Q: Would you give us some background information on the company and the fund?
Wilshire Associates was founded over 40 years ago by Dennis Tito, a former scientist at NASA’s Jet Propulsion Laboratory. Mr. Tito had the idea of taking the analytical techniques long used within the aerospace field and applying them to the field of investment management.
As asset owners such as corporate and public pension funds began using Wilshire’s investment solutions they soon realized that they weren’t equipped to fully utilize the software to its fullest potential. To help with this need, Wilshire entered the consulting arena in the early 1980s and today advises on more than $1 trillion dollars in assets for some of the world’s largest institutional investors. Additionally, Wilshire provides services to clients in more than 20 countries representing more than 500 organizations to help them better understand the risks of their portfolios.
The Wilshire Mutual Funds leverage Wilshire’s institutional knowledge, access, and knowhow. In 2002, Wilshire’s active asset management unit was spun off as an independent firm, Los Angeles Capital. At that point, the Wilshire Mutual Fund complex transitioned from in-house management to a sub-advisory structure. Los Angeles Capital no longer has any affiliation with Wilshire, but it remains an anchor sub-advisor to all the mutual funds.
Q: What is the science and art of your investment philosophy?
Wilshire’s investment philosophy is grounded in the tenants of Modern Portfolio Theory (MPT). The idea behind MPT is to combine assets that are less correlated in order to improve returns for a given level of risk. An investor should not only analyze assets individually, but also as a group in terms of how they interact or behave relative to one another. A portfolio should be sufficiently diversified across assets with positive expected returns and low correlations, such that combining them would allow an investor to maintain expected level of returns but with less risk. Using forward expectations for return, risk, and correlation, an investor can generate an efficient frontier. The efficient frontier represents the optimal portfolio for every risk and return combination.
Wilshire’s goal is to use the findings of Modern Portfolio Theory but at the individual asset class level. If an investor can find good managers expected to generate returns in excess of the benchmark (alpha) and the excess performance of these managers is expected to be uncorrelated, the investor can significantly reduce the levels of active risk taken.
The art is not only finding the right asset managers that can outperform, but managers that are also expected to remain sufficiently distinct from one another such that when they are combined, active risk levels of the portfolio will be lower. Manager diversification comes from each manager’s respective investment processes, philosophies, and implementation. When one manager underperforms because his or her style is not in favor, the other manger(s) should possess investment characteristics that help offset that underperformance.
Q: What kind of managers do you allocate assets to?
Wilshire allocates to managers that implement a variety of investment approaches. The Wilshire Small Cap Value Portfolio (the “Fund”) allocates to two mangers, Los Angeles Capital, an active quantitative manager, and NWQ Investment Management, a fundamental, bottom-up research-focused manager.
Los Angeles Capital, led by Tom Stevens and Hal Reynolds, looks for opportunity on a relative value basis and employs an active quantitative approach. They hold between 200 and 400 securities and use a quantitative-based model comprised of over 50 fundamental, valuation, and technical factors to evaluate and make slight tilts across a broad universe of securities.
Additionally, they helped pioneer the Investor Preference Theory and developed the Dynamic Alpha Stock Selection model. The manager has achieved a strong performance track record across all of their strategies while maintaining relatively low levels of active risk. Los Angeles Capital manages around $20 billion and oversees about 25% of Wilshire’s $900 million assets.
We have paired Los Angeles Capital with NWQ, a manager who uses a very different investment approach. Phyllis Thomas is the lead portfolio manager for the strategy. Nuveen Investments, the parent of NWQ, is an asset manager with a number of different boutiques which was recently acquired by TIAA-CREF.
Phyllis and her team look for stocks that are attractive from an absolute return perspective. She runs a concentrated portfolio with 40 stocks. Every stock must have significant downside protection and drivers of outperformance on a prospective basis with some change catalyst or inflection point. The total assets that Phyllis manages are approximately $1.5 billion.
On average, both managers have outperformed the benchmark and peer group.
Q: What is your manager research process?
As a firm, Wilshire provides manager research advice and fund selection activities for some of the largest pension funds in the world. The same manager research group that drives fund selection for our multi-billion dollar pension clients also drives the sub-advisor selection and monitoring activities for the Wilshire Mutual Funds.
Wilshire’s manager research process is designed to identify and evaluate the critical attributes of managers who are most likely to produce alpha (additional return to market indexes) consistently. The fundamental premise of active management is that, due to differences in acquired information and analytical skill, certain managers are more likely outperform the market.
Wilshire’s six-category qualitative evaluation process is designed to assess the attributes that form the basis on how managers compete for alpha with peer managers. We believe that managers who score above average are most likely to produce positive alpha over the long term.
Moreover, Wilshire manager research utilizes number of proprietary tools that allow analysts to dissect and analyze drivers of performance and risk. With these tools, analysts are able to examine the entire marketplace to determine if a manager has selected stocks that have outperformed the benchmark and judge whether a manger is holding positions consistent with their stated management style. Wilshire’s analytical tools allow manager research and portfolio managers to confirm the reliability of asset managers’ process and to assess if these managers are well positioned to outperform.
Other proprietary tools include, Wilshire Compass, a database that contains several decades of asset manager composites information, Wilshire Atlas, a system that allows analysts to do a variety of holdings-based equity attribution, and another tool, and Wilshire Axiom, which allows analysts to do attribution within fixed income.
Across the firm, Wilshire has over 60 investment professionals who contribute to the research process of which 15 to 20 people are dedicated solely to investment manager research.
Manager research is important because some investment strategies can have significant dispersion from the benchmark. However, not all dispersion is bad, and as a multi-manager portfolio manager, Wilshire must be aware of the potential risks being taken.
Highly concentrated, deeper value strategies such as NWQ, can have significant dispersion from the benchmark. Understanding a manager’s distinct style is important for setting performance and volatility expectations. As a multi-manager portfolio manager, Wilshire can combine a higher risk strategy, like NWQ with a lower tracking error strategy, like Los Angeles Capital, to lower the risk of the overall portfolio while still allowing for potential high levels of prospective excess return.
Q: What are total assets under management among different funds?
Wilshire serves as the advisor to the Wilshire Mutual Fund complex, while the day-to-day management of the funds has been delegated to the sub-advisors. Wilshire’s assets under management as of December 31, 2014, are approximately $900 million with $240 million in large-cap growth, $125 million in large-cap value, $29 million in each of the small-cap growth and small-cap value segments, $275 million in Wilshire 5000 Index, and $175 million to in our international equity fund.
Q: How many securities are in the Small Cap Value Portfolio?
The portfolio has 377 securities, with 346 securities in LA Capital and 41 in NWQ. The fund has existed since 1992 and as of December 31, 2014 has outperformed its benchmark, the Russell 2000 Value Index, on a one-year, three-year, five-year, and ten-year basis.
Q: How do you keep up with any changes at managers?
When a manager undergoes a significant event, Wilshire is often one of the first institutions to be informed of the change. Once notified, Wilshire’s manager research team does an immediate critical assessment to determine whether the change materially reduces the manager’s ability to outperform on a prospected basis. If the change is deemed material and detrimental to future performance, we would begin the search for a replacement investment manager. We could also significantly reduce the allocation to that manager while the replacement manager search is conducted.
Every investment management firm undergoes changes – management restructurings, retirements, analyst departures and hires, etc. If for example, an analyst were to leave an asset manager, during the critical assessment we look at what has been driving the analysts’ performance, and we can quickly determine whether the analyst has been a contributor to manager’s overall performance. This assessment helps to determine the impact of the analyst departure on the overall strategy.
Q: How do you define and manage risk?
When investors put money with a strategy, they desire the returns of that specified asset class. Wilshire defines risk as tracking error relative to a fund’s benchmark. The best way to mitigate poor performance and inappropriate levels of risk is the stringent monitoring of the investment managers.
Wilshire manager research and portfolio managers meet on a quarterly basis with any manager who is a sub-advisor to the Wilshire Mutual Fund complex. We closely monitor performance and risk, as well as the drivers of two metrics. Furthermore, we ensure that the team responsible for performance, as well as the philosophy and processes implemented, are closely monitored to ensure there are not any developments or changes we deem inappropriate.
Within the Wilshire Small Cap Value Portfolio, Los Angeles Capital tends to run active risk levels of around 200 to 300 basis points, and NWQ tends to run active risk levels of between 500 and 700 basis points. The Fund overall tends to run active risk levels around 250 to 350 basis points.
As part of Wilshire’s risk monitoring process, we not only monitor individual sub-advisor performance, but we routinely evaluate manger structure within the Fund. Historically, the Fund had been overweight Los Angeles Capital with an allocation of 60% to Los Angeles Capital and 40% to NWQ. Several years ago, we increased the allocation to NWQ, which now represents slightly over 50% of Fund assets.
The change was implemented due to the pro-cyclical orientation of NWQ. Coming out of the recession, we expected many securities to outperform, especially the stocks with a pro-cyclical orientation, so we removed the overweight to Los Angeles Capital. The move to increase NWQ’s proportion of the Fund has worked in our favor.
One of the key features of NWQ is its strong fundamental research capability. The 13-member research team has, on average, more than 20 years of equity research experience. Sector coverage is split amongst team members. Running a concentrated portfolio allows NWQ to take large active positions which gives them the potential to significantly outperform.
