The objective in our Balanced product is to provide long-term capital appreciation and income combined with superior risk-adjusted returns, and to outperform relative to balanced fund benchmarks and competing balanced funds over a full market cycle by managing a portfolio of stocks, bonds and cash equivalents.
Transamerica Investment Management, LLC ("TIM") Balanced portfolio's investment philosophy can be categorized as a fundamental and research driven approach combined with a strategic asset allocation overlay.
TIM's philosophy is to invest in a number of high quality companies with superior business models which exhibit unrecognized catalysts for positive change, which can result in rapid growth in earnings and revenue and discretionary free cash flow. Significant emphasis is placed on prudent and visionary managements with past records of success that act in the best interest of shareholders. This strategy tends to result in concentrated equity portfolios, and more diversified debt portfolios, where credit stability is also a consideration in the selection of securities.
TIM's team-oriented and peer-reviewed security selection process emphasizes independent research and seeks to limit nonsystemic risk. Our entrepreneurial investment culture is based on the powerful combination of aggressive peer scrutiny and ultimate individual accountability. We maximize the benefits of our research process in the equity portion of the portfolio through concentrated positions, while minimizing downside risk in our bond portfolios through investing in a diversified selection of improving credits with sustainable business models.
Our active asset allocation strategy results from our economic, interest rate, industry, and earnings outlook, in conjunction with broad valuation measures on stocks and bonds. These are then compared against broad valuation measures on stocks and bonds such as P/E ratios and real interest rates, to measure the degree to which these expectations are factored into valuations. This forms the top-down portion of our asset allocation analysis, which is combined with an assessment of the return outlook for OUR selection of equities and bonds.
The lead managers for the equities and bond portions of this product regularly forecast expected returns for THEIR portfolios, based upon their selection of individual securities and their return outlooks for these securities. This analysis frequently results in an asset allocation which differs from what our top-down view may suggest. For example, there may be situations in which our top-down view suggests that broad equity indices will deliver single-digit returns, but our bottom-up view suggests that OUR equity portfolio will deliver low double-digit returns. In this situation, we would overweight equity securities despite our top down view.
Although our investment process favors individual security selection as the basis of asset allocation, there will be times when our forward views on the stock and bond markets overwhelm our individual security expectations. For instance, if we felt that over the intermediate term bonds should outperform stocks, we would continue to be overweight our favored stocks within our stock portfolio, while increasing our weighting to bonds. This allows us to reap the benefits of an outperforming asset class, while still being exposed to outperforming securities.
This thoughtful and active approach to asset allocation differentiates the product from our competitors, many of whom take a more passive approach to asset allocation, seeking merely to maintain a fixed asset mix.
We believe that value can be added when we identify early stage positive changes affecting a company which the market has not yet to discerned. This groundswell of change may be a result of long term secular trends such as changes in demographics or technological advances, or positive fundamental changes such as an industry or a management-related change.
The entire team also reviews economic indicators and events occurring in each of our analyst's respective sectors on a daily basis. We then synthesize our conclusions into an outlook on the economy, what type of growth is to be expected and what portions of the economy will drive that growth.
Universe and Industry ScreenTIM's capitalization strategy is a by-product of our investment philosophy. We tend to favor mid to large capitalization companies for this product. The investment team focuses primarily on growth companies with market capitalizations between $3 billion and $200 billion at the time of purchase. This universe has remained consistent over time.
Independent ResearchOriginal research is the core of our investment process and has added value for over 20 years. Our team-oriented research process emphasizes in-house research and seeks to control or limit non-systematic or business risk. In addition to a dedicated and experienced equity research team, our portfolio managers (who are analysts as well) also have the benefit of a large group of fixed income analysts as a resource.
The generation of "new ideas" starts with an eclectic group of sources including: securities industry contacts, trade shows, industry conferences, trade and general media, quantitative screens and, on a limited basis, Wall Street research. A manager or analyst then identifies a company or group of companies that may be positively impacted by change, whether secular or fundamental. An assessment of the underlying business model is also made, to determine what its particular strengths and weaknesses are, and to determine whether it is a sustainable, defensible, model. After this initial review, promising "ideas" are presented to the entire management team to undergo further scrutiny under Transamerica's peer review process.
Companies that warrant further investigation are contacted and a meeting set up with senior management by several members of TIM's research team. Through these meetings and interviews with management, the research team identifies the companies best positioned to benefit disproportionately from change; generally those with superior business models, proven management teams and businesses that produce substantial free cash flow.
Superior Business ModelsTIM's philosophy is to invest in a concentrated number of companies that offer distinct and sustainable competitive advantages (5-10 years) over their competitors. Many of these companies maintain dominant market share yet have transparency of their operations. We also prefer to invest in companies that demonstrate organic growth instead of growth through acquisitions, recurring revenue models and an operating business that benefits from incremental unit volumes and can bring those incremental unit volumes to the bottom line.
Proven Company ManagementIn meeting with management teams, the evaluation includes a determination of their vision, culture, incentive plans, strengths and weaknesses, the company's product lines, distribution capabilities and product pricing. Our goal is to invest in companies that have management teams which are experienced, prudent, and visionary, that have a history of success and that act in the long-term best interest of shareholders, particularly through effective allocation of capital.
Independent ResearchIndependent sources such as customers, suppliers, and competitors are used to verify or cross-reference facts and information derived from company management interviews. These meetings and discussions can also add a different perspective to the merits of an investment idea.
Financial Statement AnalysisThe financial statement analysis is focused on companies that are experiencing a substantial increase in discretionary cash flow. Through proprietary analysis of financial statements, we look at the sustainability of a company's cash flow and reconcile it back to its earnings. Often these companies exhibit highly predictable revenue and earnings growth, strong balance sheets and demonstrate high returns on equity and assets.
Valuation CriteriaCritical to the investment process is the identification of companies exhibiting the highest growth potential at the most attractive prices/valuations. We want to make sure we do not overpay relative to a company's intrinsic business value and/or projected growth rate or relative to alternative investments within an industry. Proprietary valuation models are built for every company considered for investment and form the basis for our valuation judgments.
Research ReportsTIM company research includes a "Porter's 5 Forces" analysis which reviews entry barriers and the threat of new entrants, threat of substitutes, bargaining power of buyers and suppliers and rivalry among competitors.
Research documentation will include a business discussion, an earnings model which reflects historical and expected financial performance and a quantitative analysis of the stock's potential risk-reward characteristics.
Companies not eliminated from fundamental research are presented to the equity team for review. These group evaluations ensure that the reasoning and analysis behind each recommendation is solid and defensible and the securities ultimately selected truly fit all criteria and controls.
The final equity security selection is a result of the compilation of all fundamental analysis. Our primary risk control mechanism is our evaluation of a company's competitive position, business model, management team and valuation (i.e., minimizing non-systemic risk). All portfolios are well-diversified, and will generally consist of 40 to 50 securities (with an average holding representing 2% - 3% of the portfolio). A typical individual position size at purchase is 1% - 2% and generally doesn't exceed 8% at market value. No more than 35% of the portfolio can be invested in any one broad Russell sector in the Russell 1000 Growth Index.
The sell disciplines we use incorporate several factors, including: identification of a better idea (crowding-out), overvaluation relative to TIM-determined fair value and as compared with other like securities, a deterioration in company fundamentals, or if management is changing strategy in a questionable way or not meeting operating objectives. The research group also formally reviews all holdings which have declined 25% from cost or trailing twelve month high.
TIM's equity trading desk is staffed by six equity traders. Traders and portfolio managers work together to establish trading priorities, order entry, and if necessary, the execution process. Portfolio managers review trade tickets at the end of the day and all trade tickets are reviewed the following morning by the investment team. While the traders do their best to minimize market impact while executing orders, the ultimate decision on execution lies with the portfolio managers where opportunity costs may outweigh short-term market impact costs. TIM's Best Execution Oversight Committee monitors trade execution costs on a quarterly basis.
TIM's Fixed Income portfolio management style uses fundamental and credit research to capitalize on misvaluations in the least efficient portions of the fixed income markets. Strategies in security selection, sector weightings, and duration and term structure management are all critical to generating excess returns.
Outlook for the Economy, Interest Rates and the Investment EnvironmentTIM believes that it is essential to gauge the outlook for the economy, Federal Reserve policy, interest rates and the investment environment when managing fixed income portfolios through the economic cycle. This focus assists us in the management of sector allocation, duration and portfolio term structure. Other factors considered in this analysis include the political environment and its potential impact on fiscal policy, taxes, regulation, foreign trade, consumer confidence, entrepreneurial risk-taking, and the outlook for corporate growth.
We also assess the demographic changes which can influence demand for products and services and the outlook for growth in our major trading partners, in order to capitalize on longer term, secular changes in the economy. The entire team also reviews events occurring in each of our analyst's respective sectors. We then synthesize our top-down and bottom-up conclusions into an outlook for specific sectors within the economy and for the economy as a whole. This process culminates in a quarterly investment outlook publication summarizing Transamerica's view on the economy and current investment opportunities.
Duration ManagementThe portfolio team will generally take a moderate duration position against their benchmark (the Lehman Aggregate or Lehman Gov't/Credit benchmark) in accordance with their view on the economy The objective is to primarily add value via individual security selection and to use maturity/duration positioning as a secondary source of return. Changes in the duration of the portfolio are typically not altered on a frequent basis, but rather only when the investment team determines such a change to be consistent with significant changes within the macro-economic environment, including inflation expectations. Historically, changes in portfolio duration positioning occur 1-2 times per year, with duration positioning constrained to +/-10% of the benchmark.
Portfolio Term StructureYield curve analysis and management is another source of added value in TIM fixed income portfolio management. Our economic and Fed policy outlook results in a yield curve strategy to capitalize on anticipated changes in the shape of the yield curve.
Sector WeightingsWe believe that active sector allocation (between US Government, corporate, mortgage-backed, asset-backed and convertible bonds) is an important source of excess returns. Sector allocation decisions are driven primarily by cyclical factors, such as our economic and interest rate outlook, secular factors, such as demographic change, and technical factors, such as supply and institutional demand, which is calibrated against valuations in each sector. Reviewing historical yield spreads and comparing them to our outlook for a given sector assists us in determining the relative attractiveness of a given sector. Our mortgage-backed securities strategy is determined by our outlook for the yield curve, interest rate volatility, and our interpretation of secular trends in the mortgage-backed market.
Industry WeightingsEach analyst is required to recommend a weighting (i.e. underweight or overweight) on the sectors they cover in accordance with their outlook for relative fundamental performance. Inputs assessed in making this determination include the economic outlook, input costs, pricing power, capacity utilization, global competition, as well as near term financing needs. Our outlook for specific industry sectors assists us in the search for improving credits in beneficial environments.
Credit ResearchOriginal and proprietary research is the core of our investment process and has added value across asset classes and through time, for over 20 years. Our team-oriented research process emphasizes in-house research and seeks to control or limit non-systematic or business risk. In addition to a dedicated and highly experienced fixed income research team, our portfolio managers (who are analysts as well) also have access to a large group of equity analysts.
We believe that we add value when we identify early stage positive changes affecting a company or a sector, which the market has yet to discern. This groundswell of change may be a result of long term secular trends such as changes in demographics or technological advances, or more fundamental changes occurring within a company, such as a management-related change.
Superior Business ModelsIn conjunction with an unrecognized catalyst for positive change, the fixed income team also seeks to invest in companies with sustainable, competitive, defensible business models. Our experience has shown that fundamentally unsustainable business models present one of the greatest sources of long term credit risk for a corporate bond. Since stock underperformance can be an early warning sign of a failing business model, we monitor stock performance closely as part of our analytical process. This similarity in research focus and focus on share performance results in synergies with our equity team.
TIM's philosophy is to invest in a portfolio of companies that offer distinct and sustainable competitive advantages (5-10 years) over their competitors. Because it takes time for unrecognized positive change to impact credit ratios and to become fully recognized, a by-product of our process is very low turnover.
Proven Company ManagementsOur goal is to invest in companies that have managements that are experienced, prudent, and visionary, have a history of success and act in the long-term best interest of debtholders, particularly through the effective balancing of shareholder and debtholder interests.
Our fixed income analysts, working with our equity analysts, attend industry conferences and sit in on conference calls to gain additional insights into the financial intentions of company management. Management is often more frank with equity analysts with regard to their plans for share repurchases, dividend increases and leveraged recapitalizations, actions which are harmful to debt-holders. Through time we have found that the soundest, most sustainable business models result in outperformance for both equity and debt-holders. This aspect of our philosophy results in synergies between our equity and debt research teams.
Independent ResearchIndependent sources such as customers, suppliers, and competitors are used to verify or cross reference facts and information derived from company management interviews similar to the equity analysis.
Financial Statement AnalysisThrough proprietary analysis of financial statements, we look at a company's cash flow and reconcile it back to its earnings. To the extent that the two have divurged through time, further investigation is merited. Sometimes this is a result of efficient use of capital, but at other times this may be a warning sign that the business model is unsustainable, or at the extreme, there may be financial fraud. We seek companies which exhibit highly predictable revenue and earnings growth, strong balance sheets and demonstrate high returns on equity and assets.
Valuation CriteriaCritical to the investment process is the identification of companies exhibiting the highest credit improvement potential at the most attractive price. We want to make sure that we don't overpay relative to a company's intrinsic risk or relative to alternative investments within an industry. The relative valuation process involves a comparison of a specific credit to other credits with similar levels of risk, or of similar industries and ratings, calibrated with its prospects for credit improvement. When a corporate bond is purchased, a valuation target and thesis for improvement is presented by the analyst, with the target valuation stated either in terms of other credits of lesser risk, or credits in similar industries with higher credit ratings. Because the corporate bond market is less transparent and dealer-driven compared to the stock market, each analyst has to sit on the trading desk to assure that relative valuation does not occur without real-time market information.
All TIM bond portfolios are well-diversified with respect to issuers and sectors, and will generally consist of 40 to 70 securities (with a corporate issuer representing less than 2.0% of the portfolio). A typical individual position size at purchase is 1-3% and will not exceed 5% at market value. No more than 55% of the portfolio can be invested in any one broad Lehman sector and industry weightings are limited to 15% of the portfolio as defined by Lehman's industry sub-sector breakdown. Derivative securities are not used in the management of this product.
CMS BondEdge is used to measure duration, convexity and yield by sector and to insure that portfolios remain within any predetermined parameters for credit quality and industry concentration. Proprietary models monitoring credit exposure by portfolio provide another level of analysis. Because we believe that there is no substitute for fundamental research, computer and optimization models are not used in the construction of portfolios.
Our sell discipline includes several factors, including: the realization of the original investment thesis, an issue matures or it's tendered, identification of a better idea, overvaluation relative to TIM-determined fair value and as compared with other like securities, a deterioration in company fundamentals, or a change in the original investment thesis.
Portfolio Managers and analysts sit on the trading desk and generally trade for the portfolio they manage. TIM's dedicated trading group has developed an extensive network of brokers, and is able to leverage negotiations for best execution practices, due to our organization's size.
Our internal research is presented at our weekly research meetings as well as monthly at our equity strategy meetings. Weekly meetings tend to focus on a review of the ongoing economic outlook, investment strategy, and positioning, while Monthly meetings tend to cover more comprehensive reports such as buy or sell recommendations. Our internal credit research is presented at our daily and monthly research meetings. Internal research is also easily accessed by everyone through e-mail and voicemail. TIM's entire investment team convenes daily by conference call to go over economic indicators, news impacting our holdings, and new investment ideas. This daily call culminates in a trade review of all trades which took place in the institutional portfolios, a process which ensures full transparency on an ongoing basis. TIM's extensive peer review process also incorporates daily internal meetings/conference calls involving the Chief Investment Officer, portfolio managers and analysts of all investment classes.