The one thing seen among all of this year’s winners?
“Dividend yield,” says Gib Watson, Prima Capital’s president and CEO, which probably doesn’t come as a surprise, given the desperate search for income in this slow-growth world.
This is the eighth year Investment Advisor has teamed with the Denver-based research firm to announce the best separately managed account managers in multiple categories. Prima, whose planned acquisition by Envestnet was announced in February (closing of the deal is expected in April; see the June 2011 cover story for more about Envestnet), looks for repeatable and sustainable processes in the products and managers they consider as candidates for this annual honor. The products must report to the PrimaGuide research application, have at least $200 million in assets and have tenured management of at least three years. Products and managers must rate highly according to Prima’s due diligence process, which uses a proprietary, systematic, multifactor manager evaluation methodology that combines both quantitative and qualitative criteria. There are 13 factors that the Prima analysts consider before recommending the finalists for SMA Managers of the Year, including performance, firm, people, process, style, customer service, tax efficiency and composite.
The goal? To identify two finalists for each award, with one of the finalists being recognized as the primary recommendation.
The categories are: Large-Cap U.S. Equity Manager; Mid-Cap U.S. Equity Manager; Small-Cap U.S. Equity Manager; International or Global Manager; Taxable or Tax-Exempt Fixed Income Manager; and Specialty Manager, which involves a specialty stock, dividend strategy, opportunistic alpha manager, all-cap, go-anywhere or tax-aware strategy.
Unfortunately, no one qualified for the Specialty Manager category this year, but fortunately, two competing firms in one category were so close in the outcome of Prima’s due diligence process that both were awarded the prize. It was just one of many pleasant surprises to come from this year’s crop.
(Read about the 2011 SMA Managers of the Year.)
Sure, behavioral economics is a fascinating subject in the abstract; something routinely discussed at conferences and featured in magazine articles. It’s even broken through in pop culture as the underlying concept driving Billy Beane, Brad Pitt’s character in “Moneyball.” But how many advisory and money management firms actually employ Nobel Prize winner Daniel Kahneman’s prospect theory, mental accounting and the other tenets on a sustainable and repeatable basis in the models they’ve developed?
Denver-based BRC Investment Management does, and it’s a major reason they’ve taken the U.S. Large-Cap Equity award from Prima for 2012. It’s even in their name; BRC stands for Bounded Rationality Concepts, which the firm defines as “a modification of the theory of rational choice that takes into account the cognitive limitations of the decision maker—limitations of both knowledge and computational capacity.” In plainer English, it’s the reason we’re too often our own worst enemy, especially when it comes to investing.
“Our strategy is to monetize irrational behavior,” says John Riddle, BRC’s managing principal and chief investment officer. “In that respect, Kahneman and prospect theory are very important to us.”
So how do they do it?
“We can’t produce economic forecasts better than the average of the experts, so we play in a different sandbox,” Riddle explains. “We instead concentrate on what we think changes the expectations of investors and institutions by focusing on the behavior of security analysts.”
Security analysts are tasked with essentially predicting the unknowable, often far in advance, he says. By the very fact that they are human, they tend to rely on things that make them feel good and validate the calls they’ve made, which often results in a herd mentality when raising and lowering earnings outlooks. This, according to Riddle, is much easier for his firm to anticipate and capitalize on then the vagaries of the global economy.
“We’ve developed proprietary models of behavior that include raw data that is publically available,” he adds. “Everything we do is in-house; we don’t use any outside research services. We rank the beta each night and plug the information into our models.”
Riddle, along with Sharon Ward, Mark Jaeger and David DuRie, were “lifted out” of financial services and investment banking firm Duff & Phelps in 2005. BRC typically includes 30 to 35 stocks in the portfolio, “because our clients don’t need us to diversify away business risk, they need us to find alpha at understandable and sustainable levels of risk.”
The firm looks at the tail of a particular industry universe. It then takes a group of stocks in that tail and turns it over to Ward, Eric Butler and Susan Zeeb on its fundamental team. Using the skills of that fundamental team, it can identify what companies in that tail will behave most consistently with its proprietary models. And there is a valuation play; all else being equal, Riddle says the firm would rather buy companies that are cheap as opposed to expensive.
“We don’t make big sector bets,” he concludes. “Our success comes from the stock selection effect. We want to take a concentrated risk on things we understand, which is analyst behavior.”
“We believe dividend growth equals capital appreciation,” says Jim Boothe. “Therefore we manage a dividend portfolio of 40 companies that generates above-average yield and is balanced among sectors.”
Boothe, portfolio manager with Nuveen-owned Santa Barbara Asset Management, is a “player/coach,” meaning he takes on analyst duties at the boutique firm with four others.
“We look for clean balance sheets, a competitive advantage, very strong cash flow and a commitment to dividends,” he adds.
Santa Barbara Asset Management was founded in 1987, and on Aug. 1, 2005, the firm announced its acquisition by Nuveen Investments. Santa Barbara continues to operate independently with no changes to the investment process or methodology.
According to Prima, the firm’s dividend growth strategy’s philosophy is to seek total return from both dividend income and capital growth with lower-than-market volatility. Santa Barbara does this by investing in dividend-paying companies using three elements when constructing the portfolio: aggregate dividend yield that is higher than the S&P 500; volatility that is lower than the S&P 500; and identifying companies that grow their dividends.
Prima notes the dividend growth investment process begins by identifying a universe of approximately 5,000 companies. This universe is reduced to approximately 1,000 companies that are currently paying dividends on their equity securities. The investment universe includes both domestic and non-U.S. companies and is generally restricted to companies with a current market capitalization above $3 billion.
Santa Barbara then removes companies that do not pay tax-advantaged dividends, including REITs and limited partnerships, resulting in approximately 800 companies. The firm then applies quantitative screens to identify high-dividend-paying companies by sector and industry, resulting in approximately 250 companies. Additional screens are then applied to identify companies with high dividend growth rates.
From the remaining pool of approximately 100 companies, Santa Barbara applies bottom-up fundamental analysis to evaluate the prospects for sustainable dividend growth and capital appreciation. When selecting companies for the portfolio, the firm evaluates certain factors, including a sound business model, strong overall financial position, earnings growth, return on equity, quality of management, potential for dividend growth, market valuation and the commitment to return cash to shareholders. Using this information, Santa Barbara constructs a diversified portfolio, which generally consists of 30 to 50 holdings with broad sector and industrial representation.
We recused ourselves from voting in the Mid-Cap Equity category, citing familiarity bias. We featured Milwaukee-based Geneva Capital Management on our cover announcing the awards in April 2009, which at the time was the third year in a row it took home the prize. The firm took a few years off to give other managers a shot, but it’s back with a vengeance in 2012.
“The firm was founded in 1987, and it’s used the exact same investment philosophy ever since,” says Michelle Picard, a principal and portfolio manager at Geneva. “This was before anyone really knew what the mid-cap space was. There were no Morningstar boxes back then, and it’s only in the last decade that it’s come into its own.”
They like mid-cap companies, she explains, because they’re past the volatile, entrepreneurial small-cap stage and management is focused, yet they haven’t reached the large-cap space where growth is harder to achieve due to the law of large numbers.
“We’re dedicated to finding that next great company,” she says. “One that has above-average earnings and growth with a great management focus.”
“We’ve been able to achieve great returns because of our unwavering discipline to our investment philosophy,” adds Scott Priebe, also a principal and portfolio manager at the firm. “Other managers may say they stick to a particular investment philosophy, but their results say something different. Sticking to our philosophy means we perform very well in broad-based bull markets, but not as well in speculative bull markets. But it doesn’t matter; we don’t change what we do. As a result, we outperform significantly over the long term.”
A speculative bull market typically appears near the end of a broad-based bull market, when high-beta, lower quality stocks outperform.
“When you see that large discrepancy between the performances of higher quality versus lower quality stocks is when we begin to lag on a relative basis, like in 1999, 2003 and 2009,” Picard says. “But we still have strong absolute returns so our clients are happy. And we have a solid, long-term track record over 25 years.”
Both Picard and Priebe count the firm’s collegial atmosphere and strong management from founders Amy Croen and Bill Priebe as ingredients in its success.
“We like to have fun, and everyone brings something to the table,” Picard concludes. “We have a high level of respect for each other. We have experienced management, but we also have young, fresh faces that have a different perspective that we find helpful.”
To say it’s been a wild ride in the small-cap space is an understatement, which makes Kayne Anderson Rudnick’s win in the small-cap equity category all the more impressive.
“We’ve weathered it well,” says small- and mid-cap manager Jon Christensen matter-of-factly. “Research is our life blood; we view ourselves as analysts as well as portfolio managers, and because of our position, we usually talk directly with CFOs at the companies we buy on a consistent basis.”
Christensen and his team (which includes co-managers Bob Schwarzkopf and Todd Beiley) look for 25 to 35 stocks that have a sustainable competitive advantage and can develop, protect and nurture their market share.
“We like them to have niche dominance and be self-financing, which leads to high cash flow and low amounts of debt,” he adds. “This allows them to generate good returns in good market cycles as well as bad.”
And of course he looks for a strong, competent management team, people who are good stewards of cash.
“A lot of these firms have a large amount of cash, and how they handle that cash is very important to us,” Christensen says. “There are typically a few things they can do; declare a dividend, buy back shares, reinvest in the business or look for acquisitions. Reinvesting to grow the business is most important to us while acquisitions are the least.”
The team, he says, are typical growth investors, but they don’t look at the magnitude of growth, because a high magnitude of growth too often can’t be sustained.
“Our goal for our investors is to get the returns of the asset class with a lot less risk. How do we do it? We manage risk differently by mitigating business, balance sheet and profit risk, which helps us protect on the downside. We also generate returns differently by focusing on exceptional companies with high returns on capital, great valuations and lots of cash.”
The portfolio typically outperforms in a recession, he says. Coming out of a recession it’s able to “keep up with the market, while in slow-growth environments (like the one we’re in now), the portfolio outperforms as well.
Which is a good thing since, according to Christensen, “we’ll be living with this market for quite a while,” something that is probably of little concern to his clients.
“We’re bottom-up stock pickers that stay fully invested,” he concludes. “No cash. If we can’t find 25 to 35 good investments for our clients, then we’re not doing our jobs.”
Truth be told, the voting committee at Prima was so impressed with both of the primary nominees in the International Equity Category that they couldn’t pick one over the other, so they gave it to them both. It’s a good problem to have and reflects the quality of the management in the space overall.
Three key ingredients— philosophy, team and process—helped Invesco’s International ADR Growth SMA/Wrap make this year’s cut.
If you haven’t heard of Invesco, you’re probably living under a rock, but we’ll provide the basics anyway. The firm is based in Atlanta and is an independent global investment manager providing worldwide investment management capabilities in a wide range of investment strategies and vehicles to retail, institutional and high-net-worth clients around the world.
“We’re bottom-up stock pickers,” says Clas Olsson, CIO of the International Growth Equity team at Invesco, when describing the philosophy. “We employ EQV, which stands for earnings, quality and valuation, when looking to purchase high-quality growth companies at attractive prices. And we’re true active managers; we’re not looking to replicate a benchmark.”
Olsson says he and his team are long-term investors, with 20% to 30% turnover of the maximum 75 stocks in the portfolio.
“We also have a stable team in place,” he adds. “The portfolio management team has worked together for over 10 years, and most of us arrived at the firm in the mid-1990s.”
The team is stable, diversified, experienced—and most interestingly—from different nationalities, something that gives them a unique global perspective that differentiates them from other management teams in the space.
“It’s very much a team-managed strategy,” he generously states. “I get written up and get all the accolades, but we all participate in getting the shareholders’ returns. Our process has been in place since 1992, it’s been through good market cycles and bad. It’s time-tested and it works.”
Prima agrees, noting “The Invesco International Growth strategy is a good choice for investors seeking international large cap quality-growth exposure. Lead portfolio manager Clas Olsson has managed the strategy since 2001 and we have a positive opinion of the team that supports them. In terms of style, Mr. Olsson is conservative in his approach to investing in growth companies; thus, we expect the portfolio to generally lag in up markets, but protect in down markets. Overall, the investment team has demonstrated its ability to execute on its stated strategy and Prima has confidence that it will be able to add value going forward.”
Platform shoes and leisure suits quickly faded (thank God), but one other product of the seventies, Cambiar Investors, founded in 1973, has withstood the test of time, much to the delight of its clients.
“You don’t have to find every single great stock out there,” says Jennifer Dunne, the firm’s international portfolio manager and senior analyst. “But if you put one in the portfolio, it better go up.”
The Denver-based boutique firm is 100% employee-owned with roughly $7.5 billion in assets under management. The inception of the ADR portfolio (for which they won the award) was February 2006. The International Equity Fund was launched in 1997 as a trust and converted to a ‘40 Act fund in 2002. Currently, the ADR overlaps the international fund by 100% (the fund owns two additional names).More impressively, the global investment team averages 18 years experience for each of its 10 analysts.
“Our president, Brian Barish, was the driving force behind the launch of the international strategy,” Dunne adds. “We are all sector specialists. We don’t rotate; we stay focused on our areas of expertise, which translates to a tremendous amount of trust when it comes to the insight and recommendations we offer.”
Cambiar’s single investment philosophy, according to Molly Cisneros, the firm’s senior vice president, is to find relative value across multiple asset classes.
“However, we’re not out there buying cheap for cheap’s sake,” Cisneros stresses. “We also look for high-quality companies, a quality and experienced management team and low amounts of debt. We feel that last point kept us out of the problems that plagued so many of our competitors in the past few years.”
The team’s inflection point is one with a one- to two-year time horizon. During the period the position is held, they expect 50% (yes, 50%) of total return—roughly 40% of appreciation combined with roughly 10% of dividend distributions.
“We ask ourselves why a particular valuation is compressed,” Dunne says. “Is it structural or transitory? This is where the experience comes in.”
The point, she concludes, is to have a very analyst- and research-based process.
“We have between 40 and 50 stocks in the portfolio,” Dunne says. “Lots of stocks go up 20% or 30%, but our 50% hurdle really concentrates the mind, and that’s something that separates us.”
Predictions of mass default, European sovereign debt, outlooks from Bill Gross, Bernanke’s shenanigans—anyone still think fixed income isn’t “sexy?”
It’s dominated headlines since the crisis began and for good reason; when done right, there is alpha to be had, despite current conventional wisdom about the availability of yield. Gannett Welsh & Kotler is one of those firms doing it right, and the reason the Boston-based money manager’s municipal bond strategy took the fixed income award this year.
“We have a top-down/bottom-up approach,” says Nancy Angell, GW&K’s senior vice president who co-directs the firm’s fixed income investments along with John Fox. “In rising interest rate environments, we extend out a bit longer. In declining rate environments, we’ll shorten our maturities and take more of a defensive position. We’re total-return-focused and our alpha comes from our positioning on the yield curve.”
The firm, founded in 1974, is run by CEO and CIO Harold Kotler, a Babson College alum who joined the firm a year later. Angell has been with the firm for 27 years, Fox for almost 22, and four of their five traders have 10 years under their belts.
“We tend to be a bit longer in our duration and more active in our management than many of our competitors,” Angell says.
“The muni space is dominated by the retail market,” Fox adds. “Retail investors think risk comes from longer durations, but the primary concern is actually reinvestment risk. You have to reinvest at lower and lower rates that continually decrease the investment capital. Recognizing this, our bias has been to worry about deflation, which we’ve warned our clients about for 20 years.”
The firm’s competitors, Fox says, buy into client fear about longer-term duration and allow them to purchase shorter-term paper, which increases reinvestment risk.
“Our job, as managers, is to protect principal and income,” Angell says. “We’ve had two years of negative performance in 30 years, and in those two years it was barely negative.”
So how do they take advantage of days of record issuance, like those seen in early March?
“That was a technical blip,” Fox says. “It created opportunity and was a great time to be buying. There was a nice slate of new issues for us to choose from.”
We’d be remiss if we didn’t end with one final question—what kind of headaches did Meredith Whitney’s famous non-prediction cause for the team?
“It was a headache, but it gave us an opportunity to explain the story of this dire prediction to our clients,” Angell says. “And as this wave of massive net redemptions occurred as a result of what she said, we were actually buying. We were able to take advantage of that headline risk.”
“It was a high-profile example of a mistake so many others make,” Fox adds. “They confuse ‘distressed’ with ‘default,’ which are two totally different things. It was nice for us because it all panned out the way we said it would, which built our credibility with clients.”
See more complete profiles of the 2012 SMA Managers of the Year.