Pathfinders: The 2015 SMA Managers of the Year

As you recall, 2014 was a challenging year for energy investing, to put it mildly. The Envestnet | PMC analysts lauded Toudouze and her portfolio team at Swank Capital, general partner for Cushing, for outperforming its peers in a good year for energy investing (2013), but more importantly in the challenging 2014. Two data points tell you much of what you want—and need—to know about the Cushing strategy (and any good manager's strategy, for that matter). From Jan. 1, 2012, through Dec. 31, 2014, the MLP Core strategy's capture ratio was 150% on the upside and 65% on the downside, as measured against the Alerian MLP Index (AMZX).

In the pages that follow, and in video interviews on ThinkAdvisor.com, we'll tell you more about this elite group, their processes, and their people and culture.

A webinar on June 9 (archived on ThinkAdvisor.com) featured the winners of our two newest categories: Impact Award winner Duane Roberts representing Dana Investment Advisors for its Socially Responsible Equity strategy and Strategist Award winner Geremy Van Arkel for Frontier Asset Management. Unbidden, Roberts and Van Arkel repeatedly uttered the words "consistent" and "independent" throughout the session in describing their investing processes and their corporate cultures—which should be sweet music to the ears of advisors everywhere.

Continue reading to find out who else won awards for the 2015 SMA Managers of the Year, and follow the link to find all of our coverage on this year's awards.

Specialty and Overall SMA Manager of the Year

Cushing Asset Management won last year's SMA Specialty Manager of the Year award for its long-only MLP Alpha Total Return strategy. We quoted Swank Capital President and portfolio manager Libby Toudouze as saying that "there are winners and losers in the MLP space, and they are not cheap." However, she said then that "the potential for returns is certainly there," with the key to maximizing returns consisting of "going with a manager who has been in this space and dedicates the time and the resources to do the necessary research."

That's certainly the case with Cushing, and is reflected in it being awarded the SMA Specialty Manager of the Year in 2015, this time for its MLP Core strategy, and the overall SMA Manager of the Year for its nimble performance during the soaring and then tumbling fortunes of energy investments in 2014, especially in the MLP space.

If it's true that, as Dr. Martin Luther King Jr. said, "The ultimate measure of a man is not where he stands in moments of comfort and convenience, but where he stands at times of challenge and controversy," then Toudouze and her team at Cushing can stand tall. As we said in presenting the award to Toudouze at the Envestnet Advisor Summit in May, 2014 proved to be a tumultuous year, when energy prices were volatile and alpha was difficult to find, particularly in the MLP space.

In 2014, the SMA returned 22.37%, far outpacing its benchmark, the Alerian MLP Index, which was up 4.8% for the year. That's nothing new for the Core strategy portfolio, which has outperformed the index in each calendar year since its 2010 inception. In the fourth quarter of 2014, a dire one for energy investing, especially MLPs, the Cushing Core SMA saw a decline of 6.24%, compared to the Alerian index's -12.29% return.

However, as the Envestnet | PMC analysts argued in proposing the Cushing MLP as a candidate this year, "it isn't performance that drives our positive opinion on this portfolio," but rather "Cushing's innovative culture, highly experienced investment management team, deep research capabilities, consistent management approach and keen focus on risk control."

In accepting the SMA Manager of the Year award, Toudouze made sure to first thank her "phenomenal" team, especially co-portfolio manager John Musgrave. Cushing also has an oversight committee that includes Jerry Swank, who founded Cushing in 2003. Toudouze has 29 years of investment management experience and knows the issues advisors face, since she ran a family office before joining Swank Capital.

The goal of Cushing Core is to outperform the Alerian MLP Index but with less risk by identifying energy MLPs that can grow their cash distributions rapidly. The portfolio construction process blends a bottom-up fundamental analysis of energy infrastructure companies with a top-down analysis of the energy industry, but with a unique risk approach. The objective is to find companies trading at a compelling valuation or at a level that has not priced in all the holding's identified positive attributes.

In an interview, Toudouze characterized the Cushing Core process as "60% fundamental, thematic," with the balance being portfolio construction, "which is what really helps you in volatile markets to preserve capital." She credited the strategy's outperformance in 2014′s fourth quarter to the "rigorous risk metrics we use in portfolio construction."

Cushing's risk controls include using the services of a dedicated risk manager who looks at both company-specific and portfolio risks, like liquidity and concentration risk and the impact of macro events on sub-sectors and individual MLPs and portfolio correlations. The strategy normally has 25 to 30 names in its portfolio and never more than 7% in an individual holding; as of year-end 2014, it had 26 holdings in the portfolio. In addition to a risk manager, the investment team includes a CPA, reflecting the importance of capital allocation and heavy capital use among energy MLPs.

"We have such a big investment team—19 people and nine portfolio managers for a relatively small universe of 150 energy infrastructure companies that trade on the public markets," Toudouze said. That big team looks at that small pool of candidates, she said, "because we want to have a choice, a large choice, to select from as portfolio candidates." In addition, Cushing "won't take big position sizes; we want to identify 25 to 30 companies" that will deliver the performance the firm is looking for. So Cushing looks at an underlying stock's liquidity—"if a company looks strong from a fundamental perspective but we can't get in and out of it cleanly, we may not use it as a position" at all or take a smaller position, she said. Finally, "we look at cash flow variability at the underlying company" because "in volatile markets, stocks with high cash-flow volatility won't fare as well."—James J. Green

Strategist SMA Manager of the Year

In presenting the first-ever Strategist SMA Manager of the Year award to Gary Miller of Frontier Asset Management, Tim Clift of Envestnet | PMC stressed that Frontier has "one of the longest performance track records in the third-party strategist space, dating back to 1999." But we don't make the award for longevity's sake. Instead, we're honoring Frontier for its cutting-edge set of "globally diversified, multi-asset, risk-based portfolios" and its "subset of unique multi-alternative portfolios." Moreover, Clift said that "in a period where it's been difficult for active managers to outperform, Frontier has been able to provide outperformance from both their active asset allocation decisions as well as their manager selection."

Miller, founder of Sheridan, Wyoming-based Frontier (with outposts in Denver and Atlanta), calls the firm "very academically based" and only half jokes that when he got out of graduate school, he thought investment managers "actually studied Modern Portfolio Theory. It turns out they didn't." In looking at the "brilliant" work of Bill Sharpe and Harry Markowitz, though, Miller (an engineer and CFA) said that many investment managers were "misusing the inputs" by "looking backward at historical information that would mislead them about what was going to happen in the future." At Frontier, "our process starts with Markowitz's MPT model, but we work very hard at better inputs."

In recommending it as a candidate for the premiere Strategist award, the analysts at Envestnet | PMC lauded Frontier for its "unique and diversified product offering" of five global diversified asset allocation portfolios and four specialty strategies. The analysts cited the long tenure of its investment team, all of whom have "sizable investments in Frontier portfolios," which helps align the team's "interests and actions along with their clients," and "strong, attractive long-term performance driven by both active asset allocation and manager selection."

On performance, is Miller worried about continuing to outperform? "It's tough right now," he admitted. "We know fixed income yields are low; equity prices are pretty high, so it's hard to find returns." However, mere performance is not the goal, he said. "We try to get the best return we can" for what he calls Frontier's "downside constraints."

On risk, "we use drawdown numbers rather than volatility. Our balanced portfolio doesn't have a standard deviation of 10, but is designed so that there's only a one in 20 chance that a portfolio will lose more than 10% in a year." That approach—measuring risk by the possibility of major drawdowns in a specific portfolio—"fits in more with how clients" and advisors measure risk. It also allows Frontier "to build portfolios that vary equity exposure over time. When stocks are low, their future returns are higher, all else being equal, so you can own more of them. When stock prices are high, like they are now, there's a bigger chance of going through" that drawdown threshold, "unless we reduce our equity exposure a little bit. That's how we design our asset allocation mix: because return expectations change." Frontier's multiple portfolios all have "different annual drawdown numbers."

Don't let Miller's folksy humor—"We're like weathermen: We don't make the weather, we observe it," or "We're headquartered in Sheridan, Wyoming, so we're a close-knit group; we make up half the town's population (okay, not quite)"—deceive you on Frontier's academic credentials or seriousness of purpose. All four members of Frontier's investment committee are CFAs, but there's diversification there as in its portfolios: "We all have different attributes, different personalities. My job is process; we don't make economic forecasts at all. My job is just figuring out ways to improve the process."

Then there's Frontier's trademark "complementary genius" approach that it uses in picking managers. "We use mutual funds to implement our asset allocation mixes," Miller explained. "So when we come up with an asset allocation mix, we go through the same process every month. We design what we think is the best portfolio for the next 10 years every month. It doesn't change much every month, but we also know it's not the best mix—nobody has the best pie chart." So instead the Frontier process culminates in picking mutual fund managers that "we like, which can add value, so as a group they look like" our target asset allocation mix.—JG

Impact SMA Manager of the Year

"Impact" investing, also known by the monikers "socially responsible investing" or "environmental, social and governance investing," has become particularly popular over the last few years, and multiple studies show that younger, millennial-type investors and female investors prefer to invest their dollars with companies that match their strongly held social, religious or environmental views. But impact investing is old hat for Duane Roberts of Dana Investment Advisors, having created and run such a strategy—quite successfully, thank you—since Jan. 31, 2000. The Dana Socially Responsible Equity strategy was the consensus pick of the SMA Managers of the Year awards committee for the inaugural Impact SMA Manager of the Year, a new award that was encouraged and supported by Envestnet's partner, Veris Wealth Partners, in building an Impact Investing Solutions program. The award was presented to Roberts in May at the Envestnet Advisor Summit.

The big argument against SRI strategies is that an investor must sacrifice return to match the strict screens that such portfolios use, but the experience of the Dana portfolio belies that notion.

"Our track record shows you don't have to sacrifice" returns for socially responsible investing, said Roberts, a CFA, senior vice president and director of equities for 35-year-old Brookfield, Wisconsin-based Dana Investment Advisors. "Our social strategy has outperformed our large-cap equity" SMA portfolio, which won SMA Manager of the Year honors in 2014, Roberts pointed out. Yes, "we have more flexibility on market cap," Roberts admitted, but "even after you factor that out in terms of attribution, there's still" outperformance in the Dana SRE portfolio.

Dana's equity investing strategy sounds simple enough: attaining better returns with less risk for clients by finding high-quality but undervalued companies that, in the words of Envestnet | PMC's analysts, "possess attractive future growth prospects." The firm-wide process uses top-down quantitative models to analyze a large universe of stocks—in the SRE portfolio's case, that's 3,000 U.S. stocks. The firm process ranks the universe, eventually creating a "Dana rank," by relative valuation and earnings revision/surprise trends. Furthermore, pointed out the analysts, "thematic and demographic considerations also play a limited role in the stock selection process, as they [Dana] firmly believe it is smarter to invest in companies that have long-term trends working in their favor, rather than against them."

Using that quantitative process "can take some of the fear and greed out of the process" of securities selection, but Roberts said Dana uses fundamental analysis "to confirm and extend" the quant findings.

"We think there are some reasons that historical relationships persist, even if they change. We evaluate and adjust our model to those changes," said Roberts, but there are also "weaknesses to the quantitative approach, so the Graham-Dodd fundamental approach also has merit." After all, he said, "sometimes quantitative models miss some obvious things," mentioning the Deepwater Horizon accident five years ago in the Gulf of Mexico. At that time, said Roberts, "any companies involved in Gulf drilling looked attractive, but there was a good reason why" their stock prices were so low. So the "traditional fundamental work picks up information that isn't easily quantified," Roberts said. "Investing is not a pure science yet, so on the fundamental side there's art." It's "the balance of those two approaches that gives us the best of both worlds."

In building the SRE portfolio, Dana uses data from multiple third-party research services and makes automatic exclusions across the board—adult entertainment (aka, pornography); alcohol; gambling; military and weapons; and tobacco. There are specific screens as well in the environmental (climate change, nuclear power), social (workplace diversity, human rights) and governance areas (board composition, audit and accounting). However, Dana calls its screening process "holistic," which allows its portfolio managers to "emphasize companies that consistently score well across multiple screens" rather than reward companies that only "excel in one area."—JG

U.S. Equity Large-Cap

Golden Capital Management's Large-Cap Core is the first of two SMA Managers of the Year for U.S. Large-Cap Equity strategies. Jeff Moser, the company's co-founder and chief operating officer, created the strategy and manages the portfolio, which is restricted to 50 stocks.

"We believe there is both an art and science so we developed an active quant approach that combines both quantitative analysis and qualitative analysis," said Moser, who has been managing the portfolio for 20 years.

Golden Capital starts with a broad universe of approximately 1,200 stocks, each with a market capitalization greater than $2 billion, then applies a proprietary quantitative composite model based on valuation, earnings and trading momentum to identify undervalued companies with the potential to deliver better than expected future earnings.

"With a market that is fairly valued to overvalued, earnings matter all the more," said Moser. "We want companies that have a higher probability of reporting positive earnings surprises, and we choose those based on attractive valuations."

Then the qualitative work begins, which "allows the team to build a deeper understanding of those ideas that emerge from our quantitative research and ultimately either validates or disproves the findings of our quantitative screens," said Moser.

For example, said Moser, "If, say, profits are improving, I want to know why and how sustainable that is." He also wants to know what's going on with the company's management team and products, and the industry they're competing in.

This "best valuation for the best earnings" strategy has served Golden Capital's Large-Cap Core strategy well. The portfolio has outperformed the benchmark S&P 500 Index for one, three, five, seven and 10 years with a beta of 90.

Since 2007, the stocks in the portfolio have beaten earnings expectations 83% of the time, compared to 72% for the stocks in the S&P 500.

The portfolio has outperformed the S&P 500 for the last three years, following a moderate underperformance in the previous three. Last year, it beat the S&P 500 by 2%, and in 2013, it outperformed by a whopping 8%.

Golden Capital Management's Large-Cap Core portfolio consists of 50 stocks, representing the 10 sector weightings in the S&P 500, give or take 5%, and Moser maintains a buy list that he can choose from in the future. The buy list serves another purpose as well.

"The composition of my buy list typically changes over time and tends to be a pretty good early indicator of future opportunities in the market," said Moser. The 100 companies on that buy list helps him decide which sectors to overweight and which ones to underweight.

As of April, the portfolio was overweight health care, consumer discretionary stocks and, to a lesser extent, technology. "That's where we are finding the [best] earnings," said Moser. The portfolio is underweight utilities and consumer staples. "The earnings results and valuations are not there," he said.

Generally, Moser favors companies with strong organic sales growth, new products, increasing margins and rising market share. "We want companies with improving fundamentals."

Moser also wants to continue improving the portfolio. To that end he runs the firm's proprietary model every night and continues to seek new ways to enhance it. "I love uncovering new ideas for the portfolio and conducting research that adds further precision to the investing process," he said.

So does the rest of his investing team, which includes co-manager John Campbell, and several others who average 19 to 20 years of investment experience and have "unique backgrounds in math, computer science or engineering that lends itself to quantitative analysis," said Moser. "Collectively, we have a shared interest in discovering and better understanding those factors that lead to different price moves in stocks."

What stands out when talking with Moser is the disciplined approach that he and his team use to develop and maintain the portfolio. Also, unlike some other SMA firms, Golden Capital Management doesn't automatically rebalance its equally weighted portfolio of 50 stocks if a position climbs above its model 2% weighting. Once a stock's position climbs to between 3% and 3.5%, it will be trimmed back, said Moser. Turnover averages 50% to 70% annually.

The history of Golden Capital Management is also unusual. After Moser started the firm with Greg Golden, its president and CEO, and was joined several months later by John Cangalosi, the firm became part of the California Public Employees Retirement System (CalPERS) Manager Development Program, investing on behalf of the giant pension fund. CalPERS took an equity stake. Several years later, Wachovia became a minority owner, replacing CalPERS, and in 2011, GCM acquired the Global Strategic Products business from Wells Capital Management, a subsidiary of Wells Fargo, which had previously acquired Wachovia. In exchange, Wells Fargo got an additional ownership stake in the firm and now owns 65%. The remaining ownership is held by GCM partners Moser, Golden and Cangalosi, but Wells Fargo has the option to purchase half their stake beginning January 2016 and the remaining half beginning January 2017. Envestnet | PMC's analysts say they "don't have any major concerns" at this point in time, but it will be "closely monitoring the potential ownership changes in 2016 and 2017."—Bernice Napach

U.S. Equity Large-Cap

Raub Brock Capital Management's Dividend Growth portfolio is the second SMA Manager of the Year in the equity large-cap category.

The $600 million-plus strategy led by Managing Partner and portfolio manager Richard Alpert targets high-quality stocks with annual dividend increases of 10% or greater for at least five years to generate returns with less risk. That's almost twice the 5.7% annual dividend increase of the S&P 500 over the past 50 years.

The dividend yield must be greater than 1% at the time of stock purchase—"that assures that companies are committed to sharing their profits with shareholders," said Alpert—and the market capitalization must be at least $2 billion to insure sufficient liquidity in the stock's market trading.

"Our focus on dividend growth makes us different," said Alpert. "Many growth fund managers do not have an interest in dividends."

Dividends aren't the only criteria the portfolio uses in its bottom-up approach to stock selection. Increasing revenues, earnings and net income are also key.

"We want dividends to be paid out of current revenues and earnings, [which] speaks to the quality of the earnings," said Alpert.

The strategy tends to avoid companies that use debt to finance buybacks—an example of "financial engineering" that is "not geared to the long-term success of a company," said Raub Brock analyst Jason Rodnick.

Another distinction of Raub Brock's Dividend Growth strategy: its very concentrated portfolio of 20 stocks that are equally weighted.

"We think that good stock selection can have a meaningful impact on performance," said Alpert.

But how do you choose 20 stocks out of a universe of thousands? With quantitative and qualitative analysis, in that order, according to Alpert.