Q: What is the history of the Fund?

HSBC Opportunity Fund was launched in September, 1996. Since 2003, Westfield Capital Management Company, L.P. has been the sub-advisor of the Fund, following the same investment philosophy with the same investment team. We believe one advantage of the Fund has been the consistency, since 2003, of the philosophy, the team, the stock selection and valuation process.

Q: What core beliefs guide your investment philosophy?

The Fund employs a growth at a reasonable price (GARP) investment style favoring investments in companies with underappreciated earnings growth trading at reasonable valuations based on our belief that stock prices ultimately follow earnings growth, and fundamental research best identifies inefficiencies and investment opportunities.

Q: What are the main differentiators of the Fund?

We believe the key factors that differentiate the Fund from others in the marketplace are the in-depth research Westfield’s Investment Committee members perform across the market capitalization spectrum, the valuation discipline the Committee employs, and the depth of investment experience. Bottom-up growth equity firms traditionally place a premium on the quality of their research. However, Westfield’s Committee structure allows for contributions from each member. 

The 16-member Committee is a vocal group of talented analysts. Each investment decision is carefully considered and evaluated by the Committee before investment decisions are implemented. The fact that our Committee members are following stocks that span the capitalization spectrum magnifies this advantage. Mid-cap companies coexist and compete with small- and large-cap companies, and our Committee members are at an advantage because they understand market dynamics across the small, mid, and large cap areas of the market, and the relationships between the companies within each capitalization range. 

As the Committee strives for consistent outperformance, the group’s dynamic not only serves as a system of checks and balances, but also encourages teamwork and the sharing of information.  Our investment process has been successful in a variety of market environments, and we feel our constant review of where we can improve our process will allow us to continue to add value for our clients going forward. 

Finally, we believe our employee ownership structure aligns our interests with those of our clients and allows us to attract and retain top investment talent, ensuring the long-term stability of our business and investment model.

Q: How would you describe your investment process?

We are a team of bottom-up oriented stock-picking investment professionals. In the beginning of the process, the analysts develop their ideas and financial modeling to come up with unique and independent financial prospects. Then they vet and develop the idea within the sector with their sector peers. By the time we consider an investment, it has been fully developed by the individual analyst, vetted, tested and further developed with their sector peers. The next step is a formal presentation to the investment committee, which gathers on a weekly basis or more frequently, when time-sensitive issues need to be accommodated.

Because we manage the portfolio as a collective unit, each of us can focus on his or her particular area of expertise. We value the unique perspective of each team member and the continuity of coverage within sectors. For example, over time our technology analysts have developed a deep knowledge of their sector, a network of contacts and valued insight that continues to improve. 

At the same time, we believe that it would be very difficult to manage the portfolios without a top-down or a macro view. We certainly have a view on the direction of rates, the prospect for inflation and the economic activity that provides insight into our investment decision-making. 

We also value our process of interacting with management teams. In the second quarter of 2018, our analysts had over 400 meetings with management teams. In the course of a year, these meetings can number more than 1,000. 

The process of developing investment ideas differs by analyst and sector at the beginning, but it ends in the same way. We require a standard recommendation template to be followed, this way investments can be evaluated relative to each other and across sectors. 

Q: How are both the team and the Investment Committee structured?

We have structured our Investment Committee along sector lines. We have four broad sectors and we staff them relative to the investable universe in growth stocks within those sectors. The sectors are technology, healthcare, a collective sector of energy, materials and industrials, as well as a sector consisting of consumer, business services and financials. 

These groups are headed by our senior analysts, who provide direction to the other members of the teams. Each member covers specific industries and stocks in the Russell 3000® Growth Index. As much as we look for individual ideas, we make sure that we are always aware of the investable alternatives and that the investments are done purposely. Our analysts are judged by investment performance versus the investable universe of stocks under their coverage.

Q: What is your definition of growth? Would you describe your investable universe?

We look for identifiable earnings growth that we can model. The earnings growth has to be real, within the control of the company, and not necessarily predicated on any cyclicality. We may be interested in cyclically oriented growth only as a complement to a core of organic growth.

As a domestic growth manager covering the small- to mid-cap space, we start with the broad definition of growth of the Russell 2500™ Growth Index. We look for growth stocks with a market cap below $6 billion and we consider the investable universe to be within the market cap range of the Russell Index. 

However, we can also own stocks outside of that universe and, as a result, we may own stocks that the Russell Index might not consider growth stocks. As an example, Energy is an area that we are currently overweight and are finding interesting growth opportunities but there are few Energy companies defined as growth stocks within the Russell Index.  In our view, this affords us the opportunity to find other interesting secular and cyclical growth stories.

Q: How do you find ideas and what type of growth do you look for?

Westfield’s investment professionals seek to identify companies with broad market opportunities, accelerating earnings growth, and quality balance sheets. Superior company management, disciplined capital allocation, strong returns on invested capital trends, solid financial controls and accounting, unit volume growth, cash flow sufficient to fund growth and unique market position or pricing power are all criteria on which we place a premium. As a ‘growth at a reasonable price’ manager, Westfield’s view is that companies with high foreseen earnings potential can be purchased at a reasonable valuation. Companies that are trading at excessive valuations, in our opinion, will be excluded from purchase.

As research specialists, all fundamental factors are important, and in specific industries some may be more important than others. However, earnings growth is the most integral to our stock selection process. If there is one common theme to all of our holdings, it is that our forward earnings estimates (growth rates and projected EPS) are higher than Street consensus. Depending on the industry and market cycle dynamics, we may use a variety of metrics when valuing stocks, including but not limited to P/E, P/E to growth, EV/EBITDA, P/B and Discounted Cash Flow. These are viewed on absolute, relative, and historic levels.

Q: What is your price discipline?

Our price targeting process is integrated into our recommendation template. The valuation projection has an upside case, based on aspiration of multiples on optimistic earnings. It also has a downside projection, which reflects a pessimistic earnings scenario, as well as a washed out multiple of these projections. Then we come up with an expected return, which is a by-product of the probability weighted outcome for the two scenarios. The expected return impacts our position in the stock.

Overall, we look for opportunities with 2:1 to 3:1 upside/downside risk. These opportunities are a by-product of reasonable valuation metrics, which are debated in the group, challenged and often revised because of the Committee discussion. The weight of each particular stock is related to a model, given the upside and downside expressed by the analyst. The model weight is not mandatory; its purpose is to inform the debate of the Committee, which makes the decision.

Our turnover has been in the 65% range, consistent with two-year modeling and 18-month time horizons on our price targets. We don’t look for everlasting investments and we don’t pay high multiples for predictable earnings growth. Our key consideration is the GARP criteria, and the portfolio turnover is the result of opportunities being recognized or achieved.

Q: What is your strategy when the investment thesis has not worked out?

We learn both from our successes and from our mistakes. For any investment, we archive our decision making process and the identified risks. If things go wrong, we can review the risk that we saw at the time and identify what we may have missed. That approach helps us to improve over time. We don’t point fingers, because we collectively own the decisions, but we are open to an objective review. The source of the idea may be an individual analyst, but the decision to make the investment is made by the group.

As part of the process, we follow the developments in each investment to see if they follow our expectations. We need to know if stocks are approaching their price targets or if they are not performing as anticipated. The stocks that are down 20% from our entry point are evaluated by the Committee. However, we also evaluate stocks that perform as expected. We make sure that we give them sufficient attention to avoid a false sense of security. When a stock performs well, we don’t just assume that it will continue to do so. If we continue to hold the stock, we need to justify a higher price target based on fundamental considerations.

Similarly, when stocks have not met expectations, we evaluate the reasons. If we perceive a market mispricing, we may add to that stock or at least re-underwrite the investment. We may acknowledge that we are missing something, and then we would sell the stock and move on. So, there isn’t a formula that is applicable to all cases, but we make sure to convene on important issues and make the next best decision that we can.

Q: When do you decide to include a name in the portfolio?

The idea is developed over days and weeks, but the decision on the investment is typically made in the Committee meeting itself. All the issues are discussed in an open environment and can be addressed immediately, which leads to a less subjective process. The Committee meets weekly and more often when needed. We travel to meet management teams and we also communicate electronically if we need to make a decision in short order. The one-year name turnover for the fund is 55% and the one-year asset turnover is 72% as of September 30, 2018. 

Q: How does the investment committee function?
There are 16 voting members in the Committee and each vote has an equal weight. The Committee rarely rejects a stock because it is a bad investment idea. Instead, rejections may occur as a result of questions regarding modeling assumptions, a risk that has been overlooked by the analyst, or the impact of the stock on the portfolio. 

If someone in the Committee dissents in a material fashion, that is usually enough to reject an idea. If an analyst feels strongly about the recommendation, he or she has the opportunity to go back, provide answers to the questions and present the idea again. However, most of the ideas are fully vetted and ready to be presented to a broad group of investors. As a consequence, the rejection rate is less than 25% on average.

Q: Who evaluates the Committee and what goes into making the committee better?

In terms of the efficacy of the Committee, we put a lot of onus on the individual themselves. There is a qualitative component to our compensation, which reflects our contributions to the Committee. Making the Committee better by questions, developing ideas and helping the decision-making process, is evaluated principally by our CIO. 

The review of every step of the process, whether or not that particular step has added or detracted value, and identifying what is working and what isn’t working, are part of our effort to improve, to make the next best decision, and to continue to evolve as the market environment changes. The market keeps changing, so it is an ongoing and evolutionary process.

Q: What are the key elements of your portfolio construction process?

Philosophically, we believe in relatively concentrated portfolios of approximately 50-70 investments in small and mid-cap stocks. While we believe in sufficient diversification, we want the individual investments to be able to impact overall portfolio returns. 

We limit our sector exposure to 2.5 times the benchmark sector weight or 20% of the portfolio assets, whichever is greater. We can be overweight relative to the benchmark if we find interesting ideas that are sufficiently compelling from an investment standpoint. We are benchmark aware, but we are not benchmark driven. In terms of position sizes, we limit our investments to five percent of the portfolio or two percent points more than the security’s benchmark weight, both valued at market.  

Q: How do you define and manage risk?

We wouldn’t be able to generate meaningful return for our clients unless we embrace risk in some fashion. While there is no universal definition of risk, we define and manage three types of risk. First, there is fundamental risk, which is the downside in any individual investment. The second risk is related to the process or deviation from the historic sources of alpha generation and the third is exposure to common factor risks. 

Westfield has embraced a focus on continual improvement and has had a Portfolio Strategy group since 2006 that measures the discrete steps of our investment process to determine if there are any areas where the Committee can improve their decision making. A focus on identifying and understanding underperforming securities in the portfolio has been a core tenant in Westfield’s risk management process since the firm’s founding. We have evolved this principle over the years to help identify underperforming securities earlier based on a combination of fundamental, technical and price sensitive flags. Stocks with fundamental trends or price action at odds with our investment perspective are identified and undergo an intense review by a subset of the Committee. We feel strongly that a systematic introspection of the Committee’s actions within the context of our investment process has allowed us to continue adding value for our clients.