Knowing Well What You Own

Neuberger Berman Genesis Fund

US > Small-Cap > Growth

Apr 10, 2017
  • 52 Week HL
    0 - $0
  • Net Assets
    $0 M
  • Expense Ratio
  • Inception Date
    Jul 31, 2015

Q: Would you tell us about the history and the mission of the fund?

During the past 20-plus years, Judy Vale and Bob D’Alelio have been the fund’s co-managers, employing a consistent investment philosophy and process. We have a well-resourced and experienced team, with nine individuals who, on average, have more than 20 years of industry experience 
Our investment philosophy is based on applying a consistent approach to high-quality investing across market cycles. We use a research-intensive process that ensures a thorough understanding of not just prospective holdings, but even those that have been in the portfolio for several years. The process continues to be refined, and is repeatable.

We use a research-intensive process that ensures a thorough understanding of not just prospective holdings, but even those that have been in the portfolio for years. The process has been refined so it is repeatable.

We believe frequent contact with management teams is crucial to the process and truly sets us apart from our peers; in a typical year, we have over 300 direct interactions with the companies we own or are considering for the portfolio. Ultimately, our goal is to find high-quality businesses that we believe can grow their earnings on a sustainable basis. 

Q: What core principles guide your investment philosophy?

The fund seeks to deliver superior, risk-adjusted returns on a long-term basis. We focus on companies with consistent and solid free cash flow generation, high returns on capital, and strong balance sheets.

First, companies that generate consistent and solid free cash flow are attractive because they can self-fund their operations and growth. This is critically important for smaller businesses which do not always have easy access to the capital markets like their larger-cap peers might have.  Consistent free cash flow can also add to a company’s sustainable returns through tuck-in acquisitions, share repurchases, and dividends.

Second, businesses with high returns on capital typically have business models that are differentiated – products, services, or offerings that have meaningful barriers to entry.  Such companies are in a better position to deliver sustainable growth.

Third, companies with strong, conservative balance sheets are in position to enhance shareholder returns through acquisitions, share repurchases, and dividends. Conservative balance sheets also mitigate the downside risk if our fundamental analysis proves to be incorrect.

Our high-quality approach means we often trail in up markets. However, we have tended to outperform meaningfully in down markets, and have historically generated positive relative returns through full market cycles.

Q: Would you describe your research process?

We combine both a macro view and bottom-up approach. Our macro view shapes our view about sector positioning. For instance, in 2005-2006, the portfolio was underweight financials due to our concerns about bank underwriting standards as well as a bubble in the housing market.

There are some sectors we avoid because they are inconsistent with our investment philosophy. We do not own small-cap biotech companies because they are speculative in nature, are generally unprofitable and need access to the capital markets.  Also, we generally do not buy real estate investment trusts (REITs) because they typically need continuous access to the capital markets and their business models are often not particularly differentiated. 

Most of our research and focus is on bottom-up analysis; the majority of our time is spent analyzing individual securities in the portfolio as well as prospective names, through reading, analyzing, modeling, and extensive meetings with company management.

Our research process is quite intensive. Before putting a new idea into the portfolio, we will examine the company’s relevant SEC filings (the 10-Ks, 10-Qs, and the proxy statements), read transcripts of recent earnings calls, and look at any investor presentations the companies might have. We build models that forecast what we estimate to be the company’s sustainable earnings and cash flow growth.

Meetings with senior management are critical to the research process, as they allow us to thoroughly pressure test all elements of the investment thesis. We go through each segment of a company’s overall business to understand long-term growth, competition, profit margins, free cash flow, and how the free cash flow as well as balance sheet might be used. 

These conversations also provide us with vital information about how management views their business model, risk factors, capital allocation, and shareholder interests.

Finally, time is spent on understanding the metrics used to determine management compensation. Are they measured simply on top-line and bottom-line growth? Or are their financial rewards also based on a return-on-capital metric? 
If an idea gets into the portfolio, we continue to examine our investment thesis over time. It is not unusual for us to meet with companies in the portfolio multiple times in a year. 

Q: Would you cite an example to illustrate the process?

Pool Corporation, one of our top-ten holdings, is a good example. Pool is a boring company with a very powerful franchise.

The company is the leading wholesale distributor of swimming pool supplies in the U.S. With roughly a 45% market share, Pool is 10 times larger than the next biggest player. The company has been able to consistently increase revenue at a mid- to high-single digit rate, increase operating profit at a mid-teen rate, and over the last six years, earnings-per-share growth has been close to 20%. 

Pool is a classic example of what we want to own in our portfolio. The company is a dominant player in a growing market, and has a durable business model with significant recurring revenues – 80% to 85% of its revenues are recurring in nature.

Even though we have owned this company since 2011, we spoke with the CEO a few weeks ago and met with its CFO in our offices last week. We stay in close contact to always make sure we understand what we own, and remain comfortable with the investment thesis. 

Q: What kind of barriers to entry does a wholesaler like Pool Corporation have?

In this case, the barriers are largely related to its scale advantages. From a purchasing standpoint, the company can buy product more cheaply than any competitor. With its leading market share and greater resources, Pool can also provide services to customers that no one else can.

For instance, Pool can offer merchandising programs to its retail customers. The company can help its retailers understand how to better allocate shelf space to products or provide them with IT systems to more efficiently manage their inventory. 

No other pool supply wholesaler would be able to do that; nobody else is big enough. Most of the other players are mom-and-pop operations. Looking out over the next five to ten years, it is hard to imagine a scenario where any competitor could even approach the company’s scale.

It is also worth pointing out that its business is largely Amazon-proof. Pool’s customers often need products the same day, and because they can be bulky and heavy, the products do not lend themselves to shipping.

Q: Are you comfortable with Pool Corporation’s high debt load?

We do not think that Pool has a high debt load relative to its profitability, cash flow, and recurring nature of its business. 
Currently at 1.5 times EBITDA, we believe Pool’s debt level is appropriate, and at the lower end of its targeted range of 1.5 to 2.0 times. 

Q: How do you construct your portfolio?

Our diligent, bottom-up approach has led to low turnover in the portfolio. Our 10-year turnover is 17% and in terms of beta we are at 0.74 versus the Russell 2000 Index, which is the fund’s primary benchmark. 

A hallmark of the fund’s performance is its relative outperformance in down markets. This doesn’t happen by chance. It goes back to our high-quality approach of owning the businesses that we believe should perform better during periods of economic stress. 

In terms of parameters, we are limited to a maximum of 5% per stock at market value, or 20% maximum per industry at market value. Currently, only a few positions exceed 2% and our top 10 holdings represent roughly 17% of the portfolio. Sector weights and position sizes are monitored daily so we always have a clear view of both. 

We seek to remain fully invested, although the fund keeps a cash position of approximately 2% to provide flexibility and allow us to be opportunistic. 

Our sell discipline is typically driven by one of three things: making room for superior investment opportunities, increased concern about fundamentals, and stretched valuation leading to an unfavorable risk reward. 

The portfolio typically has 120 to 150 holdings; generally, they have a market cap of less than $2 billion at the time of purchase. 

Q: How do you define and manage risk?

We manage risk through a quality-focused investment philosophy and a diligent investment process. This is a highly effective method for not investing in companies with what we believe are outsized risks.

A key way we to mitigate risk is through spending significant time analyzing and thinking about what could go wrong with a company’s business model and financial outlook. As we examine a new name for the portfolio, we closely scrutinize risk factors pertaining to the company’s durability and growth prospects.

The recent financial crisis truly pressure-tested our investment philosophy, including our approach to risk management. Despite the meaningful strain that the economy and many companies faced, particularly small ones, those in our portfolio performed relatively well due to their consistent free cash flow generation and conservative balance sheets. 

Annual Return

NBGNX 14.6 20.1 22.2 -6.9 15.8 18.1 0 -0.3 37.2 9.9
NBGIX 15.3 20.2 22.2 -6.8 16 18.3 0.3 -0.1 37.4 10.1
NRGSX 14.8 20.2 22.2 -6.7 16.1 18.4 0.3 -0 0 0
NBGEX 14.5 20 22.2 -7 15.7 18 0 -0.4 37 9.8
NBGAX 14.2 19.6 21.8 -7.2 15.4 17.6 -0.4 -0.7 36.7 9.5

in percentage

More Information

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The history of the fund actually starts before it was established. The team came together at the end of 2003. Using the same strategy we employ today, we primarily managed institutional international and global equity portfolios.

The history of the fund actually starts before it was established. The team came together at the end of 2003. Using the same strategy we employ today, we primarily managed institutional international and global equity portfolios.