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Quality, Growth, and Valuation
AllianzGI Mid-Cap Fund
Interview with: Steven Klopukh

Author: Ticker Magazine
Last Update: Aug 09, 10:28 AM ET
Finding good companies that are struggling and out of favor is relatively easy, but understanding and detecting the drivers of improvement requires extensive research and knowledge. Steven Klopukh, portfolio manager of the AllianzGI Mid-Cap Fund, relies on the management teamís dedicated staff and sector expertise in identifying beaten stocks that are likely to regain their footing and create wealth for shareholders.

ďWe do not just pick stocks; instead, we are focused on constructing portfolios where most of the risk is coming from our specific stock selections. Our objective is buying high-quality names at a discount.Ē
Coach continued to grow in Asia; and, while they had pretty much avoided Europe due to competitors like Michael Kors, we viewed Europe as a major growth opportunity. Then they had recently acquired Kate Spade New York, the fashion designer, which we thought was a smart acquisition. Kate was very strong in Japan, but had zero business in China. Coach, on the other hand, had built a strong China franchise.

Another thing about the acquisition we liked was based on our evaluation criteria. They paid only 8 times EBITDA on forward earnings, which we viewed as a bargain, without even including the potential top line growth. Coach had cost synergies with Kate that were very visible, especially after considering Kateís entire supply chain.

After the acquisition, we estimated that Coach was able to achieve a $50 million of cost synergy, which was offset by a $50 million revenue synergy. So, when we looked at the forward numbers and the growth profile, we felt comfortable that Coach would be able to profitably integrate Kate into their business.

We have owned Coach over the years and know the management team well. They just hired a Chief Financial Officer who has been tasked with identifying strong brands to bring into Coach.

By using their leverage and brand strength, their attractive valuation suggests that the stock has room to move higher. And if they can rebuild their top line momentum, which we think they are actually close to doing, the Coach brand can do well again.

Q: What is your portfolio construction process?

A: Portfolio construction is a key part of our investment strategy. It is all about understanding risk and making decisions to mitigate those risks.

The fund is not diversified across sectors; but, while we donít have a hard limit on sector exposure, we typically stay within plus-or-minus 500 basis points relative to our benchmarkís sectors. It is easy to fall in love with a certain area, so it is important to have limits on sector concentration.

For example, in 2017 the financial sector was viewed as the sector most likely to outperform. We bought into that view and added names in that sector. Today it is clear that financials are underperforming; and, itís good that we didnít go overboard. I think our guiding principle of plus-or-minus 500 basis points relative to sector overweights has helped our performance.

Initially, we owned well over 100 names; but over the last few years, we have aggressively worked to reduce that number and the count now stands at 60. The characteristic of the portfolio didnít change all that much and it remains a mid-cap growth portfolio.

We characterize the nature of our portfolio construction process as growth at a reasonable price that is based on a fundamentally driven, bottoms-up, stock picking process. Our portfolio typically has a higher, earnings growth profile than the benchmark; yet we construct portfolio in such a way that the price-to-earnings is at or below the overall benchmark.

The portfolio is not diversified. Many of our largest overweights are roughly 2.6% of the portfolio; and we are comfortable letting our overweights increase to 3%. Rarely do we allow individual names to exceed 5%, because we donít want one or two names driving our entire performance.

We use the Northfield Fundamental Risk Model to evaluate our portfolio daily and review an APT model every month. Both models essentially tell us the same thing: that most of our risk comes from stock selection. At least 75% of our risk is coming from stock selection and very little is coming from factor exposure or beta.

We like to maintain a little bit of price momentum in the portfolio to offset the small amount of beta skew from the stocks. We also try to minimize our factor exposures. Typically, we strive to have more exposure to price momentum and earnings growth, but less exposure to leverage.

Q: How do you define and manage risk?

A: Understanding the exposures we have and bets we are taking is one of the most important aspects of our portfolio management process. We make sure that what we are doing is purposefully and that there is nothing unintended emerging from the process. We sit down with our risk assessment team monthly to go through risk and attribution to understand what is working out in the market and where our risk is coming from.

Ultimately, our job is to differentiate ourselves from our benchmark by taking positions, but to make sure that those positions and the associated risks are justified. The positions that we take are typically justified in terms of a higher earnings yield, earnings growth profile, a lower debt-to-equity, or leverage profile.

As a result, our portfolio typically has a higher price momentum and a lower dividend yield profile than the benchmark. We also look for free cash flow and the growth of free cash flow, where the free cash flow is used to buy back stock instead of paying out dividends.

Q: What lessons did you learn from the financial crisis?

A: We learned two lessons. By focusing on companies with lower leverage and better free cash flow profile, we were able to outperform the benchmark when the markets were coming out of the downturn. We also learned that some of the fundamental risk models were very slow in providing signals during the downturn because they did not capture risk at a fast-enough rate.

However, the APT model that we use does provide interesting results. It often picks up sensitivity in our portfolio for which we were unaware. Just recently, it signaled that we had some exposure to the Japanese yen. We donít own Japanese securities, but owned companies that had exposure to Japan.

That forced us to think that maybe we had some risk that we werenít considering; and that we should start thinking about how to manage it.

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