Mid-Cap value investment strategies often work in various market cycles. Mid-cap stocks are in the sweet spot of future large companies and companies which also get acquired by private equity buyers or by larger competitors.  24/7 Wall St. was recently given the opportunity to interview Jim Schier, portfolio manager for the SGI SMIDValue strategy, and SGI Small Cap Value strategy.

SGI is the institutional name under investment manager Rydex|SGI, which manages about $23 billion in assets under management.  The SGI Mid Cap Value strategy offers access to the same investment team, and while nearing capacity, is currently open to new investors.

On the retail side, Schier also manages an equally notable fund, Rydex Small Cap Value, which is open to new investors and recently attained a 3-year track record Rydex Small Cap Value Fund is rated 5-Stars by Morningstar; the Rydex Mid-Cap Value Fund (SEVAX) is rated 4-stars.

The explanation behind “nearing capacity” is rather simple.  The strategy is currently about $3 billion at SGI. The trick is to avoid owning a fund that is too large compared to its investment targets.  Since the fund has roughly 85 holdings, it is conceivable that the fund could have a real impact down the road on a stock simply by getting in and out of positions or when inflows or if redemptions hit in the future. The fund generally holds 65 to 100 positions.

Schier likes to play his cards close to the vest as he does not like to give away his investment strategy to outside managers and he does not want shadow trading around his entrance and exits of positions.  That being said, Schier did note that three areas offering great opportunity are property and casualty (P&C) insurance and energy, with a surprise sector interest in companies with significant public market exposure in various industries.  The surprise is that in the age of austerity, many companies selling to and servicing the federal government expect caution in orders.

In the realm of property and casualty insurance, or P&C, Schier likes The Hannover Insurance Group Inc. (NYSE: THG).  Despite being down about 30% from its highs in the last year, this one trades at a wide discount to peers.  It also pays a 3.2% dividend for you income seekers out there.  Schier credited them by saying, “They are effective operators.  They are gaining market share and their underwriting results are usually above peers.”  A recent acquisition of Chaucer in the United Kingdom is something the Schier expects will only add to earnings and profitability ahead.

Schier is incredibly bullish on parts of the energy patch.  While he said that there are many attractive outfits, he often finds that investors jump in and out of these in too close of an association with the price of crude.  His note should be music to oil patch investors’ ears: “You just don’t see much more global production and these oil shale plays today sometimes offer 50% to 70% return on investment.”  Schier further said, “The reinvestment opportunity is huge for this group.”  His picks in this arena: SandRidge Energy, Inc. (NYSE: SD) and Gulfport Energy Corp. (NASDAQ: GPOR).  Both stocks are down considerably from recent highs and each have asset values that fall into the small to mid-cap ranges.

The surprise of companies servicing Uncle Sam and other governments comes in technology services. Schier noted a brain drain happening inside the government that forces them to contract in technology and IT-services.  In this realm, Schier likes Computer Sciences Corporation (NYSE: CSC) due to its deep value.  This is one that we have our own experience in as it always shows up as a value pick but it has failed to post great gains for its shareholders.  Schier noted, “CSC strikes us as intriguing since many of the government workers will have to be replaced or assisted, and it is deep into various IT infrastructure projects, NSA pacts, cyber security, healthcare and more. The free cash flow is over $4 a share easily and it is not a leveraged company.” 

Before we got to some Schier’s key picks, we asked what the biggest driving force is in identifying value for Securities Global Investors clients.  This is crucial, because many investors use different metrics from book value, P/E ratios, return on equity, and a dozen other metrics. Schier’s approach is to evaluate the risk-reward with a market regression via pre-tax return on invested capital.  The goal is find growth and reinvestment that ends up with a debt-adjusted price-to-book value at a discount to peers.  He noted, “We look for companies that have the potential to earn higher return on invested capital. If purchased appropriately, valuations will expand disproportionately as profitability improves.”

Our biggest concern is the same that is voiced by our readers: Very choppy markets and an uncertainty of growth versus recession ahead.  Our own take is that this value segment is more likely than not expected to become the more desired trend rather than chasing high-beta growth stocks at high multiples with high expectations on growth figures.

On this topic, Schier noted, “Value versus growth is somewhat of a contrived notion and it makes no sense to buy without caring about growth just like it makes no sense to buy a growth company without caring how much you are paying.  Sure, you can find great growth stocks but we take a conservative approach and we look for companies that are not too aggressively priced.”

Schier also gave some interesting macroeconomic evaluations of the economy today.  He noted, “In a market of cheap stocks, the world is awash in excess capacity as there is not enough end demand and generally too much competition.  This makes it hard to grow a company, and the valuation for many growth stocks is often masked.”   

A second notion brought up is another troubling issue for investors and for the economy.  Investors are worrying that profitability levels today might not see higher levels of profitability ahead.  The concern of many is that profit expansion is hard to easily find at the right value and this is pressuring valuations.

One last concern is another obvious one but an issue that requires talent to navigate through.  With incredibly low interest rates like we are seeing today, the reinvestment opportunities are often low.  Schier ended with a quote that growth investors might want to consider before chasing high-beta names, “If companies were awash with 12% reinvestment rates then interest rates (and valuations) would be much higher.”   

We would like to thank Jim Schier for his time and opinions.

JON C. OGG

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