“The value of due diligence is greater now than it ever has been,” says J. Gibson Watson III, president of Prima Capital Holding, and the best money managers, he argues, “are focusing on investment quality to restore investor trust.”
We present seven of those best money management teams in the pages that follow, all of which are 2010 Separately Managed Account Managers of the Year. This is the sixth year that Investment Advisor and Prima Capital, the Denver-based firm that conducts due diligence on SMA managers, have joined together to choose the best SMA managers in multiple categories. What constitutes “best” for the committee that chooses the winners, which consists of Watson, Prima CIO Cliff Stanton and director of research Shane Calhoun, along with Wealth Manager Editor-in-Chief Kate McBride and this writer?
The committee starts with a quant approach, making sure each portfolio scores high marks in firm strength, resources devoted to the particular strategy, tax efficiency, and performance, compared to their benchmarks and their peers. Each portfolio must also be open to new investors and be widely available to advisors and their clients. The quant analysis (all data in the following profiles come from Prima’s Prima Guide online tool, with data as of 12/31/09) goes on for some time, but the discussion on the candidates–chosen by Prima’s analysts–ends with a quality discussion on the manager (or, usually, team), including their tenure and the ownership of the firm, whether they have skin in their own games, and what makes them unique in their process of stock or bond picking through different business and market cycles. The SMA Managers of the Year are not flashes in the pan who’ve been able to scrape together a good year or two: their processes and their human capital allow them to perform well, and consistently, year after year.
Being able to rise to the top is a particular accomplishment not simply because of the challenging markets of 2008-2009, but also because the SMA industry itself is in the midst of a “transition, a transformation,” argues Watson, as evidenced by the rise in particular of unified managed accounts. He says that assets in UMAs grew in 2009, despite a decline in overall assets in SMA accounts of about $20 billion, leaving about $540 billion in total SMA assets, following 2008′s ouflows of $36 billion, citing Cerulli and Money Management Institute data. The wirehouses still control the bulk of SMA money–about 70%, says Watson. In a higher-tax environment, which we may well see over the next few years, UMAs could also be more tax-efficient, suggests Watson.
“They must have clarity in their alpha thesis,” responds Watson to a question about the common traits of this year’s winners, with each showing “a demonstrable edge in their discipline.” Such an approach allows these managers to “add value, but always on a risk-adjusted basis” to their high-net-worth and ultra-high-net-worth clients’ portfolios, Watson says, and they must all show “consistency and repeatability.”
In the profiles of these sterling managers that follow, you’ll learn how the SMA Managers of the Year ply their trade; you can learn more in a series of Webinars that begin in April with these managers; consult InvestmentAdvisor.com for details.–James J. Green
[Editor's Note: The following profiles are extended versions of those that appeared in the print edition of Investment Advisor, April 2010]
Specialty Manager Award: Tradewinds Global Investors
Attractive valuation is a mandatory pre-requisite for Los Angeles-based Tradewinds Global Investors’ Global All-Cap portfolio, and the company dedicates a substantial portion of its due diligence efforts toward determining the value of stocks across the globe. But Tradewinds is also interested in getting to the heart of businesses with strong franchises and good forward growth prospectives, in trying to understand the risks they face, and how those risks will impact performance in the longer term.
“We like to understand the industry a company is in, get a handle on the supply and demand dynamics, and look at what’s happening at a sector level,” says Emily Alejos, equity analyst and portfolio manager at Tradewinds who manages the global ADR portfolio, which follows the same strategy as the all-cap and every other strategy in the firm. “We buy businesses rather than stocks, so we’re really not looking at how a company will do in the next few months: We go beyond the economic cycle and try to understand whether a particular business will do well over time.”
Once Alejos and the rest of the Tradewinds team have identified a company as being a “survivor” with a sustainable competitive advantage, they add its name to the one list of stocks that all the firm’s strategies–international as well as domestic, all-cap and small- to mid-cap and ADRs–use.
In many cases, the names that make the cut are under-appreciated by the market at large, Alejos says. “Maybe they’ve disappointed on a quarterly basis or have relatively low earnings compared to their peer group. But being contrarians, we know that the market is punishing these companies for a particular reason, and we try and get beyond that to understand whether or not it’s a good business in the long-term.”
Wal-Mart and Whole Foods are two classic examples of this approach. The market loved both companies when they were going through a period of great growth, Alejos says, and as such, they probably got overvalued, and then subsequently disappointed because investors had set their expectations so high. Tradewinds bought both stocks when they were at their lows, knowing that “we were buying best-in-class franchises at a point in time when they were unloved,” Alejos says. Both companies have since bounced back very nicely.
Tradewinds also places an emphasis on company management, particularly what management has done in the past with respect to capital allocation, acquisitions, and stock buybacks. A management team’s track record at growing a business organically, and whether that has added value over time, is very important, Alejos says.
In the aftermath of the financial crisis that began in 2008, more and more stocks became appealing from a valuation perspective. The Tradewinds team had much to choose from, particularly in the emerging markets, where names such as Brazilian oil refiner Petrobras and India’s ICICI Bank were trading at distressed levels. These and other stocks Tradewinds purchased in 2008 performed very well in 2009.
“It was tough to figure things out in 2008, but we stuck to our guns and we remained fully invested when many people were in cash,” Alejos said.
The universe of stocks that Tradewinds chooses from includes companies whose capitalizations typically range from $100 million and above. The firm’s investment strategy is typically benchmarked to the MSCI All Country World Index, and its portfolios are broken down such that position weightings are no greater than 5% at cost; industry allocations are less than 25% and sector weightings are less than 30%. Tradewinds weights countries excluding-U.S. at less than 35%, and has a 25% exposure to emerging markets.
The company follows a strictly discipline approach that also takes into account a broad range of fundamental valuation metrics such as price-to-cash flow, price-to-book, price-to-earnings, and liquidation/replacement value. Tradewinds’ portfolios are generally diversified across 40 to 85 companies representing strong risk/return characteristics.
Tradewinds Global Investors is an affiliate of Nuveen and manages $2 billion in its Global All-Cap Strategy, which is available via major national broker/dealer platforms such as MorganStanley, UBS, and Wells Fargo Advisors, as well as through several of Tradewinds’ partners serving independent investment advisors.
Specialty Manager Award: Forward Uniplan
Common stock, preferred shares, REITs or MLPs? Or why not all of them at the same time and in the same vehicle?
That’s what Rick Imperiale, principal and founder of Union Grove, Wisconsin-based Uniplan Advisors offers clients who are interested in all four asset classes and who are keen to get the best of the spread differential between them.
“We decided to do this because we saw that people were always comparing them when deciding where to put their equity money,” says Imperiale who, with the support of a team of research analysts and traders, manages Forward Uniplan’s $60 million High Income Total Return (HITR) portfolio (Forward Uniplan is one of a number of financial companies owned or controlled by Imperiale or Uniplan Advisors, through which various products are managed). “Most people compare common stocks, MLPs, and preferred stocks with REITs, so we thought we’d be simplifying life for everyone if we put all four together in one packet and added some intrinsic value for a financial advisor.”
Combing these four into a single portfolio is the fruit of the decades of experience Imperiale has in credit analysis and in assessing the relative value between different yield opportunities. He believes in strong quantitative research, combined with exhaustive bottom-up fundamental analysis, to build a portfolio with lower risk than the benchmark but that offers stronger returns during a market cycle. Imperiale has been managing portfolios since 1984, starting out with fixed income and then moving into equities, and he believes that while common stocks, preferred stocks, REITs, and MLPs get cheap and expensive relative to each other over time, eventually they equalize.
Meanwhile, taking advantage of the spread differential between the four investment vehicles continues to be a winning strategy. Imperiale tracks this spread on a weekly basis, and if all categories are within one standard deviation of each other, he weights them at 25% each in the portfolio. “Once we get beyond one standard deviation, we migrate money from one category to another,” he says.
Imperiale says the process of migration is a slow one, however, and is designed to be strategic rather than tactical. The one hard constraint on the portfolio is that it must always have at least a 10% weighting in each asset class, “which means you will never have 70% in any one category,” Imperiale says.
Beyond this, Imperiale tries to keep the portfolio diversified by industry and by sector, employing all the usual portfolio management procedures. However, the focus–particularly with respect to REITs–is maximizing on current yield as opposed to total returns, he says, and income generation is the fund’s primary mandate. So if REITs are currently yielding 4%, “we’d ideally be looking for those that are yielding more than 4%,” he says.
Imperiale makes sure to choose only top quality REITs, made up of properties in the best locations, and with high caliber management teams capable of taking advantage of the supply and demand dynamics in the industry.
When it comes to choosing dividend-paying stocks, Imperiale uses the Altman Z-Score method (formulated by Edward Altman in the 1960s) to find companies that are relatively cheap compared to where they have been in the past, but have positive fundamentals as evidenced by improving credit scores over a four- to six-quarter period. He employs similar scoring and evaluating systems for master limited partnerships and preferred stock.
At present, the High Income Total Return Portfolio has a 43% weighting in common stocks; an 8% exposure to MLPs; a 23% exposure to REITs; and 26% of the portfolio is invested in other assets such as convertible bonds and preferred stock.
Uniplan’s HITR portfolio is available on both Smith Barney’s and UBS’s managed accounts platform, as well as through Schwab. The product is available in two versions, Imperiale says, one that comes with close-ended MLP funds instead of MLPs, (since endowments and other ERISA accounts cannot own MLPs), and another that comes with MLPs. Imperiale says he is also in talks about offering the High Income Total Returns portfolio as a mutual fund.
Large Cap Award: Atalanta Sosnoff
New York-based Atalanta Sosnoff Capital focuses all its efforts and resources on managing a single product. “We just do one thing and we do it to the best of our ability,” says Craig Steinberg, the firm’s president.
That “thing” entails investing in large cap companies that have above average growth rates through a disciplined, three-step process, the most important part of which is assessing their potential for “earnings acceleration.”
“The rationale behind earnings acceleration is that there is a very strong correlation between growth rates and valuation, so companies with high growth rates are rewarded with multiple expansion,” Steinberg says. “We identify companies where we anticipate the growth rate of earnings looking forward a year or two to be higher than looking backwards.”
A company’s ability to multiply its earnings in the future are not only a consequence of its business model and process: Changes in industry dynamics, movements in supply and demand, new product expansion, and other factors also contribute to earnings acceleration, Steinberg says. Take Apple Inc. (AAPL), for instance: Atalanta Sosnoff first bought the stock in 2005 as the iPod’s popularity was starting to soar. “But the management of Apple, through almost continual product innovation, has taken things much further than we originally expected, so today, Apple is still a 5% weighting in the portfolio and we still see plenty of upside to it,” Steinberg says.
He also gives the example of specialty pharmaceutical company Celgene (CELG), which introduced a new cancer drug that was so popular on an industry-wide basis that it resulted in an explosion of the company’s earnings power.
Once Atalanta Sosnoff has crunched the numbers, read the research, and identified a company that fits the earnings acceleration bill, it will validate that knowledge independently in a security analysis process, partly by building its own earnings model. Finally, the firm values the stock in order to decide whether the earnings acceleration is discounted or not vis-?-vis the stock price.
The continued monitoring of earnings acceleration is the cornerstone of portfolio management for Atalanta Sosnoff.
“If we buy a company because we expect it to gain market share and then we see it’s losing market share, our philosophy is that that stock should be sold to stay true to the model of earnings acceleration,” Steinberg says. “We have been doing this through the years and it has enabled us to avoid having torpedo stocks that would otherwise have undermined the entire portfolio.”
Stocks are also sold when they reach their price target. Atalanta Sosnoff had, for example, invested successfully in Brazilian metals and mining company Vale (formerly known as Companhia Vale do Rio Doce), a leading iron ore exporter, and Freeport McMoRan (FCX), the world’s largest producer of copper, on the premise that high demand from emerging markets–China in particular–accelerated both their revenues and earnings growth. Atalanta Sosnoff sold both stocks earlier this year, Steinberg says, because they reached their price target and also because the demand for both iron ore and copper is likely to slow down if the Chinese authorities decide to rein in the Chinese economy.
Atalanta Sosnoff manages a total of $10 billion in separate accounts for institutions and individuals, 85% of which is invested in large-cap stocks. Typically, the firm owns about 40 to 50 stocks in the large cap equity portfolio, and unless a client issues special directives, or has unique tax considerations, all individual accounts are managed in the same way.
Steinberg believes that an investment in a particular stock only has meaning if it is given a significant weighting in the portfolio. The firm has a 3% to 5% allocation to all its holdings, he says, and these are not necessarily stocks that figure in the benchmark Russell 1000 index.
“We don’t own a stock simply because it’s part of the index; to perform slightly better than the index, one needs to be willing to be significantly different from the index,” he says.
All four senior portfolio managers at Atalanta Sosnoff–Steinberg, Atalanta’s founder Martin Sosnoff, Robert Ruland, and John McMullan– work as a team and they are all equity holders in the firm. Recently, though, New York-based financial firm Evercore Partners purchased a stake in Atalanta Sosnoff, a move that Steinberg and his colleagues are excited about. “Adding the experienced and talented partner that is Evercore will supplement our business development efforts and allow us money managers to continue focusing on stocks,” Steinberg says.
Large Cap Award: C.S. Mckee
There are two key elements to Pittsburgh-based C.S. McKee’s approach to the large-cap equity space that, according to Lloyd Stamy, senior VP and member of the executive committee of the firm, have not only distinguished it from its peers, but have also allowed the firm to take advantage of some of the best opportunities in the market and avoid some of the greatest pitfalls that got the better of many others in the business.
First, C.S. McKee–which manages $3.7 billion in large cap value equity–essentially performs a Wall Street buyout valuation by measuring a company’s enterprise value to its EBITDA, which entails taking the company’s total value compared to its real earnings divided by its five-year forward growth rate.
“This is one of the key elements of our valuation model,” says Stamy. “We place the highest value on measuring enterprise value to EBITDA, and although it often works better in the small-cap space where there is more M&A activity, it still gives us a stripped-down value of a company whose assets we can buy at a discount to their earning capacity.”