Quantifying the Inflection Point

Russ Kinnel: Hi, I'm Russ Kinnel, director of fund research for Morningstar. I'm joined today David Kovacs, chief investment officer of quantitative strategies at Turner Investment Partners.

David, why don't we start and talk about your two mutual funds. You've got two quantitative mutual funds that launched about three years ago. Can you tell us a little bit about what they do? As I understand it, change is maybe a big key as to what sets your quantitative funds apart from other quant funds.

David Kovacs: Correct. We have two mutual funds: the Turner Quantitative Broad Market Equity Fund, as well as the Turner Quantitative Large Cap Value Fund. What differentiates our process relative to other managers is that our focus as quantitative managers is to identify the inflection points, those changes in the marketplace. Our process identifies predictive characteristics or factors on which we rank stocks relative to one another, and then we own the stocks that rank well on these predictive factors.

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The premise of our quantitative process is that the factors that may have been very predictive and very helpful in identifying the right stocks may change over time. Therefore, a successful manager should be able to identify those changes that you alluded to.

So our process identifies those characteristics as they become more significant and relevant for identifying the right stocks to own. Our process evolves with those such that those factors that are no longer relevant are being dropped from our model. The stocks that used to rank well on these factors and now rank poorly, we typically sell those from the portfolio. And then we own the stocks that rank well on the factors that are predictive and relevant at the present time.

Kinnel: Can you give us a real world example of how that attention to change and what factors are working, how that actually worked for one of the funds?

Kovacs: Sure, absolutely. A period of great interest would be the summer of 2007. That was a period where we identified a sea change in the way in which investors evaluated stocks, primarily in the financial sector as well as in the consumer discretionary sector. From the period of 2001 through the summer of 2007, valuation factors, elements such a price to earnings, price to book, enterprise value to the companies' EBITA, earnings before interest, taxes, those factors were very predictive. During the spring of 2007 our work had identified that those factors are no longer predictive, which was very surprising for sectors such as financials and consumer.

Other factors that became relevant were factors such as revenue growth, which is unusual for sector such as financials. Because of these changes, we ended up selling many of the stocks that ranked well prior to those changes and then ranked poorly on the new factors. We sold many of our regional banks, real estate investment trusts, and other interest rate sensitive stocks.

In the consumer sectors, we sold many of the retail apparel type companies, and bought other companies that were less economically sensitive.

So as a result of the fact that we have identified those changes in the marketplace, and the fact that we modified the positions in the portfolio, subsequently 2007 was a very successful year for us, where many other quantitative managers had more challenges during that period of time.

Kinnel: OK. David, thanks so much.

Kovacs: Sure. Thank you for having me.