Objective and strategy
The fund pursues long-term capital growth by investing, primarily, in domestic small cap stocks. Their discipline stresses the importance of managing risk first and foremost. They seek to avoid the subset of sometimes alluring names which seem set up for terminal decline, then identifying high quality small firms with the sorts of sustainable competitive advantages and competent leadership that might lead them one day to become high quality large firms. As of 2013, the stocks in their target universe had market caps between $50 million and $4.8 billion. The portfolio holds about 100 stocks.
Arrowpoint Asset Management, LLC. Headquartered in Denver, Arrowpoint was founded in 2007 by three former Janus Funds managers: David Corkins, Karen Reidy and Minyoung Sohn. Arrowpoint provides investment management services to high net worth individuals, banks and corporations and also advises the four Meridian funds. The firm has grown from 10 employees and $1 billion AUM in 2007 to 37 employees and $6.2 billion in 2014. Part of that growth came from the acquisition of Aster Investment Management and the Meridian Funds in 2013 following founder Rick Aster’s death.
Chad Meade and Brian Schaub. Before joining Arrowpoint, Mr. Meade worked at Janus as an analyst (2001-2011) and portfolio manager for Triton (2006-2013) and Venture (2010-13). His analytic focus was on small cap health care and industrial stocks. Mr. Schaub’s career paralleled Mr. Meade’s. He joined Janus as an analyst in 2000 and co-managed both Triton and Venture with Mr. Meade. Mr. Meade is a Virginia Tech grad while Williams College is Mr. Schaub’s alma mater. They are supported by six dedicated analysts who report directly to them.
Strategy capacity and closure
Between $1.5 – 2.0 billion. The managers were responsible for handling up to $9 billion at Janus and think they have a pretty good handle on the amount of money that they and the strategy can profitably accommodate.
Not yet available.
Management’s stake in the fund
Both managers have over $1 million in each of the funds (Growth and Small Cap Growth) that they oversee. Everyone at Arrowpoint is encouraged to have some amount invested in the funds but since each employee’s needs and resources differ, there’s no mandated dollar amount. Two of Meridian’s independent trustees have over $100,000 invested with the firm and two have no investment.
December 16, 2013.
$99,999 for Investor Class shares, $2,500 for Advisor Class which is widely available through brokerages.
1.60% for Advisor Class, 1.35% for Investor Class, both on assets of about $45 million (as of September, 2014)
So far, so (predictably) good. Meridian Small Cap Growth draws on its managers’ simple, logical, repeatable discipline. It is, like its forebears, quietly thriving. Janus Triton (JGMAX), the fund’s most immediate predecessor, outperformed its peers in seven of seven years that Messrs. Schaub and Meade managed the fund. Over their time as a whole, it crushed its benchmark by over 400 bps a year, beat 95% of its peers and exposed its investors to just 80% of its average peer’s risk (per Morningstar, 5/22/13).
Here’s the visual representation of that performance, with Triton represented by the blue line and Morningstar’s proprietary small-growth index in red. A $10,000 investment in Triton grew to $21,100 over their tenure, a similar investment in the average small growth fund grew to $15,900.
That’s a remarkable accomplishment. Only 9% of all small-growth managers have managed to exceed their benchmark over the past five years, much less over seven years. And much, much less over seven years with substantially reduced volatility. The questions, reasonably enough, are two: (1) how did they do it and (2) what are the prospects that they can do it again?
One hallmark of really first-rate minds is the ability to make complex notions or processes seem comprehensible, almost self-evidently simple. As I spoke with the managers about Question One, their answer made it seem almost laughably simple: they buy good companies and avoid bad ones.
One possibility is that it really is simple. The other is that they’re really good.
I’m opting for the latter.
Chad and Brian attribute their success to two, equally significant disciplines. First, they identify and avoid losers. They illustrated the importance of that by dividing the five-year returns of the stocks in their benchmark, the Russell 2000 Growth, into quintiles; the top quintile represented the one-fifth of stocks with the highest returns while the bottom quintile represented the one-fifth with lowest returns. The lowest quintile stocks in the index lost an average of 80% in value over five years. That’s over 200 stocks which would need to return over 500% of their lows just to break even. Chad argues that it’s the dark side of the power of compounding; that those losses are simply too great to ever overcome. “We could never afford to invest in that quintile, regardless of the exciting stories they can tell,” he noted. “Avoiding them has probably contributed half or better of our outperformance.”
There is no reliable, mechanical way to screen out losers, which explains their continued presence in the indexes. “There are many failures,” Brian argues. Many firms have products that won’t be relevant in three to five years. Many can’t raise prices. Some are completely dependent on a single large customer; others suffer disruption and disintermediation (that is, customers find ways to live without them). Many are reliant on the capital markets to survive, rather than being able to fund their operations through internally-generated free cash flow.
Each stock they consider starts with the same question: “how much could we lose?” They create worst case, base case and best case models for each firm’s future and eliminate all of the stocks with terrible worst case outcomes, regardless of how positive the base and best cases might be.
They trace that staunch loss aversion to personal history: they both entered the profession in mid-2000 when it seemed like every stock and every screen was flashing red all the time. “I don’t think we’ll ever forget that experience. It has permanently shaped our investing discipline.”
The other half of the process is identifying firms with sustainable competitive advantages. “All large caps have them,” they note, “while few small caps do.” The small cap universe remains under covered by Wall Street firms; there are just a handful of sell-side analysts attempting to sort through several thousand stocks. “Overall, they’re less picked over and less efficiently priced,” according to Mr. Schaub. Among the characteristics they’re looking for is a growing industry, evidence of pricing power (are their goods or services sufficiently valuable that they can afford to charge more for them?), of strengthening margins (is the firm making money more efficiently as it matures?) and low market penetration (are there lots of new opportunities for growth and diversification?).
Schaub and Meade’s goal is clear, sensible and attainable: “we try to run an all-weather portfolio that would be an investor’s core small growth position; not something that you trade into and out of but something that’s a permanent part of the portfolio. We’re not trying to shoot the lights out, but we think our discipline and experience will allow us to capture 100% or a little bit more of the market’s total return while shooting downside capture of 80%. We think that should give us good relative results over a full market cycle.” While the track record of the fund is short, the record of its managers is long and impressive. Investors looking for intelligent, risk-managed exposure to this important slice of the market owe it to themselves to look closely here.