Formula Growth Limited
Formula Growth Limited (“FG”) is an independent investment firm established in Montreal in 1960 by pioneering growth stock investor, John Dobson (1928 – 2013). Dobson passionately believed great countries were built by encouraging entrepreneurial spirit, investing, and free enterprise.
Launched in 1960, the Formula Growth Fund represents one of Canada’s earliest mutual funds and one of the most successful long-standing mutual funds in the world. It has been creating wealth for high net worth individuals, family offices, and institutional investors for 53 years.
Formula Growth is well known for its successful track record of bottom-up growth stock investing with the original long-only product, the Formula Growth Fund (FGF). Today, in order to broaden its product offering and to better serve its clients, the firm offers a hedge fund platform comprising the following three products: FG Hedge Fund, FG Global Opportunities Fund, and FG Alpha Fund. These are some of the most successful hedge funds in the market today.
With offices in Montreal, New York, and Hong Kong, the firm’s team of 16 manages a portfolio of over $600 million in assets. One third of the company’s assets are in the original FGF, with the remainder allocated in the firm’s alternative investment strategies (hedge fund platform), ranking FG in the top 5 largest independent hedge fund investment firms in Canada. The firm also makes it a point to operate as a completely independent firm, being 100 per cent owned by its employees with no corporate affiliations. Just as importantly, approximately 10 percent of the funds’ assets are from corporate insiders, making FG a compelling case for new investors.
The Canadian Business Journal spoke with Randall Kelly, CPA, CFA, Chief Executive Officer and Co-Chief Investment Officer, about alternative investing, about how the firm accrued a solid track record, and what skills, strategies and tactics created the overall long-term success of the firm in an industry which rarely offers a long term record, particularly one spanning multiple decades (most hedge funds are short lived).
“We stayed in business for this long because FG has been a spectacular vehicle for creating wealth for Canadian and global clients. John Dobson and his partners put up $10,000 each to start the fund in 1960, and this money has compounded to over $6 million today. This tells you that we are persistent and we know how to make money. Unfortunately, John Dobson passed away this past summer, but his legacy will live on through FG,” says Kelly.
Public equities have always been the right way to build wealth, and this is what the firm’s culture and “formula for growth” focuses on. Historically, the firm had focused mainly on the U.S. markets, but also invested globally, with a particular interest in the growth and development of the Asian markets over the years.
“The reason why we like public equities is that when you have good growth companies run by good management teams carrying out solid business plans, we can compound clients’ money at fabulous rates. If the company can grow earnings per share quicker than the market, that growth will be recognized by the stock market, and we call this the Double Play: first, because the compound earnings per share makes us money over time; second, we make more money because the price earnings multiple that is applied to that earning stream will probably raise over time as the market recognizes that this is a strong growing company,” explains Kelly.
The formula is simple. The firm focuses on small to mid-sized capitalization companies ($1 to $10 billion in market capitalization) that can offer exponential secular growth. FG believes that small and mid-cap companies generally can grow faster than large cap companies and usually this growth can persist for a two to three year time frame. After that, these companies will invariably become too large to offer higher than average growth. The firm devised sophisticated screening systems that reveal the key characteristics of a stock and a company that will provide FG with the right investment opportunity and the highest return with the lowest possible risk.
“We have nine investment managers who research investment opportunities and each visits some 150 companies per year. Our entire focus is on touching and analyzing the companies, talking to their competitors and clients, visiting tradeshows, triangulating as many sources as possible to create a true picture of these companies,” says Marc-André Pouliot, Director of Risk Management & Client Servicing.
Another investment approach that has proven successful is knowing the managements of successful companies, and following strong, entrepreneurial managers and their teams from company to company. “Great entrepreneurs who have built successful businesses often sell their existing companies and move on to launch new business ventures that eventually have the metrics FG is looking for in its investments. We continuously foster and deepen our information network,” says Kelly.
The important distinction between FG and other fund companies is in their platform of alternative investments. FG does not shy away from “going short” stocks, and the firm offers this form of investment through its Formula Growth Hedge Fund (FGHF), the Formula Growth Global Opportunities Fund (GOF) and the Formula Growth Alpha Fund. These three funds include long/short equity and market neutral strategies.
The “short” strategy takes the opposite view of the market, so when FG research shows that a company stock may decrease in value (rather than increase), FG may sell the stock short (with the hope of buying back later at a lower price). “In these investments, we are looking for unsustainable business models that are beginning to unspool, and a high valuation that will not be supported by the stock market as the business decays,” says Kelly. While this strategy does not produce as high returns as a “long-only” strategy, long/short funds have the ability to offer solid risk adjusted returns by reducing volatility and performing well in downward (bearish) markets.
2012 was the Formula Growth Hedge Fund’s 10th anniversary in the alternative (hedge fund) investment space, and the firm was the No. 1 Hedge Fund in Canada for 2012, and No. 12 globally according to the HFR (Hedge Fund Research) Database over the previous decade.
The Hedge Fund Landscape
By definition, when equities or stock markets are doing poorly, hedge funds attract more investor interest, and vice versa. Accordingly, it has been a challenging time for hedge funds as the U.S. markets continue to rebound strongly since 2009. Hedge funds have been underperforming in this landscape. Canadian hedge funds are currently showing returns of zero or worse on average (with the TSX up 10.3 per cent), and U.S. hedge funds showing returns of about nine per cent (with the S&P up about 25.3 per cent). “With these results, the challenge for us is to make investors remember why they are invested in the hedge fund in a first place – to protect the downside and curb excess volatility, while still making respectable returns,” says Kelly.
FG sees the Asian markets as a great area with many investment opportunities in a backdrop of strong capital formation creating many new businesses in a now maturing public equity market. According to Kelly, these markets offer great opportunities for both equity and alternative investments. However, even with tremendous improvements in these markets over the past decade, Asia remains an “Experts Only” playing field. “We have the expertise and the network in place in these markets, and our Hong Kong office has been doing a tremendous job helping us to research suitable investments there,” says Kelly.
With the strong U.S. markets, FG is seeking new ways of marketing and distributing its products to a broader investor base. “We want to get the message out that the FGF has been making 21 per cent return per year over past three years. The U.S. market has been strong, and I think that we are only in the middle innings with lots of game left.
Investors have had an infatuation with bonds and structured products for many years, but we expect a steady influx of money to flow back into equities.This, along with improving global economies, should drive equity values higher over the course of the next few years. We plan to continue our on-the-ground research, keeping our strategy simple, and remain focused on the goal of creating wealth for our clients,” concludes Kelly.