Q:  What is the investment philosophy of Columbia Small Cap Growth?

A: We're definitely growth oriented investors. We’re looking for companies that participate in higher-growth markets and therefore have higher earnings growth rates. We’re also looking for mispricings within the growth universe because we want to combine high earnings growth with the prospect for a rising valuation. It’s that combination that leads to potentially superior investments if you’ve done your analysis and your valuation work correctly.

The investable universe for this smallcap product ranges from about $200 million to $2 billion market cap. I manage the fund on a weighted average marketcap basis, so the fund is pure both in terms of the style and capitalization.

We're looking not only for companies participating in a higher-growth market, but also for companies taking share within that market. That gives us an idea about management’s ability to execute and about the differentiation they have against other players. It doesn’t necessarily mean owning one stock within a high-growth market, but it means being aware of who's growing faster within that market.

Two factors of considerable importance to use are a company’s organic growth rate and its capital efficiency. Ultimately, the organic growth rate of a company is limited by its ability to generate its own cash to fund this growth. As a result, we tend to avoid companies that are dependent on the capital markets to sustain their growth. In terms of business models, we look for capital-efficient businesses. An important issue is how much capital needs to be invested to generate a dollar of income.

Q:  Why do you believe that investors should pursue the small-cap growth asset class, which is usually associated with better reward, but also with higher volatility?

A: Time horizon and the need to access one’s capital are important factors in asset allocation decisions. Historically, small cap stocks have delivered greater returns over time than large cap stocks, but with greater volatility. To get the benefit of these greater returns, you need to have a long enough holding period in order to withstand the high volatility that can occur over shorter time horizons.

Additionally, a strong argument can be made that active management adds value in the small-cap area. This holds true for both growth or value strategies.

Q:  How does your strategy differentiate you from other funds in your space?

A: Many small-cap managers are stock pickers who manage a collection of stocks. We see three different layers of alpha – fundamental research, valuation, and portfolio construction.

Structurally, we organize our fundamental research along industries, with some overlapping coverage. For example, one person is primarily responsible for energy, but two other people are quite conversant in energy, so the system of primary coverage is reinforced by our broad backgrounds to get multiple perspectives within industry groups. Over time, our vertical structure has resulted in information networks consisting of people in industry, senior-level management teams, people on Wall Street, and other investors. We derive proprietary research from that information network. That's core to what we do.

The second aspect is the valuation work. In a growth universe, the value of a security is more dependent on future cash flows, and therefore, expectations for future performance are reflected in the stock price. Those expectations change and create volatility, an environment where valuation becomes a crucial guide. Without that framework, you'd be navigating the investment universe without a compass or a map, and you can easily get pushed around by price action. Valuation informs our entry and exit points.

The people on the team have a pretty good sense of risk and reward and translating that into upside and downside valuation. We're calculating not only the price target for the upside, but also the downside if things don’t go as planned. The result is a risk/reward spectrum for each particular security.

When that is aggregated, we get into portfolio construction and allocation of capital, which is the third layer of our work. I don’t think the majority of smallcap managers are spending that much time on capital allocation, so I believe that's a differentiating factor within the small-cap universe.

Finally, I can create an investment process around a guiding philosophy, but I can’t strive for consistently superior results without great talent. I work with five talented people, most of whom have been in the business for eight to ten years. Three of them, in addition to being great fundamental analysts, have portfolio management experience in their own right.

Q:  What type of growth do you base your decisions upon? How far into the future or history do you look at?

A: We're growth investors so we are looking prospectively and trying to understand what the earnings power of a company will be over the next 12, 24, 36 months. When a company reports a disappointing number today, people’s perceptions of its sustainable earnings growth can change. We need to see if that makes sense. Proper research and valuation could lead us to conclude that we’ll get adequate return on the stock based on a different conclusion about the company’s earnings power over the next two and three years.

The difference in horizons is why we think a time arbitrage exists. I think that has become more important over the last several years because of the rapid increase in alternative investment vehicles, particularly hedge funds, which can be driven by shorter-term time horizons.

Q:  What kind of quantitative parameters do you consider in the small-cap area, where the information is not as readily available as in the large-cap area?

A: That’s a good question. We have a very extensive universe of potential investments. Because of that, we engage in systematic screening of both our holdings and potential investments. From a historic perspective, the quantitative aspect is a change for this product, but to sort through a universe of more than 1,000 possible investments with six people, you have to know what you’re looking for.