Andrea Horan, CFA, has spent the last two decades analyzing funds.

She began as an institutional media analyst in the mid-1990s, receiving top honours during her seven-year stint at RBC Capital Markets. She went on to become a founding partner, first at Westwind Partners, and then Genuity Capital Markets. She also headed the research departments at both firms.

Today, Horan is co-founder of Toronto-based Agilith Capital.

Her career has kept her busy. So how does she unwind?

“That’s a hard question,” Horan jokes.

It’s the only time we stump her during the interview, which is surprising when you see how we put her to the test. But after some thought, she admits when she’s not busy with her three kids, she enjoys skiing and spending time at the cottage.

What are your short- and long-term global outlooks?

China is negotiating a soft landing, and Japan’s efforts to stimulate exports by deflating its currency are finally working.

Although Europe is still probably the most vulnerable to shock, banks are more confident of Germany’s growth outlook. We’re not expecting a lot from Europe, but it seems the headline risk has faded into the background.

In the U.S., economic growth is on the upside. Improvement in the housing and equity markets, and steady progress in job growth have all led to an improved consumer balance sheet. The U.S. still has to work through its fiscal issues, but it’s well positioned. Economies do not grow in a linear fashion. They tend to move in vicious or virtuous cycles. If you happen to get yourself on a virtuous cycle and you don’t get knocked off, you can get some pretty good recovery.

What is your investment process?

We’re a bottom-up shop — we look for value. That doesn’t mean we only buy stocks trading at very low earnings multiples; we also look at the projected and likely growth rates, and use that to determine value.

We like to find companies with strong business models — leaders in their fields, with barriers to entry, and underlying growth in their industries or markets. Once we find that perfect mesh, we take a high conviction position.

We typically buy for the long term but will on occasion be opportunistic on a portion of the portfolio. We will allocate the capital in the portfolio according to the opportunity we see — greater opportunity typically means greater allocation. We don’t pay attention to index weightings when we’re considering portfolio weightings or when we’re allocating capital. We might have 20 to 25 long positions at any one time and six to 10 short positions. For short positions, we’re looking at the opposite (e.g. weakening business model, increased competition, a turn in fortune, expensive multiple).

Horan on stock picking

Can everybody succeed at stock picking? no. Success requires experience, education, and freedom from the constraints of illiquidity. The opportunity in stock picking hinges on the question of efficient markets. If markets are efficient, then market moves are best described by a random walk with a log-normal distribution of returns, and there’d be no gain through stock selection.

Under a log-normal distribution curve, we would see a 5-standard deviation move in the market about once every 7,000 years. In one month alone—October 2008—there were five 5-standard deviation moves. So, you have to question the efficient market hypothesis. But what about the underperformance of active managers?

Stock picking isn’t easy. Many mutual funds underperform their respective benchmarks. Critical to differentiating performance is choosing from a broad spectrum of market capitalizations, and constructing a portfolio that’s different from the index.

But the economics of our industry encourage funds to focus on gathering assets. As a result, many funds become so large they’re unable to construct a portfolio that’s different from their benchmark. That said, the failure of some to achieve outperformance doesn’t mean it can’t be done.</p

One of the companies we own is Exfo, a global leader in test and measurement of optical networks. We expect telecommunication carriers to increase spending on their networks as capacity is strained to the limit, and Exfo should benefit from this trend.

What are your short- and long-term risk controls?

The very best risk control is having a manageable number of stocks and knowing them intimately. We don’t use mechanical stop-losses to close us out of positions because these processes lock in losses.

What you need, instead, is a manager override to understand why a stock is moving differently than what you expected. Then decide if you should sell because your thesis has changed, or if you should wait for a moment to buy more. We have limits on position sizes and consider the liquidity of our investments. We try to ensure the portfolio is highly liquid at any given time. Also, we use minimal leverage.

How do you identify quality companies?

It’s about getting to know management and looking at their track records. For instance, do they successfully negotiate bumps in the road, or do they tend to run into sharp objects? We try to understand their competition, including who they are, which companies have a leading market share, and what their relative margins and growth rates are.

For instance, Corus Entertainment has a very strong management team. Even during a downturn they focused on managing the costs while keeping their employees a priority, allowing them to maintain superior margins and above-average growth rates. It has left them well positioned for an upturn.

Management is also very adept at communicating with investors and keeping them informed of their decisions.

What kind of sector exposures do you have?

We have solid exposure to technology, both hardware and software, but not to the big U.S. names (e.g. Apple, Intel, IBM). Instead, it tends to be smaller suppliers where we see a lot more value and overlooked situations — companies such as Exfo and Sandvine.

Also, we’ve increased our positioning in financial companies because we think we’re in an expansionary credit cycle, and lending will increase. We expect capital markets activity will improve and the yield curve is likely to steepen.

How are your picks doing?

We had a fantastic 2012 — we were up 44%, and we started this year very strong. We had several strong technology companies in our portfolio, including Peer 1, Miranda, and 20-20 Technologies, which was acquired in 2012. Canadian Satellite Radio, which is now Sirius XM Canada, has also been a very strong performer for us, doubling last year.

What investments are people ignoring?

While equities get a lot of press, there’s money on the sidelines. Also, the money that’s in equities has leaned toward highly defensive stocks. If our outlook on global and North American growth is correct, and we do get some strengthening, it’s the low-growth, defensive stocks that will have a more difficult time protecting investors from inflation. This is one of the important jobs of equities.

For example, we’ve shorted utilities stocks, which have high multiples and require access to capital markets to execute their plans.

What’s the biggest danger that nobody’s talking about?

Inflation. If economies start to grow, the market may find that central banks are behind the curve in keeping a check on inflation.

What currencies do you hedge against?

We’re primarily involved in North America. We’ll take a view on currencies, as opposed to hedging out currency exposure. Our current positioning is based on our expectations that the U.S. dollar will strengthen relative to the Canadian dollar. We don’t position ourselves for currency movements outside of North America.