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Bucking the Trend in Portfolio Management

Russel Kinnel

Russ Kinnel: Hi, I am Russ Kinnel, director of fund research. I am joined today by Zach Egan, comanager of Columbia Acorn International. Zach was an analyst for a few years and then was named comanager in 2003. Zach, welcome.

Zach Egan: Thank you.

Kinnel: I was curious about the setup you have for managers and analysts. Everyone has sort of a different arrangement for those duties, but it seems at your firm the lines are kind of blurred. Can you walk us through a little bit of how that works?

Egan: I think it's really a sort of a distinctive feature of Columbia Wanger Asset Management [which manages Columbia Acorn funds], and it comes from our origins as small-cap investors. If you think about how the typical fund management organization is structured, particularly in the global small-cap space, you'll have one or two portfolio managers supported by maybe two or three analysts. And the job of the analyst is really to chase down ideas that the portfolio manager comes up with, such as modelling things or maybe at the very best creating a menu of stocks from which the portfolio manager constructs a portfolio. We've really tried to turn that organizational structure on its head and push responsibility and decision-making out to our team of analysts on the international side of our firm, where we have 10 analysts.

We have broken our investment universe into 10 discrete components and then assigned those components to each analyst whose job it is to beat their custom piece of the benchmark on a trailing three-year view. We look at actual dollars in the portfolio. It's not sort of a fictitious portfolio, theoretical portfolio. It's real dollars.

The intuition behind this is that small-caps stocks are different. They are different because they are small, and that means their fortunes are, to a larger extent than is the case with large-cap stocks, shaped by developments competitive, regulatory, whatever they happen to be, that are really operating at a more local or regional level, almost certainly below the radar of global portfolio managers who go to conferences and then might take a view on the Asian consumer, the yen, the euro, or whatever it happens to be. We think that if you have a structure where you are running the show from above so to speak with portfolio managers really driving decision-making and research agendas that it inevitably becomes sort of a macro-positioned portfolio because it's a very big world. There are a lot of things going on. It's hard for any one or two individuals to get their heads around all those things.

We found that to identify opportunities early and to know when to exit these positions before things go south, it's much, much better to have analysts who really have their heads in the field--[in that they] speak local languages, read the papers, or have their own networks of contacts that they have developed over the years--setting up their own research agenda and then really determining what the weightings of those ideas should be in the portfolio or whether those ideas should be in the portfolio at all.

Kinnel: So the analysts are kind of like managers. They have a lot of discretion over what goes in the fund, and then as a manager, you've got your own coverage area too, so you're also more like an analyst?

Egan: Yes. Everybody is an analyst at Wanger; that's sort of a terminal position. So the chief investment officer, Chuck McQuaid, is also an analyst. He covers telecom stocks in the U.S., Ralph Wanger when he was still working for the business was covering stocks, and so the role of the portfolio manager is really kind of player-coach.

We have to have veto power over what goes into the portfolio; we're responsible to the board for the performance of the fund. Everybody understands that, and that seems to work well. Specifically, what portfolio managers do is provide kind of a degree of quality control and what goes on. They are also uniquely in a position to see where relative value is in the portfolio. If you're talking to a Japan analyst who might be really enthusiastic about a certain type of company, he may not be aware that we have three others like that in Taiwan that are trading at a 40% discount or something like that. We're in a better position to kind of contextualize individual analysts' ideas.

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Kinnel: Maybe you can tell us about your top holdings and a couple of the things that are kind of key to getting you to own those names?

Egan: Yes. One is not an idea that I cover; it's a colleague's. It's a Luxembourg-based business called Eurofins. We've held it in the portfolio for many years, but it wasn't previously a highly weighted stock. It's in the business of testing food, pharma, and soil, and it's gone through a 10-year period of consolidating that laboratory business globally. About 40% of its revenues are generated in Europe. It has substantial revenues in the U.S. and elsewhere.

This is a good business because with increasing regulation, with increasing attention on health and safety factors, trade, and complex supply chains, there is just more and more testing that's going on. So, it's a growth company. When you look at the revenue growth, it's not a 20%-revenue-growth company, but it's kind of a high-single-digit sort of thing. Then, because it went through this very long period of consolidation, the profitability of the company was burdened by acquiring loss-making or barely profitable businesses, and now it's on the march to restoring really attractive mid-20% operating margins that it had a long time ago. This is a business we're quite excited about. We know that you can get those sorts of margins because they've done it in the past, and it also makes sense when you look at what specializing laboratories and modernizing laboratories could do with respect to efficiencies in the business.

It's a very classic Wanger-type stock where you have structural growth opportunity, plus a margin uplift story, and it's just a very good business. It's a network-type business where you have global customers who need to be able to do this in lots of different countries, and the competitors are still very decentralized.

That's just one of the businesses we are more excited about. Off the top of my head, I can't tell you what the weight in the portfolio is, but it's probably around 1% of the fund. The top 10 ideas in our fund are 12% or 13% of the portfolio, so for us a 1% position is quite a big position.

Kinnel: Zach thanks a lot and thanks for watching. I am Russ Kinnel.