From the October 2008 issue of Investment Advisor • Subscribe!

Not Alone

American Beacon's manager-of-managers style produces cheap stocks with growth potential for Adriana Posada's large-cap value fund

AMR Corp.'s decision to sell its money management arm, American Beacon Advisors Inc., to a private equity consortium--a deal that was announced in April 2008--bodes well for the firm, not least because the increased financial flexibility will allow American Beacon the chance to develop new products to its roster of offerings and employ new managers.

All the same, William Quinn, American Beacon Advisors' chairman, is firm in stating that American Beacon has no plans of following anything other than its tried-and-true approach of offering investors access to low-fee, well-diversified portfolios in a range of asset classes through a manager-of-managers strategy.

One of these products, the $8.4 billion American Beacon Large Cap Value Fund (AAGPX), has performed far better than its peers in recent times, something that Adriana Posada, managing director of trust investment at American Beacon Advisors, credits wholly to the benefits of following that multimanager strategy with the aim of realizing long-term gains, and to maintaining a strict focus on selecting cheap stocks that have the growth potential to perform better than the overall market.

We caught up recently with Posada, who oversees American Beacon's equity portfolios and some of its debt offerings, to ask her about the large-cap value fund and the recipe for its success.

The fund is a large-cap value fund and a strong performer in a sector that has not done so well of late. How do you explain your better performance vis-? -vis that of your peers? There are a couple of things that distinguish us from our peers and, at certain times, will impact our performance. We are quite unique in that I oversee the fund but I don't pick the stocks, since all of our equity strategies are sub-advised. This comes from our heritage of originally being a pension fund, but we really think that the multiple manager strategy is better over the long term, as it means we have a diversified portfolio. The subadvisors are similar in their long-term strategies--they tend to get to the same place, but in different ways, because in the short term, they behave in different ways to offset each other. Most of the time, if one of the managers is struggling, there are one or two more who are doing better and pulling the fund along. In most normal markets, this strategy works well, although there are extraordinary times when it doesn't and our fund will lag.

Many would say that the market over the past year-and-a-half has been quite abnormal. Do you credit your success only to your subadvisory strategy or is there something else? Our subadvisors follow a bottom-up approach and they didn't find financials attractive from a price perspective, so being underweight financials has really been great for us.

What's your criteria for hiring subadvisors?

We have a very specific kind of manager we like to hire. We have a special definition of value, which we call "growth at a discount," and we look for managers who have a portfolio of stocks that are expected to grow faster than the market, but are selling cheaper than the market today. We absolutely like to buy growing companies; we just don't like to pay for them. When stocks are cheap, this usually means there's some issue that we have to isolate. Our subadvisors can identify and isolate the issue and determine that it is temporary. In selecting subadvisors, we also are very focused on identifying firms that have a strong team that has been in place for at least five years, because we focus on firms where there is an incentive to retain people. Just as important, we're looking for firms where the discipline has been in place for a long time, so that they haven't strayed from their performance and it is repeatable.

We focus a lot on the people and the process, and if the two are in place, this means that performance should be replicated over complete market cycles. We are very long-term focused and patient with short-term disruptions. To identify managers, we ask them to plot every security in their portfolio on a grid where the X axis shows forward P&E ratios and the Y axis shows the investment growth rate. This enables us to see that their portfolios are, on a stock-by-stock basis, weighted toward companies that are cheaper than the market and growing faster than the market.

Is there a universal investment strategy for all subadvisors?

Each subadvisor has his own way of selecting stocks, but regardless of how they do it, regardless of their focus and process, their portfolios have to be composed of cheap companies that are growing. Because each is somewhat different in their approach, they end up with portfolios that don't have a lot of overlap, and we end up overall with a very diversified portfolio. At the end of the second quarter, there were 139 names in the total portfolio, and despite the similarities of the philosophies, only 55 companies were owned by two or more managers, and only one company was owned by four managers.

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How many subadvisors do you use?

In the large cap value fund, we have four subadvisors. The fund was established in July 1987, so it is a very senior fund and of the four managers managing today, two have been managing since the day the fund opened its doors. So while we like the multiple manager structure, we are not in the habit of turning over our managers, and this is another factor that makes us different.

How much do you manage in the large-cap value fund?

At the end of June, we had $8.4 billion in assets under management.

What sectors have done well for you this year?

As I said earlier, being underweight financials has helped. That's not to say that we don't think some of the financial companies are now extremely cheap and most of them are the biggest financial franchises in the country, so when the credit crisis is over, they will begin to deliver good returns long-term. We were also helped in the last quarter by companies we owned in the industrial, technology, and energy sectors. Even though we were underweight energy, which had hurt in the past few years, the energy companies we owned really helped us, as did the industrials.

Do you have any specific examples?

We owned ITT Corp. and Burlington Northern Santa Fe Corp. and they were the best performers in the second quarter in the industrials sector. In the technology sector, where we performed very well, IBM Corp. was one of our largest holdings, the second largest in our portfolio. In the energy sector, we made out well with the usual culprits like ConocoPhillips and Occidental Petroleum Corp.

What sectors might you be looking to get out of or reduce your exposure to?

We have not been invested much in materials; we've had a very low weighting to that sector for the longest time because materials have been overpriced. Our subadvisors truly believe that there is a bubble in the sector and so we are waiting for the day when that bubble bursts, when things get so hot that they inevitably shoot toward the downside. We don't know when it will happen but we will wait.

We have pared down on the consumer discretionary sector and have kind of reweighted it. Until two years ago, we had a heavy weighting in home builders, which is now pared down to very little because that weighting did hurt us.

Which sectors do you think might be interesting somewhere down the line?

Given the economics right now, there are better opportunities in the financial sector, for instance, than the consumer sector. But again, there is no macro view on this portfolio. Our subadvisors don't make their decisions based on what's happening in the economy: They are really looking for good companies that are valued below their intrinsic value. The fact that we end up in certain sectors is a complete fallout of that stock selection.

There are several share classes to the large cap value fund: Where would an advisor gain access to it?

It would be in the "PlanAhead" class [AAGPX], which is the retail class and is available to the likes of Fidelity, Schwab, etc. It requires a $2,500 investment. We also have an "Institutional" class that's sold to pension funds, for which you need $2 million [initial investment], and a "Service" class for broker/dealers and third-party administrators (TPAs).

Is there anything else that makes your fund different from others in the large cap value space?

There are three things that make us different. I've spoken about the multiple manager structure and how that impacts volatility and tries to smooth the ride, and our focus on cheap stocks that are growing. But in a low-return environment, we also have very low expense ratios. Even in the retail share class, that expense ratio is only 84 basis points and it is even lower, at 59 basis points, in the institutional share class. We make every effort to keep our expenses low and we are very proud of this because at the end of the day, we know that that's the only thing that will help your return.

Are you yourself invested in the large cap value product?

Absolutely, yes. This fund and others are the options in our company 401(k) plan, so American Beacon employees, from top to bottom of the company, are invested in these funds.


Savita Iyer-Ahrestani is a freelance business journalist who is currenly based in Arnhem, The Netherlands. She can be reached at siyerwriter@yahoo.com.
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