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Multi-Manager Investing for a Smoother Ride
American Beacon Small Cap Value Fund
Interview with: Cynthia Thatcher

Author: Ticker Magazine
Last Update: May 19, 11:06 AM ET
A key advantage of multi-manager funds, among other benefits for individual investors, is the ability to provide access to high quality sub-advisors through their expertise and scale. Portfolio manager Cynthia Thatcher follows a disciplined process of identifying, monitoring and allocating capital to a selection of value managers under American Beacon’s investment model.

“Overall, we find that the multi-manager process gives us a smoother ride. By avoiding big losses, we tend to outperform over the long run.”
Hotchkis has been a manager in the fund since inception, but they closed capacity to us in 2003. They are a traditional, deep value manager, looking for high quality companies with temporary issues, priced at a discount. Hotchkis believes that a value approach can provide superior long-term performance with below-average volatility. Investor psychology can lead to irrational decisions resulting in the mispricing of stocks. They strive to exploit these opportunities by employing disciplined purchase and sell criteria, rigorous in- house fundamental research and a bottom-up stock selection process with emphasis on tangible valuation support.

We hired The Boston Company Asset Management, LLC in 2004. They closed capacity to us but have recently reopened. They have three portfolio managers and six dedicated sector analysts. I call them more relative value. They go to great pains to identify what the appropriate metrics are for every industry in which they invest.

The Boston Company believes that successful small-cap investing is achieved through a program that is focused on: valuation, to provide significant upside potential while mitigating downside risk; research, as a thorough understanding of company fundamentals is the key to determining value; and discipline, as consistent outperformance requires a disciplined, repeatable investment process.

Foundry is a good example of our relationship and in-depth knowledge of a process and a team. We hired the small-cap team while they were at a previous firm in August of 2005 but didn’t fund them until June of 2010. When the team was acquired by Foundry in June 2016, we stuck with the team.

Foundry is an independent, boutique asset-management company that specializing in providing active management to the institutional investment community. Foundry deploys a value-oriented philosophy in selecting small-cap stocks. While small-cap stocks may outperform large-cap stocks (“the small-cap effect”), Foundry’s research has shown the small-cap effect is, in fact, largely a low P/E effect. Thus, they believe that the best way to capture the higher potential returns in small cap is to employ a low P/E value approach.

Our final sub-advisor would be Hillcrest. We hired Hillcrest in 2014. This is a real small shop. We knew the founders, Brian Bruce and Douglas Stark, way back when they were at PanAgora Asset Management. The firm’s strengths lie in the combination of philosophy, people, process and the resulting performance. Hillcrest believes that a consistent and repeatable pattern of outperformance is achieved by combining the techniques and insights of traditional analysis with concepts related to behavioral finance. At the center of the Hillcrest investment philosophy is the belief that company information alone is not the only factor that affects the price of a stock. Instead, investors have behavioral biases that cause irrational price fluctuations, a human element often ignored. Hillcrest uses behavioral finance in its investment process to take advantage of mispricing opportunities derived from the human element.

Q: How do you allocate capital?

A: In a perfect environment, we would allocate equally. We do not try to tactically allocate among managers. Unfortunately, in small cap, several of our sub-advisors are closed and they have no additional capacity or we have no additional guaranteed capacity with them. Thus, we are forced to allocate any new flows to the sub-advisors still available to us and with which we have additional guaranteed capacity.

We don’t want our managers selling securities to enable us to reallocate, or, on the other side, a manager buys because we’ve reallocated to him. Such activities only drive commission costs. So, we use cash flows to effectively reallocate among the remaining managers open to us.

Q: How do you select and monitor sub-advisors?

A: It boils down to people, performance, process and protection on the downside. We look at the depth and longevity of the team. In terms of their process, we see if it has changed over time or does their process make sense to us. Are they able to articulate their process? We also assess whether it is repeatable on an ongoing basis. When we meet with them each quarter, we ask them questions to determine whether they are continuing to follow that process.

From a performance standpoint, we are looking at consistency of performance, downside protection, and the process.

Once we hire a sub-advisor then we strive to be patient. If we come to a period where there is underperformance, we will dig deeply to understand why that occurs and what market environment caused the underperformance, or the manager’s style, to be out of favor. However, when the market environment turns and once more becomes favorable to the manager’s process, we expect to see that manager turn as well. It’s important to us their process does not change and they participate in the upside when factors change to favor their process.

Guidelines are established the same manner across all sub-advisors. We keep the liquidity constraints, issuer constraints, and most sector or industry limits, the same across the sub-advisors. In that way, we reduce the risk of the fund violating the parameters.

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