CAM’s marketing presentation (we requested this as part of the initial packet of information (Chapter 3).
If we decide that CAM’s small-cap value portfolio is worth taking to the next step, we will need to set up some kind of meeting with the in- vestment manager or one of the other decision makers for the portfolio under review. I rarely hold meetings just with marketing or client service professionals because at this stage in the process, I have done a fair amount of due diligence and have put together a list of targeted invest- ment-related questions that I feel can be answered only by the investment professionals. In addition, because the people involved in the manage- ment of the underlying portfolio are the most important piece of the puz- zle, I’m looking to gain an initial understanding of what makes the investment manager or team tick. No marketer or client service profes- sional can relay this information to me—it has to come from the prover- bial horse’s mouth.
As Exhibit 8.1 illustrates, the next logical step in the process is to set up an initial investment meeting. However, before we do so we need to de- termine if a given manager is worth the time and effort. Thus far, we have limited the level of work we have done and kept it at a minimum. We have analyzed performance data, quickly reviewed a sample portfolio, and read through some basic information about the firm and the underlying prod- uct. However, it is at this stage in the process when we start to put in some time and effort. Meetings take time to prepare for, set up, and actually sit through. In addition, we have more detailed analytical work to perform in the next few stages as well as an on-site visit. On-site visits are lengthy meetings where the investment manager analyst travels to visit the invest- ment management firm. They are time-consuming and often take some time to set up.
So that we can keep using CAM Asset Management as a case study, we will take them on to the next level and set up a meeting.
ready done a lot of homework on the investment firm and the product un- der review. I do not have to ask basic questions because I have likely found the answers in the data already provided to me or through the internal an- alytics that I would have performed thus far in the process.
To better illustrate the format for an initial interview, I have created a fictional phone conference between the portfolio manager at CAM Asset Management, Mark Innes, and myself. The following transcript does not include every word that would be spoken during one of these meetings. I have eliminated the introductions, niceties, and any other information that is not relevant to this chapter. In addition, I have included some commen- tary in specific places to explain my reasoning behind certain questions or my interpretation of Mark’s answers. The commentary appears in italics after each relevant question or response from Mark.
Transcript of conference call between Frank J. Travers, CFA, and Mark Innes, portfolio manager of the CAM small-cap value product.
[Conversation picks up after introductions.]
FT: Tell me about yourself.
MI: Do you have a copy of my bio?
FT: Yes, but as you know it just lists where you previously worked and the dates you were there. I’m looking to get a feel for what you did previously and how you ended up at CAM.
Remember, the three P’s: people, process, and performance. Because the people involved in the investment process are the key element in making a decision to hire a particular investment firm, it is important to delve into each professional’s background. However, due to the fact that this is a short initial phone conference, I tend to keep this line of questioning short. I will follow up in more detail if I conduct an on- site visit, during which I will try to get to know each investment pro- fessional who works on the product.
MI: Sure, just tell me when I start to bore you.
FT: Okay.
MI: I started out in this industry back in 1982 when I graduated from Penn State University. I had received my undergraduate in finance.
I took a position as an equity analyst covering consumer cyclicals with a small asset management firm out of Los Angeles called Mackey Capital Partners. I recognized pretty early on that their in- vestment style and mine did not mesh, so I left in 1985 and started my own firm, IAM, short for Innes Asset Management.
FT: Let’s back up. What was so different about your styles?
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It seems interesting to me that Mark took the job in the first place. If it was so obvious that their styles didn’t mesh in his first few weeks of employment, why didn’t this come up when he was interviewing? It could be that he was just out of school and didn’t have the experi- ence to recognize the incompatibility at that time, or it could be something else. In any case, this line of questioning will help me to get to know him better and will tell me something about his decision- making skills.
MI: They were a quantitative shop. They de-emphasized fundamental analysis and focused exclusively on statistical measures of mean reversion. You know . . . look for stocks trading below their mean, then find the ones with some catalyst that will push them back to that mean level.
FT: I’m surprised that you had a sector specialty at a quantitative shop.
They tend to be generalists.
MI: Good point. I got a bit ahead of myself. When I had started there, I worked on a product that had a fundamental orientation, but the firm decided shortly after I joined that they preferred to focus ex- clusively on the quant product. I was essentially reassigned at that point.
FT: How long had you been there?
MI: Not long. A month maybe.
FT: So, within a month you had gone from performing fundamental analysis on consumer stocks to working on a quant-oriented prod- uct.
MI: Yes.
FT: What were your specific job responsibilities after the change?
MI: Jack-of-all-trades. I did portfolio reconciliation, trading, report- ing, and some client service.
FT: You stayed with the firm for another three years before finally leav- ing.
MI: Yes.
FT: What took so long?
MI: At that time I didn’t know what I wanted to do. Fortunately, the firm made the decision for me when they went out of business. I had made some good contacts in those three years, so I decided to branch out on my own.
His answers have me a bit confused. He knew three years earlier that he didn’t fit in, but never did anything about it. It was only when he had no choice that he made a move—and what a move. Additionally, his decision to start his own firm at that stage in his career seems a bit premature.
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FT: Seems pretty adventurous for a guy in his mid-twenties with just three years’ experience under his belt.
MI: Chalk it up to inexperience and, to some extent, cockiness. I shut down the business less than a year later. I had a few clients, but not nearly enough to make a living. Suffice it to say that I lost my shirt. Should I go on?
FT: Yes.
MI: I took a position as the co–portfolio manager of a small-cap equity mutual fund at Atlantis Capital and basically stayed there until I started CAM with my two partners.
FT: So you stayed there for just over 10 years.
MI: Yes. Good firm, strong product mix. I was the co-manager of their small-cap mutual fund along with another guy for a few years and then took over full control of the fund when he retired back in the early 1990s.
FT: Tell me how you progressed at Atlantis. You know . . . how had your portfolio management skills developed and changed in the 10 plus years you were there? How many people did you have work- ing with you and what were their roles?
MI: [Joking] I feel like I’m on the witness stand here. Most people just want me to explain what I do now.
FT: [Not joking] Then I’m doing my job well.
In order to understand how someone invests today, I have always found that it is important to chart their progress over time. After all, investment firms often tout their investment staff’s level of industry ex- perience (as does CAM in their marketing presentation), so it is only fair to inquire about that experience.
MI: At Atlantis, I managed the product in what the consultants might call a GARP process—growth at a reasonable price. I have always been a value investor at heart, but I refuse to buy a stock simply because it’s cheap. Once I took over the fund full tilt, I made some slight modifications over the ensuing years. Rather than screening just for value-oriented factors, like most other value managers, I started to include growth factors. I look for companies with strong profitability, defined by ROE, as well as both top- and bottom-line revenue growth.
Bells should be going off at this point. The fact that Mark spent a decade investing using a GARP methodology is not surprising based on the returns-based analysis and portfolio analysis that we have per- formed. The CAM portfolio has consistently exhibited growth charac- teristics, from its excessive outperformance in the growth-oriented
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market of 1999 to the extremely high weight in the health care sector, usually favored by growth managers. His comment about changing the investment criteria at Atlantis piqued my interest.
FT: Who was your co-manager and what was the difference between the portfolio when he was there versus when you took over?
MI: His name is Chris Ahearn. I would best describe his style as deep value. He was “old school” value and, as you can imagine, we had some pretty interesting discussions in our years together.
FT: Chris was the lead portfolio manager?
MI: Yes. He was one of the original founding partners of the firm back in the 1970s. The changes that I incorporated can best be de- scribed when we discuss CAM’s philosophy and process. The process that we utilize at CAM is an extension of the one that my team and I utilized at Atlantis for many years.
FT: Let’s talk about CAM. Why did you branch out a second time and start your own firm?
MI: The fund at Atlantis had gotten too big to effectively manage. I thought it should close at $750 million, but because its perfor- mance was so good, it was always an easy sell. As you know, At- lantis is a huge firm with billions in assets under management across a dozen or so asset classes. As a result, at the time when I left to form CAM the fund had over $1.2 billion in assets. I could- n’t manage the fund the way I wanted to because of the size.
FT: So what did you do while you managed the fund at Atlantis . . . buy more issues?
MI: That’s right. I like a portfolio with between 40 and 60 names.
When I left, the fund had about 100 names.
FT: But performance was still good?
MI: Yes and no. The fund’s long-term performance numbers were still at the top of the list, but the more recent numbers were about av- erage. It was at this time that Jim and Andy, my two current part- ners, approached me about starting CAM. I thought it was a good idea. I had put away enough money over the years, so that wasn’t an issue.
As a double check, I will load the historical performance information for the small-cap fund that Mark managed while he was at Atlantis. I will fo- cus on three time frames: (1) when Chris was the lead portfolio manager, (2) when Mark was the lead portfolio manager, and (3) the last two years of performance (to see the impact of the fund’s size on returns).
FT: Tell me about Jim and Andy. How did you meet? What do they do at CAM? What are their strengths and weaknesses? Actually, I’d like to know what your strengths and weaknesses are, too.
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MI: I think I’d rather have them address that question. My strength is my ability to find strong value stocks. I’m a stock picker—pure and simple. My weakness is worrying about operational business issues. That’s what Andy does so well. He is the CEO and COO of the firm. As far as how we all met, I have known Andy since my university days. Jim and Andy had met and worked together at a firm called Victory Asset Management. VAM is a firm that caters to the high net worth crowd. Jim managed clients’ assets and Andy was in charge of marketing and client service.
I am not familiar with VAM. I will make a point of researching this company so I can form a more complete picture of Andy’s and Jim’s investment backgrounds and overall levels of experience.
FT: Does Andy have any investment responsibilities?
According to their marketing presentation, Andy does have investment responsibilities. However, the presentation is not specific as to what those responsibilities are. Since his background is not investment re- lated and because Mark stated that Andy is the CEO and COO, I wanted to clarify this issue.
MI: He markets the product and is also part of our investment com- mittee. He, Jim, and I sit on that committee. We also have a young analyst, Tara, who does a lot of the grunt work at this time. We hope to train her and move her directly into stock analysis.
FT: How many people did you have working with you at Atlantis ver- sus CAM?
MI: At Atlantis, I had four analysts working for me. They each worked on different sectors, but they did not have any decision-making authority. If they had a stock they thought should be in the portfo- lio, they pitched the idea to me. I flat out rejected it, accepted it, or told them to go back and answer some additional questions. At Atlantis, I was a generalist. Here at CAM, I work on the portfolio with three others: Jim, Andy, and Tara.
FT: But Andy is more operations and Tara seems a bit junior at this time. Is it fair to say that you and Jim co-manage the portfolio?
I ask this question so that I can determine exactly who does what. It is important to understand who the decision maker is. I’m looking to see if it is Mark alone, Mark and Jim, or some other combination. The an- swers to this line of questions will help me to focus my questions if I conduct a second meeting or an on-site meeting later on in the process.
MI: Andy and Tara contribute plenty, but you are right—it’s basically Jim and I calling the shots.
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FT: Tell me about that. How do you and Jim split the job? Are you generalists or do you have specific sector responsibilities?
MI: We are all generalists. I can go into the investment process if you like.
FT: Okay.
MI: As you know, we are a small-cap shop. We specialize in stocks with market caps below $1 billion. We start off by screening our database for stocks with caps less than $1 billion—so we have room for them to grow. And we also eliminate stocks with caps below $100 million, penny stocks, and illiquid stocks.
We already know from our analysis that the portfolio has a few stocks with market caps below $100 million.
FT: Define “illiquid” for me.
MI: We don’t have any hard and fast rules here—just that we will not purchase a stock in which we wouldn’t be able to close out our position within a week without materially impacting the price of that stock. Naturally, things can happen after we purchase a stock that make it less liquid. But we tackle those issues on a case-by- case basis.
FT: Who trades the portfolio?
MI: Jim and I rotate that responsibility. Andy also kicks in from time to time. Just remember that our turnover is pretty low—about 30% per year. We are more of a buy-and-hold firm.
FT: What value factors do you screen for?
MI: The initial screen looks to isolate companies with low relative P/E, P/B, and P/CF and high or growing revenues and earnings.
FT: Give me the cutoff for the price-related factors and tell me what growth and earnings factors you focus on at this initial screen- ing stage.
MI: Each of the factors we screen for is relative to our small cap uni- verse. We use the Baseline database to rank each small-cap stock based on our criteria, such as P/E, P/S, and so on; then we focus only on the top quartile of names. This is just using the value crite- ria. After this is done, we overlay the results with the growth and earnings criteria—we use earnings growth, revenue growth, and ROE. We rank the remaining stocks according to these criteria and take only the top quartile of stocks from this list. So the net result is that we start off with about 2,000 small-cap companies. We eliminate the illiquid names and the penny stocks and are left with something like half of that figure. The valuation criteria narrow that list to about 250 names, which is the top quartile or top 25%.
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Then the growth overlay reduces that list again to about 75 names. At this stage, the computer has done all the work. We then take the list of 75 names and start to perform detailed fundamen- tal analysis on the list.
Mark’s answer confirms our previous conclusions regarding the port- folio’s growth element. But here we can finally start to understand ex- actly why the stocks in the CAM portfolio have such strong growth tendencies—they actually screen for companies that exhibit strong rel- ative growth.
FT: Who does the screening?
Again, I am just trying to get a complete picture of who does what.
This information is certainly helpful when making a decision to hire a given investment firm, but it is pure gold years later when a company has experienced employee turnover. When I reevaluate a company in the years that follow, I can refer back to my notes to see how current employees have progressed and can also check to see what responsibil- ities some of the departed employees had previously.
MI: Tara. It’s pretty automated. The database can be manipulated to do just about anything in a flash.
FT: So you have a list of 75 or so names to evaluate. What happens at this point?
MI: Tara e-mails the list to each of us first thing every Monday morn- ing. We each look it over on our own for a while, then have a meeting at some point in the morning. We are a small shop, so we don’t set formal meeting times. The four of us convene in our con- ference room and discuss the list for an hour or so. We divide up the stocks among ourselves and go back to our offices to start the analytical process.
FT: How is the list divided, and when do you discuss the results?
MI: We don’t have any formal methodology in place—we simply check off the names that we are each going to follow. I may, for example, know a company reasonably well. So if that company were in the list, I would offer to take it based on my previous experiences.
Only when one of us feels that they have found a stock that is worthy of making it into the portfolio do we spend any time dis- cussing it among ourselves. Keep in mind that this is an ongoing process. We always have a list of stocks that we are evaluating. But again, our turnover is not too high. Buying a new stock is a big deal for us. On average, we buy only about 15 to 20 new stocks in a given year. So we analyze hundreds of stocks in detail and act on
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