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A Fund in the Hands of Analysts

Bridget B. Hughes, CFA

Bridget Hughes: Hi. I'm Bridget Hughes. I'm one of the analysts here at Morningstar, and I am here today with Elizabeth Slover. Elizabeth is the director of U.S. research at Dreyfus and is also portfolio manager on the Dreyfus Research Growth Fund.

Thanks for joining us, Elizabeth.

Elizabeth Slover: Thank you, Bridget.

Hughes: So, let's just talk first about the Research Growth Fund. It's got "research" in the name, so we already know there is maybe a component that's bigger than one portfolio manager. Can you just maybe differentiate the fund from some of the funds that are at Dreyfus?

Slover: Sure. Much like the rest of Dreyfus, we are very bottoms-up, but what we do a little differently is we allocate the capital to the 14 analysts on the team, and we really give the decision-making to them, and they are both responsible for deciding what names go into the product and for deciding the weight of the names in the product. So, those two decisions are put in the hands of the 14 industry experts in our team. We really think that decision-making by those closest to the information leads to long-term successful investment results.

Hughes: Okay. So, the benchmark for the portfolio is the Russell 1000 Growth Index.

Slover: Correct.

Hughes: It's a little bit different in how you come at that, but for the most part, the sector weightings of the portfolio are pretty close to the Russell 1000 Growth Index.

Slover: Every stock in the Russell 1000 Growth Index, which is our benchmark, is assigned to one of the 14 analysts. We take the bottoms-up weight of the stocks assigned to that analyst, and that's the amount of capital they have to invest. So, if 7% of the benchmark is in stocks assigned to one analyst, they have 7% of the portfolio in which to invest, and they decide both which stocks and the weight, and that way, if they want to buy something, all they have to do is sell something. We don't have to have arguments over capital.

Hughes: So, can you talk a little bit about these active decisions? We talked about this earlier: there is an active decision to own something, and also there is an active decision not to own something. Maybe you can talk a little bit about what that means and if you have any examples off the top of your head to illustrate that?

Slover: Sure. In the past, I've found that when you analyze your results, you oftentimes find out that it's what you didn't own that hurts you just as much as what you did own. So we think that if something is over $10 billion in market cap in our benchmark, it's equally important to make an active decision not to own a stock, and that means that a stock like ExxonMobil, which is 5% of our benchmark, we are either going to own it active weight or we are going to be out of the stock. We are not going to underweight the stock. We take all of our risk on stocks, and we feel we can do the work and make a decision as to whether or not that's a name we should be in. So, we'll be either overweight or completely out of a name even though it may be 5% of our benchmark.

Hughes: Because the analysts are really driving the portfolio, they have the decision-making authority on the stocks they own and don't own. Can you talk a little bit about the accountability that comes along with that responsibility?

Slover: I think accountability is incredibly important, and this really allows us to measure contribution, and each analyst is expected to outperform their opportunity set by at least 150 basis points a year, with 300 basis points being at the upper end of the target range, and then we measure them on a one-year, which is 50% of their compensation, a three-year, which is another 30% of their compensation, and then the five years, another 20%. And so, we really measure whether or not they do what they're supposed to be doing, and we can do that because they are both responsible for making a decision as to what to buy and how much to buy and they have the timing decision in their hands. So, it's very easy for us to measure and our expectation is that every analyst will outperform 150 basis points over sort of a complete cycle.

Hughes: So, this is a growth portfolio?

Slover: Yes.

Hughes: So, let's talk about how you define growth and how that might be different depending on each analyst sector that they cover or their temperament or their individual talents. How does that work?

Slover: I think it is different in different industries. So, if you talk to Tim McCormick, who is our industrial analyst, he will tell you that 80% of being successful when you're investing in the industrials is really getting the cycle right. So, he will spend a lot of time trying to get in the cycle. He feels like you have to be in the railroads early. You can't get in too late, but you can't overstay your welcome or else you are really going to do a round trip in terms of performance. So, he spends all of his time really thinking about where we are in the cycle, trying to be in the stocks early in the cycle and trying to be out of the stocks at an appropriate time too. So, it's important to us to get the railroad stocks right and get the right railroad stocks, but it's even more important to be in there at the right time.

If you look at, for instance, the technology sector, that's really about products, and knowing what products they have out and really whether or not they are exceeding earnings expectations. So, in technology we spend a lot more time thinking about earnings and whether or not companies are beating earnings expectations and how many quarters they are able to continue beating earnings expectations. So, that's much more important to us. Can they continue to release products and are the product cycles continuing? Very different depending on the industry we are looking at, and we really asked the analyst to tell us what growth is depending on the industry and their expertise within there.

Hughes: And this fund has been in this incarnation for a little over six years now?

Slover: Correct.

Hughes: As you look back at the performance of the fund, how would you rate the team and the rate the performance?

Slover: Well, up until last year, I would've given us sort of an A in that I thought we'd made it through a bunch of different markets, a very narrow market driven by just energy, followed by a very defensive market. We were really able to catch the inflection point pretty early on in 2008, followed by 2009, where I thought we were really able to get an inflection point as to things getting more positive pretty early and then 2010, to me which was much more of a classic stock-pickers market.

In 2011, we had a little bit of an issue, and I think that's because it was really macro sentiment that was driving the market instead of reality, and that's a lot harder when you are really trying to get the information right on the companies, but nonetheless we try to outperform every market. So, I would say that that sort of took away from our A and puts it into B+ there, the 2011 performance.

Hughes: Well, congratulations so far. B+ is pretty good. Thank you for joining us.

Slover: Thank you. Thank you very much for having us in today, Bridget

Hughes: Sure.