This is part of a series of extended profiles of the 2014 Separately Managed Account Managers of the Year. Briefer profiles and an overview of the 10th annual SMA Managers of the Year can be found in Investment Advisor's July 2014 cover story. Additional reporting and video interviews of the winning managers can be found on our 2014 SMA Managers of the Year home page.
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, modestly 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 Large-Cap Equity 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 helps 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, but they were lower-quality stocks, which he wasn’t interested in. 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.” The team of five analysts on the strategy will track “eight or nine” of the standard pricing metrics when considering a stock for inclusion in the portfolio, but will lean slightly toward growth: “We might be ahead of the growth benchmarks.”
Dana also has learned the lessons of behavioral finance which helps it on both value and growth. “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.” The team asks, “’Is there some other reason why this stock is out of favor?’ Behavioral finance helps you distinguish between those two sides of cheap stocks.”
What about growth? “On the flip side there’s 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.
The investment process includes first running a quantitative model, followed by fundamental analysis by the team that seeks to “confirm that the quant model is giving us valid info,” then considers metrics that are common to the “classic DuPont analysis,” which measures performance by profitability, operating efficiency and financial leverage. “We want to see strong returns, and improving trends, with sustainability.”
However, one thing the team doesn’t like to see is rising leverage—“it’s another source of risk.” They look at how a given company’s valuations compare to other companies in the sector, along with forward earnings and cash flow. While “we’re basing our analysis on models done by Wall Street, we see that as a conduit for information and ignore their recommendations.”
In fact, Roberts says that while “investment returns is how the outside world views us, we look at internal measures to see how well we’re doing,” including tracking positive and negative surprises in every earnings season.
Turnover of the portfolio averages about 60%, though a third of that comes from rebalancing and risk controls, 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.
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This is part of a series of extended profiles of the 2014 Separately Managed Account Managers of the Year. Briefer profiles and an overview of the 10th annual SMA Managers of the Year can be found in Investment Advisor's July 2014 cover story. Additional reporting and video interviews of the winning managers can be found on our 2014 SMA Managers of the Year home page.
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