Thomas Graff, Brown Advisory - “We expect movement away from narrow bucketing of asset classes and more interest in strategies less dependent on any one market data point”

Thomas Graff (pictured), a partner and member of the fixed-income team at USD25bn investment manager Brown Advisory and portfolio manager for the Tactical Bond Fund launched in September, says the fund stands out from the competition through the way the firm uses quantitative models and the holistic way it approaches its portfolios.

Thomas Graff (pictured), a partner and member of the fixed-income team at USD25bn investment manager Brown Advisory and portfolio manager for the Tactical Bond Fund launched in September, says the fund stands out from the competition through the way the firm uses quantitative models and the holistic way it approaches its portfolios.

GFM: What is the history and background of your company, principals and funds?
 
TG: Brown Advisory is an independent investment management firm based in Baltimore, Maryland and Washington, DC with approximately USD25bn in client assets. Brown Advisory was founded within Alex. Brown & Sons in 1993 and became an independent, employee-owned firm in 1998. The firm’s institutional and private clients are based in 49 US states and 18 other countries and are serviced by over 250 employees worldwide, all of whom are equity owners of the firm.
 
The firm’s management includes president and chief executive Mike Hankin and head of investments Paul Chew, as well as portfolio managers Tim Hathaway and Chris Berrier (small-cap growth), Ken Stuzin (large-cap growth), Rick Bernstein (large-cap value), David Schuster (small-cap value) and Mike Foss (equity income).
 
I am portfolio manager for the Tactical Bond Fund launched on September 30 this year. An open-ended mutual fund focused on total return that does not seek to track any particular benchmark or index, the Tactical Bond Fund seeks to invest in fixed-income instruments including tax-exempt municipal bonds, corporate bonds, US Treasury bonds, Treasury Inflation Protected Securities and cash equivalents, as well as derivatives providing long or short exposure to these assets.
 
The firm’s other funds are the Brown Advisory Growth Equity Fund (launched June 28, 1999), Brown Advisory Value Equity Fund (launched January 28, 2003), Brown Advisory Flexible Value Fund (launched November 30, 2006), Brown Advisory Small-Cap Growth Fund (launched June 28, 1999), Brown Advisory Small-Cap Fundamental Value Fund (launched January 1, 2009), Brown Advisory Tactical Bond Fund (launched September 30, 2011), Brown Advisory Intermediate Income Fund (launched October 31, 1995) and Brown Advisory Maryland Bond Fund (launched December 31, 2000).
 
GFM: Who are your main service providers?
 
TG: The Tactical Bond Fund is administrated by US Bank, which serves as custodian and handles all legal matters. The auditor for the fund is Tait, Weller & Baker.
 
GFM: What is your distribution strategy and targeted client base?
 
TG: We look at the Tactical Bond Fund as a sensible option for almost any investor looking to diversify away from traditional fixed-income portfolios. We in no way view the fund as a replacement for any fixed-income strategy; rather, our strategy seeks to generate returns without relying on income generation or declining interest rates. We believe this is a solid solution in today’s market environment and a value-added product for our clients.
 
We believe that because of the fund’s structure, it is an easier selection for tax-advantaged accounts such as IRAs, 401Ks and family charitable foundations. We are marketing the fund both in the US and abroad.
 
GFM: What impact has the recent global financial crisis and economic downturn had on your business?
 
TG: The investing world is complex and sometimes opaque. Brown Advisory’s investment philosophy is not. In the wake of the severe market downturn, institutional and private clients are drawn to Brown Advisory’s sophisticated, transparent, fundamental, bottom-up, team approach to investing. The success of the firm has driven enormous growth during a period when most firms have contracted. Client assets grew more than 25 per cent compounded over the past five years and more than doubled from two years ago – even during the market fallout of 2008 and 2009.
 
GFM: Please describe your investment process.
 
TG: The concept for the Tactical Bond Fund is born out of Brown Advisory’s process of traditional fixed-income management. Like any fixed-income manager, we had fundamental factors that we viewed as important to various sectors of the fixed-income markets, but being quantitatively oriented, we also wanted to come up with ways in which we could quantify the relationships that we observed.
 
We developed quantitative models that help us better understand the relative value between different sectors in the universe. Using these models, we started thinking – couldn’t we take those ideas and put them together into a single fund that was more focused on trying to make money for our clients than beating a benchmark?
 
Whereas before it had been oriented toward alpha generation in a benchmarked way, we knew from experience that there was a straight return element to how they operate – particularly as interest rates got extremely low. Therefore we could see that income generation was going to be meagre and the prospect for continuing declining rates was challenged. So the prospects for the upside potential in traditional fixed income are similarly limited.
 
The three quantitative models we developed seek to identify investment opportunity in various fixed income sectors: the Municipal Model, which identifies relative value between tax-exempt municipals and Treasury bonds; the TIPS Model, which indicates relative value between TIPS and Treasury bonds; and the High-Yield Model, which indicates whether high-yield bonds are attractive investments. What the fund does is invest its capital in those sectors where our models are more bullish and avoid those where our models are bearish.
 
GFM: How do you generate ideas for the fund?
 
TG: To generate ideas for the Tactical Bond Fund, we intentionally went looking for simple, fundamental factors for which we could use sophisticated statistical techniques to quantify their relationship with the underlying asset we were looking at.
 
Our model does not attempt to say how much any data point might move, up or down. Rather it’s very direction-oriented, and we simply try to judge the best time to enter into a specific trade.
 
For example, in the TIPS market, to ascertain whether inflation will accelerate or decelerate, we focus on the commodities markets and the dollar as key indicators. We know that inflation, or at least CPI, has to influence the TIPS market, so we don’t need to rely on the past being prophetic of the future for that model to work. We simply need to be sure we can estimate whether inflation is accelerating or decelerating. In the end, if we believe that inflation is accelerating at a certain point in time, we will ultimately own TIPS.
 
GFM: What is your approach to managing risk?
 
TG: Each of our strategies has an underlying momentum element. As a result, we are not likely to remain in a particular position once it starts moving against us. Further, allocations in the Tactical Bond Fund are made tactically, meaning that the fund will remain invested in each sector only as long as we believe the relative value is attractive, which at times may be a matter of days or weeks, as opposed to holding investments in certain sectors for years at a time. This creates a natural risk management element. While you may incur a series of small losses, you are protected from bigger losses incurred over a long time horizon.
 
GFM: Are you looking at any particularly attractive opportunities right now?
 
TG: Currently the opportunity set in traditional fixed income is challenged due to the reliance on yield, which is low or rate falling. This wasn’t by design, but the sectors we are most heavily involved in are actually very lowly correlated with the broader bond market. Much of this comes from our belief that the Tactical Bond Fund has strong upside even in a market where bonds would traditionally be losing money.
 
As investors know, high yield tends to move with the market – when the economy improves, it tends to rally and when the economy is getting worse, it tends to sell off. If we were to go through a period where rates rose because the economy was getting better, we have that high-yield lever to pull. If yields rise because inflation is going up, we have the TIPS lever to pull. In short, our strategies give us several options to choose from when making investment decisions for our clients in the current environment.
 
GFM: What developments do you expect to see in your industry field in the coming year?
 
TG: We believe there may be some movement away from the narrow bucketing of asset classes and more interest in strategies that are not very dependent on any one market data point. As investors look out over the horizon and see various challenges, we don’t believe they will be as willing just to accept whatever the market gives them as perhaps they might have been in the 1980s or 1990s. We don’t believe that mentality will work in the future – investors will be much more active in broadening their investment strategies moving forward.
 
GFM: How will these developments affect your firm and the performance of your fund?
 
TG: One of our primary objectives with the Tactical Bond Fund is to create scenarios where we are able to generate small opportunities consistently over a long time horizon. An ideal situation for the fund is when the buy and hold of any given market doesn’t produce much return, yet we are still able to pick off small opportunities on a consistent basis and generate solid returns as a result. We think we are doing that now and will continue to do that.
 
Should the market follow an upward trajectory down the road, we will still be well positioned to perform, but for this fund an ideal market is where assets move sideways but we are able to pick up smaller opportunities over and over again.
 
GFM: What do investors currently expect from managers, and how do you deal with those expectations?
 
TG: Investors expect managers to react to what’s going on around them. In this environment, many investors are being pulled out of their comfort zones since so much of the risk today is political as opposed to economic. In addition, clients expect managers to have a coherent response to financial events even though many advisors are more challenged to come up with the right “answers”.
 
That said, Brown Advisory works hard at cross-communication among different asset class managers, which we believe is very rare in this industry. While many firms separate their fixed-income and equity teams, we believe this limits the opportunity to cross-utilise the skill sets and idea generation of each team.
 
For example, we had a lively debate amongst investment groups regarding what the credit downgrade in the US really meant. Through those discussions, we were able to hash out our opinions and ideas, and therefore invest better for clients because we put all our intellectual capital from different disciplines to work at once.
 
GFM: What differentiates you from other managers in your sector?
 
TG: The modelling philosophy for the Tactical Bond Fund is one of the things that we believe differentiates us in our sector. While we may not be the only fixed-income manager to use a lot of quant to help make decisions, in most cases that quant is a lot more technical and more searching for correlations rather than causations.
 
We believe that our approach, rather than taking the decision out of a manager’s hands, helps create discipline around ideas that we fundamentally believe in anyway. It helps when you get the final, real decision point and clarify what the timing of that decision should be and its magnitude, as opposed to turning to some type of rogue black box.
 
Another differentiator is the holistic way we approach our portfolios. A lot of asset managers operate in sector silos. Typically a large asset manager may have a group of people who focus on the mortgage market or another that focuses on financial corporates, and will overlay on top a series of interest rate hedges or long and straight positions that try to manage the duration.
 
The benefit for us is that we don’t have to operate that way. We can come up with a macro theme and then think about how to approach it across sectors or even intra-sectors. We believe it’s easier when you operate in a more holistic manner. In the end, you see a lot more conceptual consistency in how we are investing money across longer- and/or shorter-duration strategies, municipals, taxables and the like.
 
GFM: How do you view the environment for fundraising over the coming 12 months?
 
TG: We had a successful initial round of fundraising providing a strong start for the Tactical Bond Fund, more than enough to operate the fund optimally. Looking ahead, we feel very good about the market appetite for what we are doing. We have had a lot of good conversations with large prospects, and as we further develop our track record, we expect to have additional opportunities to increase allocations to the fund.



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