A Class Apart: The 2011 SMA Managers of the Year

The firm has a long history of real dedication to investment research and to being early with new opportunities,” says Mitch Begun, partner and co-director of mid-cap growth research. “The Concentrated Mid-Cap Growth strategy was designed as a best-ideas, high-conviction product.”

Begun says the mid-cap asset class is extremely attractive, and the firm’s sweet spot is companies with between $1 billion and $10 billion in market cap. They are a little more developed than their small-cap brethren, he says, but still more flexible and with more opportunity for growth than large-cap stocks.

“We generate alpha from our stock selection,” Begun explains. “We look for a nice balance of growth, value and quality characteristics. We also look for companies that are either market leaders or can gain market share. From a secular standpoint, we look for dynamic growth in an industry; from the more cyclical industries, we look for an inflection point in which to enter. Overall, we have company-specific drivers, rather than top-down drivers.”

A key differentiator for the firm, he says, is that it focuses on risk management and a strict sell discipline. The latter is something not enough managers focus on, according to Begun.

“Our risk screen helps us identify characteristics that lead to underperformance. And we don’t want to overpay for our stocks. We sell when the market recognizes what we recognize. We have to be very disciplined about this because when you make mistakes in the growth space, they tend to be more violent, so we focus on delta.”

When looking to buy, the team looks to see if the overall industry is growing, if the company is gaining market share, if margins are expanding and if the valuation if attractive. When looking to sell, naturally the signals are the opposite: a slowing industry, losing market share, compressed margins and valuations that are simply too expensive.

The firm names health care company Varian Medical Systems by way of example of a company they like. The x-ray and diagnostic provider is a leader in its space and recently released a new product, TrueBeam. The new product is gaining market share in radiation oncology and diagnostics, and is expanding, in particular, in economies where wages and quality of life are increasing.

Begun notes that the firm is structured as to avoid the echo chamber by assigning managers to sectors rather than entire industries.

“For instance, we have one manager dedicated to technology hardware,” he says, “and another to technology software. In this way it helps in the collaborative process.”

Small-Cap Equity Award
The London Company
Small-Cap Core Strategy

“We don’t think we’re better than anyone else, we just take a rational approach to investing,” says Stephen Goddard, when asked to brag on himself and his firm.

Goddard, managing director and founder of The London Company, based in Richmond, Va., then gets down to basics. The firm takes positions in low beta, conservative companies that are large enough to make an impact to portfolio performance, but with a primary focus on downside protection.

“It’s far easier to determine downside risk than it is to determine the next winner,” Goddard says. “What really hurts the portfolio are the names you’re wrong about.”

The firm was founded as “a very small shop” in 1994, but soon got the attention of industry consultants and today has roughly $2 billion in assets under management.

Jonathan Moody, a principal and portfolio manager with the firm, says he distills the investment process into four pieces. The first is that they go into a new investment with a long-term approach and don’t key in on short-term fluctuations.

“We don’t want to try to outguess the other 1,000 analysts on what the earnings will be for this quarter,” he says.

The second is buying in at attractive valuations, or building the portfolio “on the backs of the companies’ balance sheet.” They look at valuations in the same manner as an owner or private equity investor, and assume zero to little growth because they don’t trust the analysis coming from Wall Street.

“We’re private equity wannabes,” says Goddard. “We look to control what we can. We can’t predict the future, but the balance sheet is something real; something that’s in the here and now.”

The third piece, Moody says, is to find the appropriate investments and then weight them accordingly.

“We hate positions of 1% or less,” he says.
The last piece is ensuring tax efficiency on the part of the portfolio. Moody claims turnover is currently less than 25%.

It all sounds pretty staid and conservative. Is there anything that really sets their philosophy apart?

Yes, according to Prima. The London Company takes a somewhat unusual approach in that it seeks to determine a company’s optimal cost of capital, which it then uses to discount future cash flows. A discount of 40% or greater to the firm’s determination of intrinsic value is sought in potential “buy” candidates, thus, the product’s value bias. The firm conducts intensive research on each company which includes knowing management’s capital allocation strategies. The methodology is similar to evaluations by private buyers (Goddard’s “wannabes” comment), which can benefit returns in an environment in which private equity buyers, and mergers and acquisitions are prevalent.

According to Prima, “The small-cap strategy has been an exceptionally consistent performer on an absolute and risk-adjusted basis since its inception.”

Specialty Manager Award
Forward Uniplan Advisors
Uniplan REIT Portfolio

As we said; second time’s the charm, even more so for Forward Uniplan Advisors, as this is the firm’s second win in as many years.

“The team started out in the balanced portfolio space,” says president and portfolio manager Richard “Rick” Imperiale. “Our REIT portfolio came out of that.”

It’s a good thing, since REITs are what won them this year’s award. REITs, according to Imperiale, raise portfolio returns while lowering volatility, something any introductory 101-investor should like, but getting the message out still takes a concentrated effort.

“Our first order of business is educating advisors to the benefits of REITs in the portfolio,” he says. “Real estate is always local. New York always seems to never have enough office space. Chicago, on the other hand, always seems to have too much. It would be nice to simply transfer that capacity from New York to Chicago but as we all know, it doesn’t work that way.”

Understanding those supply and demand fundamentals are critical, he says, as are the products to best address those fundamentals.

Once the firm solves for location and geography issues, it moves to more qualitative issues; meaning the quality of the management team and how they’ll take advantage of the relatively good real estate outlook in their local market.
“Just as advisors evaluate us when looking for help in managing the REIT portion of their portfolio, we too evaluate REIT managers to ensure the right fit,” Imperiale says. “That qualitative analysis is something, I feel, that’s a bit different from how other managers evaluate the opportunities in the space.”

Prima would seem to agree, and notes Forward Uniplan has one of the longest and most consistent track records in the SMA REIT peer group, and has outperformed the Wilshire REIT Index 18 times in the last 22 years. The boutique firm manages roughly $500 million in assets, with $288 million in the REIT portfolio.

Prima considers Imperiale to be a pioneer in REIT investing and his extensive experience, willingness to move to cash in turbulent market environments such as 2008, and consistent sell discipline are the chief value-adds for the strategy. Imperiale and his team of six blend macro/microeconomic, quantitative and qualitative analysis to construct a concentrated (25 to 35 holdings), benchmark-aware portfolio with low turnover. The REIT strategy has had tremendous success throughout its history, with top quartile annualized alpha over all trailing time periods in the last 10 years.

Fixed Income Award
Sage Advisory Services
Intermediate Fixed Income Portfolio

When Bob Smith, (right), decides on a course of action, he doesn’t mess around. After meeting Mark MacQueen, (left), at the wedding of a mutual friend, the two opened the door of Sage Advisory Services three weeks later.

Smith and MacQueen, both Merrill Lynch alums, decided on a fixed income focus, not a popular message in the tech bubble build-up of 1996.

“It was all equities at that time, so we knew we needed a specific strategy to get people interested,” Smith recalls. “I also knew that in order to keep them engaged, we’d have to have complete transparency about what it was we were doing. It’s their money; they should have access to it whenever they want and I had no problem with them looking over my shoulder about the moves I was making. That holds true today.”

It’s that strategy that brought the firm from nothing to their current $10 billion asset level, Smith says.

According to Prima, the intermediate fixed income portfolio ended 2010 with $3.7 billion in total assets. The investment team is reasonably staffed with 14 investment professionals. Like many taxable fixed income processes, Sage begins with its six member investment committee setting specific duration, yield curve and sector positioning for each portfolio. For the intermediate portfolio, maturities range from one to 10 years, and include all of the sectors of the taxable market, though the MBS sector is consistently underweighted relative to the Barclays Intermediate Aggregate. Sage leverages several street research sources in addition to its own internal research.

The approach in security selection is different from most managers in that Sage isn’t looking for the “hidden gems” in the corporate credit space (typically 30% to 40% of the portfolio), but rather focuses on liquidity and relative value comparisons, looking to capture the broad beta of the preferred industry segment. Given this approach, the average corporate holding is just 1% to 1.5% and the typical account will hold more than 25 corporate issues. Treasuries, agencies and, to a lesser extent, the MBS holdings in the account are used to modify duration and provide liquidity.

As Prima notes, the performance of the intermediate strategy has been exceptionally consistent over the past 14 years. The composite has outperformed the Barclays Intermediate Government Credit Index in 12 of the 14 years, underperforming by a total of just over 1% in 2002 and 2003 combined. The outperformance has always been relatively small (only in 2009 was the outperformance more than 1% in a calendar year). On a risk-adjusted basis, the rolling two-year alpha on the product has been positive 96% of the time.

But Smith notes another area where the firm is finding alpha: the efficiency with which the firm executes its trades, keeping transaction costs low that it can then pass along to clients.

“It’s an area where we find considerable alpha,” Smith says. “We make the street compete against itself for the benefit of our clients.”

International Award
Thomas White International
International ADR Strategy

“We really consider ourselves a research firm,” says Tom White, a man who needs little introduction in the separately managed account space, but we’ll do so anyway. The chairman and president of Thomas White International, White has over 40 years of investment experience, beginning in 1966 at Goldman Sachs. Stints as an officer of Lehman Brothers and managing director at Morgan Stanley soon followed, and White founded the firm that bears his name in 1992.

The firm’s international ADR strategy is something that sets it apart, White says. Its research driven approach translates to “people on the ground,” so to speak, most notably with the opening of its office in Bangalore, India.

“We have the capability not only to buy ADRs in many countries, but we often can actually trade securities on their exchanges, which gives our clients a distinct advantage,” White says.

Prima notes that Thomas White was their primary candidate for the 2011 International SMA Award from the beginning, as the firm has the highest aggregate ranking (i.e. sum of the four category scores) of the five finalists. Additionally, the organization has been very stable over the years, has gradually built out retail SMA relationships and continues to execute their well-designed investment process. This was especially the case in 2010, when the portfolio was underweight emerging markets and overweight Japan (i.e. this was non-consensus positioning) and yet still managed to outperform the Index.
“The international ADR strategy is a derivative of the firm’s ordinary share strategy; however, no apologies are necessary as it has performed equally well,” Prima writes. “Our overall opinion of the firm is quite high, particularly in regard to the investment process, the pedigree of the investment team, and the consistency of performance.”

Thomas White International employs a consistent, repeatable process that relies heavily on a quantitative system to rank stocks in deciles among over 100 valuation groups that are based on industries, sectors, regions, countries and combinations thereof, according to Prima. There are qualitative aspects to the process whereby team members analyze each company in terms of its management team, products and accounting quality, thus making the process more balanced than a purely quantitative approach.

Douglas Jackman, executive vice president and chief operations officer, runs the firm on a day-to-day basis. It is employee-owned, a business model Prima favors in its deliberations, and repeatedly White took pains to point to the expertise and performance of the entire team during our interview. The investment team consists of Wei Li, Ph.D.; David Sullivan II; Douglas Jackman; John Wu, Ph.D.; Jinwen Zhang, Ph.D.; and Marc Ma, Ph.D.