By virtue of the fact Nicholas-Applegate focuses on growth, not value, it managed to escape the worst

effects of the sub-prime crisis, suffered by other quant managers. By Nick Fitzpatrick

07_12_interview.jpg“It’s going to be another year before this all ends,” says Horatio Valeiras, chief investment officer of Nicholas-Applegate Capital Management, a subsidiary of Allianz Global Investors (AGI). He’s refering, of course, to the sub-prime related turbulence that spilled out into the markets in August. Most of Nicholas-Applegate’s strategies underperformed that month, though relative performance remained ahead of the year-to-date quarter.

Quant funds were hit especially hard right across the market. Given that quant investing is in Nicholas-Applegate’s blood (the firm describes itself as a pioneer in the field), in hindsight it was inevitable the firm would be affected. But within the universe of quant managers, it was those that employed value-driven models that were particularly fractured by the summer mayhem. Nicholas-Applegate was not among them.

“Most quant managers are value managers and valuations haven’t worked since August, while growth has outperformed. Our models are growth models so we did better,” says Valeiras.

Ironically, growth assets have not always been so kind to the firm. In the last great crash, growth stocks were the cause of Nicholas-Applegate’s downfall when its tech-heavy portfolios turned sour in the dotcom bubble. This preceeded the sale in 2001 of Nicholas-Applegate – based in San Diego, United States – to AGI, one of the world’s largest asset managers which is owned by Allianz, the German insurance group. Nicholas-Applegate has around $15bn (e10.2bn) under management.

There was a significant management change because performance was terrible,” says Valeiras. “We were managing products that we should not have been doing.” As an example, he points to the management of European equities from the firm’s US base.

Valeiras can afford to be critical of the firm’s past: while the dotcom downturn was rocking the small American manager, Valeiras was not present. Fairly soon after Marna Whittington, Nicholas-Applegate’s current CEO, was hired from Morgan Stanley Asset Management in 2001, Valeiras was brought in – also from Morgan Stanley – to help further revamp the firm in 2002.

Funds were closed and portfolio managers were changed. Risk models were revamped and a behavioural finance became more important, with AGI providing distribution in Europe.

In portfolio terms at least, this revamp has lately resulted in a shift to overweight in the technology sector. This occured in February when the firm also scaled down its positions in materials, industrials and energy – a move that may have helped the firm defend itself against some of the sub-prime damage when quality liquid stocks in these sectors were sold off. 

“We like the technology sector. We think there’s scope for earnings improvements because there is a lot of demand for features such as flash memory and miniaturisation,” says Valeiras.

Georgraphical diversity
Time will tell whether this will prove a clever move or not, but on a broader strategic level away from investment strategy the firm is putting a strong focus on building international revenue streams and on client service.

Valeiras says Nicholas-Applegate does not seek to grow at a rapid pace; rather it wants to broaden revenues along geographical lines. The firm also appears more interested in keeping old customers rather than gaining too many new ones. “We will be more successful in the long run if we take care of existing clients rather than just  focus on gathering assets,” says Valeiras.

Keeping existing investors happy and broadening geographical revenues could be a good tonic for the fallout that the sub-prime situation may bring to many fund managers, especially if a downturn in asset management – which is thought possible by the likes of consultancy McKinsey – sets in.

The downturn after dotcom forced senior executives to turn their attention to seeking operational efficiencies in their back and middle office activities. In this area Nicholas-Applegate seems well-positioned. In 2002 a strategic review of Nicholas-Applegate’s infrastructure took place under Chris Cieri, director of operations at the firm. This resulted in greater automation and in many functions being consolidated with one provider. Outsourcing was considered but rejected, said Cieri. “We found that from a cost perspective there was little difference. The transition costs from insourcing to outsourcing were not good enough.”

Another factor in Nicholas-Applegate’s back office revamp was its new parent, which incorporated the manager into its ‘Vision’ product. Vision is an alpha strategy which sits on a Luxembourg Sicav platform and takes advantage of all the competencies within the AGI group, which includes fixed income manager PIMCO. Within its operations group in San Diego, Nicholas-Applegate has to have a sub-group dedicated to operational support for its contribution to Vision. This contribution to Vision includes a quant large-cap capability and 130/30 funds.

Vision represents a way in which AGI has been helpful in building Nicholas-Applegate’s business. Whereas some insurance-owned asset managers appear keen to distance themselves from their parent (Britain’s Standard Life Investments is an example) Nicholas-Applegate is not amongst them. As well as broadening the manager’s European distribution capability through related firms like AGF in France, RAS in Italy and Dresdner in Germany, the parent company has seeded the three 130-30 funds launched by Nicholas-Applegate.

AGI has also helped the manager pick up European mandates in global and emerging market equities with e1bn flowing into the firm in recent months.

There are essentially three parts to Nicholas-Applegate’s business: traditional US and global equities ($4bn); its systematic (or quant) group ($4bn), which focuses on US and non-US global equities; and its income and growth team ($7bn).

“There isn’t a huge demand for US equities in Europe. There is more opportunity in global and emerging market equities,” says Valeiras. In February it was reported that the firm had closed its US value equities funds, saying this was a strategic decision to provide resources to other parts of the firm.  

Microcap investments
Recently the firm has invested in its microcap growth equity business. In July Nicholas-Applegate said it will acquire Duncan-Hurst’s microcap growth equity business, which includes the hiring of the firm’s Robert Marren and Blake Burdine to replace Travis Prentice, Montie Weisenberger, and Joshua Moss, who said they were leaving to form a new business.

Both firms are based in San Diego and trace their roots to Pacific Century Advisers, a subsidiary of Security Pacific Bank. 

Marren and Burdine will report to John McCraw, managing director and portfolio manager, who oversees Nicholas-Applegate’s emerging growth, microcap and ultra-microcap strategies. Since McCraw has led the team, the Nicholas-Applegate microcap portfolios have outperformed the Russell Microcap Growth Index in the one-, three-, five-, and seven-year periods ending 30 June, 2007.  They have also outperformed their former benchmark, the Russell 2000 Growth Index, by 9% annualized for the ten- and 15-year periods ending June 30.

© fe December 2007 / January 2008

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