Unlike its previous iteration, manager Phil Hart and his team play a key role in this strategy’s process, though the quant model designed to drive outperformance remains largely the same. The investment universe here was previously the small-cap-oriented Russell 2000 Index, but it now uses the small/mid-cap Russell 2500 Index and seeks “best in class” names from an ESG perspective. Hart and four analysts curate a working list of such companies, but it is skewed toward certain sectors like industrials and away from energy names because of ESG concerns.
From this universe, a quant model constructs a portfolio of stocks scoring the best on three factors: value, momentum, and quality. Comanager Wonseok Choi works with Hart to explore new automated techniques to extract value from data, such as using natural language processing to scan through earnings-call transcripts for clues regarding a company’s business momentum.
The model now builds a roughly 80- to 100-stock portfolio with few portfolio construction constraints. This is in stark contrast to the portfolio’s previous form and the other strategies that Phil Hart and crew run. A greater tolerance for risk has helped differentiate this portfolio, but the results have been poor. The strategy’s lack of energy has detracted, but its poor stock-picking across most sectors has been the main cause of the underperformance.
A mandate shift in July 2021 completely transformed this portfolio. It used to hold 400-500 stocks and track the sector composition of the Russell 2000 Index rather closely; with ESG now playing a role, the portfolio is much more concentrated and differentiated. As of September 2023, it held just 85 stocks, with notably fewer holdings in the energy and technology sectors. The percentage of assets invested in the top 10 holdings increased from about 8% at the start of 2021 to more than 24% by September 2023. Still, the portfolio is relatively diversified, as individual positions rarely exceed 3% of assets. Global consulting firm Huron Consulting Group HURN was the largest holding in September, at just 3.1% of assets.
As a result of its pivot, the strategy’s style profile also became more growth-oriented, though it remains in the blend section of the Morningstar Style Box. Historically, it hovered around the blend and value portions, but the addition of a quality factor and shift away from resource-related stocks was enough to alter the skew. The managers also scrapped a 1.5-percentage-point limit on the portfolio’s sector deviations from benchmark. As a result, the portfolio’s 0.5% energy stake as of September 2023 was 8.0 percentage points lighter than the index. The portfolio will also not own any companies involved in the production of alcohol, firearms, tobacco, gambling products, and thermal coal.