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Equity Perspectives

The Calibrated strategies employ a distinctive approach to delivering performance and mandate consistency.


Why did Lord Abbett develop the Calibrated investment approach?
The Calibrated investment approach was specifically developed to address two challenges commonly associated with active equity investing: delivering consistent performance and maintaining a high degree of style, or mandate, fidelity. To elaborate, consider that in each of the past 10 years, on average only 37% of domestic mid-cap value funds outperformed the Russell Midcap Value® Index. Meanwhile, style drift has become pervasive amongst actively-managed portfolios: more than 70% of funds that were classified by Lipper as mid-cap value five years ago are classified as something other than mid-cap value today1.


Chart 1. Many Active Portfolios Drift Over Time
Style trails for select mid cap value funds2
(12/31/2011 – 06/30/2015)

Source: Morningstar, Lord Abbett.  Most recent data available. 


Why do so many portfolio managers fail to deliver on performance and mandate expectations?We believe there is a common thread among most managers who fail to deliver performance and mandate expectations: factor betting; that is, deviations from a benchmark in terms of factors such as sectors, market capitalization, or investment style (“value” or “growth” stocks). The relative performance of common risk factors, such as sectors or market capitalization segments, is quite difficult to forecast, yet many managers engage in factor betting. Given the inherent unpredictability of factors, we believe that factor timing is often responsible for performance surprises and/or style inconsistencies. For example, at the beginning of 2014, most prognosticators expected that interest rates would rise and oil prices would remain stable [see Chart 2.]


Chart 2. Factors are Difficult to Predict
Interest rate and oil price forecasts for 2014

Source: Bloomberg. 


These views likely inspired many factor bets, such as underweighting the utility sector and overweighting the energy sector. Of course, both interest rates and oil prices declined precipitously, and the penalty for those misplaced factor bets was severe: the average return of the funds in the Morningstar Mid Cap Value category underperformed the Russell Midcap Value Index by more than 500 basis points in 2014, according to Bloomberg.

How does the Calibrated approach address these challenges?
Empirical research indicates that stock picking has been a reliable means of capturing excess return over time, but only when factor exposures are carefully managed3. The Calibrated process, therefore, is specifically designed to emphasize bottom-up security selection, while carefully limiting active exposures to common factor risks such as sector, market capitalization, and style. This approach enables us to direct our risk budget toward idiosyncratic, company-specific opportunities as opposed to factor betting.

What distinguishes Calibrated from other fundamentally driven approaches?
The Calibrated investment process distinguishes itself in two ways: generation of stock-level alpha and risk-controlled portfolio construction.

We seek to achieve stock-level alpha through the integration of quantified fundamental projections and a proprietary valuation approach. Quantified projections include estimates of future earnings and growth rates, and typically are sourced from Lord Abbett’s global equity research team. This team is comprised of industry experts who have an analytical focus on the key drivers of company performance. This focus results in a probabilistic assessment of potential earnings outcomes and is distilled into a set of quantified fundamental projections.

The Calibrated investment team then translates these fundamental projections into intrinsic value estimates using independently derived, stock-specific discount rates. As market prices converge with our intrinsic value estimates, stock-level alpha may be realized. In contrast to certain approaches based on heuristics [i.e., rules of thumb], our valuation methodology results in robust estimates of intrinsic value and is consistently applied across all sectors and industries.   

From a portfolio construction perspective, our process seeks to maximize stock-level alpha, while constraining active factor risk. Again, despite the challenges associated with predicting factors, the active management industry continues—intentionally or not—to lean in that direction. For example, many mid-cap value managers are still allocating meaningful portions of their risk budgets to factor bets [see Chart 3]. The Calibrated strategies, in contrast, focus active risk on diversified stock picking, while minimizing the impact of factor exposures.


Chart 3. Distinguishing Factor Betting from Stock Picking4
Intentionally or not, many managers engage in factor betting

* Ten largest funds in the Lipper Mid-Cap Value category by assets as of June 30, 2015.
Source: Lipper, AXIOMA. Contributions are relative to the Russell Midcap Value Index.


Why is the Calibrated approach beneficial to investors?
We believe that portfolios guided by diversified, factor-neutral stock picking represent better building blocks—ones that can more reliably deliver full-cycle performance and mandate consistency. A clear focus on stock selection potentially provides our Calibrated strategies with a platform to deliver more consistent outperformance, while rigorous adherence to a stated mandate offers a high degree of consistency with respect to portfolio characteristics. This mandate consistency should be particularly beneficial when constructing multi-manager portfolios, potentially minimizing unwanted overlap while bolstering the diversification benefits of combining complementary investment styles.


1For the period 12/31/2009 to 12/31/2014--the latest data available. Style Drift refers to the percentage of funds in the Lipper Mid Cap Value classification at the beginning of the time period that were in a different Lipper classification at the end of the time period.
2The select mid value funds are actual funds that are available for investment and have been classified in the Morningstar Mid Cap Value category.  Criteria for selection were funds in the Morningstar Mid Cap Value category with over $1 billion in AUM as of 03/31/2015 that have moved from the Mid Cap Value style box at some point during the time period 12/31/11 – 03/31/15.
3Antti Petajisto, “Active Share and Mutual Fund Performance,” Financial Analysts Journal, July/August 2013.
4Latest available holdings as of 06/30/2015. Calculated versus the Russell Midcap Value Index. Stock Picking Contribution is the percentage of projected portfolio variance which is attributable to stock selection risk. Sector  & Other Factor Contribution is the percentage of projected portfolio variance  which is attributable to sector and other risk  factors. Portfolio variance is a measurement of the volatility of excess returns relative to the benchmark.


The information in this article is being provided for general educational purposes only and is not intended to be relied upon as a forecast, research, or investment advice regarding a particular investment or the markets in general, nor are they intended to predict or depict performance of any investment or serve as a recommendation or offer to buy or sell securities. Any examples provided are for informational purposes only and are not intended to be reflective of actual results. There is no assurance that the investment process will consistently lead to successful investing. Diversification does not guarantee a profit or protect against loss in declining markets.

The Russell Midcap® Value Index measures the performance of those Russell Midcap companies with lower price-to-book ratios and lower forecasted growth values. The stocks are also members of the Russell 1000 Value index.

Index is unmanaged, does not reflect the deduction of fees or expenses, and is not available for direct investment.

The Morningstar Mid-Cap Value Category Average: the U.S. mid-cap range for market capitalization typically falls between $1 billion and $8 billion and represents 20% of the total capitalization of the U.S. equity market. Value is defined based on low valuations (low price ratios and high dividend yields) and slow growth (low growth rates for earnings, sales, book value, and cash flow).

Lipper Mid Cap Value Funds Average: Funds that, by portfolio practice, invest at least 75% of their equity assets in companies with market capitalizations (on a three-year weighted basis) below Lipper’s USDE large-cap floor. Mid-cap value funds typically have below-average characteristics compared to the S&P MidCap 400 Index.

Alpha is the return on an investment that is in excess of the expected return, given the investment’s level of risk. In a portfolio of securities, this excess return is attributed to the portfolio manager’s skill. This implies that it requires some form of active management, such as  selecting securities (selection alpha) or timing a market, sector, or asset class correctly (timing alpha).

A Note about Risk: Calibrated Mid Cap Value Fund investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies, including market, liquidity, currency, and political risks. Mid cap company stocks tend to be more volatile and less liquid than large cap company stocks. Mid cap companies typically experience a higher risk of failure than large cap companies. Investments in value companies can continue to be undervalued for long periods of time and be more volatile than the stock market in general. These factors can adversely affect Fund performance.

Additional risks to consider: Growth stocks are subject to the daily ups and downs of the stock market, their long-term potential as well as their volatility can be substantial. Value investing involves the risk that the market may not recognize that securities are undervalued, and they may not appreciate as anticipated. Small and Mid-cap companies may be less able to weather economic shifts or other adverse developments than larger, more established companies and may have less experienced management and unproven track records. Small and Mid-cap companies may rely on limited product lines, may have more limited financial resources, and may be more susceptible to setbacks or economic downturns.

Treasuries are debt securities issued by the U.S. government and secured by its full faith and credit. Income from Treasury securities is exempt from state and local taxes. Although U.S. government securities are guaranteed as to payments of interest and principal, their market prices are not guaranteed and will fluctuate in response to market movements.

Forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.

The Lord Abbett Calibrated Mid Cap Value Fund is actively managed and may change significantly over time.


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