Podcast: Managing a Highly Focused Portfolio
With focused strategies, the portfolio manager cannot hide behind mediocre stock picking.  We aim to strike the optimal balance between maximizing exposure to best ideas, while having enough positions to achieve adequate diversification.  Ed Minn, Portfolio Manager for the Alger Weatherbie Select 15 strategy, discusses what it's like to construct and then manage one of Alger's most focused portfolios.  

ALEX BERNSTEIN:​ Hello. I’m Alex Bernstein and you’re listening to The Alger Podcast: Investing in Growth and Change.  As we continue our series of interviews with Weatherbie Capital Portfolio Managers, I’m joined by Ed Minn, Portfolio Manager for the Alger Weatherbie Select 15 strategy, which has the goal of investing in exactly fifteen equity holdings.  At Alger, we’ve been focusing on focused portfolios for some time now.  So today, we have a unique opportunity to discuss this kind of portfolio from a highly focused point of view.  Ed, thanks so much for joining me this afternoon.
ED MINN: Thanks, Alex.

ALEX: Ed, first of all, why do you think focused strategies are in favor?  And do you think they’re likely to remain in favor for the long term?  
ED: I think focused strategies have better potential for delivering meaningful outperformance.  With focused strategies, the portfolio manager cannot hide behind mediocre stock picking.  But with a proven and effective strategy, a portfolio manager can really shine with a focused approach.  
I'm bullish on the long-term outlook for focused strategies, because with a proven and effective investment philosophy, we believe you can deliver meaningful outperformance for investors.  I think risk should be viewed from an overall standpoint, and extreme risk management of one's strategy, when it's going to be one of more than a dozen strategies in an investor's overall portfolio, it may be overkill to have extreme risk mismanagement for one piece of the whole.   
ALEX: Let’s talk about portfolio construction.  When you know you’ve got to get a portfolio down to such a specific number of holdings, how do you find the right balance?

ED: We aimed to strike the optimal balance between maximizing our exposure to our best ideas while having enough positions to achieve adequate diversification.  But it was more than a judgment call.  We created hypothetical portfolios with different numbers of holdings, taking the top10, 15, 20, and so on and rebalancing those hypothetical portfolios monthly.  

What we found is that over a 10-year period, a portfolio of the top names tended to outperform portfolios using other numbers of holdings.  We also noted that this hypothetical portfolio did not result in a big jump in standard deviation.  This is some of the analysis we did to determine the right number to maximize outperformance and leverage our best ideas, while providing adequate diversification.  

ALEX: And how do you manage risk with a highly focused portfolio?  
ED: That's a great question, Alex.  Well, the first step is knowing our companies extremely well and doing extensive, deep fundamental research, and not ignoring the downside possibility and factoring that into our valuation analyses.  And then rigorous monitoring of all positions once they get into the portfolio.  That, for us, is the first step in risk mitigation.  I cannot hide behind extreme diversification as a crutch for mediocre stock picking or downside protection.  Part of that is analyzing the downside case for each security and factoring that into our valuation analyses.

But then you layer on top of that some risk quantitative parameters, such as maximum industry exposure, as well as some qualitative parameters on diversification.  I, to the extent possible, want the stocks to not zig and zag at the same time, so by having a portfolio with a lot of different animals, we can get them offsetting each other to certain risks, if done properly.  

Being the best ideas version is very helpful from a sell discipline standpoint, because we always have a big pipeline, so to speak, of high-quality backups to upgrade to, if any of the holdings start to show a deterioration in fundamentals.  Although the holdings are chosen with the long term in mind, I am not afraid to upgrade the holdings to those with better risk-reward profiles if circumstances change.  

ALEX: As you develop a focused portfolio, are there any themes that you currently favor?  

ED: Yes, absolutely.  One of the factors that I use is growth potential.  Part of that is I'm looking for companies with high exposure to a powerful secular tailwind.  That can be a number of things.  

Oftentimes it relates to a technology trend.  For example, cloud computing, or there's some innovation in software that drives up productivity for employees or automates processes for companies.  That's the kind of secular trend that I look for in the companies that we invest in.  By exposing ourselves to those secular trends, you can ride out little soft patches with a macro backdrop that inevitably occur.  

ALEX: When you're managing such a focused portfolio, do current market trends impact your stock selections and shifts?  

ED: I do consider market trends for stock selection and portfolio construction.  For example, I have to consider the exposure to the China trade war, changes in oil price, wage inflation in the economy, and so on.  But ultimately, it's a bottom-up stock selection process, and one of the good things about our growth orientation—in particularthe turbocharged growth of many of the holdings-- is that, we believe they are not dependent on healthy U.S. GDP growth in order to deliver some solid revenue growth, thanks to the product cycle or secular trend that they're riding.   

ALEX: Ed, what kind of investor do you think a focused portfolio would be appropriate for? 
ED: Well, I believe in the power of focus.  I think it would be suitable for a wide array of investors, provided they could have a decent prospect of a long-term holding period, and if this were one of several funds within their equity allocation.  

I would encourage investors to be long term in nature, because in any given quarter, you could have an above average position perform negatively for reasons that may not be clear, just simply the vagaries of the market.  That could be an opportunity to add, or it could just be noise.  More focused and particularly uber-focused portfolios can have some swings naturally, but when executed properly with a proven and effective strategy, for that reason, we believe you can achieve meaningful outperformance over time.   

ALEX: Ed, listening to our conversation, I’m sure some investors are wondering, what requirements do you need to be an effective focused portfolio manager?  What's the toolkit that you personally bring to the table to effectively manage this kind of portfolio?    

ED: I analyze securities across all the sectors and I sit in on all the meetings and participate in the debate of all ideas.  It's very helpful to be able to compare and contrast the attractiveness of the different ideas.  Sometimes you can see the same movie and recognize patterns because of that.  That's extremely helpful.  Also, it's helpful to have an evenlykeeledtemperament, because there is some volatility that goes hand-in-hand with managing a focus strategy, and it's important to not let emotions influence the decision-making.  

ALEX: Ed, you said a second ago "I believe in the power of focus."  What do you mean by that?  

ED: Well, active management at the end of the day is about picking winners.  If you can do that well, we believe you might as well do it in focused manner.  

ALEX: Ed, thanks so much for joining me this afternoon.  

ED: Thanks, Alex.  My pleasure.  

ALEX: And thank you for listening.  For more information on Alger and Weatherbie focused portfolios, please visit www.alger.com​.  

​​The views expressed are the views of Fred Alger Management, LLC (“FAM”) and Alger Management Ltd. (together with their affiliated entities “Alger”) as of October, 2019. Alger has used sources of information which it believes to be reliable; however, this publication is not intended to be and does not constitute investment advice. These views are subject to change at any time and they do not guarantee the future performance of the markets, any security, or any funds managed by Alger. 
Risk Disclosures:  Investing in the stock market involves risks, and may not be suitable for all investors. Growth stocks tend to be more volatile than other stocks as their prices tend to be higher in relation to their companies’ earnings and may be more sensitive to market, political, and economic developments. A significant portion of assets will be invested in technology companies, which may be significantly affected by competition, innovation, regulation, and product obsolescence, and may be more volatile than the securities of other companies. Investing in companies of small and medium capitalizations involve the risk that such issuers may have limited product lines or financial resources, lack management depth, or have limited liquidity. Assets may be focused in a small number of holdings, making them susceptible to risks associated with a single economic, political or regulatory event than a more diversified portfolio. Past performance is not indicative of future performance. 

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