Rob Battista and Ryan Shugrue rarely take the easy route. As the two top gatekeepers for broker-dealer Janney Montgomery Scott, they are responsible for building a recommended list of 235 strategies to be used by the firm’s 800 advisors.
It’s a hefty responsibility, and one they clearly take seriously. And yet they have made things harder for themselves by opting to populate 50% of this list with smaller, lesser-known managers. By their very nature, these firms are harder to find and analyze.
But Battista and Shugrue believe it’s worth the extra effort, as these niche managers have proved to be a hit with the firm’s advisors.
‘I think it's often the smaller boutique firms that like to commit to a firm like Janney. They spend more time in our branches and have a lot of success,’ says Battista, who is head of product and research at the $85 billion firm.
‘We are very proud of our boutique culture, and they often connect a lot closer with our advisors,’ he says.
Although it can be a risk to go with smaller firms due to their less predictable futures, Battista says he can recall several cases where a smaller shop’s performance has exceeded expectations.
One such firm was Los Angeles-based boutique Kayne Anderson Rudnick Investment Management (KAR). It may have a total of
$23.9 billion in assets today, but when Battista and Shugrue first invested in the firm’s Small-Mid Cap Core strategy in 2011, the boutique had just $5 billion in assets. They have also since invested in KAR’s Small Cap Growth strategy, managed by Citywire AAA-rated Todd Beiley and Jon Christensen.
‘We adopted the Small Cap Growth strategy to fill a need on our recommended list a few years after adding the Smid strategy, in a large part due to the high level of conviction we already had in the overall investment team and process,’ Battista says. ‘We will often add products like this that are coming from a team or firm that we are already comfortable with.’
KAR’s Small Cap Growth strategy is available via the Virtus KAR Small-Cap Growth fund, which is ranked first out of the 140 funds of its type tracked by Citywire. It has returned 134.2% over the past three years to the end of August, compared with the average fund in the category’s 62.1% return and the Russell 2000 Growth’s 57% over the same period.
‘We can take any company in that portfolio and ask [the KAR team] about it. They have an extremely detailed answer about why they own it, what their thesis is behind it and what they’re looking for the company to do moving forward,’ says Shugrue, who is director of wealth management research at Janney. ‘They clearly have a really detailed understanding of the investments they’re making and how they intend to add value, and they’re willing to take overweight and high-conviction positions in their best ideas.’
Battista and Shugrue’s appreciation for smaller firms is not limited to active managers.
One unexpected success for the duo has been a boutique ETF strategist that the team has kept on its roster for almost five years. The firm, which specializes in global allocation model portfolios, has gathered $1 billion in assets from Janney, having received widespread adoption among the firm’s advisors.
Battista and Shugrue recall that although they had conviction in the firm and its process, they never anticipated it to take off to that extent in Janney’s system.
‘I think it’s largely down to the simplicity of the story. The team can give you a very clear delineation of what it does and what it does well,’ Battista says.
‘This firm tends to have a top-down view of the world and spends most of its time getting the asset allocation decision right. It can effectively implement its strategy with ETFs because it’s not trying to add value through individual security selection. We are really comfortable with that approach now.’
Battista and Shugrue work alongside analysts Nick Herbert, Brendan McCarthy and Ira Miller to put together a recommended list consisting of 150 SMAs and 85 mutual funds, in addition to another list of 100 ETFs and eight goals-based model portfolios.
The process focuses on managers’ style, characteristics and risk profiles. After running an initial screen to whittle down a given search, the team takes a deeper dive into the remaining strategies by requesting materials from the most promising candidates. At this stage, the team looks for a performance record that matches the manager’s version of events.
‘We want to ensure that performance has been in line with the expectations set by the manager and that the strategy’s success has been driven by the alpha drivers laid out by the manager, rather than by other factors,’ Shugrue says.
At the final stage of the process, the team sets up calls and meetings with the shortlisted managers to identify which offering is the best fit for Janney’s needs.
While these steps might seem fairly typical of a manager selection process, the Janney approach involves a mixture of different criteria for managers who want to get onto the platform, the buy list and the model portfolios. For Battista and Shugrue, the most important traits in a manager are a clearly defined and sustainable alpha source and an understanding of their competitive advantage.
‘At the highest level, we believe that most capital markets are largely efficient. For an active manager to be able to generate alpha consistently, we feel that there must either be some sort of competitive advantage or a key differentiator that allows the manager to capture that alpha consistently,’ Shugrue says.
‘With the proliferation of products out there on both the active and the passive side, it is more and more important for active managers to demonstrate what their true value proposition is. So that’s what we try to focus on when finding managers – a good understanding of their sources of alpha and a clearly defined and repeatable investment process,’ he adds. ‘We want to see that the manager truly understands what their success or their struggles should be attributed to.’
Battista agrees. ‘A dividend manager, for example, can’t just say that they add value through an overweight to high-quality dividend-paying companies, because we could go and get a dividend-weighted ETF for that. We need to understand what is the true value in picking dividend stocks specifically,’ he says.
Evolution, not revolution
At a qualitative level, the team favors managers with a sense of humility and accountability.
‘[We like] managers that have the ability to acknowledge their missteps and have a willingness to adjust their process from the lessons they have learned,’ Shugrue says. ‘We like managers that are willing to evolve over time. It’s usually not a great sign if a manager says they have been doing exactly the same thing for the past 30 years.’
Battista emphasizes that a manager’s ability to evolve is now more important than ever, as markets are changing rapidly and investment strategies need to move with them.
‘We don’t expect an overhaul of the entire investment strategy, but they should be making small tweaks and enhancements periodically as they evaluate the efficacy of their process. If managers aren’t constantly exploring how they can improve, eventually they will be left behind,’ he says.
Battista also explains that managers will sometimes get defensive and emotional under questioning, meaning that they fail to deliver thoughtful responses.
‘We appreciate it when managers don’t react emotionally when we ask them difficult questions related to portfolio management decisions. We have to challenge those missteps,’ he says. ‘When we evaluate a poor investment decision, we want to understand what was the thought process around the initial thesis, how it broke down and how and why they reacted as they did.’
While individual managers are an important part of the team’s selection criteria, Battista and Shugrue also pay a lot of attention to firms’ management structures. According to Battista, it’s essential for the investment team’s incentives – from day-to-day goals to compensation – to align with what’s best for investors.
‘It’s extremely important for us to understand the landscape of the business. If they’ve had success, we need to assess whether we believe it’s likely to continue in the future. Poor firm management can be highly disruptive to an investment process,’ he explains.