Conviction through Five Ms
JAG Large Cap Growth Fund
Author: Ticker Magazine
Last Update: Oct 16, 1:22 PM EDT
|Not all growth investors share the same view when it comes to the sustainability of the growth phase and its trajectory. Norman Conley, portfolio manager of JAG Large Cap Growth Fund, maintains a long-term and patient outlook as he looks for companies that generate attractive financial metrics and also find acceptance among investors.
“We look for companies that exhibit superior growth characteristics, solid fundamentals, and compelling price appreciation potential. The result is a focused but diversified portfolio of stocks with strong fundamental and price momentum.”
Subscription models exist in a variety of different industries, and investors tend to value recurring revenues higher than non-recurring revenues. We always have to monitor the company, the competition, the market leadership and the pricing policy. Once we own a position, we get an opportunity to analyze results, pricing, guidance and performance in various markets. Since we bought the stock, Adobe has expanded into adjacent verticals, applying the same subscription-based approach. I believe that we, as investors, benefited because the company continued to grow not only its original market, but also adjacent served markets.
In another example, we’ve owned Amazon for about three years. We’ve actually owned it several times over the last 19 years, but we most recently got a position in the summer of 2015. As a consumer, my Amazon membership goes back to 1998, when the company was a just an online bookseller. It is a well-known story now, but Amazon has consistently expanded its addressable market and leveraged its internal technology to enterprises in the form of services. Their subscription-based Prime memberships continue to provide their customers with more reasons to buy products and services from Amazon, which has created a flywheel effect over the last couple of decades. These types of growth stories are rare, but we think it is our job to identify them.
Q: What is your portfolio construction process?
We run a focused portfolio of 30 to 40 individual positions. Because of the concentration, we need high conviction to enter a name and that’s embedded in our process. Our buy discipline begins with our factor model, followed by the fundamental research and the qualitative process. When we buy a position, we typically start with 2% weight in the portfolio.
We don’t want to be overly diversified; as active managers we view over-diversification as a potentially negative factor. We cap our individual sector exposure to 150% of that sector weight within the Russell 1000 Growth Index or to 15% of the portfolio. Our largest position typically is about 6%. An exposure of 10% to a single stock would be a rare occurrence, but we do have the flexibility to hold a particularly large weighting in an individual name. We also cap our industry exposure to 30% of the portfolio.
Overall, we have a bottom-up process that results in a focused portfolio comprised of our best ideas. Over the years, the main driver of our excess returns has been security selection, not sector allocation. Of course, we like to be in the right sectors but we don’t have a top-down overlay that dictates the sector weightings. The construction of the portfolio stems from individual security selection.
Q: How do you define and manage risk?
We are not big believers in some of the standard volatility-derived measures of risk, such as standard deviation. The primary risk in growth equities is the permanent loss of capital. That’s the type of risk that we aim to assiduously avoid. Situations like those in Enron and WorldCom in the early 2000s can be catastrophic to portfolios, particularly if an active manager becomes stubborn in his view of the fundamentals or intrinsic value. So we keep a close eye on permanent loss of capital. Portfolio diversification, sector-specific, industry-specific and security-specific exposure limits represent another layer of our risk management.
As we discussed earlier, price momentum is a significant component of our investing process. It is incorporated in our buy discipline, sell discipline and risk management. Since positive and accelerating momentum is a component of our buy discipline, we incorporate negative and decelerating momentum into our sell discipline. When stocks exhibit negative divergences or deteriorating momentum as measured by our internal tools, they become candidates to be reduced or eliminated from the portfolio.
Another area related to risk management is opportunity cost. It can be summarized by the question, “what are we missing?” As growth equity managers, we know that every day and every month there are innovative companies that are poised to do incredible things for their shareholders and customers. Although this concept is not typically included in risk management discussions, we think a genuine risk for active managers to miss transformative stories and companies that are doing great things. We do our best to guard against that risk, and our process is designed accordingly.
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