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Advisor select

Kara Murphy joined SunAmerica in 2006, and is Chief Investment Officer and Senior Portfolio Manager. At SunAmerica, she also served as an equity analyst and Director of Researc +

Timothy Campion joined SunAmerica in February 2012, and is Senior Portfolio Manager. Prior to joining SunAmerica, he held investment-related positions at PineBridge Investments +

Michael Skillman joined Cadence Capital Management in 1994 and serves as Chief Executive Officer. Additionally, he is a member of the portfolio management team and Managing Dir +

AIG Small-Cap Fund
SASAX (Class A)
SASCX (Class C)
SASWX (Class W)
Fund Family
AIG Funds
Fund Advisor
SunAmerica Asset Management, LLC
Sub Advisor
Cadence Capital Management LLC

3200 Harborside Financial Center, Building 5
Jersey City, NJ 07302

T: 800-858-8850

Growth Potential through Small and Smaller
AIG Small-Cap Fund
Apr 21, 2017

Q: What is the history of the fund?

SunAmerica: The AIG Small-Cap Fund was launched on February 6, 2014, to give access to very small-cap or micro-cap stocks with some help from an index sleeve. Micro cap is traditionally a difficult asset class to get access to because of limited liquidity, but there also is an opportunity for alpha or excess return to the benchmark because the stocks typically don’t get a lot of attention among institutional investors. There is a fair amount of volatility among micro cap, but by adding an index strategy in there we seek to dampen that volatility a little bit, and still have access to the potential alpha. 

SunAmerica Asset Management, LLC is the fund’s investment adviser, managing the allocations and the index strategy. Cadence Capital Management, LLC is the subadviser of the micro-cap growth strategy.

Micro cap is traditionally a difficult asset class to get access to because of limited liquidity, but there also is an opportunity for alpha because these stocks typically don’t get a lot of attention.

The index strategy provides broad exposure to small-cap stocks by tracking the Russell 2000 Index (the “Small Cap Index”), which measures the performance of the 2,000 small-cap companies in the Russell 3000® Index. The Micro-Cap Sleeve is actively managed to help enhance alpha potential relative to the Russell Microcap® and Small Cap Index by investing in the common stocks of small-cap or micro-cap U.S. emerging companies with market capitalizations within the range of these indices.

Kara Murphy is the Chief Investment Officer, and Timothy Campion is the Senior Portfolio Manager of the Index Sleeve and the co-portfolio manager of the rules-based investing at SunAmerica Asset Management, LLC, which is a member of American International Group, Inc. (AIG), located in Jersey City, New Jersey. 

Michael Skillman is the Chief Executive Officer, and Robert Fitzpatrick is the Portfolio Manager at Cadence Capital Management, based in Boston.

Q: What is the index strategy and market capitalization that you focus on?

SunAmerica: The index strategy follows the Russell 2000, so we have a broad universe to draw from. But basically, the idea is to mirror the index exactly. We seek to fully replicate the underlying holdings and rebalance as the underlying index rebalances, but we have the ability to optimize the portfolio as well, investing in a sampling of Small Cap Index stocks.

For now in the index, the market cap at the top is $3 billion and $700 million at the bottom.

Q: What is the allocation in the micro-cap part of the fund?

Cadence: The allocation within the micro-cap sleeve with Cadence can vary. Today it’s close to 40%. Our mandate is to focus on the companies in the bottom half of the Russell 2000 Index; however, generally, we may include companies whose market capitalizations are equal to or less than the largest company in the Microcap Index during the most recent 12-month period. The average market cap is close to $500 million.

Micro-cap companies historically have reasonable revenues and profitability, but are often ignored, underappreciated, and institutionally underfollowed. There is the potential for a nice tradeoff of opportunity because of that lack of coverage.

Q: Do company earnings factor in your investment strategy for the indexed portion of the fund?

SunAmerica: Not in the index construction. We rely on Russell to determine who should be in that index and then we seek to fully replicate it. The potential advantage there is that we are not making those fundamental decisions based on earnings, profitability, or valuation, and that’s why we get such a diversified access to that asset class. Ideally, we may pick up some things that maybe a fundamental manager would ignore for those very reasons.

Q: How would you describe your investment philosophy and process for the micro-cap sleeve?

Cadence: Our investment philosophy starts with looking for companies with an improving earnings profile. We believe that ultimately earnings can drive stock prices higher. However, the price we pay for that earnings stream ultimately determines our investment experience and drives our growth. We follow a systematic investment process to create our portfolio.

The first step is the use of a proprietary model to identify attractive candidates. Our second step is fundamental research to understand key investment drivers and risk. We try to get a handle on pace and duration of earnings growth. We avoid stocks where the investment outlook is excessively driven by hard-to-call dynamics such as litigation or regulatory outcomes. There’s a lot of information and resources available at Cadence and our asset management input is part of our process. While meeting with management is not a requirement prior to investment, we do get to visit with many companies in our offices in Boston.

The third and final piece of our investment process is portfolio construction. We start with 1% position sizes, resulting in a diversified portfolio. Our top 10 holdings are typically about 15% of the portfolio. We invest across all sectors, but since we have a growth orientation in this portfolio, we can have more exposure to sectors like information technology and healthcare.

We have some risk controls at the individual stock level as well. We trim stocks that get to 2%. And we have some risk controls around sector weights to help prevent undue concentration in any individual sector.

Q: Can you expand more on that stock selection model?

Cadence: We want to find companies that have improving growth profiles, have quality financials, and represent some value.

From a growth perspective, we are looking at companies that have positive business momentum and have been beating expectations. We also like to see positive price momentum to confirm the market is seeing opportunity.

  • Inception: February 6, 2014
  • AUM: $54 million

From a quality perspective, in addition to generally accepted accounting principles (“GAAP”) earnings, we also look for strong cash flow, good returns on capital and improvement in margins.

Finally, from the valuation perspective we are looking historically at cash flow to enterprise value and prospectively at price to forecasted earnings. We focus our time on companies in the top 20% of our ranked universe to help identify candidates with what we believe is a growing bottom line through growing revenue, improving margins and the strengthening of their balance sheet.

Q: Does liquidity factor in your investment model?

Cadence: Yes. On the front end, we have a liquidity screen. Additionally, when we decide to make an investment, we make a determination if the stock is going to have sufficient liquidity to be a viable candidate in the portfolio. Sizing can come in to play where the neutral weighting will be a 1% position but there will be cases where we will take half weighting positions because of the liquidity stress.

Q: Do critical events play a role in your investment process?

Cadence: Generally, we establish a position in companies we believe offer some margin of safety. But the other side of that is asymmetry of payoffs. So we cut losers when a company misses their earnings.

We see disappointing earnings as representative of a potentially eroding fundamental profile for earnings growth. So, we anchor back to our investment thesis, interpreting that stock move.

One area that personifies this is biotechnology. Biotech stocks comprise close to 8% of the Russell 2000 Growth, and many of the best performing companies have little to no earnings or revenues. There is not a lot of fundamental financial analysis that can be done on these companies, and it requires deep scientific expertise. Over our entire history it has helped serve us well to limit our exposure to this volatile sector of the market.  However, over shorter periods this can be a headwind to our approach.

Q: What is growth at a reasonable price for you?

Cadence: We prefer stronger top line growth, but may invest in companies where earnings are driven importantly by things like margin expansion or share buyback. We consider some younger companies if they invest in their business, even though there is no share buyback or dividend.

We have some stocks in the sleeve that have multiples above Russell 2000. We don’t have a lot of those, but we will own them if a company’s fundamentals are strong, they are gaining share in an expanding market, have a strong market position and better product, product cycle – all of those types of things. We will consider those because we have no absolute cutoffs in terms of valuation.

Q: Would you walk us through some examples to illustrate your research process?

Cadence: Historically, the way we have found some of our winners was if the stock ranked well through the upfront process based on the earnings profile, fundamental improvement and reasonable valuation. If a stock ranks well, it bubbles up within the top 20% of the universe. 

We found, for example, a small company in the veterinarian market that had a product priced below its peers, and a different way of selling, on a subscription basis. In this case, the customer, the vet, saved upfront capital costs when they bought equipment, and since it was priced lower, they saved money. So they were gaining share and selling to an expanding market. 

However, the valuation started as reasonable and is not particularly well known or well covered on the sell side. Moreover, the stocks appreciated nicely as the thesis has played out. It has continued to do well for us and we continued to hold it despite the fact we had gains when the multiples expanded. The great names are not always well understood by the market and our process helps identify those.

Q: Do you set price targets when you look at these companies?

Cadence: We don’t have price targets. We evaluate the upside and the downside on a regular basis. Our time horizon is one plus years. We have owned some stocks for almost three years, and some for less than a year. When we own it less than a year it is generally because we had quicker success or the thesis was not playing out and we had a disappointing investment.

Q: Could you give us a historical perspective on your approach across different market cycles?

Cadence: One way to get an understanding of how what we do is different is by looking at periods when our strategy may underperform. For instance, there are times when larger-cap stocks within the small-cap universe may be doing well and that’s going to be a headwind for us because we are focused on the micro-cap companies. 

There are also periods of time like the tech bubble in 1999 or 2009 and even 2010, where low-quality stocks led the market and became headwinds for us; earnings didn’t matter, and improvement in earnings wasn’t being priced by the market. So, it’s those periods of time when we might find the kind of attributes that we look for may work well over the long term but are out of sync in the short term. 

Generally, the fundamental attributes that we described can correlate highly with long term stock price performance so that’s why these have worked well over the long term. We are likely to have limited exposure to the biotech category even though there have been periods of times over the last five years that it has been one of the best performing cohorts of the market.

Q: What is your portfolio construction process in the index portion of the fund?

SunAmerica: The Russell 2000 Index rebalances monthly, and rebalances quarterly including the newest IPOs, so then there may be some additions. The big rebalance of the index is in June when names either migrate up to the Russell 1000 or smaller-cap names migrate out.

The Russell 2000 has a turnover in low double digits, so generally, from year to year, that can move up and down depending on a couple of factors including things like mergers & acquisitions (M&A) and spin-offs. Our index sleeve will generally mirror the overall turnover for the benchmark. Position sizes can range from a basis point to a couple of percentage points. From an overall portfolio perspective, because of the combination of the index sleeve and the micro-cap sleeve, you may see it skew towards micro cap and growth. 

Q: How do the index and micro-cap sleeves work?

SunAmerica: The two sleeves are managed completely independently. There are occasions where we will rebalance between the two sleeves. For instance, if one sleeve were to greatly outperform the other, we could rebalance back to the target. We haven’t had to do much of that because the differential hasn’t been wide.

Q: Do you do any research on a little bit larger market cap stocks in the index portion?

SunAmerica: We are pure index replication, so no company-specific research is involved. One of the potential advantages of the index strategy is the minimal trading cost. We generally seek to get as close as possible to the underlying index, so the team takes a close look at any index changes and is in close contact with the index provider to help ensure that we are up on corporate actions, pricing, or changes to the index to help us trade efficiently.

Q: What is your definition of risk? How do you manage it?

SunAmerica: From our perspective, we look at tracking error. We use an optimization tool to monitor the tracking error daily and match the benchmark.

From a portfolio level, having that index sleeve, which is diversified and has very low tracking error relative to the underlying benchmark, may help reduce the portfolio level risk. We have had above-average returns with average risk, which we believe points to an advantage of marrying this diversified index sleeve with the more concentrated, potentially volatile micro-cap sleeve.

Cadence: From a stock specific risk standpoint, in the micro-cap sleeve our investment process is built to mitigate some of that volatility. We pay attention to valuation and own companies, diversified by industry and sector, to help mitigate some of the risk in the sleeve. We rebalance our holdings if stocks that start at 1% grow to 2%, and use that rebalancing to take some winners, and redeploy the capital.