client portfolios for any of four reasons:

• as the primary mechanism for investing in small cap companies and for investing internationally. We believe mutual funds are the best way to achieve the style, strategy, diversification and liquidity benefits we like in making investments in these areas.
• as a supplement to individual stock investments we make for clients to obtain exposure to different investing styles or investment sectors than are represented in the Essential Growth Portfolio℠.
• in smaller portfolios (less than $200k), we use mutual funds exclusively 
• for certain fixed income investments in order to provide diversification and liquidity

Searching for Consistency of Results 

Our approach can be summed up with one word: consistency. Just like our processes for investing in individual stocks, hedge funds and closed end funds, our mutual fund investment process focuses on finding investments that may deliver consistent results.  We have well-defined disciplines for following current and prospective fund investments each week against their competition and market indices and for reevaluating the fund universe each month as new data is available.   These disciplines focus on investing in funds that can deliver solid risk-adjusted returns in both good markets and bad. 

Scouring the Universe of Funds using Proprietary Analytical Tools

Our mutual funds selection process is based on proprietary analytical tools that use both quantitative and qualitative factors.  The process we follow takes a long term view of investment performance and related attributes.  We are searching for managers and products that we believe will best serve our clients needs for the long term. 

The quantitative screening process begins with the Morningstar database of information on more than 22,000 classes of mutual fund shares.  We do not use Morningstar’s proprietary rating system for funds.  Rather, we have developed a series of initial screens which reduces the raw database down to a manageable number.  For example, we screen out funds with high expenses, extraordinarily high volatility, poor performance records and other similar unattractive features. 

We then use a more technical, proprietary model to score this smaller group of funds based on a series of factors such as performance versus peers, risk-adjusted returns, and tax efficiency.  We weight these factors and calculate a weighted “score.” This process allows us to eliminate funds that have not produced consistent, risk-adjusted returns.  We then rank the funds and begin the process of examining the top ranked funds.  We always include funds our clients already own in this process so that we are constantly re-evaluating existing choices against possible alternatives. 

After this quantitative process is complete, the real work begins when we find potentially attractive new choices.  We review the fund prospectus and fund holdings to start assembling a more complete picture of the manager’s investment process.  We also review commentaries prepared by management and other materials to understand the investment process and other factors that may have a bearing on the attractiveness of the fund. 

The qualitative process is intended to identify and evaluate potential issues that may materialize such as: (1) large sector, industry or security bets; (2) unstable organizational structure at the fund sponsor; (3) concentrations of positive performance in short time periods; (4) significant cash flows into or out of the fund that may affect management; (4) regulatory problems; and (5) potential tax liabilities or benefits.

Our goal is to identify how the manager has achieved their track record of excess risk-adjusted returns and ascertain if the manager is likely to continue to produce excellent results. Once we are satisfied that a fund is a good investment prospect, we will put it on our list of funds to follow. The fund will be considered for inclusion in client portfolios where it might appropriately fit, in the context of the client objectives, our investment policy stance and pairing with other fund investments already in the portfolio.

Diligent Monitoring after Investment

As noted above, we continually re-evaluate existing fund holdings against other prospective choices.  We also monitor developments at the fund companies (ownership changes, portfolio manager changes, etc.) and communications from the fund companies to identify potential risks for our clients. We scour published commentaries to assess what the portfolio managers are thinking and make sure they are reasonable in the context of our outlook.  We also sit in on conference calls with portfolio managers so that we can ask questions and understand in greater detail the strategies they are currently utilizing.  All of these activities are further qualitative inputs into our continuous fund evaluation process.   

When Selling Becomes Necessary

Having spent this much time and effort on evaluating prospective fund investments, our intent is to hold each fund investment for a long period of time.  However, circumstances change and there are several events that could lead us to sell a fund and replace it including an unanticipated change to the portfolio management team, ownership change at the fund sponsor (such as a “cash out” sale), dramatic change in investment policy that is inconsistent with past practices or prolonged high cash holdings or other extreme investment choices.

Like individual stocks, our preferred holding period is forever.  So we search carefully before making a fund investment, in the hope that the manager and the strategy will serve our clients well over a long period of time.  However, our continuous evaluation process allows us to be prepared to replace a fund with another suitable alternative should circumstances change and action become necessary. 

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