Morningstar - Q3 2020 - 64

Investors

Hillman Value HCMAX
Growth of $10K

$16K

HCMAX

14
12.45

11.13
Morningstar US Large Value

10
8

07/2017

07/2018

07/2019

Morningstar Category

Large Value

Morningstar Rating

QQQQQ

Expense Ratio (%)

0.96

Source: Morningstar Direct. Data as of 06/30/2020.

his perspective as an analyst, but both he and
Hillman are generalists. They collaborate on every
decision. "It's an interesting working relationship in that we're both somewhat introverted and
spend a lot of time on our own studying and
reading. We email each other even though we're
only 20 feet apart," Hillman says. "But when
it comes time to hash something out, I'll walk over
to his desk, and we have a really excited
conversation that leaves us exhausted. We'll make
a decision and go back to our corners and get
back at it again."
Hillman is 58 and not retiring any time soon,
so succession planning is not a pressing concern,
but he does plan to build the investment
team. His priority is preserving the culture that
he and Lee have cultivated: "I'm looking for
people with high confidence coupled with low ego,
as well as strong analytical skills coupled
with intuitive abilities." Not incidentally, Hillman
says that sailboat racing tactics require that
same combination.
Willing to Commit

Hillman and Lee analyze a number of factors
to assess a company's sustainable competitive

Morningstar Q3 2020

advantage, including whether the company
dominates its industry or niche, has pricing
and purchasing power, delivers excellent products
or services, and has a strong brand. The
analysis is similar to that used by Morningstar's
equity analysts to determine whether a
company has a moat against competition. Indeed,
most of the companies that Hillman invests
in have been deemed by Morningstar to have
either wide or narrow moats.
In June, 165 companies were in Hillman's qualified
investment universe. The cheapest companies
on the list make it into the portfolios, with roughly
equally weighted positions-the 20-stock
Focused strategy targets 5% weights, for example,
while the mutual fund has a 3% target.
From there, valuation drives trading,
unless changing fundamentals mean a company
no longer merits inclusion on the qualified
investment list, in which case it is out completely.
Positions are rebalanced as stocks fall
below or above their target weights. When
a stock is sold, it is replaced with the
cheapest name in the qualified investment
universe, period.

In other words, Hillman doesn't factor in
sector exposure or other overall portfolio metrics
when choosing stocks for the portfolio.
"What creates risk is owning poor-quality
companies or overvalued assets," he says.
"Considering sector allocation might actually give
us more risk than we want because we
might be tilting towards less undervalued assets."
Industry weightings are, therefore, largely
an outcrop of the best value opportunities, though
there are some limits. For example, the
Focused strategy has no broad sector constraints
and may have as much as 25% in one industry.
The mutual fund can hold up to 25% in a broad
sector, and its healthcare stake was close
to that limit in May. Hillman says that healthcare
is a large and growing piece of the U.S. economy
and that major pharmaceutical and biotechnology companies-such as holdings Biogen BIIB,
Bristol-Myers Squibb BMY, and Merck MRK-
enjoy competitive advantages stemming from their
R&D spending, robust product pipelines, and
patent portfolios. (For Morningstar's take on Merck,
see "A High Bar" in Best Ideas, Page 55.)

Morningstar - Q3 2020

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