How We Construct and Manage the Alpha Ring

Today, we welcome back Todd Peters, who's the chairman of the Investment Committee of NS Capital. Welcome back, Todd.

Todd Peters  00:16

It's great to be back, Doug. Thanks for having me.

Douglas Heikkinen  00:19

Last time we set some groundwork and your career, and why you do what you do, let's dive a little deeper into NS Capital’s Alpha Ring. What is the NS Capital’s offering?

Todd Peters  00:31

Well, so as you may know, and for those that don't, that are listening, NS Capital utilizes three strategies that we put together for a total portfolio solution for our clients to use exchange traded funds, and one uses independent unaffiliated investment managers. And the Alpha Ring is our manager partner portfolio, leveraging the characteristics we discussed on the last podcast, we identify the partners to implement and oversee that portfolio for our clients.

Douglas Heikkinen  01:04

So what's the methodology for constructing and managing the portfolio?

Todd Peters  01:09

So I think the core of what we do with the Alpha Ring is a realization that one, you cannot beat an index, if that's what you're trying to outperform. By looking like one. And two, you have to assemble a portfolio that is different from those held by most investors, if you're trying to be an another solution. So the real kind of core foundational part of the Alpha Ring is that knowledge that we know we have to be different. In both cases, in order to have a chance for success long term, the long term is an important additional part of this, we believe that no one should invest in equities with less than a five year time horizon. And so with our clients, we tell them that in order to get the Alpha Ring, they have to give us five years at a minimum. And then every subsequent year, when we meet with that client, we make them give us another five years from that date. And that will play into our discussion going forward, particularly with how we interact with our managers. But those two are sort of the founding kind of core principles of we know we have to be different. And then we also know we have to give this time to work. Now, when you take it a step down into the actual construction of the portfolio. As you may recall, and your listeners may recall, from our last podcast, we are not style box investors. So we're not trying to populate that way, we work at a little bit more of a broader scale. And we have two categories that we believe are important when we work within the alpha re. And those categories are what we call market leaders are emerging market leaders. These are typically well known companies, both domestic and international, the real and they are obviously major parts of the broad indexes that are out there. So we understand the value of these companies and Amazon got to its level because of the quality of the business, Apple, Microsoft etc. So we know the value that those companies can bring to a portfolio. But to be a part of the alpha Ray, our managers need to make sure that they give us at a minimum two times the weighting of what that name is inside of a benchmark. So for example, you know, if an Amazon is 4%, our manager needs to give us a minimum of 8% weighting, preferably a 12% rating. So two to three times, you know, the weight of an index. So approximately 50%, give or take movements of the markets are in what we call the market leaders category. The other 50% are in what we call too cheap to ignore. And essentially, these are companies that have come on troubled times, they are likely under followed if without or have no following at all in the investment community. Again, both United States and internationally. And most importantly, these have little to no representation within the indexes. So what we're trying to do here is to truly bring in the unique diversifying benefit of something that's not in the broad indexes that people have access to. And so we combined those two kind of characteristics of market leaders and too cheap to ignore, to make a total portfolio concept now when you do kind of combine them together and you receive a global viewpoint, you receive companies of all sizes, you we cross multiple industries. And we're diversified also across multiple corporate events. And so you market leaders kind of stands for itself, but a lot of the too cheap to ignore, they may be going through a turnaround, they may be going through a merger or an acquisition, there may be a management change. So you have this kind of truly unique perspective across multiple corporate events, which we think are important to building a total portfolio concept with inside of the alpha Ray.

Douglas Heikkinen  05:25

Now, this is not a new portfolio. How is the portfolio evolved, since its inception in 2009?

Todd Peters  05:33

It's a great question Doug. And, you know, we really pride ourselves on trying to be a learning organization. We're always trying to challenging ourselves, we're talking to multiple, you know, sources that we have been able to create, with through our network to just see where can we do things better? How can we think about things differently, and then when we kind of identify those, we want to put them into, into into practice and make sure that we're bringing the best solution to our clients. And we're always looking to kind of make those enhancements, I would say there are really three kind of critical areas that have evolution thus far. The first one is I'll kind of call it the strategies that we utilize. In 2009, as you recall, we were still in the midst of the Great Recession, you know, we just didn't know where the world was going. And one of the things that we thought was an important part of any strategy, particularly at that time, was to have a more at least some port percentage of the portfolio in a thematic management strategy, where that manager or group of managers could play some offense and defense based on what the macro situation looked like. And so when we started because of that environment, that was really a critical piece of the portfolio, as we've worked through, in 2015, we had had two managers in that in that category. And we had reached a point where we were needing to make a change. And we took a step back, and we were like, do we really need to have that top down thematic offense slash defense type strategy anymore, and the Investment Committee ultimately decided no, and so in 2015, we kind of put our stake in the sand to say, we're only going to invest with managers that are going to buy specific companies with inside of their specific disciplines. And we're going to allow our total portfolio concept at the NS Capital level, to be that kind of defensive mindset. So we have other strategies we can utilize for that with inside of the Alpha Ring, we just want managers that will pick specific companies that they believe have the opportunity to outperform going forward. So I would say that is number one, and probably one of the biggest, because that then helped us restructure the way that we kind of viewed the entire allocation strategy with inside of the alpha rank. The second that I would mention is the number of managers. So when we started in 2009, we started with zero assets. under management, we were we were truly a new shop building from the ground up. And we were fortunate enough to partner with four exceptional firms, you know, from that point to get us kind of off the ground. And we worked with them for many, many years. But as we grew, and when we did have a couple of instances to make a manager change, we started to have assets enough to where we could spread it around a little bit more. So in 2016, or excuse me, 2017, we grew the number of managers from four, to six. And in 2019, we grew that from six to seven. And we currently have seven strategies today. Now we feel very comfortable with seven. We don't want to make this a huge number of managers, we want each manager to matter, we want each perspective to have an important role. But that has been something that allowed us to kind of spread our coverage spread our reach globally by moving just from four to seven strategies. And the last kind of point of major evolution is the way that we work with the within each manager from a concentration perspective, we have always tried to work with managers that are willing to keep a very concentrated portfolio. But in the beginning, when we had four managers, we kind of had this 15 to 30 stock range amongst you know, where they could work within that kind of range. As we've kind of gone further and further and further with this. We've methodically moved it down and now we're really kind of in the five to 7% range, or excuse me, five to seven name range within each portfolio and so I think that is the third kind of major evolution. So the strategies, we utilize the number of managers, and then the concentration within each managers have been kind of the three major evolutionary points,

Douglas Heikkinen  10:12

Are there directions that you give to each manager.

Todd Peters  10:16

So, yes, and they really kind of get the same, because we brought them all in for their specific expertise. But what we really want them to know is, we want them to have full confidence to operate with maximum flexibility. And to do it in a free as free fashion. As we can do do that for them, we totally want to take the handcuffs away, we tell all of them that they are one of seven. So they don't have to worry about diversifying their portfolio, we'll take care of that at the Investment Committee level. And so we just want the best of their brainpower. So what we tell them is, we just want their best ideas with the highest potential upside. That's number one. Number two, we say Don't worry about performance consistency, we don't we don't care how that performance gets to us, if it's what we call lumpy, meaning it happens all at once, that's just fine. Number three, we tell them we're going to be patient, because we realize it can take time, particularly in that too cheap to ignore category we were talking about earlier, for the investing public to recognize value in these names. So we want to give them time. And so they really have that five to seven year outlook that that we've talked about earlier. The fourth thing we tell them is we will be encouraging when something goes wrong, we understand this is not going to be a straight line. And so if something goes down 5060 70%, we're actually calling saying do we add here, we're not calling to be upset at them, we're saying, you know, do we add here, and if they ultimately determine it's not the right thing to keep in the portfolio, we're like, that's okay, move on, let's find the next great idea. So we're going to all we tell them we want to be encouraging. And then we also tell them that we're always going to be supportive for creative thinking and application, they do we want them to be totally free to bring their best ideas to us. And so we kind of give them those five directions and say, Alright, this is what we expected, you go do it. And that's what we think we can unlock the best opportunities for our, for our clients,

Douglas Heikkinen  12:15

Is there a certain way you communicate with them to implement and oversee their portfolios?

Todd Peters  12:21

Well, it's great. Number one, we feel that we are the luckiest people to have these manager partners. And so our relationships are very important to us, we always want to be respectful to them, we want to make sure we're not taking their time because we know their time is absolutely precious. And but what we've done is we've really kind of created a collaborative communication and collaborative dialogue. So when they want to make changes, or they want to build, you know, the initial portfolio, they will communicate with us and predominantly with me, and we will go back and forth. And they will sort of not, I don't want to say pitch the idea, but they will let me know what they're thinking. And it gives me a chance to ask some questions, I really get an understanding as to why they want a name in the portfolio, or they want to make changes to their existing portfolio. And then I ultimately kind of say, give me a stamp of approval. And that's how a name gets in or a change is made or a stock is eliminated. So we have this collaborative partnership. And this collaborative dialogue that is is awesome, from my perspective, because I actually get to see their real time thinking number one, but number two, it gives me a chance to look at the total portfolio to make sure that what they're bringing in or what they're trying to execute within their individual strategy actually works within the context of the total portfolio. And that's really this collaborative communication and how it can be effectively implemented, implemented for us, you know, as we oversee and monitor the Alpha Ring.

Douglas Heikkinen  13:56

Do the managers complement each other when looking at the total portfolio?

Todd Peters  14:00

Yeah, this is probably the most important I would say one of the most important parts of the whole process for us. We want to make sure that we bring in experts that have a unique perspective. Now, they may have the same language, they may talk in the same way. But they're looking at all They each have their own different area that they look in or their segment or their geography or their industry. And we want to make sure that that all partners up really well. So to us, the whole point of bringing in seven managers is not to have seven people essentially doing the same thing. We want them all to work well together. So we they truly do compliment it is absolutely one of the arts of this. It's one of the things that we believe the industry has sort of gotten away from understanding is how all the pieces and parts really fit together to make the best total portfolio. The way that I can try to illustrate that is in the, you know, since 2009. So now we're working on 12 plus years of executing this strategy, we have only had three instances where two managers have owned the same name. In 2014, we had two managers own IBM. In 2020, we had two managers owned Vivendi. And today, we have two managers that own Tencent. And so when you think about the life of the strategy, when you think about the way that these managers work together, and how they're all searching for ideas, we feel that that's an important distinction to say, like, during the course of all this, we've only had those three instances where only two managers had the same name. So there's no overlap. And in all three of those cases, we knew about it because of this collaborative partnership that we just discussed. But we and we also kind of put our stamp of approval, because we believe that those three companies, particularly at those times, deserved a little extra, you know, allocation. But that complimentary approach is absolutely critical to making sure that this, the Alpha Ring executes the way that we wanted to.

Douglas Heikkinen  16:14

There's so many more things we could talk about with the Alpha Ring of like, how many how often do you make changes, when and why have you removed a manager, but I think if people really want to dig in there with you, they should, they should contact you. But let's get into what's the ultimate goal of the Alpha Ring.

Todd Peters  16:30

So the ultimate goal, and we do tend to follow the a lot of the football monitors out there, which is, you know, focus on the process, not the outcome. And so, to us, that is an important thing. So our true beliefs in order to partner with these investment experts, you know, to stay patient and allow time to work for us, and to make the necessary changes, but do it in a thoughtful way. And so one of our key principles, particularly for what we call active management, which is the offering is mindless diversification is not a substitute for intelligent thought. And so we're always looking for managers that have that intellectual skill and emotional gift to strike to stay stray from the crowd. And so when you kind of put that all together, we believe that doing those concepts, gives us the best probability of success over the long term, which is really the ultimate goal. If we focus on the process that we've discussed both on the prior podcast and on this one, then we believe we've increased the chances of truly creating something that can outperform over the long term. And that's the ultimate goal, stay true to ourselves, stay true to the expectations our clients have, and then allow that time and the discipline to work to our benefit, and increase that probability of success. So that's really the ultimate goal of the alpha Ray.

Douglas Heikkinen  17:52

Todd, it really comes through that you put a lifetime of work into this. And it's it's a fantastic product.

Todd Peters  18:01

Well, thank you, Doug. We really appreciate it. We're always focused on trying to improve it, but we're really proud of what we've we've been able to build.

Douglas Heikkinen  18:07

Todd, thanks so much for joining us today.

Todd Peters  18:10

It's a great pleasure. Thank you, sir.

Douglas Heikkinen  18:13

If listeners want to know more, please visit NSCadvisor.com for everybody on the Conviction Creates Alpha podcast team. We thank you so much for joining us.