Q: Bill, please provide a brief history of Forstmann-Leff Associates, LLC.
A: Forstmann-Leff Associates (FLA) was founded in 1968 as an investment counseling firm. We built a very successful business constructing and managing domestic equity portfolios for institutional investors and high net worth individuals. Our diverse client base includes Fortune 100 corporate pension and profit sharing plans, major US endowments and foundations, jointly trusteed employee benefit accounts, and selected taxable accounts. Since 1989, the company has managed long/short hedge funds. Currently, institutional assets stand at about $5 billion and hedge funds at $3 billion.
Q: How would you describe Forstmann-Leff’s overall investment philosophy and goals?
A: Forstmann-Leff has applied a consistent investment philosophy of using in-depth fundamental, quantitative and technical analysis to uncover opportunities in under-researched segments of the market. This approach is overlaid by a top-down macroeconomic and thematic view. We enhance our investment process by refining our buy/sell discipline and implementing a rigorous quantitative risk measurement discipline. This process has also helped us better manage portfolio downside, especially with regard to unintended risks. In addition, we require approval by two of our three Investment Policy Committee members in order to initiate a new buy or sell program. This procedure has enhanced the consistency of our decision process. Forstmann-Leff’s primary goal, as a risk-averse, asset allocation-oriented investment manager, is to achieve its clients’ objectives, while minimizing the assumption of market risk within portfolios. The Frank Russell Company risk-adjusted rate of return data indicate that Forstmann-Leff has outperformed the S&P 500 while assuming a risk-averse posture.
Q: What kinds of equity products do you offer? Could you tell us a little about them?
A: FLA offers portfolio management capabilities tailored to the risk profiles and investment objectives of its clients. We emphasize large- and mid-cap growth equities, defensive asset rotational portfolios, and hedged portfolios utilizing long and short equity securities. The firm's equity expertise encompasses a strong commitment to fundamental equity research principally within the US market, combined with a broad macroeconomic overview which provides thematic and sector orientations to the portfolio construction process. Our Large-Cap Portfolios focus on the S&P 500. To outperform this market index, we look for companies that dominate their industries, demonstrating sustainable growth rates of 15% or more. This is done using internally generated fundamental equity research, combined with quantitative and technical trading overlays. We may overweight or underweight certain market sectors in a portfolio, and/or focus on macroeconomic investment themes. Our Mid Cap Equity product is similarly designed, with the focus on the mid cap segment of the equity market. Over each of the last five years, this product has provided investors with a 46.80% return (gross of fees) on average, outperforming the S&P 400 Mid Cap Index by +22.74% on an annualized basis. In addition, we offer All-Cap Portfolios which combine stocks from the S&P 500 and S&P 400. We also use a customized benchmark for this product. Over the last five years, this product has returned 37.73% (gross of fees) on an annualized basis, outperforming the S&P 500 Index by +10.97% (also on an annualized basis). Our hedge fund strategy has an absolute annualized return objective of 20% net to shareholders after all fees, and benchmarks itself against the S&P 500. It has outperformed both objectives over the last five years.
Q: How do you use macroeconomics to determine the most attractive market sectors?
A: We define GDP growth in the US and worldwide relative to the US. We develop assumptions for corporate growth and interest rates and determine where we are in the economic cycle and we also look at interest rate scenarios.
Q: How do you weight the effect of macroeconomic factors on both the whole market and each stock?
A: Macroeconomic factors influence the market and individual stocks depending on where we are in the cycle. During the current period of extended growth, macroeconomic factors are not nearly as important to us today as the themes that are represented in our portfolios.
Q: Once a sector is identified, how do you narrow down your investment choices?
A: We like the leading dominant companies in an area which is determined by our microanalysis. We look at relative earnings increases, expected rate of returns and we tend to gravitate toward companies with greatest depth and management.
Q: How do you use derivatives in your portfolios?
A: Primarily for hedging and to control sector risks. Derivatives provide us with the opportunity to make significant shifts in the portfolio exposure in seconds.
Q: MMR ranks you among the nation’s top managers, both in terms of high returns and low risk. How did you achieve this? Isn’t high return synonymous with high risk?
A: We achieved this through raw intellectual talent and discipline. Generally high return is synonymous with high risk except for ALPHA creators.
Q: What strategies do you apply to your fixed-income and balanced portfolios?
A: Our investment strategy begins with a thorough assessment of the geopolitical environment, including global and domestic trends; Federal Reserve policy; the intermediate interest rate outlook; and earnings momentum. Based on this analysis, we develop appropriate allocations among equities, fixed income and cash within client-specific parameters. Forstmann-Leff’s Fixed Income strategy is centered around a gradual slope riding the yield curve of the US government market. We search for yield optimization and price appreciation. Forstmann-Leff avoids high-yield issues and credit risk. Careful scrutiny and weighting of economic, monetary, and technical indicators in relation to real rates of return are the tools used in constructing a risk-reward matrix. Our emphasis is always on a custom tailored portfolio to meet client benchmarks. On the equity side, investment strategy is set by the Investment Policy Committee, which meets weekly, or as needed, to determine policy on 1) Allocation among asset classes, 2) Investment themes deployed in portfolios, 3) Strategic sector weightings relative to the indices, and 4) Capitalization emphasis. The resulting investment themes are applied to the analysis of the equity market. In this way, portfolios are directed to those areas most advantageously positioned to benefit from prevailing economic conditions and developments. Similarly, economic sectors are identified for concentration within portfolios, reflecting the Committee’s macroeconomic assessment of the best growth opportunities as well as those microeconomic observations derived from the analysts’ bottom up research. Sector weightings generally range from 0 to 2 ½ times the benchmark sector weight. Finally, capitalization orientations may be established in order to maximize opportunities based upon the outlook for relative performance among the larger and smaller segments of the market. Investment research focuses on the analysis of the critical factors that affect earnings growth and cash flow. Candidates are sought with dominant market positions and earnings growth rates of 15% or more. This analysis is reviewed with the Investment Policy Committee and our quantitative research team to determine the risk and reward of portfolio candidates. Quantitative stock screens, risk analysis and portfolio controls are utilized by our dedicated quantitative research team to monitor and enhance the investment process. Stock selection is based on 80% fundamental, 15% quantitative and 5% technical factors. Our universe of stocks consists of the 900 companies within the S&P 500 and S&P 400 Indices, as well as another 200 or so “Best Ideas”. Stocks are screened on a variety of quantitative variables for attractive fundamentals. The screening criteria depend on the investment environment and the macroeconomic overview. Portfolio managers and analysts closely monitor fundamentals and valuations for 250 to 300 companies. These core universe stocks provide a quality, representative sample of S&P leadership names providing coverage across all 15 economic sectors. Valuation targets are developed both quantitatively, from the analyst’s opinion of sustainable growth and company quality (valued in a 3 stage DDM), and qualitatively, using several comparative fundamental techniques which may involve peer company comparisons based on earnings, specific industry valuation conventions, cash flow evaluations, or any method deemed reasonable and appropriate by management. While several alternative valuation opinions may be available, the firm weighs the preponderance of valuation evidence in making final judgments. Companies having a 20% or more upside potential between the current price and valuation target are regarded as undervalued. Companies with less upside are reviewed as candidates for possible sale.
Q: You manage your portfolios by committee. Please tell us more about how that works.
A: The Investment Policy Committee meets weekly and as needed, to set investment strategy and to determine policy on industry and sector weighting targets, investment themes and market capitalization exposures. For domestic equities, the committee consists of senior portfolio managers Mr. Joel Leff, Mr. Richard Adelaar, and myself. We require two signatures to approve every decision that might impact performance.
Q: Tell us more about your research. I’m wondering how much of it is internal, as opposed to being gathered from external sources.
A: One of Forstmann-Leff’s key strengths is our extensive reliance on fundamental research to achieve superior, consistent returns. Our portfolio managers are actively involved in conducting research. We use our extensive industry knowledge, portfolio management experience and networks to thoroughly research and assess investment opportunities, thereby maximizing the value we bring to each client. Our research-driven investment process combines fundamental investment research, quantitative analysis and technical analysis with the strategies determined by the Investment Policy Committee. Structurally, Forstmann-Leff’s equity team differs from the teams at other investment firms. Our portfolio managers and analysts cover “contra-industries” to encourage a broad view. For example, one of our portfolio managers covers the Food and Airline sectors while a second portfolio manager is responsible for both Beverages and Chemicals. Within this structure, our fundamental analysis concentrates on earnings growth and cash flow expectations. This is supplemented by extensive company visits and in-depth analysis of the competition and the operating environment. This fundamental research develops stock ideas for use by the portfolio managers, and provides sector and quantitative ideas to the Investment Policy Committee. Analysts and portfolio managers meet daily to review research ideas and investment themes. This analysis is reviewed with the Investment Policy Committee and the quantitative team to determine the risk and reward of portfolio candidates. Our analysts are highly experienced in both quantitative and qualitative research. They use proprietary research, external databases and sophisticated performance evaluation tools to assess current investments and opportunities. All Forstmann-Leff professionals freely share and debate ideas both within and across asset classes to ensure that the firm’s full resources are focused on serving our clients’ investment needs. Roughly 80% of our research is generated internally in the form of primary fundamental research. The balance is obtained from outside sources, specifically major and regional brokerage firms. The entire investment community is drawn upon for services including: 1) Input from leading economists from brokerage companies and banks, as well as independent economists; 2) Numerous publications such as the Bank Credit Analyst; 3) Various consultants, including industry specialists and sources such as A.B. Laffer; 4) Industry and stock research reports from brokerage firms.
Q: Bill, what is your investment background and how did you get into investment management?
A: I began my career at Chase Manhattan Bank in 1968 after earning my B.A. at the City College of New York and completing a graduate curriculum at New York University. From 1970 to 1978, I served as portfolio manager at Chase Investors Management Corporation New York, where I handled special equity investments. In 1978 I joined Forstmann-Leff Associates, and am proud to have been associated with the team here for more than two decades. I'm a Chartered Financial Analyst, and over the past 15 years my work has included extensive research on biotechnology. Recently I had the honor of delivering the keynote economic address to the Pharmaceutical Manufacturers Association. My immersion in biotech sparked an interest in in the diagnosis and treatment of certain ailments. This motivated me to contribute philanthropically to research into the causes and cure of Tourette’s Syndrome. The Harnisch Family Philanthropies have also given grants for Habitat for Humanity houses, training sessions for women interested in seeking public office, diversion programs for first-time arrestees, scholarships for at-risk youth, conflict resolution workshops for public schools, studies of women on corporate boards, preventing urban sprawl, the development of a national nonprofit organization addressing the growing income gap, and hundreds of other organizations.
Q: Tell us something about your investment team. How many of you are there and how do you work together?
A: Our senior portfolio managers, namely Joel Leff, Richard Adelaar and myself, have worked together at Forstmann-Leff for nearly 20 years and have an average of 35 years of investment experience between us. The remaining five portfolio managers have an average of over 12 years investment experience and average seven years with the firm. They are part of a team of 18 investment professionals dedicated to servicing equity portfolios. Our research team includes 12 analysts who cover contra-sectors to promote cross-fertilization of ideas. Our analysts monitor a focus list of about 250 to 300 companies on a daily basis for changes in fundamental factors. Once the direction of the portfolio has been set by the Investment Policy Committee, FLA’s analysts use bottom-up stock picking in an attempt to identify stocks that can achieve above average expected returns on a dividend and capital appreciation basis. The aim is to achieve significant participation in up market cycles and defensive reallocation to resist capital loss in down markets.
Q: Do you use a sell discipline and do you ever time the market?
A: We buy stocks that are expected to return a minimum 15% or more within one year. Holdings are reviewed for potential sale on the basis of new information. For example, analysis may reveal a substantial negative revision of earnings expectations sufficient to result in overvaluation. A stock's longer-term relative earnings potential may have declined, or its valuation relative to the forecasted discount rate may be assessed as full. Conversely, an analyst may believe that reasonable growth assumptions can no longer be set due to a lack of information or other unanalyzable company-specific factors. A sell decision may also be triggered by events - for example, if the initial investment thesis has been disproved or if dividends are suspended; if a stock has fallen 15% or more relative to a benchmark and/or its industry group; or if a stock has violated certain moving average price trends. Finally, a stock may be sold following a period of supernormal appreciation - in general, where the rate of price advance represents 3-4 times the rate of forecast annual earnings growth. All sales must be approved by 2 of the 3 senior portfolio managers. Our sell discipline is designed to be specific enough to provide fixed, quantitatively based review points, yet flexible enough to allow portfolio managers to exercise their judgement. The firm considers these criteria flexible enough to accommodate changing market and economic conditions. As for timing the market, no, we do not time the market. However, we do reduce exposure in asset allocation in hedge fund assignments to protect against market risks based on valuations.
Q: Is there an upper limit to the amount of money you can manage using your present technique before liquidity becomes a problem?
A: Considering today’s volume and total value of the stock market, we feel five billion is a comfortable level of hedge fund assets. Our institutional capacity is virtually unlimited.
Q: What makes Forstmann-Leff unique among managers? What do you offer that can not be gotten from other money managers?
Mr. Harnisch: Forstmann-Leff utilizes a structured, highly disciplined stock selection strategy based upon internal fundamental research. Within the middle capitalization segment of the equity universe, studies indicate that the market is less efficient, with less research commonly available than in the larger cap segment of the market. The firm’s reliance on internally generated fundamental equity research on all equity positions allows it to operate independently of usual street sources of information, which are less well developed in the mid-cap sector, providing an advantage over competitors in the selection of securities. Further, the firm employs a top down analysis of the economic and market environment which helps management to focus analytical efforts into those segments of the economy which stand to outperform in the prevailing and expected economic environment. This thematic or sector orientation allows the firm to efficiently allocate resources to take advantage of opportunities in the market. We have seen practically every kind of market and economy. We offer immediate reaction to major geopolitical, economic and market events.