Q: How has your investment approach evolved in recent years?
The fund has been around for a long time and I have been managing the portfolio since April 2001. In 2011, we added an enhancement to our valuation framework. Previously, we had used price targets to drive our new buy and sell decisions, but at the time we added another dimension called upside/downside framework. This added a downside forecast for all the stocks that are in the portfolio, in addition to our upside forecasts.
From 2012 to the present moment we have had one of our strongest periods of performance. The enhancement improved our overall performance relative to our peer group and on an absolute basis.
In this fund we look to invest in all market caps, but we focus primarily on large caps. Although we may own stocks that are more mid-cap oriented, the overall makeup of the fund puts us in the large-cap category.
Q: What kind of growth are you seeking?
We are agnostic with regard to the type of growth we are looking for. To us, growth exists in unexpected places. Personally, I am agnostic relative to sector, geography, market cap, and also relative to how a company is achieving that growth, or its level of growth.
What I care about is the relative differentiation that we have. For example, I want to own a company that is expected to grow 15% but instead grows 20%, and I will avoid a company where consensus thinks they will grow 25% to 30%, but they only grow 20%.
At the same time I am somewhat indifferent to how they achieve that level of growth. It could be all organic or partially organic, with some percentage coming from inorganic avenues. It could also be referring to real earnings growth, which could in turn be coming from margin expansion either from leverage in the model or cost cutting that the company is undertaking.
Q: What is your investment philosophy?
First of all, we take a holistic view of the stocks that we consider without thinking about market cap per se. Looking at these stocks on a bottom-up basis, we try to find the ones that fit our criteria—an overall framework that we refer to as ATOM (Accelerated Tangible Operating Momentum).
We seek companies with accelerating growth and improving margins that will lead to better-than-expected earnings growth. In doing so, we identify companies with a catalyst which will propel the company to show accelerating trends on their top line.
Furthermore, we look for names where we have a differentiated view relative to consensus. Accelerating growth, in and of itself, is not a reason to buy a company. To do so, we also need to understand that the implications of this accelerating growth will lead to better-than-expected earnings growth.
Q: Would you describe your investment strategy and process?
After we conduct our fundamental research to identify a catalyst for growth, we enter it into our earnings models to determine what we believe a company is likely earn over the next couple of years. Essentially, we try to anticipate growth over the longer term.
We are currently looking out to 2017 to determine our relative differentiation and determine the relative upside for particular companies. If we have a differentiated view relative to consensus, then we will put it through our valuation model. If we have more upside relative to downside, our general threshold being that we need to see at least two times the upside relative to the downside, we will then initiate a position in that company.
Our process is based on anticipating situations that are going to result in strong stock performance. In other words, we are anticipating the change in earnings and revenue growth that will drive that fundamental change. We look at what other investors are going to be excited about in six to 12 months from now. We are not chasing after the hot growth story of the day.
Q: What sectors do you focus on in your investment process?
As I mentioned earlier, we employ a bottom-up investment process. Still, part of what we do, as we are fundamentally focused, has to take the macro environment into account.
One of the sectors that we have not been excited about is the commodity sector. After driving the global economy for a number of years, China is shifting from infrastructure to more consumer-oriented spending. In that context we felt that the commodity sector was not going to be attractive for us for the next several years.
On the positive side, we think that the technology sector is going to continue to be incredibly interesting. The ramp up of smartphone penetration is going to be transformational on a global basis. Today there are two billion smartphones in the install base, and that is going to go to five billion in the next three to five years.
For many of the three billion incremental people who buy smartphones this will be their first computer. The business models that are going to flourish and thrive in that environment will be huge, so we spend a lot of time in technology.
Q: How do you go about looking for companies?
We are trying to find companies where we have a differentiated view, so trying to screen for it and using consensus numbers or historical data does not really tell us much. It is predicated on taking a lot of shots on goal. We meet with a lot of companies individually; we attend conferences and visit companies at their headquarters. We have vast resources in terms of the number of investment people at Wellington who are seeking opportunities on a daily basis.
As far as analysis is concerned, we benefit from our eight-member investment team and the input of 56 global industry analysts. On top of that there are 24 additional investment teams within Wellington. We have a tremendous amount of knowledge and information that is being shared every day as part of Wellington’s collaborative culture.
My process differs from others within the firm; I have my antennas up and my role is to try and understand when somebody, be it from my team, our global industry analysts, or other teams, is talking about identifying an investment opportunity based on accelerating operating momentum. I understand what the catalyst is, and then quantify the impact of those changes to decide if it is something we should be pursuing.
A lot of investors fail to identify companies where there are accelerating trends. What is more, they are also going to be less good at valuing those companies. If somebody sees a company growing at 7%, they will probably assume they will grow at 7% going forward. There is a lot of inefficiency in people’s ability to identify and forecast the change in expectations. When we see acceleration that others do not see, that is where we get the most differentiation.
Q: Could you give some specific examples?
A company such as Actavis plc, which has been an aggressive acquirer over the past several years, has been a good, large holding for us. The vast majority of their growth has come from acquisitions, their latest acquisition of Allergan being a perfect example of how they execute on their strategy.
You have to look at the landscape and understand what the dynamics of that landscape are for that specific industry. In the pharmaceutical/generic branded drug industry, right now there is a lot of consolidation going on. Fortunately, our analysts were on this trend several years ago, which led to us owning Actavis.
Our largest holding in the portfolio is Bristol Myers-Squibb. We owned this stock early before others were getting excited about immuno-oncology drugs. We withstood several sets of data that were viewed controversially because others did not feel the data was that strong in terms of the survival shift of the patients in the trial and the safety of those trials.
However, our healthcare analyst stayed true to what she thought was going to happen over the next several trials. Not only did we remain in that stock but we also kept adding to the position. When we owned the stock in the forties, nobody would have suggested it as a momentum story, but now we are starting to see the fruits of our labor.
Q: How do you collaborate as you research?
The research process seeks to find a clear answer. It starts with talking to companies, management teams, drilling down with the heads of management in order to get the best view of what is going on and what opportunities a particular company has to offer.
We triangulate all information with suppliers, competitors, industry experts, and others that will help us confirm what we are learning from a company. The global industry analysts could do this, or one of our team analysts—who are more generalist in terms of what they do—or there could be collaborations between our team and other teams.
Apple Inc is an example of a collaborative effort between other investors at Wellington and members on my team who will analyze one dimension with reference to how they think about the company and how we build our models. In the meantime, our global industry analyst also covers the stock within his technology companies. Then there are others, such as our Asian analysts or analysts who are covering the growth of Asia through a macro or micro basis. All in all, there are a lot of voices as part of the conversations on Apple that have led us to make some great decisions over the past few years.
When we bought the stock back in mid-2014 we had had quite a substantial underweight since late 2012. It was the reverse side of our process. With Apple we were seeing decelerated trends for a period of time and we did not have a differentiated view. So, we largely sold our positions.
However, when it became apparent to us that the iPhone 6 and the iPhone 6+ were going to reaccelerate the trends of the company, based on our own internal research and proprietary surveys, we re-engaged with Apple and made it a large overweight in our portfolio, at a time when most growth managers were underweight. This provided a very big differentiation for us.
Q: What do you do if you initially overlook a good company?
I am very open-minded and pragmatic. Even if we initially miss a company with trends that are accelerating, we are quite open to revisiting the idea. We did not catch Apple when it was a single-digit stock. We did not anticipate some of the success of the original iPod, which was the first real driver of the company. Yet, we continued to revisit Apple, trying to figure out if there was something we were missing, or if there was a catalyst we were identifying, and eventually that came to fruition. It has been our number one contributor over the last several years.
Q: What is your portfolio construction process?
It is a conviction-weighted portfolio and it all starts with fundamentals. As we determine the companies that fit our investment framework, we proceed with the valuation framework, which is the upside/downside framework.
If we take a company that, in our opinion, has 40% upside and 20% downside we will have a two-to-one ratio. That is a rough threshold for initiating positions into the portfolio. We combine that with our overall conviction level on the fundamentals to drive position sizes within the portfolio, and this is largely done on a bottom-up basis.
Our benchmark is the Russell 3000 Growth Index. I am benchmark aware; I am not benchmark focused. Since my benchmark awareness is more driven by the relative weights of the sector in the portfolio, I am less concerned about what stocks are in the Russell 3000 Growth Index.
My general rule of thumb is to avoid being more than two times the index in any sector in the portfolio. I am less concerned with the smaller sectors, but in terms of technology, consumer, healthcare, and other such sectors that make up a substantial part of the index, I never want to be more than two times the index. My philosophy is that if you start to get too concentrated in any one sector, it assumes a level of confidence and knowledge beyond what any portfolio manager has.
I want to make sure that when I win or lose in any given year, it is the underlying stocks in the portfolio, and not our weight in any one sector that is driving our performance.
Q: What happens if the portfolio lacks diversification?
In 1999, I started seeing competing funds that were 80% in technology, media, and telecom. When the market turned down in 2000, all of those funds were some of the worst performers in the country. A lot of people did not make it out of the tech bubble and that was an important lesson: you always want to have diversity in the portfolio, even if you are in love with any individual sector.
I have learned over the last 25 years that no matter how much work you do on companies, sectors, and industries, there is still a lot you are not going to know. You have to have some risk overlay and some controls on how concentrated you are in the overall portfolio construction.
Q: What is your sell discipline?
The drivers of why we sell are the most challenging. For us, there are two primary drivers— fundamentals and valuation.
The fundamental side is a situation where we were just wrong. We thought there was going to be accelerating trends, we thought we were going to see a re-rating of the company, we thought there was a lot of upside, but the company simply did not come through. Instead, it missed earnings expectations, and the driver we thought was going to accelerate trends never occurred.
I am generally a quick seller as I want to have a portfolio of companies that I believe in. If those companies are now stocks where I am hoping things are going to work out, that is not a great situation for the portfolio, so I will sell those stocks and move on.
Another reason to sell is driven by our up/down analysis and valuation. If we have a stock in the portfolio and we start off with a two-to-one ratio, or greater than that, we are tracking that on a dynamic basis.
We continue to review the situation as the stock price changes. If our thesis plays out and the stock price appreciates we may not see as much additional upside. Our earnings numbers may go up over time, we may start rolling to the following year, we may decide there is more re-weighting in that stock, but when that ratio starts to go reverse and we now have a one-to-two downside, that is where I start to get very uncomfortable. We will start to trim positions and probably eventually sell out of a position where we do not think the upside is substantial relative to the downside.
Q: How do you define and manage risk?
Some people will focus on risk in terms of the beta of the overall portfolio, while some will assess their portfolio relative to its specific factors, such as valuation, momentum, growth, and size. Others will look at stock-specific risk and what percentage of the risk of the portfolio is coming from any specific stock, before taking risk into consideration on a sector basis.
We look at all factors in terms of determining the risk in the portfolio. I track my stock specific risk very closely. There is risk in the portfolio of a stock and the size of that position in the portfolio, but there is also risk in the portfolio in terms of determining the individual beta of those stocks and then looking at that stock relative to other stocks in the portfolio to determine how much of the stock specific risk is coming from each position in the portfolio.
Any stock that gets to over 10% of the overall stock-specific risk of the portfolio is getting into a danger zone. I do not allow any individual position to undermine the performance of the portfolio.
We run a reasonably diversified portfolio. We generally have 80 to 100 stocks in the portfolio. Within that we try to ensure that no one stock makes up a very big percentage of our overall risk in the portfolio.
