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Fairponte Capital’s Thyra Zerhusen

Q&A: Thyra Zerhusen

Fairpointe Capital’s Thyra Zerhusen on why mid-cap companies are an active manager’s sweet spot.

Mid-capitalization stocks are often a forgotten asset, dwarfed in attention by large-cap and small-cap equities.

But Thyra Zerhusen, CEO and Chief Investment Officer of $5 billion Fairpointe Capital, is all about mid-caps. And the AMG Managers Fairpointe Mid Cap Fund (CHTTX) that she manages has beaten the average return of Morningstar’s mid-cap value funds over the one-, five- and 10-year periods ended Sept. 20. The fund produced an annualized return of 12.9 percent during the five-year period.

She prefers mid-cap stocks over large-cap stocks, because the former afford more access to management, higher growth rates and more attractive valuations. And Zerhusen favors mid-cap over small-cap, because the mid-cap sector is less risky, has more experienced management and better liquidity.

She discussed these and other issues in a recent interview with What’s the appeal of investing in mid-cap stocks?

Thyra Zerhusen: First, we have access to management. With IBM, it’s difficult to get an hour or more of time from top management. We often get a lot more than that with founders and CEOs, and they often come to our offices. 

Every time we buy a stock, we at least have a conference call and usually meet with top management. We can learn a lot about management by observing how they answer questions in a two-hour meeting. We sat across from the CEO of Nvidia after a substantial rise in its stock, which we held, and thought afterward that we must keep it rather than take our gains. The stock has soared since then, contributing to a seven-fold gain over 4 ½ years.

In addition, mid-cap stocks have higher growth rates than large-cap. They also have more attractive valuations, less coverage by Wall Street analysts and are frequently takeover stocks. There are more mid-cap stocks that are acquisition targets than large-cap. Large-cap stocks are more efficiently priced, but there are more opportunities in mid-cap stocks. 

WM: What are the advantages of mid-cap stocks over small-cap?

TZ: Mid-cap companies already have moved through the small-cap space, so they are less risky. Mid-caps have more experienced, professional management.

As a portfolio manager, you can get away with using less names. With small-cap, you would need maybe 100 or so stocks [for a diversified portfolio], while we get away with 50. Liquidity is better for executing trades in mid-caps. Mid-cap growth rates are comparable to small-cap, but mid-cap stocks often have lower valuations. 

Mid-caps have better access to capital, so their financial resources may be greater. It’s more efficient for companies to execute takeovers of mid-cap companies than small-cap. It takes the same amount of time, and you’re getting a bigger bang for your buck.

WM: What are the most important elements of your investment philosophy?

TZ: One is to pick stocks when valuations are attractive. In some cases, we have stocks we want to buy, but valuations aren’t quite right. One thing we look at is price-revenue ratios compared to a company’s own history and to its competitors. We like companies with good balance sheets. We don’t like too much debt. We also focus on companies with strong or improving ESG (environmental, social and governance) practices. We believe they impact a company’s sustainability and long-term success.

WM: Do you consider yourself a contrarian?

TZ: Yes, we like to buy when others can’t stand the heat or are too short-term oriented. When we buy, we look at one year from now. We are patient not to dump a good stock.

WM: It sounds like you have a concentration of positions too.

TZ: We like to keep our portfolio to no more than 50 companies. That way we don’t lose track of what we own and can manage a lot of money with those 50 stocks. It’s enough for diversity, and you tend to know them.

WM: Has your investment philosophy changed over the years?

TZ: Not at all. I try to learn from past mistakes, and I’m sure not totally successful at that. We also make new mistakes. There have been a lot of secular changes in industries so we always try to take that into account.

WM: Where are the most interesting investment opportunities now?

TZ: One name that’s quite undervalued is Mattel, and it’s very frustrating because it has been getting more undervalued in the last few months. There’s a new CEO, and we had a call with management. Its price-to-revenue is quite low compared to its own history of the last five years. And its price-to-book is comparable to the last five years.

Toys “R” Us is obviously having problems, but you can buy Mattel’s products at Amazon and others. If you have patience, it should work out. If they don’t get their house in order, they can split up, or someone can buy the whole thing. There’s a lot they can do to improve. We have added Mattel to our positions.

WM: What advice do you have for financial advisors when it comes to investing?

TZ: Don’t be so short-term oriented. That actually goes for advisors’ customers too. Sometimes a stock is down and out, and it’s difficult to take a long-term perspective. Advisors have to explain patience to their client. Advisors should have investments in what they recommend. We do.

WM: What are the biggest changes you’ve seen in the investment business during your 41-year career?

TZ: I’m flabbergasted by all the changes in industries. I’ve liked newspapers, and it’s fun to follow what’s happening in the media industry—entertainment and TV broadcasting for example. There’s been a technological revolution: there’s so much data available. When I entered the business, it came on a teletype. Now there’s so much more data available electronically.

WM: What kind of changes do you see ahead?

TZ: There’s been a change to passive investment with ETFs. But at some point, I think the pendulum will shift back. Perhaps it already is. We have long-term clients, and active management can make a difference in mid-cap stock.

That’s because we know well the companies we own. Some people say you can’t trust management, but we can see what they told us three years ago and how that compares to what we know now. I think I can trust management for the stocks we have.

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