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   Interview

    Guest Interview:

   New Amsterdam Partners LLC

    475 Park Avenue South
    New York,NY 10016

    Telephone: 212-689-1500
    Fax: 212-689-3503
    E-mail: mclayman@napllc.com

 

    Interview Quarter: 1Q2003

 Michelle Clayman

 CFA Managing Partner and Chief Investment Officer

 

Q: Michelle, please provide a brief history of New Amsterdam Partners.
A: I founded the firm in 1986 to bridge the chasm between the methods of quantitative and fundamental stock analysis. Discerning the strengths and limits of each, we have developed an approach that integrates both disciplines to yield a decisive and intellectually sound edge in stock selection.

We began managing assets in 1987 and currently manage $1.5 billion for a diverse range of clients including Public Funds, Corporate Pensions, Foundations, and Endowments, as well as high net worth individuals through our select wrap and subadvisory relationships.

Q: How would you describe New Amsterdam Partner’s overall investment philosophy?
A: New Amsterdam Partners’ investment philosophy is simple: we believe that superior investment results are driven by capitalizing on security mispricings in the market. Our strategy, grounded in years of experience as quantitative and fundamental analysts, is to bring together the best of both these disciplines, to offer plan sponsors true value-added returns. New Amsterdam Partners was founded in the conviction that a disciplined blend of quantitative and fundamental research results in superior stock selection. We believe that investment opportunities ought to be evaluated by comparing expected investment returns, since it is actual returns that our clients care about.

Our investment process combines disciplined quantitative analysis with a rigorous fundamental overlay. We search for companies with higher-than-average forecast growth and profitability, selling at, or lower than, market Price-to-Earnings and Price-to-Book ratios. Our style can best be described as “GARP” (Growth at a Reasonable Price).

Proponents of quantitative analysis believe that numbers alone suffice, while fundamentalists focus exclusively on the story, disdaining the efficiencies that can be harnessed through quantitative modeling. As previously mentioned, New Amsterdam Partners’ approach is less dogmatic and more practical. We integrate theory with practice, mathematics with common sense. We have developed a process to consistently capture the best of both worlds. Our investment process and the culture of our firm are defined by two simple questions, “Why?” and “How?” Why are things the way they are, and how can we make things better? Why do people invest the way they do, and what can we do to get an edge?

We realize that market participants do not respond to available information uniformly. Thus, we are proponents of the Rational Beliefs Equilibrium Theory (Mordecai Kurz, Stanford University) which says that active managers can add value by finding mispricings unidentified by the consensus. As investors, we take advantage of this phenomenon through a process that systematically capitalizes on market mispricings. The disciplined use of our quantitative valuation techniques, in conjunction with sound fundamental financial analysis of companies, is the key to understanding and maximizing investment returns.

Q: Could you tell us about the equity products you offer?
A: We offer four products to our investors:

• Large Cap Active Equity: large cap GARP strategy – 40 to 45 stock portfolio
• MidCap Active Equity: midcap GARP strategy – 40 to 45 stock portfolio
• Concentrated Active Equity: top ten “best idea” stocks – 10 stock portfolio
• Socially Responsible Active Equity: socially screened strategy – 35 to 45 stock portfolio

Q: What are the differences in their philosophies and goals?
A: All four of New Amsterdam Partners’ products utilize the same core investment process and philosophy. The Large Cap and MidCap strategies differ in market capitalization, with our midcap stocks typically topping off at $9 billion at time of purchase. Our Socially Responsible strategy starts with a socially screened universe and can be tailored to meet investors’ specific social needs. Our Concentrated strategy is for less risk averse investors. The portfolio holds only ten stocks – our ten best idea stocks from the Large Cap and/or MidCap portfolios, and unlike our other three strategies, the Concentrated portfolio does not consider sector diversification.

Q: Please tell us about the screening process you use to select stocks.
A: New Amsterdam Partners utilizes a front-end quantitative process with a traditional, fundamental back-end overlay to build our clients’ portfolios. Our investment process begins with a universe of over 10,000 publicly traded U.S. stocks. We apply eligibility filters to reduce the research candidates to about 1,500. These 1,500 names then go into our valuation model which ranks these candidates by expected investment return, using forecast growth, profitability, and price/book ratios. We then perform fundamental analysis on the top 100 companies. We analyze each candidate’s business strategy, management quality, and accounting practices, as well as industry trends, competitive conditions, and the fit with our general economic outlook. From these analyses we build fully diversified portfolios of 40 to 45 stocks.

Q: Who developed this model and how long have you been using it?
A: The original valuation model was devised by Tony Estep (an original co-founder of the firm). I wrote the code for the version of the model that we currently use, and developed the rest of the investment process.

Q: How do you determine your sector analysis and how do you weight your investment sectors?
A: All portfolios (excluding our Concentrated Active Equity portfolios) invest in 19 general economic sectors. We do not make extreme sector bets; for major sectors, we are never more than two times or less than one half the benchmark weighting. By investing in these 19 general economic sectors, we seek to reduce the risk of over exposure to any one segment of the economy.

A key component of our buy discipline is our quantitative process which includes a valuation model. We run this model two ways each time: once constrained by benchmark sector weightings and once without constraining sector allocations. The unconstrained run highlights industries with relatively inexpensive valuations. We maintain a general economic outlook, and employ it as we decide to what extent we wish to tilt in the direction of the more attractively valued sectors. With the exception of our Concentrated strategy, our portfolio weightings normally fall between the unconstrained and the benchmark weightings. Because our Concentrated product is a 10-stock product, concentration, not sector or industry diversification, is the objective.

Q: How do your fundamental analysts forecast a company’s cash flow?
A: Our cash flow forecast is a distillation of all that we know about a given company, its industry, and the current and long-term macroeconomic outlook. To understand a company and its financial productivity requires a number of steps. First, we examine all publicly available data, including annual and quarterly reports, paying particular attention to how the company has performed in times of both economic expansion and recession. We also examine the balance sheet relative to the cash that will be required to finance both the anticipated growth of the firm as well as the economic depreciation of the firm’s assets. Next, we speak with management about their track record, including their ability to grow the business both organically and through the selective use of acquisitions. Finally, we analyze the industry itself, trying to discern whether or not it is an inherently attractive (shareholder-value creating) industry or one with less favorable long-run return characteristics.

Once we have a good understanding of these factors, we prepare to forecast the company’s annual cash flows. Our forecasts typically cover a whole business cycle, 7 to 10 years, and take into account what we know about how revenues and margins will be impacted by both a slowing and accelerating economy. We are conservative in our estimates and do not assume endless straight-line revenue growth; most businesses/industries demonstrate some form of cyclicality and we try to capture this in our forecasts.

Q: How do you diversify your portfolios?
A: Diversification is a factor in all New Amsterdam portfolios (with the exception of our Concentrated Active Equity strategy). We approach diversification in the portfolio construction process by investing in 40 to 45 stocks in 19 general economic sectors. We do not make extreme sector bets; for major sectors, we are never more than two times or less than one half the benchmark weighting. By investing in these 19 general economic sectors, we seek to reduce the risk of over-exposure to any one segment of the economy. Our portfolios aim to be fully invested; cash is held at no more than 5%.

Q: Within your style group MMR ranks you highly in risk-adjusted return. How is this achieved?
A: We monitor and control risk at each stage of our investment process and define risk not simply as a specific quantitative measure but also as methodology risk. We believe there is inherent risk in longstanding processes that are not back tested and carefully evaluated for enhancements.

Quantitative Research Risk Control
Our backtesting process is part of New Amsterdam Partners’ investment technology diagnostics. The process tests the validity of our investment model and indicates possible areas for improvement of both the model and our investment philosophy.

Fundamental Research Risk Control
Another example of our risk control processes was the development of our Proprietary Investment Research Platform, designed to enhance the evaluation of stocks while systematically storing information to track every security we evaluate as a potential purchase. We built this database using techniques of “knowledge engineering” to systematize the fundamental analysis stage of our investment process and ensure consistent research quality. Our system allows us to see the full picture of the investment story, both fundamental and quantitative, of a company over time. Our proprietary platform captures company information and stock price versus price targets, as well as risk factors and themes within an industry. In this process we systematically identify the key risks for the companies we own and/or have researched. This has become an early warning system to help us detect problems with our holdings before their stock prices are adversely affected.

Portfolio Risk Control
During portfolio construction, we look at risk control in three areas: stock-specific risk, stock diversification, and sector diversification. On the back end, overall portfolio risk attributes are provided to us by Richards & Tierney and BARRA on a monthly basis. We examine each of our risk exposures versus those of our benchmark to make sure that our portfolios do not contain any unintended bets. Additionally, one of the things we focus on during the fundamental research stage of our investment process is whether or not purchase candidates have similar risk exposures to current holdings. By paying attention to this we can avoid unintended bets in our portfolio.

Q: Does your investment model provide you with a final stock list or does your investment committee make the final decisions?
A: As described before in our investment process, our proprietary model provides us with a list of stocks ranked by expected return. We then take the top 100 companies and analyze them further by looking at their fundamentals and underlying prospects for growth. Our investment committee then selects the 40-45 stocks, from this list of 100, used to build our Large Cap and MidCap portfolios.

Q: Tell us more about your research. How much of it is internal, as opposed to being gathered from external sources.
A: New Amsterdam’s research process is a critical component in our ability to generate alpha for our clients. Our investment process utilizes a team approach, which allows for and encourages thoughtful debate, incorporates experienced perspectives, and fosters analysts’ development.

Approximately 90% of our research is done internally by our investment team; comprised of the following professionals:

• Michelle Clayman, CFA, Chief Investment Officer and team leader
• Nathaniel Paull, CFA, Senior Portfolio Manager
• Eric Jemetz, CFA, Senior Equity Analyst
• Indrani (Rini) Basak, CFA, Senior Quantitative Analyst
• William Trent, CFA, Senior Equity Analyst
• Jeffrey Hahn, CFA, Investment Analyst
• James Hancock, Investment Analyst

Both quantitative and traditional fundamental research is ongoing in our firm. Nat Paull and I are industry generalists. Eric specializes in consumer sectors, Bill focuses on the technology and telecom sectors, Jeff is responsible for utilities and energy, while Jim focuses on the health care sector. Rini is responsible for quantitative model runs and backtesting of model components. Nat is the Director of Research for New Amsterdam Partners and oversees this function for the team.

Quantitative Research
We seek to refine the inputs that go into our valuation approach. Our research has yielded important insights into a variety of pertinent issues, such as over-estimation bias in Wall Street analysts’ estimates or the effect of one-time charges on stock prices. These insights have then been incorporated into our investment process. Our research effort is ongoing.

We monitor academic research to ensure that we are up to date on current ideas. Price-to-Book analysis has been an essential part of our process, which has set us apart from other managers. The research of Eugene Fama and Kenneth French (of the University of Chicago) highlighted Price-to-Book as the most important valuation factor. We found this a gratifying confirmation of our own research.

In addition to external research, we also perform our own quantitative analysis, which includes a backtesting of our quantitative process. An example of this backtesting highlights two important results about our investment process. First, New Amsterdam Partners’ Earnings Per Share estimates are more accurate than the I/B/E/S consensus estimates. An analysis of the estimation errors indicates that our errors are more symmetric and suffer less overestimation bias than the consensus estimates. Second, stocks where our EPS estimates are higher than the consensus estimates outperform other stocks to the extent of 3.4% per annum. This validates our investment process and our ability to add value for our clients.

We also conduct our own research related to theoretical underpinnings in our process. We have published four well-received papers in the Financial Analysts Journal which our clients and industry colleagues have found helpful; they are: One-Time Charges: Never Having to Say You’re Sorry? (Sep-Oct 1995), Falling In Love Again – Analysts’ Estimates and Reality (Sep-Oct 1994), In Search of Excellence: The Investor’s Viewpoint (May-June 1987), and Excellence Revisited (May-June 1994). In 2002, Rini and I presented a white paper on the relationship between corporate tax rates and stock prices. All of our research has been incorporated into our process and allowed us to enhance our investment outcomes.

Additionally, New Amsterdam’s professionals seek exposure to new investment theories and practices through our memberships in and contributions to organizations such as the Society of Quantitative Analysts, the Association for Investment Management Research and the Q Group. These organizations allow for critical debate regarding existing theories/practices and provide a forum for alternative theses. Discussion and interaction with our peers provides us with a fresh perspective on old theories as well as exposes us to new investment research and theories.

Fundamental Research
We have built a Proprietary Investment Research Platform using techniques of “knowledge engineering” to systematize this fundamental analysis stage of our investment process, and enhance the evaluation of stocks. This database allows us to structure, manage, and track the inferences we make from our fundamental analysis, and ensure consistent research quality. Our system allows us to see a full picture of the investment story of a company over time. Significant fundamentals are stored under the categories of key buying points, potential for positive and negative surprise and risk factors. Quantitative statistics such as expected return and growth estimates are also stored for each company. New Amsterdam’s system captures company information, prices versus price targets, risk factors and themes within an industry to produce four key reports: Company Research Report, Company Risk Factor Analysis, Price vs. Target Reports, and Investment Decision Matrix.

Q: Tell us something about your investment team. How many of you are there and how do you work together?
A: As mentioned previously, our investment team comprises of two portfolio managers and five analysts. We hold investment management committee meetings twice a month, which I chair, and attended by the entire investment team. The meetings coincide with new model runs. In these meetings, we review the firm’s investment decisions as well as discusses how the team should focus its quantitative and fundamental investment research. Current holdings and buy and sell investment candidates are discussed.

In addition to the regularly scheduled meetings, there is also daily discussion, interaction and collaboration between committee members on any developments that may impact the portfolio.

Q: Do you use a sell discipline and do you ever time the market?
A: We believe knowing when to sell a stock is just as important as knowing when to buy a stock. Thus, we do not time the market; our portfolio managers adhere to a strict sell discipline. Factors that may trigger a sale include:

• An equity’s price reaching our target, validating our analysis and purchase.
• A negative change in a company’s fundamentals accompanied by a drop in expected return.

Q: Is there an upper limit to the amount of money you can manage using your present technique before liquidity becomes a problem?
A: Our investment process lends itself to managing large amounts of assets and we believe all of our strategies have additional capacity. As targeted goals for assets under management are approached and met, we will continue to assess whether each strategy’s future target is prudent and reasonable. We have made a commitment to limit the number of our client relationships to ensure a high level of client service and satisfaction. We will not expand any strategy to a level of assets or number of relationships that would impair the quality of either investment returns or service to our clients.

The targets for our four product lines are as follows:
Product Target
Large Cap Active Equity $5.25 billion
MidCap Active Equity $2.50 billion
Concentrated Active Equity $1.50 billion
Socially Responsible Active Equity $0.75 billion

Q: What do you mean by describing yourself as socially responsible?
A: We describe ourselves as socially responsible because we can apply client restrictions and social screens to any of our portfolios’ initial screening process. Additionally, we offer a dedicated Socially Responsible product that can be tailored to investors’ specific social needs.

Q: What are your account minimums and do you participate in any WRAP programs for investors who are not able to otherwise meet your minimums?
A: Account minimums for institutional clients are typically $2-5 million in our Large Cap and MidCap products and $500,000 to $1 million in our Concentrated and Socially Responsible products. Our MidCap Active Equity strategy is offered through the Charles Schwab Select platform as well as three other WRAP programs. All four of our strategies are available on the Charles Schwab Connections and Marketplace platforms.

Q: What kind of reports do you provide to your clients to keep them updated about the market?
A: Our clients have access to every member of both the investment and the client service teams. We provide a quarterly client letter that reports returns, benchmark comparisons, and an attribution of how our specific stock selections affected returns in the previous quarter. Between quarterly reports, we provide our monthly performance update, research reports, and firm updates. Our website (napllc.com) features research papers, video of media appearances, and information about our investment process. In addition to our client reporting, we are readily available for face-to-face meetings with our clients.

Q: What makes New Amsterdam Partner’s unique among managers? What do you offer that cannot be found elsewhere?
A: What makes New Amsterdam Partners unique among managers is our approach to managing assets for our clients. We truly integrate both fundamental and quantitative techniques, and each part has proven to add value to our investment process. Our GARP style combines the best of both Growth and Value and fares well in most market environments – our strategy has historically shown good up-market as well as down-market capture.

Process and Accountability
We use a robust process that can continue to provide value added for our clients. Our approach allows for and encourages us to question existing theories and practices to enhance our investment process, as evidenced by our rigorous backtesting and development of our Proprietary Investment Research Platform. In addition to understanding the outcomes of all of our decisions, we also look to gleam insights from them to improve our process.

Results
New Amsterdam Partners has consistently added alpha for our clients over market cycles. Our critical success factor in all of our investment strategies is our stock picking ability. We have superior stock selection skill and high risk-adjusted returns (attested by external sources). Our alpha is in excess of 1% per year for a 10-year period.

Client Satisfaction
New Amsterdam Partners is a closely held firm with a stable investment team, a willingness to critically evaluate the investment process and a consistent market out-performer. Our firm is 100% employee-owned and our professionals are fully engaged in fulfilling client objectives and needs. We have good relationships with both our clients and their consultants. Our clients have rewarded us with significant additional allocations and placed us highly in client surveys for responsiveness and service.

We are steadfast in our commitment to provide our clients with investment management that is intellectually sound, disciplined, and proven.

 
 
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