Todd Beiley Todd Beiley

Kayne Anderson Rudnick’s Small-Cap Sustainable Growth Strategy outpaced the Russell 2000 Growth Index by 22.42% in 2017 thanks to strong stock selection, according to Envestnet | PMC analysts Mike Gebhardt and Brandon Rick. Plus, this portfolio team “delivered meaningful outperformance in the negative months during 2017,” the analysts say.

Credit for this record should go to Los Angeles-based Kayne Anderson Rudnick’s “consistent approach,” which has three main elements, according to Todd Beiley, portfolio manager and senior research analyst.

First, Kayne aims to find businesses “with very durable competitive advantages,” Beiley says. Second, it wants to find them “at attractive prices.” Third, it seeks to not “over-diversify the portfolio,” which means it focuses on “the most compelling ideas” it finds.

The Small-Cap Sustainable Growth Strategy includes about 30 securities — “businesses with very strong competitive barriers [that] hopefully we can own for many, many years if we do our research correctly,” he explains.

The holdings are picked using a risk-averse framework, Envestnet | PMC analysts’ say, and the managers spend a significant amount of time focusing on limiting the portfolio’s downside risk. International holdings generally represent 20% or less of the strategy.

In 2017, a holding that helped the Kayne team hit it out of the park was Autohome, a Chinese online car business that became part of the portfolio in 2015. “It has the most user-generated reviews, ratings, etc. … There was a network effect, which we thought was very powerful and would protect the business for a long time.”

How did the portfolio team zoom in on this key holding? “We look in places [where] others, hopefully, may not be, and … we do a lot of screening. We go out and visit companies — anyway we can find an idea we are open to it,” Beiley said.

The businesses that the firm reviews tend to be both “more profitable and more resilient than the average company,” he adds. “In tough economic [or] market environments, our portfolio tends to perform much better … than the rest of the market. We’re proud of not only the long-term absolute returns but how we achieve them.”

Analysts say the strategy’s edge is the dedicated research process of its team, which Kayne has been using to manage its investments since 1992. In addition to on-site visits and phone interviews with company managers, the culture at Kayne fosters collaborative thinking, which benefits its strategies, they point out.

These methods helped Kayne’s small-cap portfolio move up about 39% gross last year. And its longer-term record and 10-year results since inception “are very strong as well,” Beiley says. “In terms of healthy absolute returns, we also tend to do well in difficult market periods.”

The portfolio team’s size is critical, he explains, as it gives the group enough resources to do plenty of research and to fully understand the companies it is considering for the portfolio.

“Getting that right is important. There are obviously a lot of different ways to go about managing a portfolio, and … on our team we’re thinking about the investing world similarly — that’s intellectual curiosity,” the portfolio manager explained. “We’re trying to always learn and grow.”

Chuck Severson Chuck Severson

Baird’s Mid-Cap Growth Strategy topped the Russell Mid-Cap Growth Index by about 2% a year from June 2007 to June 2017, according Envestnet | PMC analysts Mike Gebhardt and Brandon Rick. Last year, it had a nearly 28% return, beating the index by 2.7%.

Baird has “always believed that midcap is an excellent alpha generator,” according to Chuck Severson, senior portfolio management and managing director. Within this category, the team’s approach is to focus on “better businesses — companies that grow faster, are more profitable and are better financed” than others, he says.

“We love to find those compounders of above-average growth rates and margins,” explained Severson, “because when you find them, you can really make good long-term investments.”

The portfolio, which covers all the major industry/sector categories, benefited from last year’s economic and business conditions. “In 2017, with rates starting to rise [and] with an acceleration in the economy, good quality businesses finally started capturing alpha again,” said Severson.

Drilling down into the consumer-discretionary sector, for instance, “There’s the elephant in the room, which is Amazon,” he explained, which puts pressures on traditional retailers. “Our retail exposure instead has been with off-price companies like Burlington stores or the bargain companies like Ollie’s as a way to still have good consumer exposure.”

The portfolio manager points out that capital spending is improving, and with the changes in taxation, companies are going to be able to expense this spending. “We think it’s going to take a while, but we think the industrial space will be very good” as a result, he said.

As for the corporate culture and practices that have supported the winning mid-cap growth strategy, “Baird is a very special place,” according to Severson. “You know we’re privately held [and] employee owned. There are 3,500 of us globally [and] about two-thirds of us are shareholders …, so the culture is really important. To be a Baird associate and shareholder is meaningful to us.”

The firm’s portfolio managers work with sector specialists, many of whom have spent much of their careers covering specific industries. “I ask them to help me with idea generation but also importantly with capital allocation, both at the sector and at the individual-position level,” he explained. “These partners … are critical to our success, because they’re out there investigating the businesses and then helping me allocate the money.”

Baird’s portfolio team strongly believes earnings drive stock prices. That approach could be boosted by the recent tax changes, says Severson, since more companies can expense more capital spending: “We think they’re going to take that money reinvest in their businesses to keep those growth rates very high, so we’re optimistic about it.”

While today’s markets are, of course, unpredictable, he adds, Baird works to maintain its consistency. “There’s still a lot to worry about in the world. And whether it’s tweets or what [else] goes on in the world … we stick very true to our style. We basically keep invested in all the major categories in [all] sectors. We don’t make big sector bets.”

The group’s fundamental work combined with strong business confidence bodes well for the future, Severson says. Envestnet analysts Gebhardt and Rick agree, adding that the mid-cap team and the resources it taps into give the strategy an edge.