Conversations With… Kenneth Turek
In sports parlance, the “sweet spot” is the part of a bat or golf club that produces the maximum result when hitting a ball. Some will say a similar result can occur when investing in mid-cap equities, those companies with market capitalizations generally ranging from $2 billion to $18 billion. Such stocks historically consistently outperformed both large- and small-cap stocks on both an absolute and risk-adjusted basis. Yet midcap stocks are often overlooked and left out of basic asset allocation models. Portfolio Manager Kenneth Turek has been running the Neuberger Berman Mid Cap Growth Fund for the last decade and has amassed an impressive record. Here, he discusses his investment process and the advantages of investing in mid-caps.
You have been dedicated to the mid-cap space for over two decades. What drew you there in the first place?
Back in the 1990s, I started managing all-cap portfolios and found myself leaning towards picking mid-cap securities because they were faster growing, had better valuations and offered the most interesting ideas. I also noticed that very few portfolio managers were paying attention to this space, which I thought was a mistake. Believing this represented an opportunity for me—and investors—I decided to focus exclusively on managing mid-cap portfolios.
What should investors know about mid-caps?
A significant characteristic is that mid-caps have, historically, delivered superior risk-adjusted returns versus their large- and small-cap counterparts—something that I think is likely to continue over time. Mid-caps have done well for several reasons. Like large caps, they are large enough to have strong fundamentals and established business models; like small caps, they represent companies that have high growth potential, but mid-caps have the added advantage of being past the heightened operational and financial risks stage of small caps. Additionally, mid-caps typically have seasoned management teams that have successfully married their entrepreneurial spirit with the skills and discipline necessary to bring the business to the next level.
Many mid-cap companies are also often cash-flow positive and have seasoned balance sheets. In my view, the combined impact of these qualities is why mid-caps have outperformed other U.S. equity asset classes over the past 25 years.1
Still, investors are often under-allocated to mid-cap stocks. Why?
I call mid-cap stocks the forgotten asset class, one that is often misunderstood and underutilized. They tend to get the short shrift because investors gravitate to large-cap stocks for their market dominance and perceived stability, while small caps get attention as engines for growth and innovation. And though they represent nearly 30% of U.S. market capitalization, most mid-cap stocks are not covered by Wall Street analysts.
Does the lack of Wall Street coverage help or hurt you as a manager?
In my view, less Wall Street research means more opportunity to uncover ideas. In other words, since fewer analysts cover these stocks, active portfolio managers like us can spot great stocks and realize their value before they become widely known. Also, we conduct extensive research, which I think gives us a major information edge in this underfollowed market segment.
Taking a step back, what’s your overall approach to investing?
We identify stocks in two ways: The first is through bottom-up fundamental individual stock research where we seek growth companies with strong fundamentals, material competitive advantages and underappreciated catalysts. The second approach is the development of cyclical or secular investment themes that we believe can drive investment opportunities over a threeto five-year time horizon. These themes will generally reflect major demographic, technological, industrial or economic shifts and trends.
Drilling down a bit, our investment process begins with various quantitative and qualitative screens to narrow the mid-cap universe to a subset of names that we consider viable candidates for purchase. My team has three dedicated analysts who conduct extensive fundamental and valuation analysis on those stocks, looking at earnings and revenue growth, return on capital, current market valuation and valuation expectations, balance sheet strength and, importantly, manager competence. We also like to identify potential catalysts that could raise performance above consensus expectations. Central to our process is meeting with management, as well as talking to customers, suppliers and competitors. Once a “buy thesis” is developed for a stock, the entire team meets to critically discuss the recommendation. I will make the final decision as to whether to buy the stock, including for what price and at what quantity.
Keep in mind that while our research is centered on original and independent analysis, we also draw on the resources of Neuberger Berman’s 40+ member Global Equity Research department, as well as various external services, industry contacts and the Street research, however sparse, that we may find useful.
Mid-caps can cover a fairly wide market-capitalization range. Do you have a particular preference in terms of size?
While we diversify broadly across smaller and larger mid-cap names, we will lean towards smaller companies when adding to the portfolio, with a “sweet spot” in the $2 billion to $5 billion range. We’ve had success in this area finding companies with new, unique or differentiated ideas that result in dynamic products or services that can significantly drive their growth—and where we can see profitability go from good to outstanding.
How do you manage risk in the portfolio?
Diversification, ongoing bottom-up analysis and a disciplined sell process are integral components of how we manage risk. The portfolio is broadly diversified at the sector, industry and holding levels. While we’re always looking for new ideas, the reality is that the majority of our team’s time and effort is focused on evaluating the portfolio’s 100 or so holdings, which feeds into a disciplined sell process that looks to quickly exit a position if it has suffered a negative, material change, a significant deterioration of fundamentals or has failed to meet expectations.
What do you see as the key to your success in building mid-cap portfolios?
I believe in large part it is due to the consistent manner in which we apply our approach and construct our portfolios—an approach that is very thorough and very analytical. Additionally, we don’t waver from our standards. We only make investments that meet our strict criteria and our portfolios always represent the very best of our investment thinking.
Based on your experience, what has changed for mid-caps in the last 10 years?
First and foremost, the quality of companies is better than it was 10 years ago. If you compare balance sheets then and now, you see a much greater focus today on generating cash, and if you look at performance, returns are much stronger. Many mid-caps also now want to make their businesses more global in nature, to the point where some of them now have as much as 30% of their revenues coming from an international source.
1Source: Morningstar, FactSet, Neuberger Berman.
An investor should consider Neuberger Berman Mid Cap Growth Fund’s investment objectives, risks and fees and expenses carefully before investing. This and other important information can be found in the Fund’s prospectus and, if available, summary prospectus, which you can obtain by calling 877.628.2583. Please read the prospectus and, if available, the summary prospectus carefully before making an investment.
Recent events in the U.S. and global economies have resulted, and may continue to result, in an unusually high degree of volatility in the financial markets, both domestic and foreign, and in the net asset values of many mutual funds, including, to some extent, the Fund.
Stock markets are volatile and can decline significantly in response to adverse issuer, political, regulatory, market or economic developments. To the extent that the Fund sells stocks before they reach their market peak, it may miss out on opportunities for higher performance.
The value of an individual security or particular type of security can be more volatile than the market as a whole and can perform differently from the value of the market as a whole.
The stocks of mid-cap companies are often more volatile and less liquid than the stocks of larger companies and may be more affected than other types of stocks by the underperformance of a sector or during market downturns. Compared to larger companies, mid-cap companies may have a shorter history of operations, and may have limited product lines, markets or financial resources.
Because the prices of most growth stocks are based on future expectations, these stocks tend to be more sensitive than value stocks to bad economic news and negative earnings surprises. Bad economic news or changing investor perceptions can negatively affect growth stocks across several industries and sectors simultaneously.
To the extent the Fund invests more heavily in particular sectors, its performance will be especially sensitive to developments that significantly affect those sectors. Individual sectors may move up and down more than the broader market. The several industries that constitute a sector may all react in the same way to economic, political or regulatory events.
The Russell Midcap Index measures the performance of the 800 smallest companies in the Russell 1000® Index, which represent approximately 31% of the total market capitalization of the Russell 1000 Index (which, in turn, consists of the 1,000 largest U.S. companies, based on market capitalization). The Russell 2000® Index is an unmanaged index consisting of the securities of the 2,000 issuers having the smallest capitalization in the Russell 3000® Index, representing approximately 8% of the Russell 3000 total market capitalization.
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