Morningstar - Summer 2019 - 86

Investors

Return on Time
One of Artisan's newest managers
makes his mark.
UNDISCOVERED MANAGER

Brian Moriarty

In every issue, Undiscovered Manager profiles
a noteworthy strategy that hasn't yet been rated
by Morningstar Research Services.
Artisan Partners Asset Management APAM has
long earned Morningstar's admiration. The
firm hires promising managers, provides a platform
that allows them to operate with autonomy,
and closes successful funds to preserve the
qualities that led to outperformance. As a result,
Artisan has earned a Positive Parent rating, one of
the pillars that support Morningstar Medalist
designations for a number of Artisan funds. Of the
15 open-end strategies Artisan offers, 12
are on Morningstar's coverage list, and all of those
have earned Morningstar Analyst Ratings of
Bronze, Silver, or Gold.
So, when Artisan launches a new strategy,
investors take notice. One of its newest offerings
is Artisan Thematic APDTX, which launched
in April 2017 with less than $10 million in assets
and has quickly grown to more than $300 million
as of March.
Artisan Thematic manager Chris Smith joined
the firm in 2016, but Smith and Artisan
had been on each other's radar for several
years. The two sides maintained a running
dialogue as Smith built a track record
for his thematic strategy. He had spent much of his
career at Karsch Capital Management as
both analyst and portfolio manager, and he also
managed money for a private family office
and at Kingdon Capital Management; his record
includes both long-only and long/short
equity strategies. With the blessing of then-

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Morningstar Summer 2019

employer Kingdon, Smith eventually made the
switch to Artisan.
Smith credits Artisan's patient and thorough
culture, which allowed them to get to know him
over a three-year period. That gives him the
latitude to run a distinctive strategy. The fund,
which lands in the large growth Morningstar
Category, is designed to be a core equity strategy
and is benchmarked against the S&P 500, but
it doesn't look much like the index. The portfolio is
typically concentrated in roughly 30 stocks, and its
sector exposure does not hew to the benchmark.
Smith is supported by a team of six investment
professionals, several of whom worked with
him before he joined Artisan. The New York-based
group has gotten off to a good start: From
its April 2017 inception through March, the advisor
share class of the fund has returned an annualized
29.1%, compared with 15.9% for its category
and 12.4% for its benchmark.
It wasn't returns per se that got the attention of
Andrew Krei, head of investment research
at Crescent Grove Advisors. The firm, which has
offices in Milwaukee, Atlanta, and Lake Forest,
Ill., has used Artisan funds for more than a decade.
"We appreciate the way they source talent and
do due diligence on portfolio managers," Krei says.
Crescent Grove approved the Thematic fund for
its investment list late last year. "It was helpful to
see how it did in the stressful environment of
2018," Krei says. "We like their ability to mitigate
downside volatility-we were encouraged by
the empirical data."
Theme Engine

The concentrated portfolio is a result of a process
that focuses on exploiting particular themes that

Smith and his team believe will drive aboveaverage growth. As of December, the strategy
focused on six themes, including data
monetization (31% of assets), life sciences (20%),
software (14%), and industrial gases (13%).
"When we talk about themes on our end," Smith
says, "we're really looking for inflection points
in multiyear trends that are often misunderstood
by the markets." Ideally, these inflection
points allow the team to take a strong view on
company and industry fundamentals. The team
works to understand what is driving those
inflection points, whether it's supply and demand
dynamics, societal or behavioral changes, market
conditions, technologies, or laws and regulations. These inflection points are usually fraught
with rapid change and above-average uncertainty,
and Smith notes that "the market typically
has a tough time modeling rate of change."
Once a theme is identified, the work turns
to pinpointing the companies most likely to benefit
from it. The analysts build models for research
and development budgets across industries and
go product by product to build out total
addressable market and compound annual growth
rates to forecast market share. For those
companies that best express each theme, the
analysts build rigorous company-specific models to
identify companies with earnings power that
is materially different from consensus and where
the return on investing capital is accelerating
over the next three to five years. If a company
model shows a revenue growth rate accelerating
toward 12% by 2021, and consensus forecasts
are only 6%, there is potential for alpha generation.
Plotting each company's earnings differentiation
and valuation on an X/Y axis, the team focuses
on those that land in the top-right quadrant: stocks
with the highest earnings differentiation
and most-attractive valuation. If the team has
a high-conviction idea but the price is unattractive,
it will wait for a better entry point.
A recent emblematic pick is VMware VMW,
which Smith bought in the fourth quarter of 2018
and was a 6.1% stake at year-end. The thesis
is that the cloud computing market is settling into
a hybrid environment, with businesses using
Morningstar - Summer 2019

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