Q: What is the history of the fund and how do you differ from your peers?

Al Lagan founded the asset management company in 1985 with a mission to provide investment services focused on the preservation of capital to our early clients such as insurance companies, religious organizations and pension plans.

Until the late 1990s we only had a couple of fixed-income offerings and a large-cap growth strategy. Later, we decided to broaden our line-up and take our existing process and philosophy and move it down to the mid-cap market segment. 

So, we started our mid-cap growth investing strategy in September 1999. Looking back, it was not necessarily the best time to start a new growth product, especially mid-cap, given what transpired over the next couple of years. In the evolution of the business we realized that a lot of the partners we were working with were offering more mutual fund solutions to their end clients and deemphasizing separate account management, which happened to be our core focus at the time. 

In the fall of 2012, we launched three mutual funds, including the Congress Mid Cap Growth Fund. To our way of thinking, a mid-cap company has a market cap between $800 million and $10 billion at the time of purchase, and we let our investment grow to $20 billion before it has to be sold.

Our assets in mid-cap funds have now increased to $200 million while total assets in the product have increased to over $1 billion. 

One thing that differentiates us from our peers is that we stay in our style box, mid-cap growth, without trying to go down into small-cap or up into large-cap. We do not duplicate any efforts we already see in the typical client portfolio, which already has a large-cap growth manager or a small-cap growth manager. We say what we do and we do what we say. In fact, we have been doing this very effectively over the past 15-plus years, a period in which an investor in the mid-cap growth benchmark has lost half their money twice. 

We are focused on participating in the upside and protecting on the downside, which forms the foundation of our philosophy. Growth at a reasonable risk is how we like to describe it.

Q: How would you define your investment philosophy? 

We are focused on building a portfolio of companies that are growing at a consistent rate but trading at a reasonable price to its prospects compared to its own history and its peers. We look for upside participation and preservation of capital, a tough balance to achieve. We try to capture 90% to 95% of the upside market but on the downside we try to only capture 60% to 65%.

We look at risk as just another market variable that is almost impossible to time correctly. Other managers are adjusting risks higher or lower, but that is very difficult to time and difficult to achieve through stock picking. Therefore, we try to maintain a very low consistent level of risk usually measured as the standard deviation of the portfolio. Not only do we try to stay below the benchmark, but we also try to keep that risk level as low as possible.

Some of the stocks we have in our portfolio might be too boring for other managers to put into their portfolio in a rising market for fear of falling short of the benchmark in the short term, but when the market turns south the names we have are some of the last names a manager wants to sell. 

Our risk management approach is similar to what a fixed-income manager may consider and that is what distinguishes us from our peers. We use a risk barbell whereby if we want to put a security into our portfolio that we think is going to raise the overall risk level to too high, we will make a change somewhere else on the portfolio in order to keep the overall risk level of the portfolio in check.

Q: What is your investment strategy and process? 

We have an internal equity research department that works with a team of portfolio managers and myself, and our investment decisions are made by a committee that I lead. In other words, I work on setting the agenda and guiding the discussion, playing the “devil’s advocate” where necessary. We have a weekly meeting of the portfolio managers where I solicit everyone’s thoughts and we seek to achieve a consensus decision that is in the best interest of our clients.

Our research team puts together research reports that we use as a basis of discussion. Many times a discussion about a possible change in the portfolio can take place over several meetings or even over several months. It is important to stress that we are very deliberate in terms of making changes in our portfolio. That is primarily because we try to keep our portfolio turnover quite low and we generally avoid making changes to the portfolio based on short-term noise. 

We think that being a buy-and-hold investor, and knowing your companies well, is the most important thing that a manager can do.

Strong cash flows is the first point of attraction for every investment idea that we consider. We think that there are fewer accounting gimmicks that you can come up with on a cash flow statement than you could in other places on financial statements. Apparently, you know what your cash balance is at the end of year and you know what the cash balance is 12-months later; and there are only three places you could put it—operating, investing, or financing. 

We have been through the dot com rally—a ‘growth now, profits later’ situation in which companies never reached the second stage. However, we want profitable growth now. We want a company that generates enough capital from its own operations that it can invest in the business where it is prudent to do so.

We believe that our clients, who are shareholders of the companies we invest in, hire management of these companies to be stewards of their assets. After all, cash is one of the most important assets. Having reinvested in the business, hopefully there is cash left over, and we expect the management to buy back stock and reduce the shares outstanding, initiate a dividend, or increase an existing dividend.

It is very important to us to look at that cash metric and ask what management is doing on our behalf, because we want to make sure that, just like we are stewards of our client’s assets, the management teams or firms are stewards of clients’ assets as well. We may spend more time on a proxy statement, digging into compensation or any related party transactions, than some other managers, because we want to make sure that management does not have a lot of conflicts that they may profit from ahead of our clients. In short, we want to make sure they are doing the right thing.

Q: How do you look for opportunities? 

Our idea generation is very broad. Where we have an existing portfolio, it always starts with making sure that we have the right names in our portfolio. We have a 40-name limit to our portfolio at all times and they are all equally weighted. 

If we do not have the right portfolio construction we will do comparative analysis to see if there are companies that compete with existing names and performing better. From time to time we run an index review just to make sure we see what exposures are in the index and what companies are available. At some point there may be some small cap companies that have grown into mid caps, or large caps that have fallen into the mid-cap space, so we want to make sure we are capturing all of that.

Q: Do you use quantitative screens and how do you gather ideas?

We do occasionally use some quantitative screens, although these metrics are fairly wide. In addition to attending sell side conferences and listening to company conference calls, including conference calls of companies we do not own, we meet with companies directly and use the cumulative experience of all the portfolio managers on this product. There are ideas that can come from any different avenue to make it onto our agenda for a more thorough review.

Once an idea is put on the weekly agenda, which is usually two or three weeks in advance for an analyst to prepare, the portfolio managers, who are thought of as generalists, can do their research work as well. In this way, when we go to the meeting we can have a productive discussion about all the strengths and weaknesses of the company and the overall investment idea to gain a better understanding of the nature of the opportunity.

Most typically, we will discuss a stock at several meetings before deciding if we want to add it to the portfolio or replace a current holding. We want to hold our stocks either until they reach $20 billion, which is our limit where they have to be removed, or if somebody else acquires these companies, which is not so infrequent in this space. Otherwise, as long as a company is living up to its original thesis and it is making progress on the reasons why we added it to the portfolio, it will remain in the portfolio. 

Q: Can you highlight two recent examples of investment ideas? 

One of the names we recently added was B/E Aerospace. They do a lot of work on aircraft cabins and interiors. This was a replacement for another aerospace name we had in the portfolio, Hexcel, where almost 100% of the aerospace revenues came from OEMs, namely Boeing and Airbus. The company’s performance was tightly correlated with plane deliveries and production plans of two major aircraft manufacturers whose futures have been wavering a little bit with the dramatic recent drop in oil price, and a possible change in how we are replacing some older planes that are not as fuel-efficient.

We settled on B/E Aerospace because, although the company has some OEM exposure, it is diversified with after-market exposure where the existing interior of the plane can be redone to meet the changing needs of the airlines and passengers. They have the opportunity of not only selling into the new aircraft market, but they also have the ability to sell into existing aircrafts that may need to be upgraded. 

Just from our own personal flying experience, and from our own analysis of the financials of airline companies, there is going to be a lot of money needed and available to spend on rehabbing existing planes. While the lifespan of a commercial plane could be 20 or 30 years, the interior will be replaced several times. 

Also, with the demand for people bringing devices on board, you have a whole new level of electric needs and of entertainment possibilities. There is also the possibility of putting in thinner seats so you can add more seats. On the high-end, you also have customized business and first class offerings that B/E Aerospace dominates and leads global market share.

When we looked at the overall ability of B/E Aerospace to make money, the diversification in their business gave us a lot more confidence to invest in them rather than to continue our holding in Hexcel. 

In December 2014, the company spun-off some consumables management business as well as a smaller energy business that came about from a couple of acquisitions in the past, which were not attractive to us. We are almost waiting for this company to do the spin-off to just get to be a pure aerospace company so they can focus on that part of their business. We think that by focusing on the aerospace business they will be able to take advantage of some of the investments they have made recently to work with Boeing, Airbus, and some after-market companies. That is a good catalyst for B/E to start seeing some really good growth.

We also made some changes in our portfolio on the industrial side in late 2014. Since we have one restaurant holding in our portfolio, we looked into a lot of restaurant conference calls and one of the topics discussed was changing the back of the house, how the kitchen is set up, investing in new assembly lines, their ability to reduce water usage, their ability to replace labor as the cost of labor is could rise as high as $15 an hour for wages along with healthcare benefits. We looked for anything we could see in the back of the restaurant that gave us an opportunity to invest and capture growth across all restaurants without betting on one particular concept. 

When we looked at who supplied the restaurant industry, we came across a company called Middleby Corp, which does a fantastic job of selling equipment and services to the back of the restaurant. With the company’s equipment, restaurants can reduce water usage, lower labor hours, automate some processes, keep up quality control, and meet safety regulations. We thought the risk level was much lower by going with a company that serves a diversified customer base rather than just trying to figure out whether we want to own this or that restaurant chain.

Q: What kind of growth are you looking for and does valuation matter? 

From a quantitative perspective, it is always a combination of science and art. We do look at whether the company has positive free cash flow, revenue growth, and earnings growth. When we say growth we set a bar meaning greater than zero, and I would rather take a consistent level of moderate growth than high and variable growth. We dig deep into financials to make sure that the companies we are going to analyze do fit those basic criteria. 

Every time when we are ready to buy a stock we are buying it from a seller who is not optimistic about the company’s investment prospect for whatever reason and we are mindful of that. That is an existing investor who has looked at all the same public information that we have, they have looked at it through whatever process and philosophy that they have, and they have decided it is no longer a good investment for their clients and are therefore willing to sell it to us for a particular price. 

A lot of the art is asking ourselves why we would want someone else’s cast-offs? We spend a lot of time trying to figure out if someone is selling us a lemon or whether there is something about this company or this stock that the previous holder looks at differently than we do and we might think they are wrong.

We do care about valuation, but it is not the be-all and end-all for us. We buy expensive stocks and we buy cheap stocks. It is more about what we see in that business model going forward that tells us whether this will be a company that will succeed and that we see something that others fail to see. If so, then that is clearly what will give us an advantage.

The kind of growth that is important for us is growth that we understand. It is a business model that does not need to change going forward to maintain that level of growth. Do we have a lot of confidence that those trends are going to continue? We want to make sure that our portfolio candidate is not a company that has one pharmaceutical product in Phase III of clinical testing which might not work and bring the company down. Our companies do not have to transform themselves to be successful. 

We have real companies with good balance sheets, strong free cash flow, and to us that is one way that we eliminate a lot of risk from the portfolio. 

Q: How would you describe your investment style? 

We are bottom up investors who pick stocks one at a time. We come across stocks that oftentimes we think are categorized wrong. If we try and construct a portfolio relative to a particular benchmark, we could be adding stocks that we do not like just to get to that weight, or avoiding stocks that we like because we do not want to be overweight. We are an active manager and we try not to concentrate investments in similar drivers or themes. 

If you invest in a benchmark, you are consequently taking benchmark risk. What we try to do is outperform a benchmark just from a strict performance perspective with a lower level or risk. We are not going to add names we do not like just to be aligned with the benchmark.

We are cognizant of what our benchmark is but at the same time we tell our clients that we are not a benchmark product. We have high active share and information ratios but those are output of past performance and past portfolio construction.

Q: What is your portfolio construction process? 

We have set a maximum and minimum number of names at 40. That is the best way we think you can diversify away security-specific risk while taking on market risk effectively. Then, on top of that we layer on equal weights.

For all of the names in our portfolio, our target is 2.5% in each investment. Other managers spend a lot of time trying to figure out what the relative conviction is in names they have in their portfolio without figuring out how many names they ultimately want to end up with. In contrast, we focus on having the right names and the right number of names in the portfolio. Any amount of time we take in our process to figure out what the relative weights of securities should be is wasted time. That time would be better spent making sure we have the right names in the portfolio.

Statistics will tell you that equal weighted benchmarks have historically done better than market cap weighted benchmarks. We take that a little bit further and put it into place with real portfolios that are managed actively.

Our benchmark is the Russell Mid Cap Growth Index. We have individual limit position sizes of 5% and we do not put any more than 30% in any sector or industry. That is an absolute level, which is not relative to the benchmark. 

Q: What is your portfolio turnover? 

Our turnover is generally somewhere between 25% and 50%. That translates to perhaps 10 to 20 new names in the portfolio. However, that also includes names that reach $20 billion in market cap that we are required to sell because to us they are no longer in mid-cap according to our philosophy. Then there are also names that are acquired by other companies. Last year we had one name in the portfolio that reached $20 billion and we had two stocks that were eventually acquired. That still counts as turnover for us.

Q: What drives your sell discipline? 

We will sell when the company changes the business model in a way we did not anticipate. Perhaps the company has a new CEO who prefers switching free cash flow from buying stock to be a serial acquirer. We do not want to own the stock in the face of something that could be very binary. 

We will also sell the stock if it does not live up to our expectations. That is not necessarily the expectation of the Street, but what our expectations are, and they can be very different. We have a thesis on why we bought a stock and if we were to look at that existing stock today and we see it would not make it into our portfolio then there is no reason for it to have a reserved spot in our portfolio. 

We will also sell a stock if we come across a company that is doing so well that we need to make a tough decision to bump a name out, like piglets at a trough. Making the sale decision is as important as making the buy decision. Your absolute performance is based on what you own. Your relative performance is sometimes based as much on what you do not own. The only one you can control are the stocks you do own so you want to make sure you are making the right buys and you are making the right sales for the right reasons.

Q: How do you define and manage risk? 

To us, risk is a client calling and asking why we lost them money in a particular security or their overall portfolio. That is ultimately what it boils down to. Some clients do measure us against the Russell Mid Cap Growth. However, there are clients who do not even have a particular quantitative benchmark in mind—they simply do not like to lose money.

We like to have a low beta, we like to have a low standard deviation, but we also like to avoid surprising our clients when they open up the statement coming in the mail or what they see online. That is real risk to us and that is how investors perceive risk most of the time.