Institutional Strategies

Large Cap Growth - Concentrated

The strategy utilizes the same investment approach as the firm’s more diversified Large Cap Growth strategy, but adds an additional step to filter only the best long term ideas. The result is a more concentrated strategy approach consisting of only the highest conviction Large Cap Growth stocks.

The Large Cap Growth investment philosophy is centered on the following beliefs:

Generic growth stock investing is inherently challenging

  • Failure rate of growth companies is very high
  • Risk is often underestimated
  • Most growth investors overpay for short-term earnings growth and underpay for enduring, structural earnings power

Significant, long-term excess returns can potentially be achieved by:

  • Focusing on a smaller subset of unique business franchises, which typically increases the odds for success
  • Having a mindset geared to methodically avoiding common mistakes by emphasizing franchise power and earnings sustainability over earnings growth rates

The stock selection process is based primarily on fundamental research, but does use some quantitative analysis during the screening process. From a quantitative standpoint, the team concentrates on profitability, capital intensity, cash flow and valuation measures, and earnings growth rates. Once the quantitative research is completed the team turns to the internal research department for validation of the initial findings. Key to the fundamental research effort is identifying companies that they believe possess a sustainable competitive advantage, which should enable them to generate superior levels of profitability and growth for an extended period of time. Special focus is given to those companies that appear well-positioned to benefit from secular trends embedded in the marketplace (i.e., demographics, deregulation, capital spending trends, etc.).

The investment process consists of a disciplined 4-step process:

Screening for inclusion in the “Franchise Growth Universe”

The process starts with a quantitative screen that reduces the investable universe of the 1,500 largest U.S. companies down to 200-300. Companies with a market cap of at least $3 billion, and generally above $8 billion are filtered according to the strength of their earnings growth and a profitability matrix. This matrix, an essential part of the team’s analysis, includes measures such as gross margin, operating margin, net margin, return on equity, and/or return on assets.

Franchise Growth Universe – Evaluation of sustainable competitive advantage

The next step consists of identifying the sustainable growth drivers that support the high levels of profitability displayed by this reduced list of 200-300 companies. These generally consist of strong brand equity, proprietary technology, high switching costs, greater access to distribution channels, larger economies of scale, and/or stronger network effects.

Building the Franchise Growth Portfolio

The next step consists of building a portfolio of 40-60 companies that have the appropriate catalysts such as a superior business model (structural advantages producing superior returns) and also attractive industry characteristics (having barriers to entry, large market opportunities and secular unit growth). The selection of these stocks is based on criteria such as profitability, growth, capital discipline and valuation factors.

Building the Concentrated Growth Portfolio

In the final step the team selects what they feel are the best 12 to 18 long term ideas from the diversified 40-60 growth portfolio. The concentrated portfolio consists of only the companies the team feels are the most durable franchises with superior growth characteristics. Despite the limited number of stocks, the team seeks to minimize the risk of business model disruption by paying particular attention to not being over leveraged to a theme or sector.

Bradley M. Klapmeyer, CFA

Senior Vice President, Portfolio Manager

Mr. Klapmeyer is portfolio manager of the firm’s Large Cap Growth investment strategy, appointed to this role in 2016. He has been a member of the Large Cap Growth team since 2011. He held equity investment analyst research responsibilities prior to his appointment as portfolio manager, covering large cap growth securities and the biotechnology industry.

Prior to joining the organization in 2007 as an equity investment analyst, Mr. Klapmeyer held equity analyst positions with Prudential Equity Group, LLC from 2006 to 2007 and with Commerce Bank from 2000 to 2006.

Mr. Klapmeyer earned a BS in Finance from Truman State University.

Gage T. Krieger, CFA

Assistant Vice President, Assistant Portfolio Manager

Mr. Krieger is assistant portfolio manager of the firm’s Large Cap Growth investment strategy and assists the portfolio manager in idea generation, research, portfolio construction, and risk management efforts. He has been a member of the Large Cap Growth team since 2016. He is also a member of the firm’s equity research team, covering industries in the health care sector.

Prior to joining the organization in 2012 as an equity investment analyst, Mr. Krieger was a senior associate, equity research covering the telecommunications services sector for Citi Investment Research from 2009 to 2012. Prior to his role at Citi Investment Research in New York, Mr. Krieger was an associate, middle market equity sales for Citigroup Global Markets in Denver, CO from 2006 to 2009.

Mr. Krieger earned an MBA from Rockhurst University and a BSBA; concentration in Finance from Colorado State University.

3 years, 5 years, 10 years annualized. Returns are presented on a dollar-weighted basis and may be impacted by ongoing market volatility. Past performance is no guarantee of future results. Please inquire for more current performance information.

Total Returns1,2,3

Average Annual Total Returns as of 12/31/2018
(Returns for periods of less than 1-yr are not annualized)

  QTD  YTD 1YR 3YR 5YR 10YR
Large Cap Growth Concentrated - Gross -14.46%  6.04% 6.04% 11.71% 10.56% 15.58%
Large Cap Growth Concentrated - Net -14.62%  5.24% 5.24% 10.89% 9.80% 14.83%
Russell 1000 Growth Index -15.89%  -1.51% -1.51% 11.15% 10.40% 15.29%

Calendar Year Returns1,2

  Large Cap Growth Concentrated Gross Large Cap Growth Concentrated Net Russell 1000 Growth Index
2018 6.04%  5.24%  -1.51% 
2017 31.15% 30.17%  30.21%
2016 0.24% -0.47%  7.08%
2015 4.23% 3.53% 5.67%
2014 13.71% 13.03% 13.05%
2013 40.51% 39.67% 33.48%
2012 17.21% 16.51% 15.26%
2011 6.80% 6.16% 2.64%
2010 9.85% 9.20% 16.71%
2009 33.21% 32.41% 37.21%

1Large Cap Growth Concentrated composite is comprised of 2 accounts that had $11.9 million in total assets as of 12/31/18. • Returns reflect the reinvestment of all dividends and other earnings. Portfolio returns are net of all foreign reclaimable and nonreclaimable withholding taxes, if applicable. Withholding taxes are recognized on an accrual basis or cash basis depending on client and/or account type. Additional information regarding treatment of withholding taxes is available upon request. Returns shown gross of fees reflect the deduction of commissions paid, but are gross of all other expenses. Net-of-fees returns are calculated by deducting the highest applicable advisory fee from the monthly gross composite return. The actual fees paid by a client may vary based on assets under management and other factors. A client’s return will be reduced by investment management fees and other expenses incurred in the management of a client’s account. Investment advisory fees are described in Part 2 of the ADV. Investment returns and the actual value of each client account will fluctuate, and at any given time an account could be worth more or less than the amount invested. • The benchmark selected for the composite is intended to provide a method to compare the composite’s performance to an index including securities that are generally similar to those that are included in the composite. However, composite holdings (and, accordingly, risk and volatility) may differ significantly from the securities tracked by its benchmark.

2Russell Investment Group is the source and owner of the Russell Index data contained or reflected in this material and all trademarks and copyrights related thereto. The presentation may contain confidential information and unauthorized use, disclosure, copying, dissemination or redistribution is strictly prohibited. This is a presentation of Ivy Investment Management Company (IICO). Russell Investment Group is not responsible for the formatting or configuration of this material or for any inaccuracy in IICO’s presentation thereof.

3QTD return from October 1, 2018 through December 31, 2018.

Data as of 12/31/2018

10 Largest Holdings

as a % of total assets

Microsoft Corp.
9.32%
Alphabet, Inc. Class C
6.66%
MasterCard, Inc. Class A
5.97%
Apple, Inc. 5.76%
Amazon.com, Inc.
5.76%
CME Group, Inc. 5.20%
PayPal, Inc.
5.16%
Zoetis, Inc.
4.90%
Adobe, Inc. 4.85%
Visa, Inc. Class A 4.55%

Sector Diversification

as a % of equity assets

Information Technology 46.29%
Health Care 12.90%
Consumer Discretionary
12.56%
Communication Services 10.96%
Industrials 9.90%
Financials 7.40 %

Composite Composition1

Domestic Common Stock 98.86%
Cash and Cash Equivalents 1.14%

Composite Total Assets1

Assets ($M) $11.9
Number of Accounts 2

Supplemental data: The Large Cap Growth - Concentrated holdings and sector diversification data shown are 1 of the 2 composite accounts without client specific investment restrictions and may not be reflective of the Large Cap Growth - Concentrated composite as a whole or of any other Large Cap Growth - Concentrated account currently, or in the future, included in such composite. The securities identified and described do not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in the securities identified was or will be profitable.

1Large Cap Growth Concentrated composite is comprised of 2 accounts that had $11.9 million in total assets as of 12/31/18. • Returns reflect the reinvestment of all dividends and other earnings. Portfolio returns are net of all foreign reclaimable and nonreclaimable withholding taxes, if applicable. Withholding taxes are recognized on an accrual basis or cash basis depending on client and/or account type. Additional information regarding treatment of withholding taxes is available upon request. Returns shown gross of fees reflect the deduction of commissions paid, but are gross of all other expenses. Net-of-fees returns are calculated by deducting the highest applicable advisory fee from the monthly gross composite return. The actual fees paid by a client may vary based on assets under management and other factors. A client’s return will be reduced by investment management fees and other expenses incurred in the management of a client’s account. Investment advisory fees are described in Part 2 of the ADV. Investment returns and the actual value of each client account will fluctuate, and at any given time an account could be worth more or less than the amount invested. • The benchmark selected for the composite is intended to provide a method to compare the composite’s performance to an index including securities that are generally similar to those that are included in the composite. However, composite holdings (and, accordingly, risk and volatility) may differ significantly from the securities tracked by its benchmark.

2Russell Investment Group is the source and owner of the Russell Index data contained or reflected in this material and all trademarks and copyrights related thereto. The presentation may contain confidential information and unauthorized use, disclosure, copying, dissemination or redistribution is strictly prohibited. This is a presentation of Ivy Investment Management Company (IICO). Russell Investment Group is not responsible for the formatting or configuration of this material or for any inaccuracy in IICO’s presentation thereof.

3QTD return from October 1, 2018 through December 31, 2018.

As of 12/31/2018

Portfolio Manager:
Bradley M. Klapmeyer, CFA

Market Update

It seems like ages ago, but it was just early October when interest rates were moving higher as Federal Reserve (Fed) Chairman Powell comfortably expressed his view that an accommodative Fed policy was no longer needed given the strong environment. There was a temporary pause in escalating trade war tensions, U.S. economic data was clicking off decent numbers and investors were left to debate just one “minor” issue – the duration of the economic cycle.

Flash forward to year-end 2018 and one would think the wheels are off. There is carnage in the markets. The Fed moved forward with the ninth raise but carefully signaled to the market they are tiptoeing and are willing to pause, maybe for an extended period. The equity markets still screamed “policy error” as they worried about a list of concerning data points: Weakening growth in the U.S., eurozone and China, Brexit risk back to a boil, U.S. government shutdown over a border wall funding impasse, presidential attacks on Fed Chairman Powell, and the realization that the temporary trade truce was anything but clear. Oh, and don’t forget that “minor” issue – duration of the cycle.

All this to say that equity markets struggled in the fourth quarter and reversed course on what was shaping up to be another decent year of gains. This marks the first down year for the Russell 1000 Growth Index, strategy’s benchmark, since the Financial Crisis, and although the loss was small, it still stings.

Peeling back the market performance on the quarter, equities across all capitalization ranges and styles saw significant declines in the fourth quarter. Growth styles underperformed value styles while large outperformed mid and small. This style performance in a down environment is not surprising as investors seek safety and stability.

Portfolio Review

The strategy outperformed the benchmark in this volatile environment. Changes made throughout the year to dampen exposure to cyclical and more volatile stocks helped the portfolio relatively outperform and maintain positive performance for the year.

Starting on the win side, Information Technology provided positive attribution as our strategy held underweight positions to several poor performers in the sector. We also benefited from overweight exposure to payment stocks. The Financials sector was a strong contributor to relative outperformance. Performance in the quarter benefited from stock selection in Health Care, which was a new overweight during the year. The sector historically has been viewed as more resilient during periods of slowing economic growth.

On the miss side, stock selection in Consumer Discretionary detracted from performance. Investors sold consumer stocks due to worries about slowing U.S. growth. The Consumer Staples sector was another notable detractor of performance due to an underweight position versus the benchmark. This sector is typically viewed as more stable and thus outperforms during periods of economic and market stress. While we have spent energy looking for viable exposure in this sector, the fundamentals and valuations are not attractive to us at this point.

Outlook

Anxiety is clearly high in the markets, and we would expect this to remain. Investors seem to be bouncing between optimism about modest 2% economic growth and nervousness about the graying economic cycle. Time will determine whether the Fed’s last rate hike was justified, but it is important to remember how quickly sentiment turned from October to December. In our view the markets overreacted to the December hike, as we think a couple events falling in the right direction (e.g. a real trade war truce, more accommodative Fed language) could easily shift sentiment back to risk-on, at least temporarily.

With that said, we believe the script is largely written as we are three years into a Federal Reserve tightening cycle. The rate increases since 2015 have resulted in a more neutral Fed policy, regardless of what policy tweaks the Fed may make in 2019. This view formed the basis for the material changes made to the complexion of the portfolio during 2018. The more notable changes include reducing Information Technology exposure by exiting positions in semiconductor capital equipment and semiconductor stocks. We also reduced exposure to the Financials sector as those stocks became too highly correlated with changes in the yield curve versus stock-specific drivers.

These reductions were repositioned in Consumer Discretionary where we saw growth opportunities in strong consumer brands that we felt had successfully bridged the Amazon risk chasm and were set for more sustainable growth regardless of the market environment. We also added to Health Care with multi-year accelerating growth stories.

Very often, in these volatile periods, stock correlation spikes, and investors dump stocks irrespective of fundamentals. Therefore growth stocks with durable, sustainable competitive positions often get thrown out with the bath water, and this presents a welcome opportunity for long-term investors. The net result of these portfolio changes was to skew the portfolio more toward earnings quality and profitability while maintaining a focus on strong growth. As experienced in the fourth quarter, these improvements in quality have allowed the portfolio to better withstand choppy markets. We will continue to strategically position the portfolio to accentuate stock selection over factor bets, but whereas we can’t eliminate factors bets we will skew the portfolio toward these characteristics that align with our philosophy and process. For more radical changes to occur from this point forward we would need to become even more concerned about the economic backdrop, or inversely feel better about the sustainable strength of the economy. We don’t believe a recession is imminent, however. Despite the aging cycle, many of the excesses that often precede a recession are hard to find. These include consumer debt, excess inventories, corporate debt, and excess business investment, which are very muted this cycle. It’s possible we could even see a growth deceleration with a shallow recession or no recession.

The trade war remains a wild card as it is putting a dent in business and consumer confidence. There is currently no sign of a trajectory change on the issue, which bodes poorly for the durability of economic growth. The Trump administration may react to the softening economic growth with more progress on a trade war resolution, but there is little indication of that right now.

Barring a legitimate economic recession, the current modest growth environment remains supportive of durable, long-term growers. A slowdown in growth would likely narrow investors’ focus on stocks with these characteristics, hopefully driving continued outperformance for growth styles.

The opinions expressed are those of the portfolio manager(s) and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through December 31, 2018 and are subject to change due to market conditions or other factors. Any mention of investment performance refers to gross-of-fees performance, unless otherwise noted.
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Key Features

Composite Performance History Since 1/1/2003
Benchmark Russell 1000 Growth Index
Style Fundamental, Growth
Target Alpha 200-300 bps above Index
Over full market cycles (3-5 years)
Peer Universe U.S. Large Cap Growth Equity
Typical Tracking Error 600-1000 bps
Holdings Range < 18
Max Position Size 15%
Sectors 0-2x Index weights
Proprietary Growth Spectrum Diversification across three proprietary buckets: Accelerating, Controlled and Cyclical
Investment Vehicles Institutional Separate Account