Q: What is the background of the fund?
Wilshire Associates, Inc. was founded in 1972 by Dennis Tito. We advise on more than a $1 trillion in assets.
The Wilshire Small Company Growth Fund was launched in October 1992 in cooperation with the Dreyfus financial firm, and was brought in-house to Wilshire in 1997. It invests primarily in smaller, U.S.-based companies with market capitalizations of less than $4 billion and which have strong earnings and growth potential. The Fund seeks to outperform the benchmark, the Russell 2000 Growth Index, and to do so with reasonable levels of active risk and less absolute risk than the index.
Wilshire itself does not directly manage money; all its portfolios, including this fund, are managed by two or more highly differentiated subadvisors. We believe investors are better served by a multi-manager approach like ours which preserves the excess return while reducing active and total risk.
Our job at Wilshire is twofold: hiring great subadvisors and structuring them in a complementary way to leverage the best elements of Modern Portfolio Theory, which combines asset classes that are not perfectly correlated to deliver positive return and decrease risk.
We have a dedicated manager research team that evaluates best-in-class, third-party institutional asset managers, and further, we ensure their alpha capabilities are differentiated and highly complementary to each other.
As subadvisors for this portfolio, we’ve paired Los Angeles Capital Management and Ranger Investment Management. Each brings a unique and different strategy, which in combination positions the fund to generate excess return with less volatility than its benchmark.
For example, when comparing tracking error relative to the index, Ranger has active risk levels of more than 600 basis points while Los Angeles Capital has active risk levels less than 300 basis points historically. When put together, active risk becomes much lower than what is typical in the industry and overall risk is less than that of the index.
Q: Would you describe your manager selection process?
A key reason clients choose Wilshire is our manager research. More than 70 professionals contribute to research and approximately 15 analysts are dedicated full-time. Every day, our manager research team uses proprietary analytical tools to dissect and understand drivers of risk and return; the firm also sells these tools to both large institutional investors and asset managers.
We meet with asset managers frequently – typically engaging in 1,200 or more meetings every year – to make qualitative assessments based on a critical and rigorous review of quantitative data. This process begins with a due diligence questionnaire for managers, with their responses often exceeding 50 pages in length.
Their replies are carefully evaluated as we review their performance and analyze the attribution of drivers of risk and return, be it through stock selection, sector rotation, or certain factor tilts, such as tilts towards high-dividend payout strategies, or momentum-oriented stocks. We identify whether a manager has had other factor biases that allowed them to do well and how persistent those biases have been. These assessments help us understand why managers have been successful historically and whether they have the appropriate resources and capabilities to continue to outperform.
Q: How did you choose LA Capital and Ranger as the fund’s subadvisors?
LA Capital and Ranger were paired together because we believe that the two managers provide highly complementary yet differentiated investment strategies that, when combined into a single fund, result in a portfolio with lower volatility while maintaining a desirable return profile.
Q: How do Ranger and LA Capital complement each other?
Ranger is a concentrated, fundamental bottom-up manager focused on quality growth, or growth at a reasonable price. Isolating companies that have quality financial characteristics serves as the foundation of their investment process. In addition to extensive quantitative analysis, careful consideration is given to qualitative analysis and judgment of the management team, accounting practices, governance and a company's competitive advantage.
Typically, Ranger holds 40 to 50 stocks that are growing both revenue and earnings at compelling rates. These higher-quality companies have a large degree of recurring revenues, accelerating sales and earnings growth, strong cash flows, and balance sheets with stable expanding margins. Ranger analyzes them on a stock-by-stock basis with a time-intensive, fundamental research process.
Given their quality orientation, Ranger maintains a natural bias against companies that produce no earnings. Roughly 25% to 30% of the Russell 2000 Growth Index comprises companies that produce no earnings, many of which are in the biotech sector. We would argue it is incredibly difficult to do appropriate due diligence on this sector. Avoiding this sector has generally been accretive to Ranger’s performance track record.
Where Ranger is concentrated, has high levels of active risk, maintains natural biases against certain sectors, and follows a fundamental bottom-up research process, LA Capital is somewhat the reverse. This is why the pairing of LA Capital with Ranger is so complementary.
LA Capital is an extremely diversified, active, quantitative manager holding more than 300 positions. Overall, their strategy is based on the firm’s “Dynamic Alpha Model”, which forecasts returns for over 50 different fundamental and sector factors. The model takes a tactical approach as opposed to a strategic approach. Based on the model forecasts, the available stock universe is optimized with the goal to maximize expected return given guidelines. The resulting portfolio is relatively sector neutral.
LA Capital has more modest levels of active risk than Ranger, but among the highest information ratios of any managers we’ve ever encountered. Also, for the amount of active risk they take, they generate an extremely high level of active return.
Q: How do you allocate assets between managers?
In general, strategic asset allocation anchors the risk and return of any portfolio. This holds true in our manager structure. Ranger serves as our quality growth manager, whereas LA Capital is our core growth manager, so each fulfills a distinct role within the portfolio.
Our strategic targets are a 60% allocation to Ranger and a 40% allocation to LA Capital. If Wilshire uncovers a sizable opportunity that might favor one style over the other, we may tilt toward the style better positioned given the current market environment. However, this tilt is more on the margin rather than a dramatic change in the allocations between subadvisors.
Q: Do you impose any restrictions on managers or are they independent of you?
Outside of broad portfolio guidelines, we do not impose restrictions on the subadvisors. Our expectation is that the managers will continue to generate positive returns when investing according to their specified style. To ensure this, we interact with them each quarter to monitor positions and strategy, assess whether they continue to fulfill the role for which they were hired, and identify whether we have the appropriate manager structure in place. Finally, we look at whether their styles remain complementary but differentiating, allowing us to not just maintain excess return but also reduce active risk and total volatility.
However, the last thing we want to do is impede their ability to implement the strategies as they see fit, based on their best thinking. As long as we find their overall guideline provisions reasonable and believe they are delivering the target exposure to their asset class, we don’t need to step in and change what they’re doing.
Q: How do you view risk? What do you do to manage risk in the portfolio?
Institutional investors invest across a variety of different and complementary active managers, because by design, multi-manager funds mitigate risk. Clearly, we are a big believer in them, and have brought this institutional approach to the retail marketplace through our multi-manager sub-advisory structure.
With only one individual manager, a fund has blowup risk, the risk of materially underperforming, failing to deliver the exposure to the specified asset class, or impairing capital and never recovering it. Not only can this be defrayed by diversifying risk, it’s possible to still maintain prospective excess returns, so the benefits of a multi-manager fund are substantial.
Again, this goes back to the tenets of Modern Portfolio Theory – combining strategies that are expected to generate positive excess return that outperform the benchmark, but are less than perfectly correlated from looking at their alphas. The trick is simply to hire managers with strategies that are unique and differentiated so they complement each other, like our pairing of a concentrated manager like Ranger with a diversified active quant manager like LA Capital.
Although there are risks associated with active management, these can be reduced by appropriately sizing positions. This is the job of the individual active managers on a day-to-day basis; our job as the advisor and issuer of these funds is to leverage this on the institutional side as well.
