BALANCED ACCOUNT PROCESS

At CCM Investment Advisers, we believe a disciplined total portfolio management system that identifies relative value among asset classes, as well as individual securities, will provide consistently superior investment performance. Our philosophy dictates that we manage risk first. Through the management of risk we ascertain value, which ultimately drives performance.

Our investment philosophy is based on the active management of the three basic decisions of portfolio management: asset allocation, security selection and timing.  Traditionally, other portfolio managers actively manage only the second two parts of the investment process: selection and timing. However, at CCM, we believe in order to minimize risk and maximize the total return of a portfolio consistent with each client's investment objectives, it is necessary to actively manage all three aspects of the investment process.

In a dynamic and disciplined portfolio management system, the decision making process is a sequence of events that begins with the asset allocation decision (asset mix).  For most asset managers the decision making process ends with selection and timing. If considered at all, asset allocation is performed in a static and absolute context where a typical growth portfolio maintains a constant 60% stock/ 40% bond asset mix.  In summary, our portfolio management system constantly compares the relative value of stocks, bonds and money market alternatives. Our system disciplines the portfolio manager to shift funds from overvalued assets to undervalued assets within a timely, logical and unbiased framework.

The basic fallacy of the “traditional” approach of maintaining a fixed asset mix has been that regardless of the selection skills of managers and how well they managed a particular class of assets, they were all at the mercy of the performance of that particular market alternative.  Therefore, with a significant fixed percentage of portfolio assets invested in a poorly performing asset class, portfolio performance suffered greatly.  The market “crash” of 1987 dramatically illustrated this point.

The performance we have achieved using our portfolio management system has convinced us that the “traditional” approach to asset management is outdated and far less than optimal in volatile and unpredictable financial markets.  The asset management alternative we offer is a system of proven value with the capability and flexibility to position portfolio assets among stocks, bonds and money market investments in a disciplined and timely manner.  Designed to optimize portfolio return consistent with each client’s risk tolerance, CCM’s investment management system is a balanced approach to the maximization of a client’s wealth.

FIXED INCOME PROCESS

Our fixed income selection process is an extension of the relative value philosophy of our investment management system.  Our philosophy dictates that we manage risk first.  Through the management of risk we ascertain value, which ultimately drives performance.  We measure the potential return (both income and change in market value) of a fixed income investment against the market and credit risks associated with this type of investment.  Our objective is to produce superior returns over the long term, consistent with our philosophy of preservation of principal.

 Since interest rates are a reflection of business cycle conditions and inflation expectations, fixed income selection begins with the formulation of our macro-economic forecast.  The economic forecast includes our expectations for changes in interest rates and the yield curve.  The portfolio’s target duration (a measure of bond volatility) is then determined based on these expectations and the client’s investment policy statement.  Unlike most managers, however, our forecasts are updated at least monthly.  This provides us the flexibility to make mid-course corrections in duration, rather than dramatic shifts in maturities or between bonds and cash.

 Once target duration has been established for each fixed income approach, the maturity structure appropriate for each client’s risk tolerance is determined to maximize returns within those risk parameters.  Based on anticipated shifts in the yield curve, we implement active bond management strategies to appropriately weight the maturities in the portfolio.  Maturity configurations can take the form of laddered, bell or barbell shaped maturity schedules.

 Having determined portfolio duration and maturity targets, the individual security selection process begins with relative value analysis.  This involves the evaluation of current market sector spreads, quality spreads, and specific security factors.  Sector and quality spreads are monitored versus long term averages after considering business cycle and specific industry conditions.  Default and maturity premiums are tracked and analyzed on an ongoing basis.  The credit analysis process in the corporate and municipal sectors consists of fundamental research utilizing public filings with the SEC and is supplemented by credit research from Standard and Poor’s, Moody’s and other traditional bond rating firms.

 We actively manage our fixed income portfolios to take advantage of inefficiencies within the different sectors of the fixed income markets.  Implementation of these strategies in identifying undervalued bonds adds incremental return to the original portfolio duration decision.  Emphasis is placed on quality, diversification, liquidity and call protection.

EQUITY PROCESS

INVESTMENT PHILOSOPHY:  The CCM stock selection process is an extension of the relative value philosophy prevalent in our investment management system.  The stock market is rife with numerous inefficiencies caused by the inability of investors to rationally and systematically process relevant information.  CCM exploits this potential by utilizing a relative value philosophy based on quantitative and qualitative processes to develop an equity portfolio that is designed to provide relative out-performance with less risk than the relevant benchmark, the Standard and Poors’ 500 stock index.

Investment managers are generally characterized as either “growth” or “value” oriented.  Growth managers typically pursue stocks characterized by high earnings growth or a high price to book ratio while value managers are often attracted to more stable securities with low price to earnings ratios and/or healthy dividend yields.  Focusing on value in the absolute sense can have the effect of leading investors to areas of the market that are inexpensive, but which are so for good reason.  The CCM process is concerned with valuation in a relative sense, that is, how securities compare to stocks of similar characteristics.  Stocks are held because they are inexpensive relative to their peers.  

At CCM, we seek long-term relative value.  We are not short term traders or speculators.  Our approach searches for opportunities to profit in client portfolios over an extended time horizon and only assumes risk consistent with proportional expected return.

SECURITY SELECTION PROCESS:  The security selection process begins with CCM’s proprietary Securities Valuation Model (SVM), a quantitative screen of the 1,500 securities in CCM’s research database.  The SVM is a multi-factor model utilizing both “growth” and “value” inputs.  Key inputs include:

All rankings are computed relative to the security’s peers and compiled based on CCM’s proven formula to derive the security’s final SVM score.  Those companies ranked in the upper three quintiles (top 60%) are considered to be buy or hold candidates, while those in the lowest two quintiles are sell candidates. 

After a stock passes the screening process, it is analyzed on a fundamental basis by a member of the analyst team.  Each analyst is responsible for the fundamental research of stocks in specific economic market sectors.  The weekly Investment Policy Meeting is the primary forum for new information on stocks that are currently held, or are potential buy or sell candidates.  Research tools include public information such as regular SEC financial reports, Wall Street firms’ research and reporting, and reports from third-party financial analysis services such as Applied Finance Group, Argus Research , and Value Line. 

Fundamental research is augmented with CCM’s Economic Forecast and Sector Studies, a monthly compilation and analysis of current economic conditions, as well as valuation divergences among the various industrial, valuation and capitalization sectors within the market.  While the investment process is typically described as “bottom-up”, a more accurate depiction is a bottom-up approach with a clear view of the top.  Without question, the economic cycle and prevailing interest rates have a profound effect on the equity market, and ignoring this critical input will have a profound effect on a portfolio’s risk and return characteristics.

CCM EQUITY PORTFOLIO:  Ultimately, the equity selection process results in the structuring of broadly diversified stock portfolios (35 to 65 positions) across fifteen distinct industry groups.  The strategy is primarily large-cap, as defined by average market capitalization, although the investment policy does allow for up approximately 30% of the portfolio to be invested in mid-cap ($1 to $5 billion) and small-cap positions (under $1 billion) under favorable market conditions. 

CCM strives to provide excess absolute return while maintaining a risk profile that is less than the S&P 500.  Portfolio risk is measured both in terms of volatility as compared to the equity market as well as correlation.  The target for Beta (risk) is less than 1.0 while R-Squared (correlation) is held to less than 90%.  Security-specific risk is managed with a 5% limit on an individual security’s representation in the portfolio.  The strategy also controls for industry risk—large industry groups are over or underweighted by no more than 50% of their S&P 500 weighting.  Smaller industry groups comprising less than 8% of the S&P 500 may be overweighted up to 200% of the S&P exposure, and may have no exposure under certain circumstances.

As long-term investors, portfolio turnover is relatively low, averaging 40% in most circumstances.  Because all CCM portfolios are managed individually, the impact of taxation at the portfolio level can be considered.  Although turnover is low, incidences will occur when prudent investment management will indicate that a short-term gain should be realized.  CCM makes every effort to “wash” both short-term and long-term gains with corresponding losses when economically feasible.