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Pairing Active Managers for Alpha Generation
Wilshire Small Company Growth Fund
Interview with: Nathan Palmer

Author: Ticker Magazine
Last Update: Jun 15, 11:23 AM ET
When distinguished fund managers are paired in a single fund, investors have a higher probability of generating returns with the potential to exceed market averages. Nathan Palmer explains how the Wilshire Small Company Growth Fund benefits from a mix of complementary investment approaches aimed at reducing active and total risk in the portfolio in addition to delivering consistency.

“Our job is twofold: hiring great subadvisors and structuring them in a complementary way to leverage the best elements of Modern Portfolio Theory, which combines asset classes that are not perfectly correlated to seek positive return and decrease risk.”
Q: What is the background of the fund?

A: Wilshire Associates, Inc. was founded in 1972 by Dennis Tito. We advise on more than a $1 trillion in assets.

The Wilshire Small Company Growth Fund was launched in October 1992 in cooperation with the Dreyfus financial firm, and was brought in-house to Wilshire in 1997. It invests primarily in smaller, U.S.-based companies with market capitalizations of less than $4 billion and which have strong earnings and growth potential. The Fund seeks to outperform the benchmark, the Russell 2000 Growth Index, and to do so with reasonable levels of active risk and less absolute risk than the index.

Wilshire itself does not directly manage money; all its portfolios, including this fund, are managed by two or more highly differentiated subadvisors. We believe investors are better served by a multi-manager approach like ours which preserves the excess return while reducing active and total risk.

Our job at Wilshire is twofold: hiring great subadvisors and structuring them in a complementary way to leverage the best elements of Modern Portfolio Theory, which combines asset classes that are not perfectly correlated to deliver positive return and decrease risk.

We have a dedicated manager research team that evaluates best-in-class, third-party institutional asset managers, and further, we ensure their alpha capabilities are differentiated and highly complementary to each other.

As subadvisors for this portfolio, we’ve paired Los Angeles Capital Management and Ranger Investment Management. Each brings a unique and different strategy, which in combination positions the fund to generate excess return with less volatility than its benchmark.

For example, when comparing tracking error relative to the index, Ranger has active risk levels of more than 600 basis points while Los Angeles Capital has active risk levels less than 300 basis points historically. When put together, active risk becomes much lower than what is typical in the industry and overall risk is less than that of the index.

Q: Would you describe your manager selection process?

A: A key reason clients choose Wilshire is our manager research. More than 70 professionals contribute to research and approximately 15 analysts are dedicated full-time. Every day, our manager research team uses proprietary analytical tools to dissect and understand drivers of risk and return; the firm also sells these tools to both large institutional investors and asset managers.

We meet with asset managers frequently – typically engaging in 1,200 or more meetings every year – to make qualitative assessments based on a critical and rigorous review of quantitative data. This process begins with a due diligence questionnaire for managers, with their responses often exceeding 50 pages in length.

Their replies are carefully evaluated as we review their performance and analyze the attribution of drivers of risk and return, be it through stock selection, sector rotation, or certain factor tilts, such as tilts towards high-dividend payout strategies, or momentum-oriented stocks. We identify whether a manager has had other factor biases that allowed them to do well and how persistent those biases have been. These assessments help us understand why managers have been successful historically and whether they have the appropriate resources and capabilities to continue to outperform.

Q: How did you choose LA Capital and Ranger as the fund’s subadvisors?

A: LA Capital and Ranger were paired together because we believe that the two managers provide highly complementary yet differentiated investment strategies that, when combined into a single fund, result in a portfolio with lower volatility while maintaining a desirable return profile.

Q: How do Ranger and LA Capital complement each other?

A: Ranger is a concentrated, fundamental bottom-up manager focused on quality growth, or growth at a reasonable price. Isolating companies that have quality financial characteristics serves as the foundation of their investment process. In addition to extensive quantitative analysis, careful consideration is given to qualitative analysis and judgment of the management team, accounting practices, governance and a company's competitive advantage.

Typically, Ranger holds 40 to 50 stocks that are growing both revenue and earnings at compelling rates. These higher-quality companies have a large degree of recurring revenues, accelerating sales and earnings growth, strong cash flows, and balance sheets with stable expanding margins. Ranger analyzes them on a stock-by-stock basis with a time-intensive, fundamental research process.

Given their quality orientation, Ranger maintains a natural bias against companies that produce no earnings. Roughly 25% to 30% of the Russell 2000 Growth Index comprises companies that produce no earnings, many of which are in the biotech sector. We would argue it is incredibly difficult to do appropriate due diligence on this sector. Avoiding this sector has generally been accretive to Ranger’s performance track record.

Where Ranger is concentrated, has high levels of active risk, maintains natural biases against certain sectors, and follows a fundamental bottom-up research process, LA Capital is somewhat the reverse. This is why the pairing of LA Capital with Ranger is so complementary.

LA Capital is an extremely diversified, active, quantitative manager holding more than 300 positions. Overall, their strategy is based on the firm’s “Dynamic Alpha Model”, which forecasts returns for over 50 different fundamental and sector factors. The model takes a tactical approach as opposed to a strategic approach. Based on the model forecasts, the available stock universe is optimized with the goal to maximize expected return given guidelines. The resulting portfolio is relatively sector neutral.

LA Capital has more modest levels of active risk than Ranger, but among the highest information ratios of any managers we’ve ever encountered. Also, for the amount of active risk they take, they generate an extremely high level of active return.

Q: How do you allocate assets between managers?

A: In general, strategic asset allocation anchors the risk and return of any portfolio. This holds true in our manager structure. Ranger serves as our quality growth manager, whereas LA Capital is our core growth manager, so each fulfills a distinct role within the portfolio.

Our strategic targets are a 60% allocation to Ranger and a 40% allocation to LA Capital. If Wilshire uncovers a sizable opportunity that might favor one style over the other, we may tilt toward the style better positioned given the current market environment. However, this tilt is more on the margin rather than a dramatic change in the allocations between subadvisors.

Q: Do you impose any restrictions on managers or are they independent of you?

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Sources: Data collected by 123jump.com and Ticker.com from company press releases, filings and corporate websites. Market data: BATS Exchange. Inc