Q: How has the fund evolved since you joined?

I joined the company 10 years ago with a view to improve performance while maintaining the current investment style I had been using for years with a mid-cap fund at another firm. Because of that I did not waste time reviewing past strategies. Within the first month I had repositioned the fund into how I envisioned it going forward. 

Currently, the fund has about $4.5 billion in assets under management.

Q: What is your investment philosophy?

The fund focuses on investing in growth companies and generating income, so naturally I look at growth and income-generating stocks. However, I want growth at a reasonable price, so I think about delivering total return in the fund. My overall approach is to look for solid companies with organic growth that also pay dividends.

My bottom-up investing approach is valuation driven and revolves around identifying stocks that I feel are best positioned to drive relative outperformance on a long-term basis. I want to buy a stock for less than I calculate it will be worth in the future, because the company can grow its earnings over time. 

I look for high-quality companies, those with good earnings and good cash flow profiles, solid businesses with good business practices in stable industries, and the ones featuring great management teams and holding strong market positions with defensible franchises.

My investment universe is essentially the S&P 500 Index, which is the fund’s benchmark, but everything above a $1 billion market cap is also a prospect, as the prospectus permits going 20% beyond the benchmark.

Within that universe, I start by looking at the industry to see whether it is a growth industry and whether the growth is cyclical or secular. I also consider the potential market size. If it is not a growth industry, then I need to gauge how the company fits within the industry and what the industry dynamics are.

I want companies that have a good management team, one that can consistently deliver on its financial targets. To achieve this, I scrutinize how management uses cash flow, looking at how they redeploy cash to maintain or accelerate growth, to assess whether they are shareholder friendly, such as buying back stock either to offset options or because they think their stock is cheaply valued and a good purchase at the time.

It is also important to see not just if they make acquisitions but also how they do with those acquisitions. Companies that buy a business, only to end up writing it off five years later because it was a complete mistake wasted shareholder money, and are not the names I want in this portfolio.

Furthermore, I look at how a company is positioned—what their sustainable competitive advantages might be. I want to know what, if any, barriers to entry exist, and what their product roadmap—their pipeline—looks like. I analyze how responsibly they deal with their research and development to see whether it is profitable R&D with good results.

Q: How would you describe your investment strategy and process?

One of TIAA CREF’s competitive advantages is its in-house centralized research team. We have more than 40 analysts, who not only research but actively manage portfolios within their individual sectors.

We work closely together. We meet regularly, we hold conference calls, we have management teams come into our office, and we go out into the field and visit management teams at their offices. There is great collaboration with tremendous freedom. All in all, I get autonomy plus collaboration, which is a powerful platform. 

What is more, the expertise of portfolio managers in general tends to be broad, because it spans sectors, as opposed to drilling deep into a particular specialization. Analysts are the complete opposite—they are sector-specific, and so we work in tandem, our styles complementing each other. They perform the detailed, bottom-up analysis and that enables me to make a far more informed decision about a stock. 

Once I decide that a company is attractive, I begin evaluating whether it is going to be a good stock, a good fit for this portfolio. That’s when I start crunching the numbers.

I am comfortable studying balance sheets, cash flow and income statements because I am an accountant by training and was a financial analyst before becoming a portfolio manager. Therefore, I am able to analyze a company’s growth to see where it is coming from. What I like to find out is whether its growth is derived from volume or pricing, or a combination of the two.

In addition, I look at the potential for margin expansion and how revenue growth and margin expansion can drive earnings. I then evaluate the opportunities with the balance sheet and the potential for cash flow generation and the management team’s ability to redeploy that cash flow to maintain or accelerate growth.

Once I know what all the metrics look like, it becomes a question of valuation. It is important to determine whether or not the valuation has already been realized in the stock price, because if it has, that means there is little or no upside. But if consensus estimates on the street appear too low and my analyst calculates that they should be much higher or the company is mis-valued, that translates to potential upside.

A great deal of emphasis has been placed on sell discipline in recent years, however, to me, buy discipline is just as important, because if I can buy a stock at a good price, at the right price, it cushions me to an extent against the downside.

If everything matches up and the valuation looks good, it is a good company; and if the numbers look solid too, it becomes a portfolio holding.

Q: Can you provide some examples of your research process and how you look for opportunities?

One example would be Mondel?z International Inc., a large snack food company that had been part of Kraft Foods Inc. at one time before being spun off. They make a lot of items you can see at the grocery store, from Philadelphia Cream Cheese to Triscuits. The stock had occupied a core position in the portfolio but never an oversized one, and a lot of people thought the stock was overvalued. 

I went to a conference in July with our analyst who follows the stock, we met with the CEO, and I listened to how she talked about the company. They own a large number of brands, including Nabisco, and had also acquired Cadbury long before we bought the stock, gaining some good brands with that.

What struck me, however, was their ability to improve their gross and operating margins, so I went back and looked at the numbers and decided they were too low. While everybody else was sitting back, saying the company was fully valued, I felt the numbers were going to be higher and the analyst agreed with me. As it happened, when Mondel?z reported their earnings for the second quarter, they did turn out to be higher than expected, largely thanks to that ability to improve their gross and operating margins.

Another example is Netflix, a stock we have owned on and off for a long time. In the past, management had not always handled things well, and one major faux pas a couple of years ago all but destroyed the stock for some time.

However, the company had begun to demonstrate an ability to manage their business better and improve the service they provide subscribers—they became more sensitive and responsive to the changing trends in how people consume entertainment. 

We had a small position but what solidified it for me was when Walt Disney struck a deal with them for much of their programming. As far as I was concerned, that validated their business and what they were doing with over-the-top programming.

When AMC Entertainment Holdings, which is primarily a domestic media company, signed a deal to license their programming to Netflix in order to expand globally, it was apparent to us that Netflix was not only an outlet for a lot of entertainment companies to monetize their library product but was also enabling smaller companies to go global without having to build the necessary infrastructure.

That is precisely what I mean by how we target stocks where a change has taken place, but before that value gets realized through an increase in stock price. Netflix has been a home run for us. It fits solidly into the whole theme of over-the-top programming, cord cutting—the way millennials watch TV. Management is doing a terrific job and they are also successful at original programming.

Q: What valuation metrics do you use?

There is no fixed, cookie-cutter answer to that question, as there are different valuation metrics for different stocks in different industries. 

With Netflix, for example, I also look at enterprise value to sales. The stock is trading at five-and-a-half times on numbers that are probably too low. So, while a price to earnings metric makes it look expensive, there is still significant leverage in their operating model because they license a program for a set licensing fee, which is not variable with sub growth. Since their business model is a fixed-cost model, with the growth in subscribers, the incremental revenues and profits can be substantial.

I look at a company’s current dividend as well as their ability to increase that dividend. For example, a company we do not currently own, Verizon Communications, is well run and a good company overall, but when considering valuation vs. growth and their ability to increase their dividend, it’s simply not a good fit for us.

Cisco Systems, on the other hand, which is a decent-sized holding for us, recently raised their dividend by 30%., Because of their potential ability to grow earnings and generate strong cash flow, we think they will continue to raise the dividend and buy back stock, and therefore I consider Cisco to be a better fit.

Generally speaking, I analyze a company’s ability to raise dividend yield and couple that with fundamental analysis to determine where my best upside is. It’s all about total return.

Q: What is your portfolio construction process?

I take a disciplined approach, with risk controls at multiple levels. It starts with the buy discipline, because entry point valuation is as important to me as the sell discipline. I tend to be a risk-averse person by nature so I only take risks when I am fairly confident of what the outcome will be. 

We are paid on investment ratio—alpha divided by tracking error—which boils down to how much risk I take to achieve outperformance. 

I monitor the benchmark regularly and I monitor the portfolio on a daily basis. I look at how my portfolio differs from the benchmark, what my tracking error is, what my systematic risk is, and what my sector and individual position weightings are.

Diversification plays a major role in my portfolio construction— this is a diversified portfolio across securities and sectors. I do not let winners continue to run because I never want one or two stocks to dominate the performance of the portfolio. 

Although we take a high-quality approach to stocks, a sliver of the portfolio is opportunistic, what I term “dislocated growth stocks,” companies where I felt there had been a structural or lifecycle change that represented potential GARP, growth at a reasonable price. These trade at a discounted valuation because something’s wrong—they need a new CEO or CFO or they need to change the composition of their portfolio in order to become a good company.

But aside from that small percentage, we do not buy companies in the hope that a needed change will occur. We wait until a positive change has taken place and take a position before the stock price is revalued. The key is to recognize that a change that can significantly improve the company has occurred, and to calculate the appropriate valuation of that new company ahead of the market. 

Q: Do you have a fixed formula for initiating positions?

No, my initial position size depends on how familiar I am with a company; whether it is something I have owned before and therefore have history with the company, or if it is a company I am still getting to know. The longer the history I have with the company and management team, the more comfortable I am in taking a bigger initial position size.

When I do not know the company all that well, I typically start with 25 basis points. While there are no limitations on size, I tend to remain plus or minus 300 basis points for a stock or sector, vs. the S&P 500 benchmark.

In terms of the number of positions in the portfolio, it generally ranges from 125 to 175 names, although we have strayed past that from time to time. 

Q: How do you define and manage risk?

My primary focus in managing risk is to try to preserve capital and grow it, so I perpetually monitor individual positions and sector weightings. There are several elements of risk that I keep my eye on. Liquidity is one.

Liquidity is not just the float out in the market. Given the size of our portfolios and the number of portfolio managers here, I stay on top of what we own across all funds in the family and how many of us own the same stock.

Event risk is another factor to consider, where perhaps a company makes an acquisition that I think was foolish, or they sell something I did not want them to sell. It may also be that the CEO, or another key executive, leaves the company. Typically I would sell the stock in these cases.

While I like to know who else is holding the stock—a hedge fund hotel or a list of long-only people who are long-term shareholders—I also look at the short interest levels on a stock. If I am long a stock and there is a high short interest, that is a positive, because if I am right, they are going to have to cover and that is only going to help the stock’s performance.

Thesis risk is another consideration. After all, I buy a stock for a certain reason. If that reason no longer exists, and the dynamic has completely changed, that’s when my sell discipline kicks in. 

Additionally, I will sell if I find a better alternative with a more attractive risk/reward ratio. I will also sell if the given valuation vs. upside potential is better somewhere else, or if the portfolio holding hits my target price and I do not see upside to estimates or valuation.

However, the first and foremost reason for me to sell a stock is any fundamental deterioration that appears unrecoverable. 

Today’s market tends to trade on sentiment. It can be tempting to look at the day-to-day, or even intraday, volatility on your stocks, but I am determined not to be influenced by short-term volatility. When I have conviction, when I know precisely why I own a stock, based on the bottom-up analysis that we do on every single name we own, and my thesis stays intact, there is no reason to react and make a change, but we do take advantage of these short-term movements in a portfolio holding to add to core positions.

One cannot outperform without taking risk. However, the idea is to make it as much of a calculated risk as possible. We try to avoid mistakes. In the end, mistakes are what damage performance.