Equities Fixed Income Hedge Funds Private Equity and Real Estate Sustainable Investing

Equities

We follow a philosophy that low-turnover, concentrated portfolios derived from sound bottom-up fundamental research provide an opportunity for attractive performance results over time. We have a culture and firm equity ownership structure that help us attract and retain professionals who share those beliefs, and we follow a repeatable investment process that helps us stay true to our philosophy.

We construct balanced portfolios for private clients, nonprofits and institutions depending on the needs of the client. We can be 100% open architecture, using third-party managers only, or we can put together a mix of internal and external strategies, whatever is in the client's best interest.

Fixed Income

We follow a philosophy that fixed income strategies built from a foundation of stability coupled with fundamental credit research can seek to generate alpha and control risk. We have a culture and firm equity ownership structure that attract and retain professionals who share those beliefs, and we follow a repeatable investment process that helps us stay true to our philosophy.

We construct balanced portfolios for private clients, nonprofits and institutions depending on the needs of the client. We can be 100% open architecture, using third-party managers only, or we can put together a mix of internal and external strategies, whatever is in the client's best interest. Meet the Investment Solutions Group.

Hedge Funds

Hedge Funds

The Investment Solutions Group is an investment-management team within Brown Advisory that specializes in asset allocation, manager selection, hedge funds and other alternative investment strategies. Dedicated to open-architecture solutions, our team has established a strong track record of identifying high-quality, third-party investment managers across the hedge fund, long-only and private equity universes. We leverage this expertise to help clients assemble portfolios that we believe best fit their needs and goals, offering clients a range of solutions from complete portfolio management to fulfillment of specific hedge-fund and alternative-asset mandates.

Founded in June 2002, the Investment Solutions Group now manages in excess of $3.4 billion for clients (data as of January 31, 2017) in a combination of managed accounts, advisory relationships and fund-of-fund offerings.

Private Equity and Real Estate

Private Equity and Real Estate

Brown Advisory has incorporated private equity and real estate investments in client portfolios since our founding. Today, we can provide that exposure in three distinct ways.

Feeder Funds and Multimanager Funds
We introduce clients to investment opportunities in early- and late-stage venture capital and buyout funds, as well as select real estate funds. We also construct these feeder funds into multimanager funds through our Private Equity Partners (PEP) and Real Estate Partners (REP) vehicles to make private equity investing as easy as possible for our clients.

Customized Private Equity Portfolios
For most clients, private equity is one component of a balanced portfolio that we manage. Other clients, however, come to us specifically for custom-built private equity and real estate portfolios.

For more information on private equity please click here or contact Jacob Hodes at 410-537-5315 or [email protected].

Sustainable Investing

Sustainable Investing Strategies

  • Multi-Manager Strategies
  • For clients seeking an open-architecture solution, we have access to several of the premier sustainable managers in the industry - all vetted by internal research.
  • Private Equity
  • Our private equity team is focused on evaluating the growing universe of private impact investments to identify standout opportunities that target various issues of particular concern to our clients. To date, we have placed assets in investments targeting a variety of impact themes such as community impact, microfinance, education technology, sustainable real estate, water initiatives and others.*
  • *Many alternative investments by regulation may only be sold to Accredited Investors (institutions with at least $5 million in assets) or Qualified Purchasers (institutions with at least $25 million in investments).

Customized Portfolios

This diverse assortment of solutions will meet many clients’ sustainability objectives; however, we understand the continued evolution of this space and seek to be able to react quickly to client needs.

For clients with unique missions, value-aligned investing programs, or who simply wish to ensure that they do not own certain controversial companies or have access to certain industries, we offer the following customized options:

Additional Screening: To the extent we have reliable data and can build rules into our compliance systems, we can add specific screens to a separate account to restrict companies (e.g. oil and gas providers) or industries (e.g. tobacco or weaponry).

Customized and Thematic Portfolios: Within a separate account, we can work together to solve for a sustainability need. From a universe of securities researched from both the bottom-up and for their ESG profile, we can assemble a custom portfolio of securities designed to meet many specific sustainable goals or outcomes.

PRACTICAL PESSIMISM: BROWN ADVISORY’S APPROACH TO CREDIT RESEARCH

Assessing credit risk is one thing, but translating that risk into an objective assessment of price vs. value is another. Brown Advisory’s DAZ-EL framework for pricing credit risk helps us make informed decisions based on standardized, actionable data.

A credit investor’s success rests on the strength of his or her credit research and ability to translate that research into smart capital allocation decisions about individually attractive bonds. That may sound like an obvious point, but fixed income portfolios are not always guided by that principle—some are guided more by an effort to conform to a benchmark index, while others focus on driving returns with bets on portfolio duration or other factors.

We believe Brown Advisory’s approach can lead to compelling results over time, but it requires a disciplined framework for credit research. Specifically, we need to understand why a bond is priced the way it is—improper reading of a business risk? Sentiment about the sector? Rate sensitivity?—before we can judge whether its price is reasonable or attractive.

DAZ-EL: Taking the Guesswork Out of Pricing Credit Risk

Pricing credit risk effectively is particularly important in today’s market. Credit spreads are pushing historical tights, neither underperformance nor transaction activity is having much effect on pricing, and the spread premium of high-yield over investment-grade bonds continues to erode. In short, the market is not heavily discriminating between levels of risk, making it all the more difficult to discern between good and bad value.

Avoiding these value traps is what separates average managers from great ones, and to do so requires a bit of “practical pessimism.” We need to understand the worst-case scenarios for the bonds we buy—but assessing risk is one thing, and translating that risk into an objective assessment of value is another.

Brown Advisory’s DAZ-EL calculation process (short for “duration-adjusted z-spread minus expected loss”) is vital to our efforts for three reasons.

  1. It is a standardized framework. The DAZ-EL process lets us evaluate and objectively compare bonds across sectors with varying maturities and credit quality—all using a single metric.
  2. It helps us translate risk into a quantifiable statistic. With this process, we distill historical and projected financial, strategic and qualitative issues into a single statistic.This keeps our decision making objective and prevents us from making gut calls about risk-reward dynamics in a given situation.
  3. It integrates our credit research with our risk management and portfolio decisions. As DAZ-EL standardizes the decision process, its output forces us to allocate capital to those sectors and asset classes that offer the best risk-adjusted returns, and helps prevent overexposure to any particular risk.

Ultimately, the framework aims to help us consistently choose attractive bonds for our client portfolios. For any manager, long-term outperformance is based on being right more often than wrong (and on being right more often than the competition). We believe that the DAZ-EL process is the best way for us to maximize the number of good decisions we make over time.

How It Works

Credit risk assessment focuses on two classically accepted components.

  1. Probability of default (“PD”) refers to the likelihood that an issuer under stress would fail to meet its debt obligations or breach its covenants, prompting a bankruptcy filing.
  2. Loss given default (“LGD”) refers to the likely percentage of principal at risk in a default scenario.

The multiplication of these two statistics produces an expected loss (the “EL” in DAZ-EL). For example, if a bond has a 2% PD (i.e., a 2% chance of defaulting) and a 15% LGD (i.e., a likely 15% of principal in a default), investors should “expect” a loss of 2% x 15% = 0.30%, or 30 basis points of their investment, as a midpoint assumption of all reasonably likely outcomes.

This concept is widely applied in the fixed income world. However, deriving PD and LGD consistently and accurately is where we seek to truly add value in our credit research process.

Probability of default: Using 30 years of historical default data, we use a number of factors—four quantitative and 15 qualitative factors in all—to calculate PD. These include:

  • Liquidity: Companies with stronger liquidity are typically better able to service debt obligations during periods of stress. Because capital structures and leverage ratios vary by sector, we pay close attention to interest and fixed charge coverage metrics, which help normalize our assessment across sectors.
  • Levered free cash flow to debt: Add-backs and accounting adjustments found in reported results can often cloud a firm’s real financial situation. To project “true” cash flow relative to debt, we carefully analyze historical performance and build data-driven hypotheses about expected capital expenditures (another metric that varies by sector).
  • Refinanceability: For any successful business operation, maintaining a healthy balance sheet is paramount, and that involves the ability to reliably refinance maturing debt or raise new capital. We assess a company’s ability to do so by weighing market interest rates for comparable issuers against the company’s near-term obligations, contingent liabilities, cash flow generation and equity cushion.
  • Volatility of cash flows: We further test an issuer’s ability to service its capital structure in times of stress by gauging the health of the issuer’s sector, that sector’s inherent cyclicality and how sector participants have performed historically during recessions.

Loss Given Default: LGD is derived using a “bankruptcy waterfall” analysis. We estimate losses within a modeled default scenario, taking into consideration corporate structure, relative priority of a given bond within the capital structure, indenture restrictions and precedent restructuring multiples. All investments across the quality spectrum go through this analysis, ensuring that we are always focused on the ultimate downside.

Our proprietary calculation of expected loss and our subsequent comparison to observable market spreads are the foundation of our investment decision and the framework for standardized comparison across sectors. When adjusted for duration (the “DA” in DAZ-EL), we can compare securities across both sectors and durations. It bears repeating that the risk and portfolio management implications here are twofold—objective comparison across sectors directs us to the most attractive risk-adjusted returns, and adjustment for duration helps us manage interest-rate risk.

Using DAZ-EL as Part of the Investment Process

Although we do not completely defer our decision-making to this single metric, we generally look for bonds with a higher DAZ-EL score and seek to allocate greater amounts of capital to bonds with the highest DAZ-EL scores. Many of our strategies aim to allocate capital based largely on this bottom-up, fundamental valuation exercise. In fact, our Strategic Bond Fund purposefully seeks to limit duration risk and drive returns through fundamental credit research.

DAZ-EL Calculation Example | An illustrative bond described earlier in this paper had a probability of default (PD) of 2% and a loss given default (LGD) of 15%. That bond had an expected loss of 30 basis points. If its duration was three years and it traded at an excess spread of 150 basis points, its DAZ-EL would be 40 basis points.

DAZ-EL is a powerful tool that helps us make objective, data-driven decisions, but like any research tool, it is only as valuable as the accuracy and timeliness of the information feeding it. For this reason, we regularly update our DAZ-EL model for earnings updates, shifts in sector dynamics and transaction news to maintain a relevant assessment of excess spread, as shown in the case study below. Frameworks like DAZ-EL are simply techniques that unlock the value of good credit research, but in the end there is no substitute for doing our homework and making sure our “practical pessimism” is guided not by subjective opinion, but by objective analysis.

DAZ-EL in Action: Micron Technology, Secured vs. Unsecured

A practical recent example is perhaps the best way to illustrate how we use DAZ-EL. As we’ve stated, we use this metric to evaluate bonds, compare different bonds, size individual portfolio positions and broadly allocate capital.

In this example, we used DAZ-EL to help us make decisions about how to invest in the bonds of Micron Technology, a global semiconductor company. Specifically, we sought to determine the most attractive positioning within Micron’s capital structure—in other words, whether to buy a senior, secured bond or an unsecured bond with greater risk. In the chart below, we show how these bonds have traded since our initial investment. (Note: Standard practice in fixed income management is to chart bond prices according to their spreads, as we have done below. The visual representation of price in such a chart is inverted—when a bond’s spread tightens, it generally means that the bond’s price goes up, and vice versa. However, this charting method is far more useful for apples-to-apples comparison of different bonds.)

DAZ-EL in Action: Micron Technology, Secured vs. Unsecured

An important lesson from this case study is that the DAZ-EL formula is most valuable to us when we frequently update our inputs into that formula. When we revisited our DAZ-EL calculations in November, it was a part of our regular, ongoing research process. It is not enough to “set and forget”—in this case, we only saw the opportunity because we completely updated our assumptions about both bonds after a short holding period. Even if we maintain a long-term view about a company’s underlying fundamentals, we believe that we still have ample opportunities to capitalize on short-term dislocations in the market as long as we are watchful for those opportunities. For this reason, we regularly revisit our assumptions and recalculate DAZ-EL for the bonds on our coverage lists and watch lists.

The information provided in this material is not intended to be and should not be considered to be a recommendation or suggestion to engage in or refrain from a particular course of action or to make or hold a particular investment or pursue an particular investment strategy, including whether or not to buy, sell or hold any of the securities mentioned. It should not be assumed that investments in such securities have been or will be profitable.

 

 

 

Private investments mentioned in this article may only be available for qualified purchasers and accredited investors.

The views expressed are those of the author and Brown Advisory as of the date referenced and are subject to change at any time based on market or other conditions. These views should not be construed as investment research. These views are not intended to be and should not be relied upon as investment advice and are not intended to be a forecast of future events or a guarantee of future results. Past performance is not a guarantee of future performance and you may not get back the amount invested. The information provided in this material is not intended to be and should not be considered to be a recommendation or suggestion to engage in or refrain from a particular course of action or to make or hold a particular investment or pursue a particular investment strategy, including whether or not to buy, sell, or hold any of the securities mentioned. It should not be assumed that investments in such securities have been or will be profitable. To the extent specific securities are mentioned, they have been selected by the author on an objective basis to illustrate views expressed in the commentary and do not represent all of the securities purchased, sold or recommended for advisory clients. The information contained herein has been prepared from sources believed reliable but is not guaranteed by us as to its timeliness or accuracy, and is not a complete summary or statement of all available data. This piece is intended solely for our clients and prospective clients, is for informational purposes only, and is not individually tailored for or directed to any particular client or prospective client.



⚑ Investment Insights

 

Share The Article

Mutual Funds Attestation

 

You are now leaving the Brown Advisory website and entering the Brown Advisory Mutual Funds site.

The content on this site is directed at investors in the U.S. By entering this site you are confirming that you are a U.S.-based investor to whom these Funds may legally be promoted.

If you are an international-based investor please click here.

By clicking "Exit" below I indicate that I have read the above terms and do not wish to continue into this section of the web site.

By clicking "I Agree" below I indicate that I have read and accept the terms above and wish to continue into this section of the web site.