Jim Golan, co-manager of the William Blair Large Cap Growth Fund, talks about how he identifies structurally advantaged companies, sectors and themes in this episode of Bloomberg Intelligence’s Inside Active podcast. Host David Cohne, BI’s mutual fund and active analyst, and co-host Gina Martin Adams, BI’s chief equity strategist, ask Golan his views on managing risk with a concentrated portfolio, how to work through periods when growth is out of favor and how the rise of passive investing has affected the market.
Welcome to Inside Active, a podcast about active managers that goes beyond sound bites and headlines and looks deeper into the processes, challenges, and philosophies and security selection. I'm David Cohne, a lead mutual fund in active research at Bloomberg Intelligence. Today my co host is Gina Martin Adams, chief equity strategist at Bloomberg Intelligence. Gina, thanks again for joining me as my co host.
Thank you for having me, David, I'm delighted to be here.
So, in your most recent earnings Tracker, you wrote about the case for the four ninety three. Care tell us about how the four ninety three have performed in the second quarter in which sector saw growth.
Yeah, so first I probably should define the four ninety three, believe it or not. I still get this question, not from our guest, who I'm sure as well versed in the Big seven versus the four ninety three names in the S and P five hundred. But the four ninety three is how we characterize the stocks that are not the Magnificent seven. It's sort of the rest of the S and P. Five hundred. This group has been a big laggard in terms of the earnings recovery that emerged in twenty twenty three, but suddenly we're starting to see growth. So this group was expected in the second quarter to post just under five percent growth. They nearly doubled expectations at nine point two percent growth by our last count last count, so we saw finally some participation beyond the Big seven and sort of a narrow subset of earnings growers in the S and P five hundred to a much broader group, which I view as certainly something we can talk about with our guests today, but also a general testament to the market broadening that has really helped the index power back toward all time highs.
Okay, Well, in continuing with our conversation on large caps, I'd like to welcome Jim Golan, co manager of the William Blair Large Cap Growth Fund, to the podcast. Jim, thank you for being here.
Thanks David, and thanks Gina for this opportunity.
As we start, can you tell us how you got your start in investing.
It really probably started when I was in high school fifteen sixteen years ago, fifteen sixteen years old, and you know, my father was an attorney. My mother actually handled kind of like the stock investing and I really got intrigued with that. You know, each of my brothers we had a small college fund, and you know, she let me kind of, you know, do some things in terms of investment ideas. So that really kind of piqued my interest. And then I started my career at Kemper Financial Services. It was a large investment manager here in Chicago, which is no longer it's part of Deutsche Bank now. But I started as a junior analyst working for a couple senior analysts and also a portfolio manager, and it was really a great learning experience in terms of understanding fundamentals companies, what drive stocks. I did that for about three half years, became a senior analyst covering technology, energy and a variety of things. Moved on to City Group for a couple of years, and then ended up at William Blair where I'm presently employed. I've been here since two thousand started out as a tech analyst and became a co manager of this strategy in two thousand and five along with my technology responsibilities.
Well, when you talk about you know, the actual large cap growth strategies, you know, just if you're looking at the website and the web page for the fund. You know this talk of structurally advantage companies, what is your investment process for finding those?
William Blair is known as growth managers quality growth managers, who were active managers, meaning we have active weights relative to benchmark weights and the things that we look for. There's a couple of things when we talk about structural advantage.
First, we look at.
The industry level, where we want to invest in industries that are growing faster than the overall economy over multiple years, and those sessify as secular growth, but there's also cyclical growth, and these are industries that have secular growth characteristics, but there just might be greater variability in terms of the industry profit growth. And the classic example there has been a semiconductor industry that has secular growth characteristics because of the electrification of the global economy, everything requiring more and more semiconductor content. But there is variability due to inventory cycles capital spending that may have a short term impact on the supply and demand dynamics. So we want to invest in those secular growth industries. And then we take a deeper dive in terms of the company assessment in terms of defining those quality growth companies, and we'll look at things like the quality of the management team, record success, in ability to reinvent themselves really important in the large cap space because as companies start to mature, they need to find new avenues of growth. And then we'll take a deeper dive in terms of the busines. This model where we want to invest in companies that have a strong competitive amount that allows those companies to earn excess returns and profits over multiple years. And some of the things that drive that are unique distribution, value added products and services. And then this will roll into the financial model in MS in terms of having companies that have a relatively high degree of recurring revenues versus the average company out there, which we believe leads to more predictable earnings, predictable revenues, and then free cash flow really important for us. We want companies that can throw off a lot of free cash. We look at free cash flow margin, returns on invested capital. We want companies that have high returns on invested capital, but also improving and then great balance sheets can fund their growth organically. You know, in times when the capital and markets on their a little bit stress. Companies that can fund their growth organically generally will have a higher premium in the market relative to an average company that's relying on the capital markets. So those are some of the things that we look for in terms of a quality growth company for our portfolio.
Jim, can you talk to us a little bit about how you navigate the macro, how you implement you know, the macro in some of your strategies as well. We're obviously on the verge of a potential FED shift for example, does that impact your process at all? Or a ten percent correction like we had in August, Does that, you know, change anything in your strategy?
You know, One, we're long term investors, so we're looking at three to five years, and we're bottom up fundamental investors. So the macro we think about it doesn't necessarily we make dramatic changes because we're relatively low turnover portfolio. I think our annualized turnover runs about twenty five thirty percent, So we're adding, you know, four or five new ideas to the portfolio every year. You know, this is a conviction based portfolio, so we'll have thirty to thirty five stocks, again, wanting to have an active weight in every investment we make. But you know, we do think about the macro because it's out there and this is potentially a pretty significant change in terms of the FED cutting rates and the potential broadening of the market, you know, away from you know, the mag seven that you touched on earlier, that you know, we're thinking about that in terms of you know, potentially a new idea or two that would benefit from that. But it doesn't take away from our long term view of three to five years because typically when this happens, the FED starts cutting rates, the market broadens out, you know, smaller cap stocks might be working for a time being that usually lasts about six to twelve months, and then when the economy kind of normalizes after we get the boost from the rate cuts, you know, then things start to grow at a more normal growth rate. What should benefit the type of companies that we invest in in the portfolio?
Great, So maybe we can talk about some of those themes then. I would imagine that AI has been a huge theme for you, as it has for all of us over the course of the last couple of years. How how do you see AI where it is in its stages? If you could give me sort of are we in the third innings of the implementation of AI or are we just in the first innings? And then what are some of the other themes that you're looking at as you're looking at this sort of broadening in terms of market performance. What are other themes that are popping onto your radar right now?
Yeah, so with AI, obviously that's the topic dejure for the past couple of years. You know, I think it's still relatively early. This is really the fifth paradigm shift that we've seen in technology since the nineteen sixties. You know, we started out with mainframe computers, shifted the PCs, networking, then the internet, mobility. Software as a service was the next paradigm shift in the two thousand and seven time frame, and.
Now it's AI.
And these paradigm shifts do take some time. I know, the market is all about immediate gratification. And you know, if a company is you know, views as an AI winner and then you know they miss quarters, everyone says, well, they're an AI loser now, And you know, I just go back to the Internet and the tech bubble and everyone declared, you know, the Internet dead in two thousand and you take a look back twenty years or so later, how much disruption the Internet has caused, whether it's in terms of you know, radio, print advertising, now television with streaming services, all driven by the Internet. You think about brick and mortar retailers with e commerce, I think if you went back to two thousand, people would not have expected the amount of disruption has has occurred in brick and mortar retailers. And so this usually will take, you know, before it really start seeing the fact, you know, the effects of paradigm shift five or ten years. So we're still very early. We're in the infrastructure build out phase right now. Companies are trying to figure out how to utilize this. But I think when you look out five or ten years, this will have a pretty dramatic impact on society, the economy, capital markets. But we're still very very early in the process, and so it's really hard to say, like who's actually going to be the winner, because when you think about the Internet back in two thousand, the companies that ended up dominating, a couple of those companies weren't even in the public market set, and you had Amazon out there that was still really early in terms of just basically selling books and you think what they did with in terms of e commerce, Amazon web services advertising. No one expected that in two thousand. So still very early in the process. We're in the infrastructure build out phase and that will last several more years and then the applications will develop from this. So, as I said, still very early, but I think it's going to be pretty dramatic in terms of AI, and I think ultimately what will end up happening with AI. Thing that everyone is chasing, the Holy grayl is called, you know, general artificial intelligence, our artificial intelligence, and that is really the reasoning part, you know, where it's actually taking over what humans can do, and you kind of think about like the Terminator of the movie back in eighty four with Skynet. Hopefully it doesn't turn out that way, but that is what everyone is chasing, is general artificial intelligence, and that would be really a kind of a game changer in terms of the economy and the markets overall.
Can I jump in really quick there with one follow up question, because one of the things that we're struggling to find is sort of how companies outside of the tech space are going to implement AI and if they're actually starting to embark upon kind of an AI CAPEX spending plan because we're you know, we follow the Census Bureaus data just like I think everybody else does on what industries are announcing that they're actually starting to look into a implementation of AI. And it really has been quite concentrated so far and just financials and real estate for the most part outside of tech. Have you seen anything that we're not seeing? Are you observing some companies in other industries that are implementing AI technology more or where you see some real growth prospects here?
Yeah, it again, it's still early.
What we're seeing now are enterprise is testing and trialing AI. And the most notable area is Microsoft has the Copilot product. Again, a firm like mine, we're out there testing it. A small group's just testing it to get a sense of how it can help in terms of automating and generally what we're hearing is just in terms of improved productivity with like a Microsoft Copilot, you're seeing improvements of like twenty twenty five percent in terms of a worker's productivity, So.
That would be an example.
But companies are out there basically trying to understand how it could impact them. That's why say it's still pretty early. You will see it in terms of like probably customer service with chatbots. Again we're in a test and trial phase. But again it's.
Still very very early.
But you know, the market's basically expecting stuff to happen today, and it won't happen today. I think you'll start to see stuff next year, en rolling into twenty twenty six, where we start to see some new applications that people can use. And then also having said that, there's a lot of stuff happening in Silicon Valley in terms of new startups and companies we have not.
Heard of yet, but in three or four years potentially.
Could be like the next company that you know came about, you know, after the Internet back in like two thousand and four, two thousand and five. Those companies will probably be the game changers in terms of creating new applications that people can utilize in the enterprise space, but also rumor is utilizing in terms of using it on their smartphone or their PCs. So still very very early, but don't give up hope yet.
Okay, fair enough, I'm sure there will be many fits and starts in the process as well. But what an interesting long term theme to follow, right, maybe talk to us a little bit about those other themes that you're looking at outside of AI. You know, we've observed, for instance, that the healthcare sector is starting to show some signs of life globally, financials are popping with this field curve sort of movement and the prospects for easier policy emerging. From your perspective when you're looking for long term secular trends or either of these sectors, or are there any other sectors or themes that are really sort of hitting your radar right now?
Yeah, I think one of the big areas will be just with rates, assuming the Fed does follow through with rate cuts starting in September and continuing you know over the.
Next year or so.
A lower rate environment will benefit a lot of folks, especially rate sensitive, So talk about the banks, they would be a beneficiary of that. But you know, you think about like the consumer side with lower rates, potentially on the housing side, housing's really been has had a struggle for the past couple of years as rates have risen, and part of that was just due to the fact that during COVID with rates basically at zero, everyone refinance at incredibly low rates.
I think the.
Average rate right now for a home out there is probably about three point seven three point eight percent on the thirty year mortgage. So everyone did a really good job of refinancing during that timeframe, so it makes it really hard to move when you have such a low rate. So as rates start to come down a bit, that may stimulate the housing market in terms of people wanting to move, wanting a new house. They may still have to pay up for a rate, but nothing like the seven to seven and a half percent that we've seen over the course of this year. So that will be an area I think that will be pretty interesting over the course of the next couple of years, assuming the FED follows through in terms.
Of the rate cuts.
So that's that's a pretty exciting area in my opinion.
Well, I do want to move on to actually risk and talking about managing risk with you know, the overall market and also you know risk with managing a concentrated portfolio. I believe there are you know, just over thirty stocks in the fund as of right now, and so just I'd like to hear your thoughts on that.
Yeah, great question, David.
You know, we put a lot of thought into risk just because it is a conviction based portfolio, fewer names that you might typically see from an average large gap manager. And there's a couple of ways, a few ways we actually manage that. One just our focus on quality. You know, we're not buying unprofitable companies. We focus on free cash flow, really established leaders out there. The second thing we do in terms of construction is we want to run a diversified portfolio, meaning that we're going to be sector and market cap neutral over time, so we're not going to have a huge overweight to any sector in particular. And with that, our expectation is that stock selection and to a lesser extent, industry selection will be the primary driver of alpha over time. And then we're pretty thoughtful about active weights. So this again active weights relative to the benchmark weight, and we generally keep our active weights about a couple hundred basis points or so above the benchmark weight.
So if a stock is five percent.
In the index and we want to own that company, it might be a seven percent weight in the portfolio. It won't be like ten or twelve. And so by doing that, we think we managed the risk in a much better fashion. And you look at some of the characteristics such as tracking error, it's actually below average relative to a large cap manager who has more holdings. Standard deviations pretty close to the market. Our beta again is close to the market, maybe a little bit less. We don't manage the specific numbers. It's really a result of our bottom up process. But these risk construction tools that we have in place, we think provides a smoother ride for our clients.
Again, over time, are.
There ever instances in time, say like twenty twenty two, when we had this huge inflation spike, a big value rip relative to growth. Are there ever instances where you migrate the portfolio more defensively because there's so much distress, or do you tend to ride through those adding to your conviction positions. Maybe talk through those periods of intense volatility and how you navigate those situations from a risk perspective.
Yeah, yeah, Gina, I would say during those times, unless there is something that we think has structurally changed out there, we're typically not doing a lot.
I will say that we did early that year.
In twenty twenty two, trim back some of our semiconductor holdings, but because those tend to be a little bit more volatile and we are underweight semicductors, but we generally will ride out the periods because we view them more as a short term issue. And if you look back then during the twenty twenty two period, it was really again about the FED raising rates. Secular growth was under some pressure because those tend to be longer duration assets, and people were shifting into shorter duration assets such as biopharma or tobacco, and we just don't view those as really interesting growth companies on a three to five year basis, So we're sensitive about portfolio turnover, and so we didn't do a lot of dramatic changes in the portfolio. And then you kind of look forward six months later, as the market said, well, the worst is getting pretty close to being done in terms of the FED hiking.
Even though the FED continued.
That the valuations of some of these secular growth stocks started to look more interesting. So at that point in time, we were actually kind of leaning into some of our long term favorites that had pulled back. I will point out that back in like twenty twenty one, during the second half of that year, as the markets started to get wind that the FED was going to start raising rates earlier than what people are expecting. We did see the really long duration assets. Those companies that had no earnings, it was just all based on revenue growth really get you know, got slammed during that second half of the year. You know, Fortunately, again just based on our investment process, we didn't know in those companies. So we actually held up relatively well during that time frame. But during the first half of twenty twenty two we struggled a bit just because of some of our favorite secular growth stocks that had earnings and free cash flow just got revalued because of the rise and rates, and subsequently those stocks have rebounded.
You know since then.
So staying true to our course, yeah, really big.
Difference for us, and and well stated, I think, you know, on that same line of thinking, we've been in such a long period in which growth stocks have really led returns on the market. You've got to go back to kind of pre financial crisis to think about a period of time in which value is even really in vogue for a reasonable amount of time in and up market. How would you change your approach at all if we went back to a say, two thousand and four to two thousand and seven styleble market, where value is a leadership section segment of the market and growth is not in the lead. Would that change your perspective or your process at all or would you stick with kind of the core values of your process as they exist today.
Yeah, no, I would say we would stick to our you know, definitely would stick to our core values. The advantage we do have is when I talk about these cyclical growth stocks, if we can build a case that a company over a three or five year period is going to experience you know, pretty good profit growth, it would it would you know, behoove us to take a look at those companies. So when I talk about interest rates, census stocks like the housing area, if we're going to be going through a three to five year uh improvement in terms of profitability in certain companies, yeah, absolutely we would take a look at that. And that's the beauty of how we think about things, you know, the secular growth and the cyclical growth that gives us the flexibility to pivot a bit in terms of the portfolio. I should point out that, you know, the I think the interesting thing in terms of why growth has done so well since the Great Financial Crisis is generally we've been in the low growth type environment you know, the feedsmen out there, you know, driving lower rates. But when you look at real GDP growth since the Great Financial Crisis, it's been about one and a half percent, you know, you compare that to pre Great Financial Crisis it was closer to two and a half three percent. So if you can build a case, you know, looking out over the next five years, that real GDP is going to accelerate to like, you know, two and a half three percent, then yeah, that would create an opportunity for cyclical growth stocks. Again we can we can invest in those companies. It will also be a good for like the small cap environment because those companies just have been under pressure because of low growth, low economic growth, and so if the economy starts to accelerate a rising tideless all boats, it'd be really good for the market in terms of broadening.
You talk about, you know, looking at three to five years, and so that kind of brings up another question I had, And you know, I know the portfolio aims for low turnover. Is there like an average holding period or is it basically you know, you're just holding it until it hits a certain valuation, or.
We hold until we think the fundamentals are changing. So this is a dynamic process. We're always every day is like a new three to five year period and we ask ourselves, has there been a change in the industry in terms of the growth fundamentals and has there been a change in the company all whether because of valuation or change in management or change in strategy. But you know, our average holding period is probably four years, and we've had stole that we've had in the portfolio now for fifteen years. You know, I've been a co manager of a strategy since two thousand and five, and so we've had stocks for fifteen years. But the averageably four and now with like the cycical growth stocks, you know, time horizon might be shorter, it might be three years, and so we might don't own one of those stocks for two or three years, so it might be a little bit higher turnover there just because of the cycicality of the industry.
But if you find a good secular.
Grower, you can hold it for multiple years as the company, you know, really executes on the strategy and the growth of the industry really helps in terms of driving the profits.
Jim, I want to pivot a little bit and talk about the rise of passive investing. You know, we've dedicated this podcast specifically to active investors, as you know, the undercovered universe of investment strategies. How do you look at passive investing? In our view is there's tons of myths in the market. You know, passive has had this inordinate impact on valuations presumably, and lots of different sort of narratives rising through the market. But how do you view the rise of passive with from your perspective as an active manager?
Yeah, so, I mean passive is easy to do for a lot of people. You know, people will argue the market's efficient. You know, when you see large cap companies moving plus or minus twenty percent based on earnings, you could argue, is the market really efficient? So not all the informations out there, but you know, we've just seen fun flows go there for for multiple years. You know. The issue I think today was with passive is just and this ties into the concentration issue. Just the increasing concentration that we have seen in indexes and people thinking that while they own a diversified portfolio, you know, we measure ourselves against the Russell one thousand growth index, and they're what we have seen in the last five years. So if you go back five years ago the top ten names in the Russell one thousand growth, we're about forty percent of the index. Today, that's about sixty three percent top ten names. That means six hundred and twenty other names represent the other thirty seven percent. So when investors think I'm buying a passive fund, I'm getting a diversified portfolio, you're really not. And a lot of these index fund ets are starting to run into some diversification rules, and you know, you see these big index providers like Russell and SMP starting to take feedback from managers in terms of potentially reconstructing these indexes to lower the weights in some of these big names. So that's to be continued, but kind of interesting. But you know the benefit of an active manager is as the market broadens out, you can be investing in other stocks besides these big names. And you look at like our fund, you know, we own five of the top ten names. You know, we're using those proceeds and investing elsewhere in the market. So you could argue that as the market broadens out, that should be good for active managers relative to just you know, owning a passive index.
And then the other factor you have to consider.
If you're just going passive is you know, these these indexes aren't DC plans and what have you. The folks running these plans do have a fiduciary responsibility, and we're getting a lot more questions from them in terms of do we really have a diversified portfolio if we have you know, an index that has the top ten names owning you know, sixty three percent of that index. And so we're getting a lot more questions in terms of how they can manage that risk. And you know, I think active is a way one of the ways you can go in terms of getting a broader participation in the market. Again, assuming the market starts continues to start to broaden out.
Well, I used to like to ask our guests, you know, some reflective questions or even questions on you know, something out of investment. And so I was just curious, what are actually you know what this relates to investing too, So I'll ask you that what are your favorite investment books?
Oh, I have a lot.
I mean the one book and I don't know if it's investment, it's more of economic history. The one book that really has resonated with me over time.
Is a book called The Lords of Finance.
I think it was written around two thousand and nine, twenty ten, and I've always been a bit of a history buff and just trying to understand what happened with a great depression, and this book is really centered on the four central bankers us ET, Federal Reserve Bank of England, Germany, and France and the things they did and didn't do that really made the Great Depression into the Great Depression. You know, you go to school and the lesson was always stock mart market speculation, the market crash, and then we had a Great Depression. And it's a little bit more nuanced and complex than that, and so if you have some intellectual curiosity, it's really a great book in terms of just explaining the mistakes people made. You know, after World War One, we went on the gold standard again, which really limited the flexibility of central banks to address the issues out there, and you know, you look at the Great Financial Crisis and that was kind of less than the central bankers learn was you really need a proactive FED and that's what we saw, and we saw it last year with the Silicon Valley Bank failure where the FED stepped up and guaranteed the deposits to avoid a bank run. And you know, the Federal Reserve didn't do that in the nineteen thirties and banks collapsed, and the stock market crash, which was an element of it all, ultimately led to just like horrific in terms of unemployment, the misery out there, and then ultimately World War Two. So I think that's really a great book for anyone who's interested in history to read.
Lords of Finance.
I love that. Actually I want to pipe in with that because to your point, Jim, I think my observation is that markets are still adjusting to the fact that the FED and the monetary bodies are much faster at recognizing and responding to this. I mean, my observation of the Silicon Silicon Valley crisis is the FED did step in, the Treasury stepped in, the monetary authorities of the world did such a good job of navigating that the markets were caught off guard by how quick they did. Months later, people were still telling me, oh, this is going to be an implosion because we're now behaviorally sort of conditioned to expect not to react, and they are reacting so it's fascinating when you bring that up. That's the first thing that came to mind.
Yeah.
Actually, you know, I guess Ben Bernaki was reading this book during this whole thing.
I took it boom.
It's like, we have to do stuff, we have to be proactive, and that that's the difference, you know today versus back in nineteen thirty when everything was falling apart. The central banks just set idly by, and it's just they're super aggressive now.
And you know, that's that's why.
You know, when you look at think about the market today, you know, with the FED funds rate at five in the quarter, there's a FED put back out there. Yeah, if anything really bad happens with the economy, the Fed and cut rates, you know, the quantitative easing still on the table. So that's what gives the market. I think gives the market confidence over the next couple of years, is that the Fed foot FED put is back and the Fed will be aggressive if need be.
Yep.
So a great book to read.
Well, this is a great discussion. I wanted to thank you Jim for coming on Inside Active. It was great having you.
Thanks David, and thanks Gina. Great questions A lot of fun and good luck ahead.
Thank you, Tina, wanted to thank you as well.
For being my host, my pleasure. Thank you David.
As always until next week. This is David Cone with Inside Active