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   Interview

    Guest Interview:

   Montag & Caldwell, LLC

    3455 Peachtree Rd NE, Ste 1200
    Atlanta,GA 30326

    Telephone: (800) 458-5868
    Fax: (800) 458-5868
    E-mail: acriste@montag.com

 

    Interview Quarter: 1Q2011

 Ron Canakaris

 CFA , Chairman & CIO

  Montag & Caldwell is a well- known Large Cap Growth equity manager. What makes you unique in your product category?  
  The most important factor in our success has been the consistent application of our time tested investment process by a stable and experienced team of professionals.

M&C’s Large Cap Growth buy discipline places a premium on earnings sustainability, valuation and quality. Our process is designed to capture inefficiencies in the U.S. market by looking for high quality companies with good long term earnings growth that are trading at a discount to our calculation of fair value and which are growing earnings faster than the market in the near term, and then to sell them prior to their becoming so overvalued that excessive risk is imbedded in the portfolio. What distinguishes M&C from our peers is our proprietary evaluation of investment candidates. Our employment of a stock-specific, risk-adjusted discount rate as a component of our valuation work is unique. This rate is determined by our proprietary financial scoring process which rewards high quality companies and also advantages companies with historically predictable earnings. Our proprietary investment discipline has remained relatively unchanged since its establishment in the early 1970s. Fully embraced by our entire team, it has become institutionalized, thereby lessening the risk associated with any single individual.

Our Investment Team is led by Ronald E. Canakaris and comprised of 17 experienced professionals, with a combined average industry experience of 26 years and a combined average Firm tenure of 18 years. In the last ten years, all departures but one have been for retirement. Continuing to provide a rewarding working environment should help to maintain our competitive advantage in the future.
 
  What is the background of the Firm?  
  Montag & Caldwell was founded in 1945 in Atlanta Georgia, employs 49 people and manages $14 billion in Corporate, Public, Taft Hartley, Foundation and Endowment and other client assets. Our efforts are primarily concentrated on our flagship Large Cap Growth equity product that comprises over 96% of our client assets under management.

On September 24, 2010, we completed an employee-led buyout. Montag & Caldwell is now 100% employee-owned. Ownership interest is very broad-based and no one individual holds a majority stake. All officers who were accredited investors contributed capital to the Firm.
 
  What is the firm’s investment philosophy?  
  We are long- term fundamental investors focused on buying high quality growth companies. We adhere to an active, fundamentally driven approach while properly assessing risk as the key to generating alpha for client portfolios over typical market cycles. We have relatively low turnover and run a high conviction portfolio of between 30-40 names. At M&C, we believe that good investment returns are derived from the competent, disciplined, fundamental analysis of individual securities, performed by experienced professionals operating as a team.

M&C’s primary product style is Large Cap Growth. Our process is primarily bottom-up in which we combine price with earnings momentum. Our strategy uses a present valuation model in which the current price of the stock is related to the risk- adjusted present value of the company’s future earnings stream.

Our goal is to provide superior risk-adjusted returns over longer periods of time. Although we may underperform in shorter time periods, particularly in more speculative cycles, we have a demonstrated history of providing excess returns over longer market cycles. We make our investment decisions with our eye on long- term performance and are not focused on shorter term trends in the market.

We are willing, if we do not find stocks with a combination of valuation and earnings, to delete a sector from the portfolio, and there are a few sectors which will normally be underweighted or absent from our portfolio: materials – due to the lack of earnings consistency; and utilities and telecom – due to generally high debt levels and slower secular earnings growth rates. We believe not being constrained by tracking error permits us to find relatively more opportunities to add value, particularly in markets where valuation dispersion is limited.
 
  How does M&C add value in Large Cap Equity given what many argue is the most “efficient” asset class?  
  Clearly, large cap stocks are incredibly transparent and it is difficult for any analyst to discover something that is not readily available to the marketplace. We do believe, however, that by applying a disciplined, consistent approach that identifies growth, value and quality, we have demonstrated the ability to add value over our primary benchmark, the Russell 1000 Growth as well as the broader market index, the S&P 500. We run a high conviction strategy of 30-40 names and are not afraid to look different than our benchmark. We measure risk on an absolute basis as opposed to tracking error. We are firm believers in active management and believe active managers add value by not mirroring a benchmark.

That being said, we recognize that true active management does not always show up in short term results, but requires patience and a longer time horizon. This can sometimes be a challenge given the increased focus on near term performance.
 
  One’s Sell Discipline is clearly as important as the Buy Discipline. Can you briefly describe your philosophy in this regard?  
  Montag & Caldwell’s Sell Discipline is driven primarily by the following two factors: Foremost, is achieving the target price. A holding will be reviewed for probable sale when it reaches M&C’s target price ratio, which is normally 120% of our determination of its fair value. Trimming the position, rather than total sale, might be the decision in the case of a high-growth company with rapidly compounding earnings. The second factor is earnings momentum: Any significant earnings disappointment will trigger an immediate review of the holding and a decision to “add or sell.” Since our investment policy centers on positive earnings momentum within a six-month period, “add or sell” decisions are made within that framework. This time frame may be extended for one quarter out to nine months, in order to capture exceptionally good value occurring just prior to restored earnings momentum. Unless we discern visible earnings growth for the next six-nine months and the valuation is attractive enough to justify adding to positions, we will sell on earnings disappointments. Stocks are also sold when experiencing weakening earnings momentum.  
  Quality has been referred to as a cause of underperformance by many in the last two years. How do you define quality? How does it impact your work?  
  Investment Strategies that have emphasized quality have clearly faced some headwinds over the past couple of years, although quality has also become an easy excuse for underperformance. At M&C, quality has always been an important component of our investment work, and the quality scoring work we do has a direct impact on our ultimate determination of fair value for each name.

We use a risk- adjusted discount rate which is determined by our proprietary 11 factor financial scoring process. Factors include a company’s historical long-term growth, earnings quality, balance sheet strength, and profitability. This score, combined with earnings variability, net worth, and trading volume, determines a company’s relative place within a range of discount rates. The discount rate is based off of the ten-year Treasury yield. To the base rate, we then assign a suitable equity risk premium that may range from 0.50% up to 4.00%, depending upon the quality factors listed above. Our work tends to bias us toward high quality names and more consistent earnings growth characteristics that we believe are rewarded over time.
 
  Many describe the last decade as being the lost decade for large cap stocks. What are your thoughts, and what gives you any sense of optimism for the future?  
  Clearly, higher quality, mega cap managers have faced some significant headwinds over the last couple of years as the market has favored smaller, higher beta and generally more cyclical names. QE2, the quantitative easing accomplished via Federal Reserve bond purchases, has extended that trade longer than we might have predicted, but we feel the long awaited trade to large, high quality, and in many cases, multi-national names will occur at some point.

We believe the high quality growth stocks in our clients’ portfolios are well positioned for several years of superior investment returns. The shares of these companies are attractively valued, and their earnings growth rates are more assured due to their financial strength and global diversification, particularly their exposure to the faster growing emerging markets. Our clients’ energy and technology holdings should benefit from the growth of the emerging markets and recent cyclical improvement in the U.S. economy. Furthermore, our clients’ multinational holdings with strong global brands should benefit from the robust growth in consumer spending in the emerging markets. This will be reinforced by the eventual and inevitable shift in the mix of the Chinese economy toward consumption and away from fixed asset investment. Emerging market consumer spending now represents about 35% of global consumer spending, in line with the emerging markets’ contribution to global GDP. We continue to highlight the unusually attractive dividend yields and dividend growth prospects of these leading global growth issues in an environment of low interest rates for both short and long- term fixed income investments.
 
  Many have anticipated the move to large cap, higher quality names. What do you see as the primary catalyst?  
  The catalyst for this eventual move is difficult to predict; but in our view, the realization of more moderate GDP growth given a prolonged period of de-leveraging, will make the more assured earnings growth of these names combined with the compelling valuations tough to overlook.

We are near record levels of after- tax profits as a percentage of GDP, and we seem to be right back where we were in late 2006. At that time, as the near record margins began to roll over, strong relative earnings were most evident in the high quality multinational growth space. Our clients did very well in 2007 given their overweight position to those types of names. Surprisingly, it has taken only seven quarters to get back to near peak levels. To put this in perspective, it took almost five years to get to the 2006 peak. The dramatic decline and rise of this ratio is unprecedented. In part, it reflects the superior job that management did to cut costs during a tough economic period. History again suggests mean reversion – this level of profitability cannot last, especially at the current unemployment rate. It would be typical, with margins this high, for the price to earnings multiples of lower quality cyclical companies to reflect significant mean reversion risk. We suspect that we have seen the last of the large profit gains, and earnings should begin to decelerate from here. Ultimately, there will be reconciliation between slowing profit growth and earnings expectations. It is not a question of if the market will recognize this, but when—and that is the generational opportunity for which we believe our clients are so well positioned.
 
  What is your outlook for 2011?  
  After the run-up in share prices during the second half of 2010, it would not be surprising to see a consolidation of stock market gains or even a temporary setback. The market is technically overbought, and investor enthusiasm has reached elevated levels. We do expect share prices to subsequently grind higher along with sustained economic growth that is being further supported by the additional federal fiscal and monetary stimulus.

Since the end of the recession, we have believed that the economy had sufficient forward momentum, along with pent-up demand and low interest rates, to achieve at least moderate growth of 2-2.5% and not relapse into another recession. With the U.S. unemployment rate still at nearly 10% eighteen months after the end of the recession, additional fiscal stimulus in the form of federal tax cuts and the extension of unemployment benefits and monetary stimulus (i.e., a second round of quantitative easing) are being implemented. This is all being done in an effort to ensure that the recovery will be sustained. Given this additional federal fiscal and monetary stimulus and recent encouraging economic data, we now believe real Gross Domestic Product (GDP) may increase at an annualized rate of about 3% in 2011. Another reason for our increased growth estimate is the fact that the economy continues to benefit from robust growth in the emerging markets, which, as previously mentioned, now account for about 35% of global GDP. We note, however, that the economic recovery continues to be constrained by the ongoing financial deleveraging of the private and public sectors both domestically and in other parts of the developed world. Inflation remains well contained. We still expect the Consumer Price Index (CPI) to increase at an annual rate of around 1% in 2011.
 
  Are there particular sectors that look attractive to you currently?  
  Although we are primarily bottom-up investors, our macro views often confirm what we see in our fundamental analysis. Our works will tend to bias us toward larger and more consistent growth names, but we have long maintained a balance with more cyclical growth sectors. We have been increasing our weighting in the Energy sector as we believe the secular imbalance between supply and demand will provide plenty of opportunity, particularly for the oil service names. We also believe that many names in consumer staples are being overlooked. These names offer strong relative growth rates driven by the global footprints, have extremely attractive valuations, and often pay healthy dividends.  
  Why Montag & Caldwell? Why Now?  
  We have spoken with many of our clients about what we consider to be a tremendous opportunity for high quality Large Cap Growth. Lower quality, higher beta, and smaller market capitalization stocks have all performed better since the market lows in 2009. This has magnified a primary pre-condition needed for a rotation – the very attractive relative and absolute valuations for higher quality, larger capitalization companies. In 2010, this disparity was not recognized in an environment where valuations were tallied on aggressive earnings expectations and the continuation of near record level profit margins. Throughout the year, the market reacted with vehemence based on the latest macroeconomic news; slipping with announcements of sovereign debt crises and the potential for a double dip recession, and then surging with the announcement of a second round of quantitative easing. Specifically, the market’s strong upward move in late August postponed any recognition of the very strong combination of valuation and relative earnings strength for many of the companies that we own. This left our portfolio temporarily out of sync with the benchmark but increasingly well poised to take advantage of the coming rotation. Over full market cycles our process has been consistently validated, and the coming period should be no different. We strongly believe that our portfolio is extremely well positioned to take advantage of a generational opportunity to invest in high quality, attractively priced companies with visible and predictable earnings growth.  
  What products do you offer, and what are your investment strategies?  
  As mentioned before, the primary product is our Large Cap Growth equity strategy. However, in April 2007, we introduced a new Mid-Cap Growth strategy. The process focuses primarily on companies between $2.5 billion and $10 billion in market capitalization. We employ the same bottom-up, fundamentally driven investment discipline as the Firm’s Large Cap Growth process. The primary difference in these two strategies, other than market capitalization and benchmark, is the number of target holdings (45 to 65) due to the lower liquidity in the Mid-Cap universe.

M&C Mid-Cap Growth strategy invests in high-quality, mid-cap growth stocks that offer a compelling combination of earnings growth and attractive value. Our objective is to identify stocks that are selling at a discount to intrinsic value and exhibit above-median near-term relative earnings strength. We favor companies with leading franchises, proven management teams, strong finances, and attractive long-term secular growth characteristics. Through our stock selection criteria we seek to manage risk through portfolio construction and a strict sell discipline.

Montag & Caldwell also provides investment management services for fixed –income and multi-strategy (e.g. balanced) portfolios.
 
  Does Montag & Caldwell have a website, and how can investors access it?  
  Investors may visit our website at www.montag.com and view various research papers which include our quarterly Newsletter and Economic Outlook.  
 
 
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