Conversations With…Richard Nackenson
Substance Over Style in Equity Investing
The current market environment has prompted many investors to search for investment choices that provide new sources of alpha, distinct from “brand-name” stocks and popular indices. The Neuberger Berman Multi-Cap Opportunities Fund provides a differentiated approach to the U.S. equity market, looking beyond conventional size and style categories.
We spoke with Richard Nackenson, the Fund’s manager, about his unique and disciplined style, how he finds potential investments, and why he believes the current environment is attractive for stock pickers.
As a multi-cap equity manager, you have a large investment universe to consider. How do you narrow things down?
We have a true bottom-up strategy that allows our analysis to drive our investment decisions. We look at a number of metrics when evaluating companies—revenue, earnings, earnings quality, net asset value, tangible book value and return on invested capital. We also pay close attention to capital structure. Most important is free cash flow, which we consider on a forward-looking basis. For us, market-cap size and style labels are secondary to fundamentals. At various stages of a market cycle, different areas may provide more opportunities—and thus will be more heavily represented in the portfolio.
What are the benefits of your multi-cap approach?
Investment styles shift in and out of favor, often quickly. Investors are increasingly seeking strategies with a dynamic process to help capture these inflection points. We are flexible, so we can look across “style boxes” for attractive investment opportunities while also reducing susceptibility to style-specific risk factors. We believe this gives us an advantage in the current environment and improves our potential risk-adjusted returns over time.
You have a unique investment framework. Tell us more about it.
We invest in three distinct categories: special situations, opportunistic and classic. Special situations are companies that require tailored valuation methodologies and investment research. This category includes restructurings, post-bankruptcy equities and spinoffs. Opportunistic companies are those that have become inexpensive for a tangible reason that we believe is temporary in nature. Classic companies are those with consistent long-term performance and proven management teams. Each of these categories has unique attributes and performance drivers, and the relative attractiveness of each tends to shift over the course of a business cycle. We direct the portfolio toward the areas that we feel offer the best opportunities at a particular time. It’s a framework that emphasizes stock selection and seeks to mitigate risk.
You worked at McKinsey & Company before becoming an equity analyst and portfolio manager. How did that impact your approach to investing?
My background is different from many analysts and portfolio managers on Wall Street. At McKinsey, we spent our time inside operating companies analyzing business models. We disaggregated the drivers of performance and the core elements of value creation from both a qualitative and quantitative perspective. This experience helped me understand what really drives free cash flow within companies. The Wall Street analyst community generally focuses on what a company does with cash once it has been generated. That’s obviously important—and a key part of our team’s analysis—yet it’s only part of the story.
Tell us more about your approach to free cash flow.
In our analysis, we favor free cash flow over earnings because we feel it’s a cleaner metric for determining outcomes. Earnings may be obfuscated through various accounting methods, while free cash flow is more transparent. Once we’ve identified the free cash flow for a particular company, we look at how it’s being used. On the business side, a company has a number of choices. It can reinvest in an existing business, enter a new line of business or do a selective acquisition. In terms of capital structure, a company can accumulate cash, pay down debt, buy back stock or issue dividends. The combination and potential of these choices impacts shareholder value and is an essential part of our investment process.
Do you consider macro factors when you invest? How do you balance them with stock picking?
The macro picture is important to us in the context of our bottom-up process. When looking at the key drivers of a company, it is important to consider macro-based factors that impact profitability. If you own an energy company, you should have a view on the long-term price of oil or natural gas. If you own a financial stock, you should have a perspective on interest rates. Our macro perspective provides key inputs for our analysis—particularly scenario analysis that helps us understand potential outcomes for an individual company. At the end of the day, it’s important to remember that macro is the synthesis of all things micro.
U.S. equities are thought to be fairly efficient and well understood. Does that make it hard to find alpha?
Our experience suggests that, contrary to popular belief, much of the equity market is not well researched. In fact, for special situations, small-cap and, increasingly, mid-cap stocks, many companies are under-researched or not researched at all. This reflects the dynamics within Wall Street firms, which favor coverage of larger companies. These gaps in coverage provide us with a real advantage given our in-depth fundamental analysis, which includes proprietary field research. As for large-cap stocks, there is a lot of research, but much of it is similar; large-cap analysts tend to bunch their estimates—whether positive or negative. Our opportunities for alpha emerge when we develop viewpoints that are different from the broad consensus.
You’re primarily a U.S. manager—do you have exposure to other markets? Do you use the same investment approach?
We own four types of companies: those that are pure plays in the U.S., U.S.-based multinationals, U.S.-based companies that have a portion of their business focused on exports and American Depositary Receipts (ADRs) of non-U.S. companies. We don’t rule out companies that are located outside of the U.S. and have found that our analysis applies extremely well to non-U.S. entities. We allow our disciplined investment process to guide us. Our exposure is based on opportunity sets, not geographic targets.
How do you approach risk management and address market volatility?
Our framework of investing in special situations, opportunistic and classic stocks provides an inherent risk management mechanism because of the different behavior of each group. We employ disciplined price targets and valuation work. Market price volatility can create opportunity by enabling us to add to positions that we believe have become undervalued or reduce positions that we believe have become more fairly priced.
Explain your sell discipline. How do you set price targets?
Our sell discipline is a very important part of our process. We spend a great deal of time identifying, researching and analyzing the key investment issues before we purchase a stock. We continuously refer to our investment thesis while monitoring an existing position in the portfolio. Price targets are dynamic and are based upon the real time flow of information. We will sell or trim a stock when price targets are achieved or when better opportunities become available. We will also sell if our investment thesis has changed. We try to remove our egos from investment decision making. It’s about taking the correct course of action for our clients.
Is this a good time to be a stock picker?
I’ve been in the industry for over 20 years and this is one of the best environments I’ve seen for stock picking. We’re in a market where correlations tighten and break apart in oscillating cycles. It’s exactly this kind of environment where individual companies are often overlooked and may become very inexpensive. Additionally, momentum-oriented investors drive certain stocks to extreme valuations. Part of our research process is dedicated to identifying these anomalies, and we are finding a large number of opportunities to research on an ongoing basis.
An investor should consider the 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 summary prospectus, which you can obtain by calling 877.628.2583. Please read the prospectus and summary prospectus carefully before making an investment. Investments could result in loss of principal.
Most of the Fund’s performance depends on what happens in the stock market. The market’s behavior is unpredictable, particularly in the short term. There can be no guarantee that the Fund will achieve its goal.
The stocks of small- and 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 large-cap companies, small- and mid-cap companies may have a shorter history of operations and may have limited product lines markets or financial resources.
Foreign securities involve risks in addition to those associated with comparable U.S. securities. Additional risks include exposure to less developed or less efficient trading markets; social political or economic instability; fluctuations in foreign currencies; nationalization or expropriation of assets; settlement custodial or other operational risks; and less stringent auditing and legal standards. As a result, foreign securities can fluctuate more widely in price and may also be less liquid than comparable U.S. securities.
Currency fluctuations could negatively impact investment gains or add to investment losses.
Companies that are considered “special situations” include among other things: companies that have unrecognized recovery prospects or new management teams; companies involved in restructurings or spin-offs; companies emerging from bankruptcy; initial public offerings that trade below their initial offering prices; and companies with a breakup value above their market price. Special situations carry the risk that certain of such situations may not happen or the market may react differently than expected to such situations in which case the Fund may experience losses. Certain special situations carry additional risks and the securities of such companies may be more likely to lose value than the securities of more financially stable companies.
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. Because the situation is unprecedented and widespread, it may be unusually difficult to identify both risks and opportunities using past models of the interplay of market forces or to predict the duration of these market events.
There is no guarantee that these investment strategies will work under all market conditions and investors should evaluate their ability to invest for the long term, especially during periods of downturn in the market.
Alpha is a measure of risk (beta)-adjusted return. It measures the nonsystematic risk (non-market risk—i.e., risk that can be eliminated by diversification). The formula is the mean of the excess return of the manager, over beta times the benchmark. Higher values indicate a manager’s added value over the benchmark, and are therefore desirable.
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