Ticker Symbols

OPTFX (Class A) OTFCX (Class C) OTCYX (CLass Y) OPTIX (Class I)

Investment Advisor

OFI Global Asset Management, Inc.


Subadvisor

OppenheimerFunds, Inc.

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Understanding Share Value

Jun 1, 2015

Oppenheimer Capital Appreciation Fund

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Q: What is your history with the fund?

I came to Oppenheimer Funds in 2008, originally joining the fund’s team as a senior analyst covering technology. I became co-manager of the fund in 2012, and lead manager as of July 2013.

Q: How do you define your investment philosophy?

Our goal is to generate outperformance and a meaningful risk-adjusted return over the long term. What sets us apart is that we look at everything through the lens of capital discipline and capital deployment. We target companies that invest capital appropriately according to the growth opportunities of the markets in which they participate.

When there is excess capital, we look at those companies that demonstrate the intent to be good stewards of that capital. 

We want to invest in companies that manage capital spending, manage research and development, and manage their capital investment in ways that do not decrease shareholder value. We search for companies that demonstrate to us that they understand the real value of a share, ones that are less likely to dilute the shareholder, and that structurally manage their share count flat to down over time. 

It’s all about fiscal discipline; although admittedly how one defines fiscal discipline can vary from company to company. Our target investments understand that debt has to be controlled over time. The overarching theme is to match the amount of money that you invest in your business according to its growth rate versus where you are in the maturation of your industry and the investment opportunities therein.

Q: How would you describe your investment strategy?

As a domestic large cap growth fund, we start by looking at our entire universe of large cap growth. We look at the S&P 1500 and rank those companies based upon the amount of capital they deploy. 

We then look for companies that benefit from broad global themes, and whose fundamentals we think are attractive. We match growth expectations with how each company spends its capital.

We target companies that have sustainable competitive advantages, appropriately invest according to their company’s growth potential, thoughtfully manage their capital structure, and are shareholder friendly with excess capital.

Let’s look at a couple of examples. Biogen, Inc., is a very large holding in our portfolio. Biogen deploys capital in a way that falls within the mean of our large cap growth investments. What is so attractive to us about them is that their growth is significantly better than that of the market. Great growth, with average deployment of capital, is, to us, an arbitrage opportunity in the risk/reward paradigm.

Part of our strategy is to layer fundamental analysis on top of that, together with the changes we see ahead, such as improved science and better use of data to make go and no-go decisions for new drugs. That combination to us is very powerful. We see this as an opportunity that is mispriced for long-term growth in the market.

Alternatively, we can look at Facebook, Inc. We view Facebook as being toward the bottom, that is, the most aggressive spenders of capital, but we are okay with that since we see them as being early in their growth phase and that many opportunities lie ahead for them. They have a tremendous lead in relation to monetizing mobile Internet traffic, and we like what they do. 

Another consideration is a company like Visa, Inc., or MasterCard, Inc., both of which have exceptional growth, but they structurally manage their share counts down over the long term. This is not about the announcement of large, one-time buybacks—we’re talking about a multifactor model. You won’t have to buy back as much stock if you issue less stock or make fewer dilutive acquisitions.

We align ourselves with the companies that truly understand the value of a share. We see our job as one that delivers performance to investors at the per share level. It is never just about revenue growth. It also includes per share value growth.

Our intent is to build and maintain a portfolio of 60 to 90 names, one that has a capital discipline rank that beats our benchmark, the Russell 1000 Growth Index, as well as our peers.

Q: What is your research process and how do you assess opportunities?

We have a team of six senior analysts who scrutinize the sectors they cover to see what is changing at any given time. We align that with our monthly assessment and retooling of the capital discipline profiles of our investment set. We are looking to see where capital is being deployed and by which companies, because we primarily seek companies that deploy their capital in a way that we feel is appropriate, relative to their growth opportunities.

We say “relative” because not all growth-oriented companies are, or should be, in the range of 50% to 60% growth—that’s just not realistic. We target companies that are focused on sustaining a competitive advantage, ones that use their excess capital to reduce debt, generate a dividend to shareholders, possibly achieve small, value accretive acquisitions, and, overall, make capital expenditure investments proportional to their growth potential.

In terms of diversification, we don’t want to buy the same trend, the same exposure, again and again. We want to make sure that the areas in which we are overweight are the ones we explicitly choose, in order to reduce the unintended consequences of unexpected risk exposure.

To ensure we accomplish this, we actively monitor the relationships of the positions in the portfolio using internally developed tools. We combine this data with our analysts’ real-time fundamental outlook to actively monitor how the prices in the portfolio reflect the changes, themes, and trends going on in the various industries. We buy good companies with solid cash flow that appropriately invest for the long term. We also go the extra step to determine that the investments we make act like their underlying businesses as a part of our portfolio construction process.

For example, in the past, we owned ADS, which is a great company, with a white label credit card business, and one that also owns a business involving Internet marketing. But, for us, the stock acted too much like an Internet marketing company vs. a credit card company. We would rather use that precious risk element in our portfolio for a company that has a greater exposure to Internet marketing with a more defensible competitive advantage than one with a secondary segment reflecting it. 

Biogen, for example, is a biotech company that is a market leader in medicine to combat multiple sclerosis. They have a very strong MS franchise and a very exciting pipeline of new opportunities, such as their recent data on a potential new treatment for Alzheimer’s. In analyzing this investment, we start by looking at the changes going on in healthcare right now, coupled with those going on in biotech.

In our estimation, there is a veritable sea change in biotech that is exciting. The use of information and data, in conjunction with better science, is dramatically improving the opportunity to develop successful drugs. 

Most important, of course, is the tremendous opportunity to help sick people who have had few or no avenues of either cure or mitigation in their conditions. What is also exciting is that vastly improved avenues of data collection on patients who enter clinical trials are such that our chances of developing a successful treatment are increasing.

Even in drugs that might fail their overall trial, improved and vastly more detailed data collection means that there exists the capability to identify subsets of patients, such as those possessing a certain biomarker or genetic makeup who do respond positively to the drug being tested. 

As a result, although we may not see the development of a drug that meets the overall end point, it may prove highly efficacious in treating these subsets of patients and fill a demand. In essence, we have begun to see an inflection point in the productivity that the R&D pipeline is generating for biotech companies. 

In looking specifically at Biogen, it displays the average capital discipline of the market; however, it has the potential to grow many times over the rate of the market over the next three to five years. 

The fight to find a cure for Alzheimer’s represents on its own a $40 billion market opportunity. Such potential meets our criteria: it has a reasonable valuation, given the opportunity set; Biogen is a reasonable deployer of capital; and healthcare is an interesting growth opportunity because the various pharmaceutical trends and opportunities tend to be generally uncorrelated and therefore good diversifiers.

Q: How does your portfolio construction process work?

It is important to us to create a diversified portfolio that is highly active. In constructing our portfolio, we are willing to take active sector overweights and underweights, and we manage our portfolio of 60 to 90 names by using a unique approach to maintain active share in the 70 to 80 range. 

We are intent on balancing risk, so we populate the portfolio with companies that, as I said, on average have better capital discipline than both the benchmark and the peer group. These are companies that are prudent with their cash flow, consistently deleveraging, buying back stock, and growing dividends, and they acutely manage the capital expenditures of their business relative to, e.g., deep depreciation or sales over the long term.

Essentially, we want a combination of improved growth and capital appreciation relative to our benchmark index and our peer group. 

Our target market cap range, as a domestic large cap growth fund, starts at $5 billion and up. Admittedly, we have skewed a little bit higher than our peer group over the past couple of years, but that can and will change over time. Typically, we maintain anywhere from 60 to 90 holdings, and are at 71 right now.

We anticipate a portfolio turnover rate of 40% to 60%, although we have been at the higher end of that over the last couple of years. Given the current market structure, that appears to be the right way to take advantage of the opportunities that are presented, while still remaining strategic. This has more to do with the sizing of positions than turnover of names, however.

Q: How do you look at active share composition?

It is important to align conviction with active share. Active share is a form of risk. In order to beat the benchmark you have to sufficiently differ, but we do not want active share simply for the sake of active share. We have developed a proprietary tool that allows us to build our active share from the bottom up.

By implementing this tool, we can look at every single equity investment and understand and align our active share with the conviction in those names. Every time we add a name, or add to a name, we determine whether it is going to be accretive or dilutive to active share.

We track the relationship and movements of the positions in the portfolio on an ongoing basis, and consistently look at how names move in tandem. There have been times when stocks moved together in a way that made sense on the surface; however, there are times where stocks have high correlations that do not necessarily make sense. The key is identifying and mitigating these unexpected correlations. 

In 2012, when I began co-managing, the fund was underperforming and we wanted to figure out why. We examined the relationship between every stock in the portfolio to try and understand what was going on. Interestingly, we found that Coach Inc., Ralph Lauren Corp., and Tiffany & Co. were highly correlated to Cummins Engine Inc. and United Technologies Corp. At first, that did not make sense to us. 

So, we sat down with the analyst team and started asking questions to determine what the market was excited about regarding the growth prospects of consumer discretionary and established that they were excited about exporting their brands overseas into China’s growing middle class. That made sense. 

Then we asked what the market was excited about concerning industrials. It turned out that they were excited about industrialization prospects in China, their rising economy, increased demand for housing, and an overall rise in the middle class. 

What we determined then was that we had a sizeable bet on China both in the consumer portion of the portfolio and in industrials. That gave us great insight into the risk profile of the portfolio. 

Using this tool and process gives us a greater chance of maintaining diversification actively over time. It gives us a way to diversify across factors that you might not find in a standard Barra risk model, such as a new theme or trend that the market has picked up on. 

Q: What drives your sell discipline and what are your position weight limits?

Our sell discipline is relative to the market, to the peer group, and relative to the companies themselves. If fundamentals or our convictions change, these are catalysts to eliminate positions from the portfolio; on the other hand, it might create opportunity. 

If we identify a new idea that is more interesting or exciting, some of the lower-conviction names might fall out simply so that we can introduce the new one.

We limit the overweights for individual companies to 5% , but sectors can go as high as 15% overweight—we use the Russell 1000 Growth Index as our benchmark.

The fund currently tilts generally towards the aggressive growth part of the box. That said, we will not always be there, as currently we are fairly constructive on some of the higher growth social media companies. I expect us to fall typically in the center, to the right part of the large cap growth box. 

Q: How do you measure and manage risk?

We look at overall, fundamental business risk in terms of how companies deploy their capital and how aggressively companies invest that capital. Facebook, as I mentioned previously, is one of those companies that is aggressively deploying its capital, but it is also one of those companies that we see as representing the greatest opportunities for growth over the next three to five years. That said, we still see it as a designated risk in the portfolio. Companies like Facebook represent the riskier, higher reward opportunities in the portfolio.

So, essentially, we measure fundamental business risk by way of capital discipline. The more aggressive they are, the more reward we expect to compensate for that risk. Both Facebook and LinkedIn are good examples of this.

A number of firms gauge risk by beta, however, we believe that beta, on its own, can be misleading in that it can potentially misrepresent the kind of stock it is.

We manage the risk of the portfolio through a portfolio construction and risk overlay and by consistently tracking how the positions in the portfolio move together. In this way, we endeavor to maintain a consistent level of diversification. We balance how much business risk exists and how the stock correlates with others in the portfolio.

The companies that are good solid capital discipline companies, companies that consistently shrink their share count, consistently reduce leverage, consistently institute and grow dividends, and are managing capex prudently, we see as lower risk. We keep a close eye on how the company spends and how volatile the stock is.

The companies that aggressively invest represent a higher risk. Nonetheless, risk is not always a bad thing, provided you believe it represents opportunities. We revisit those convictions continuously. 

We view risk as a precious resource, one that we allocate with extreme care and caution.
 

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