All Americans: The 2014 SMA Managers of the Year

This year’s SMA Managers of the Year are a diverse lot, with portfolios focused on different sectors and cap sizes and built by investment management teams scattered across the country.

However, they’re very similar in their consistency, especially in their outperformance over many years and through various business and market cycles. They hew to their own sustainable and repeatable investment processes. They’re also clearly members of a team.

While the lead managers of these strategies are undeniably brilliant, those managers are also cognizant that they don’t stand alone, and shouldn’t, in forming and monitoring portfolios for the ongoing benefit of advisors’ end clients.

For the 10th straight year, Investment Advisor has partnered with Envestnet | PMC to research, identify and honor those managers in the separately managed account space who we deem to be outstanding and worthy of advisors’ consideration.

What are we looking for? Performance above their peers over time, significant assets devoted to the strategy, well-tenured management, great customer service, tax efficiency and wide availability to advisors (the complete process and criteria can be found at ThinkAdvisor.com).

Tim Clift, chief investment strategist at Envestnet | PMC and a member of the judging committee, said that when considering finalists for these awards, “it generally boils down to trying to evaluate an alpha thesis: What differentiates them from other managers in the universe? What’s unique and sustainable? What’s their edge over other managers? What can they replicate going forward?” And finally, “Where are the returns coming from?”

Gib Watson, vice chairman of Envestnet and a member of the committee for all 10 years, put it this way: “It’s much more than historical performance reviews, and more than just holdings-based analytics on the managers.”

According to Watson, the overall SMA marketplace continues to grow. He cited Cerulli research that found as of the end of Q1 2014, “the SMA market went past $900 billion in AUM, in both traditional SMAs and model-based SMAs.” While SMAs were traditionally more of a “wirehouse type of product line, now we’re seeing a lot of growth in the independent BD space, among RIAs, regional broker-dealers, and bank and trust channels,” he said. Why? “Much of it has to do with an SMA’s features: The individual investor owns the cost basis of the securities in the portfolio, so advisors can engineer better tax-efficient strategies, more restrictions and can build globally diversified SMA accounts,” Watson said.

Clift argued that renewed demand for SMAs “has come from higher tax rates” but also SMAs’ customization, since specific equities (or bonds) can be excluded at the owner’s request. “We’ll see more asset managers come up with more specialized strategies to meet the needs of the markets,” Watson said of the future of SMAs, while Clift pointed out that values-based investing is “becoming more and more important; the main way to do that is through an SMA—you can say ‘I don’t want any tobacco or firearms’” in your account.

That’s why next year we’ll be adding another category to the SMA Managers of the Year—an “impact” award honoring a particular portfolio that considers environmental, social, corporate governance or faith-based criteria in its investment process, reflecting Envestnet’s partnership with Veris Wealth Partners in building an Impact Investing Solutions program.

But this year, we honor those outstanding managers in our traditional categories in the pages that follow, highlighted by the intermediate fixed income strategy offered by Oklahoma City-based Tom Johnson Investment Management, this year’s overall SMA Manager of the Year.

Watson said the intermediate fixed income strategy team at TJIM, led by Richard Parry, CIO, and portfolio manager Doug Haws, “was really impressive in that they were able to preserve capital and generate positive returns” in an otherwise dreary 2013 for fixed income. Clift pointed out that the team at TJIM, which is 100% employee-owned, “proved their worth” last year, with a portfolio featuring “a conservative investment process, very liquid” with a “flexible mandate, being able to adjust to market conditions.”

Read on to learn more about this year’s SMA Managers of the Year. You can find extended profiles and video interviews on ThinkAdvisor.com.

U.S. Equity Large-Cap

Dana Investment Advisors’ Large-Cap Equity Strategy

The first of two SMA Managers of the Year in this category is Dana Investment Advisors for its Large-Cap Equity portfolio. Duane Roberts, who has managed the strategy since its inception in 1999, said Dana’s process “is designed to give us some consistency to outperform in most market environments,” and outperform it has, only underperforming the S&P 500 in two calendar years.

The story behind those two years tells you why the strategy is so successful. “Our process is designed to be consistent, but there’s a weakness to any investment process,” Roberts said. “Because of our belief in equal-weighting holdings, which help us avoid volatility risk when performance is heavily concentrated in mega-cap companies” or when the index is being led by lower-quality companies, the Dana portfolio will underperform in comparison. Year in point, 2009, when “you had a lot of low-quality ‘rebound’ companies that were on the verge of bankruptcy before the recovery started in March, and then you saw 200% to 300% returns,” said Roberts.

Another time when the strategy will underperform for good reasons? “When you have speculative growth companies leading the markets,” which Roberts said “might not be low-quality per se but at valuation levels we don’t like.”

So what is the process? “First and foremost, we approach the stock selection process from a value perspective; there’s a consistent value tilt to our portfolio,” said Roberts. While the Dana team’s securities selection process “is consistent with a value manager’s approach, growth is an important part of valuation. So we emphasize the growth piece—we want to make sure people don’t miss that when they talk about us.” On the value side, however, “you’ll never see us compete with deep discount managers; we have a relative value approach, without sacrificing growth.”

Dana also has learned the lessons of behavioral finance. “On the quant side,” Roberts said, value might be “expectational,” but when focusing on valuation, you should remember that “some stocks are cheap for a reason.” And growth? “There are many behavioral characteristics tied to high-momentum, high-growth stocks,” which he said Dana tries to avoid. “We sometimes view momentum as indicating why the market is excited” about a given stock, but that “doesn’t make it a long-term” prospect.

Roberts said, “We want to be long-term investors. If you find companies valued correctly you can hold them for a long time, but markets are dynamic and companies are dynamic. We’d love to buy and hold companies forever, but we’re not afraid to sell, even if we like them. We want to be in long-term relationships, but we’re not married to the stocks” in the large-cap portfolio. —James J. Green

U.S. Equity Large-Cap

Robeco Investment Management Boston Partners’ Large-Cap Value Strategy

In assessing our second SMA honoree in the large-cap space, Envestnet | PMC’s analysts highlighted the minimal turnover on Boston Partners’ research team of 23 experienced analysts and the portfolio’s clearly articulated alpha thesis and consistent alpha generation. There’s another, more illustrative way of thinking of Robeco Boston Partners’ Large-Cap Value portfolio: Think of a Venn diagram with three circles representing valuation, business momentum and business fundamentals.

“Where they intersect,” said David Pyle, “that’s what we buy.” Pyle, who has been co-portfolio manager on the strategy since 2000 (lead manager Mark Donovan started the portfolio in 1995), said that the approach is based on the work of John Fullerton of The Boston Company in 1987, which he said was “controversial back then because value managers didn’t look at” business momentum and fundamentals.

That approach is followed religiously not just on the Large-Cap Value strategy, but throughout Boston Partners, where Todd Knightly is director of research. The managers ask on valuation, “How much are we paying?” On business fundamentals they ask, “What are we buying?” On business momentum, they ask, “Is the business getting better, staying the same or getting worse?” Pyle said that “what we don’t try to do is predict the future,” whether it’s corporate earnings, the economy or the actions of politicians. “We simply look at any company and ask those three questions. Does it have those characteristics?”

What about the strategy’s approach to risk? First, he said, focus on “winning by not losing. Keep pace in rising markets, outperform in falling markets and diversify your exposure.” Beyond that, Pyle said it’s important to separate risk into “two major buckets”: statistical risk and the “risk of losing money.”

On the first measure, Pyle said that as a large-cap manager he must be aware of issues like tracking errors, but an overemphasis on statistical risk “can lead you astray.” For instance, he said, “I’ve never seen an optimizer that doesn’t tell us to sell our overweight [positions] or buy underweight.” However, “we don’t let the tools make portfolio decisions”; but rather “reference where our statistical risk lies.”

And the risk of losing money? “I’ve never met a client who has to pay their bills with relative money. The laws of compounding mathematically dictate that protecting capital is the only risk that matters.”

The portfolio’s best performance has come when the markets are stable or weak, Pyle reported. “So from 2007 to March 2009 we outperformed, but from March 2009 we just kept up with the market, which was fine: By losing less, you’re winning.” —James J. Green

Small, Mid- and SMID-Cap Equity

Glenmede Investment Management’s Small-Cap Equity Strategy

On a recent trip to Chicago, during which he had to contend with major flight delays, Chris Colarik, portfolio manager for Philadelphia-based Glenmede Investment Management’s Small-Cap Equity strategy, was dismayed to find that because he hadn’t flown in such a long time, he could no longer avail himself of the privileges U.S. Airways offers its frequent fliers.

That caused some momentary discomfort, but in the grander scheme of things, Colarik didn’t mind at all.

“The successful performance of our product means that we haven’t had to go out on the road to market it,” he said. “We sowed all the seeds, and now all we really need to do is follow up.”

Colarik—who has been with Glenmede since 2001—co-manages the Glenmede Small-Cap Equity strategy with lead manager Bob Mancuso, who’s headed the team since 1993. The duo manages a total of $1.8 billion in the strategy, of which $500 million is split between SMA and UMA accounts. Both men are invested in the strategy that they manage.

Colarik credits the success of Glenmede’s $1.8 billion Small-Cap Equity product to consistency, discipline and “never wavering from our core strategy.”

Getting the best out of the small-cap equity space means thinking long term, Colarik said, and that means tuning out the daily, weekly and even quarterly noise, and assessing companies in an in-depth manner over the course of a complete market cycle.

As a firm, Glenmede, named SMA Manager of the Year in the small-, SMID- and mid-cap category, believes in diversifying across sectors, industries and individual securities, and combining that with an emphasis on quality. The firm sorts its universe of 3,500 stocks into eight economic sectors and ranks them according to their valuation; growth and profitability; earnings and company-specific catalysts; and market confirmation of price momentum. Those stocks that rank in the top 20% of each sector and that are either in the Russell 2000 or have less than $2.75 billion in market capitalization then form Glenmede’s “buy list” of about 400 stocks.

“Whatever name we want, we’ll pick from this opportunity set,” Colarik said.

The second component of the process entails combing through news articles, research reports, thought pieces and the like to get a sense of the big themes at play in the U.S. economy and how they translate into the small-cap space.

The crux of the Glenmede approach lies in matching investment themes and ideas with names on the buy list and only on the buy list. For Colarik, though, the most important factor in Glenmede’s success is that it sticks to what it’s supposed to do.

“We are small-cap managers, and we make sure we stay in that box so we don’t become mid-cap managers,” Colarik said. —Savita Iyer-Ahrestani

Small-, Mid- and SMID-Cap

Reinhart Partners’ Mid-Cap Private Market Value Equity Strategy

Mequon, Wisc.-based Reinhart Partners is a 100% employee-owned firm in which a small team, selected with great care through the years, works closely together to leverage the best of their experience, expertise and skills in order to deliver their clients top-class returns, particularly in volatile markets.

In today’s more stable market environment, “our numbers may not look that special,” said Brent Jesko, lead portfolio manager of Reinhart’s Mid-Cap Private Market Value Equity strategy, which has $950 million in the portfolio. However, “investors have continued to choose us because we have been able to navigate the bear markets, and we do very well in volatile environments.”