“All of the firms have a focus on investment quality and their alpha thesis,” says J. Gibson Watson III, president of Prima Capital Holdings. “Post credit-crisis, due diligence is more than just stringing together a set of historical returns; now, it’s all about the culture of the companies and the quality of their management.”
That, according to Watson, is the theme common to the 2011 Separately Managed Account Managers of the Year, and largely responsible for the recognition and award.
This is the seventh 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.
“We started the program as a joint venture with Standard and Poor’s,” Watson explains when asked about the awards’ genesis. “The idea was to develop an SMA ranking and rating platform to be housed in S&P’s Advisor Insight. We felt with the increasing popularity of SMAs as a product, it would be of value.”
The initial criteria for inclusion are at least $200 million in assets; tenured management (at least three years); superior ratings in five Prima Guide categories (all data in the following profiles come from Prima’s Prima Guide online tool, with data as of Dec. 31, 2010). If an attractive prospect for an award is below average in one category, or has an N/A in one category, the analyst will manually evaluate the merit of the manager in relation to the category in question. Lastly, the product should be widely available through retail SMA programs.
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. The quant analysis 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. As Investment Advisor and AdvisorOne Group Editor in Chief Jamie Green wrote when announcing last years’ winners, “they 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.”
“Our comprehensive historical analysis encompasses a rolling period of time,” says Watson, who blogs for AdvisorOne.com. “We can therefore see how the managers perform over different, extended periods of time.”
Which, he says, allows Prima analysts to evaluate not only their alpha thesis, but specifically how they exploit market inefficiencies.
“We have more qualitative questions for managers when performing our due diligence,” he adds. “And this tracks with the industry as a whole. Advisors and investors have a deeper appreciation for due diligence. It is incumbent upon advisors to go beyond historical performance. In a post-Madoff world, they absolutely must verify the independent auditors and the clearing and custodial firms and perform all the necessary operational due diligence.”
Whether it’s a UMA, UMH, traditional or model-based SMA, they should be used as part of a broader, diversified portfolio, one that include ETFs, mutual funds and other effective products.
“We don’t feel it’s appropriate to look at any product of this type in isolation,” Watson says. “What’s relevant is how they work with other products they’re teamed with in the portfolio.”
In the profiles of the top managers that follow, you’ll learn how these SMA Managers of the Year set themselves apart. Look for additional coverage on these managers and their portfolio building strategies on AdvisorOne.com.
Large Cap Core 2011 SMA Manager of the Year
Cornerstone Investment Partners
Concentrated Equity Portfolio
Throughout the month of April, AdvisorOne will focus on separately managed accounts: the money manager options advisors have, the platforms through which they can gain access to those managers, how they can conduct due diligence on those managers, and how advisors are using SMAs in client portfolios.
We begin our coverage by presenting the Investment Advisor-Prima Capital seventh annual Separately Managed Account Managers of the Year. In a feature article in the April 2011 issue of Investment Advisor, seven managers in six different asset classes were chosen as “A Class Apart.”
In this article, we focus on Atlanta-based Cornerstone Investment Partners’ Concentrated Equity Portfolio.
The philosophy: A bottom-up approach, conducting fundamental research on those stocks identified as trading at the deepest discount to their fair value.
The portfolio: Limited to 30 stocks, each of which the managers believe has a direct impact on portfolio performance
2010 performance figures (company supplied).
Gross returns: 13.10%
Net returns: 12.64%
S&P 500: 15.06%
Assets in strategy: $973.5 million
Percent of firm’s assets in strategy: 40.7%
The people: Investment Advisor Editor John Sullivan spoke in March with Rick van Nostrand, portfolio manager. Team members are Fred Wetzel, Jr., CFA, partner and architect of Cornerstone’s Fair Value model; Cornerstone’s CIO is John Campbell, CFA. Portfolio managers are Neilson Brown, Dean Morris and Cameron Clement.
The Follow-Up: AdvisorOne readers are invited to register for a free trial of PrimaGuide Plus, Prima Capital’s online research tool.
Large-Cap Core Award
Cornerstone Investment Partners
Concentrated Equity Portfolio
“Information is a commodity,” says portfolio manager Rick van Nostrand, when asked about the investment philosophy of Cornerstone Investment Partners. “We don’t try to out-research the market. Rather, we adjust for investor behavior and exploit price/intrinsic value ratios with 30 solid stocks in our portfolio. When the behavioral gap ‘snaps back,’ we’re rewarded.”
Of course, not “out-researching” the market doesn’t mean they don’t perform proper company due diligence, something for which the Atlanta-based company is particularly proud. It’s that they believe the market to be efficient, and would rather rely on the predictable irrationality of their fellow investors.
The employee-owned make-up of the firm gives each member a vested interest in doing right by the client, with the majority of ownership in the hands of the eight member investment team, in order to ensure they’re properly incentivized.
The team, whose members average 28 years of portfolio management expertise, conducts fundamental research to identify characteristics that enable a company to achieve long-term profitability and to ensure those qualities are repeatable. They include quality of management, patents, products, distribution, culture and brand value.
“We keep the portfolio limited to 30 stocks to ensure each has a direct impact on portfolio performance,” van Nostrand says. “Some of our competitors have 50 or 60 stocks in their portfolio; that completely dilutes their performance. It doesn’t make sense to us.”
The firm also looks to include those names with the greatest margin of safety and the greatest chance of achieving fair value. Industry and sector weightings are strictly an outgrowth of the firm’s bottom-up stock selection process.
In choosing Cornerstone as this year’s winner, Prima noted the firm uses a fair value model that screens a universe of approximately 800 large-cap stocks to find which stocks are trading at a discount to Cornerstone’s fair value estimate. Cornerstone then looks at which stocks are trading at the deepest discount to their fair value and conducts fundamental research on those names. The firm spends all of its time researching these stocks and works to understand why the stock is cheap since the fundamentals are strong. When researching a name the team focuses its time on understanding the current operating environment, dissecting the company’s business model and financial statements, assessing its competition, and studying the management team.
Cornerstone then builds a portfolio with its highest conviction names and will trim or sell a position once it meets its fair value, or if the manager finds a better opportunity.
Overall, Prima believed Cornerstone was a strong candidate for the large-cap core SMA award due to its clearly defined and repeatable investment process, strong risk-adjusted returns and consistent exposure to the large-cap asset class.
The investment team consists of John Campbell, chief investment officer; Edward Mitchell, Jr., managing partner, portfolio manager; Fred Wetzel, Jr., portfolio manager; Neilson Brown, portfolio manager; Rick van Nostrand, portfolio manager; Dean Morris, portfolio manager; and Cameron Clement, portfolio manager.
Large-Cap Growth Award
Wedgewood Partners Inc.
Large-Cap Focused Growth Strategy
Ask David Rolfe for the firm’s elevator pitch and he has it at the ready.
“We’re big subscribers to the arguments put forth by Charles D. Ellis, author of ‘The Loser’s Game’,” begins Rolfe, chief investment officer of St. Louis-based Wedgewood Partners. “Instead of trying to time the markets and getting sucked into short-term volatility, we take a long-term view and let the markets work for us. Too many of our competitors try to do otherwise, and we refuse to play that loser’s game. That, quite simply, is our investing philosophy. ”
This longer-term view naturally leads to a big belief in—and heavy reliance on—index investing which, as Rolfe notes, by definition is buy-and-hold investing. This means the firm has a history of minimum turnover in the portfolio. As a corollary, Rolfe notes, this approach also affects the firm’s stock selection.
“If we expect to invest in companies for many years, we focus on those select companies with the brightest multi-year prospects for growth,” he says. “Additionally, our view on risk is contrary to the typical manager as well. We don’t view risk via individual security price volatility, rather all of our risk analysis is centered on the individual business.”
The second time’s the charm for the 22-year-old firm, as Prima has previously recommended Wedgewood for an SMA award. In recommending the firm this year, Prima said it was “pleased the manager is looking to grow its business through the SMA channel and is solely focused on the large-cap growth strategy.”
With $875 million currently in assets under management, Wedgewood believes consistent execution of their fundamental, long-term-focused research process coupled with disciplined valuation can produce excellent long-term returns, according to Prima. The strategy has delivered, producing top quartile performance on an absolute and risk-adjusted basis over the last three, five and 10 years. Wedgewood builds a concentrated portfolio of 18 to 22 stocks trading at a deep discount to their estimated intrinsic value that are typically driven by two factors: overly conservative consensus estimates and compressed valuation multiples.
Confirming Rolfe’s long-term views, Prima says Wedgewood is a very patient investor focused on a three- to five-year outlook which typically results in low turnover. Over the past five years, portfolio turnover has ranged between 30% and 53%, which contributes to its tax efficiency. Additionally, Wedgewood is able to accommodate tax loss harvesting at client request, further improving potential tax efficiency. The firm was a strong candidate for the large-cap growth SMA award due to its ownership structure, talented and tenured investment team and consistency of alpha generation.
The investment team includes Anthony Guerrerio, president and founder; David Rolfe, chief investment officer; Dana Webb, senior portfolio manager; and Michael Quigley, portfolio manager.
Mid-Cap Equity Award
Denver Investment Advisors
Concentrated Mid-Cap Growth Strategy
Denver Investment Advisors has a process that works, and they’re sticking with it.
The (surprise) Denver-based firm was founded in 1958, with the separately managed account team put in place in 1998.