Ryan Thomes, Hotchkis & Wiley

Well, I started my career in investment consulting and I worked at a couple of different places, the last of which was called Slocum & Associates, which has since been acquired and I think is now part of the under the Mercer consulting umbrella. But I had a great experience there. That firm had a very fun culture, great leadership, talented people. So I learned a lot. One of my primary, probably the primary responsibility that I had there was to conduct due diligence on equity asset managers. And as it happened, Hotchkiss & Wiley was one of those firms that I was researching. And I was impressed by the firm, its people, its culture, its process, its leadership.

Yeah, no, we're definitely going to talk about the ETF in greater detail on the show. But before we kind of get into business, any hobbies? What do you like to do when you're not working?

Yeah, well, I have a couple of daughters. The older one is well into routines and pretty self-sufficient at this point. The younger one is 10 and she's a competitive dancer, which makes me a competitive dance dad. So depending on the time of year, I'm likely watching competitions or recitals. Not exactly how I probably envisioned it as a younger man growing up, but it's fun to watch. And I wouldn't trade it for the world. And if I have kind of true Ryan time, I guess I'm probably at the golf course. I just like the outdoors, spending time with friends. And that's probably the way that anybody that loves golf but isn't very good at it would describe it.

Yeah, well, and I'm sure dance competition weekends eat into your ability to sneak out on a Sunday or Saturday morning. Excellent point. Yeah, well, any young dad can relate to that who likes golf. So, look, why don't we talk a little bit about the firm in general? what all do you guys do to help clients? I know you have the products, which we're going to definitely move into. But what are all the things you're really doing to help support your client base and the things that you're delivering to them?

Sure. So, Hotchkiss & Wiley, it's a 45-year-old firm founded in 1980 by John Hotchkiss and George Wiley. They both retired in the mid-1990s and have unfortunately passed away since then. And we manage today somewhere between $30 and $35 billion across a suite of value equity strategies and also a high-yield credit business. So, the firm's majority employee-owned, and I would classify it very much as a research firm. So, if you were to just look at the headcount alone, if you add up the research team, the research associates, the trading team, so basically everybody that's solely dedicated to the research effort, that's more than half the headcount of the firm.

So, you guys recently launched the SMIDCAP Diversified Value ETF, ticker HWSM. Can you talk about having such a long history at the firm? What kind of inspired you guys to enter the ETF game? And if you wouldn't mind, maybe just talk about what the fund's trying to accomplish at a high level.

Sure. So, yeah, like you mentioned, the SMID ETF, we just launched it at the end of March or early April of this year. The SMID strategy, so not the ETF vehicle, but the strategy itself via, separate account dates back two and a half years. But the investment process that we use for that strategy is effectively identical to our small cap diversified value strategy, which is a $3 billion strategy that dates back 20 years. So, the strategy is only a few years old. The ETF is only a couple of months old, but the process kind of dates back, 20 years. And the firm offers, value equity strategies really across the cap spectrum and also, globally.

So, why don't you walk us through kind of the core investment process behind HWSM and kind of what I've read. And again, you're the expert here. It looks like there is some quantitative factor to this as well as some analysts working on it. And those two things kind of work together. So, if you could, can you just walk us through the core investment process here behind this particular fund?

Sure. So, basically, it's a three-step process is the way I think about it. The first step, like you alluded to, the quantitative element where we run these proprietary models. The second step is we have an analyst review of those models. And then the third step is portfolio construction. You could sort of consider a four-step being ongoing monitoring of it. But, that three-step process might not sound like a terribly unique strategy, but I actually believe it's a little more unique than it might sound on the surface. And there's a few reasons for that. First, I think these models that we use are different than what most quantitative screening tools that I've seen in the past.

So how can you how do you view kind of balancing that systematic model output with the human judgment? Right. Like how much credence, I guess, when you go to rerun the model, does that most recent kind of I'm going to use the term. Well, let me use a different term kind of human judgment. How much weight does that really hold in your next run of that of the model?

Right. It's a good question. So I guess the way I think about it is it's it's really the human adjustments that we're after. And I think that's what we would place greater value on. The models, I think, in my view, are a way to sort of house all those adjustments in an efficient way. And when you run a diversified portfolio, having efficiency embedded in your processes is paramount. And so that's that's kind of how I think of it. Like the models are almost a research prioritization tool for our analyst team.

That makes a that makes a lot of sense to me as well. So one of the things I read, too, is you guys emphasize investing in out of favor and under followed stock. So, like, why is that a segment that's really compelling for you and your team?

Yeah, I think this process lends itself well to, I'd say, the less efficient segments of equity markets. And those tend to be on the smaller and mid side, side of things. You just have a lot of stocks there that are overlooked because there's less Wall Street coverage. There's also less buy side coverage. There's also a lot of a lot of stocks in that group that you probably wouldn't want to own. negative earners, subpar businesses, those with a lot of financial leverage, those that might have below average management teams that aren't shareholder friendly. and so active management is, of course, about what you own, but it's also, about what you don't own because we are compared to passive indexes.

So I was reading as well that HWSM uses a proprietary fundamental risk rating system. Like what does that score actually measure and how does it impact your portfolio construction?

Yeah, so this is something that we employ firm wide across all strategies. In this strategy, this would occur during the analyst review stage. So I referenced earlier that the analysts give us these financial adjustments to the models. They also give us these fundamental risk ratings. And basically what these are, they're scores of one to five, one being very positive, five being very negative on three different sort of risk pillars. One would be the quality of the business. The second would be the strength of the balance sheet. And the third would be the quality of its corporate governance. So simply put, the better these scores are, the higher the valuation that we're willing to pay and, vice versa.

So let's talk about like rebalance frequency or cadence. How often are you kind of rerunning the model? How often are analysts relooking at everything? And, how often are you going in and making adjustments and or rebalancing the portfolio?

So we do that kind of whole process that I walk through. We refer to that as our major rebalance process, which is really going from the process to beginning to end. And we do that twice a year and it takes about six to eight weeks, to go through that entire process. The in between that, we have minor rebalances, which take place no less than monthly. And that really involves primarily trading back to target weights just to take advantage of volatility in the market. But we'll change target weights if there's been a major change in valuation or risk. And we've used this cadence really just because we found it to be sort of the right balance of, making sure the work is fresh, letting the process work and then also minimizing trading costs.

It looks like the ETF holds quite a number of between 150 to 200 stocks. They have what I look at is like a tiered weighting kind of what's the rationale behind the tiered weighting? Does that have to tie back into the fundamental risk rating system? So like how are you weighting these names inside of the portfolio?

So the 150 to 200, and we've been closer to 150 than 200, represents somewhere in the neighborhood of 10% of the eligible universe in which we can invest. And that's similar to the small cap strategy that we've been running for 20 years that's worked pretty well. So it just kind of feels like the appropriate balance of being diversified, but still not an enhanced index strategy. the active share for this strategy is somewhere in the mid to high 80s at the moment. And so that's kind of the justification behind it. The tiered weighting structure, the way it works is, and this is approximate, but we have approximately 50 names at 1%, 50 names at 0.6%, and 50 names at 0.4%.

And it's funny, the last, the episode prior to this is also, it's a mid cap strategy, not a SMID strategy. But as we've known, kind of mid caps and small caps have been a little bit out of favor, which I think could make them a little bit more attractive in today's market environment, especially from a value perspective. What is the firm's overall kind of take on this area of the market and why SMID caps or small and or mid or the both of them combined in this particular instance, kind of attractive given how the market has kind of relied largely on large cap growth over the last, gosh, 36 months?

Yeah. it's almost more like the last decade. Yeah. it's, it's a good point. I think the large cap growth index is up like 350% over the last decade cumulatively, which is, I don't know what that would equate to annualized 15, 16, 17%, something like that, where I think the index that we're being compared to the 2,500 value is up, like 100%, which would be whatever, 7, 8% over a 10 year period per year. So to say it's underperformed is kind of an understatement. large cap and growth has done incredibly well.

So what this is always a million dollar question, right? You're working with an RIA who's already has a diversified portfolio. Where is HWSM kind of where is its role in that portfolio? Is it kind of a core holding? Is it are you looking at kind of satellite exposure? Like how would you kind of go into that conversation recommending how to use this particular product?

Yeah, I think a core long term holding would make sense. If you have an individual or a plan that's looking to simplify their lineup. So maybe not have small and mid and get that together. maybe we would pair well with a SMID growth manager. I think that would be a pretty logical balance. and I think so investing in this, even though the track record isn't very long, it does provide access. I think to, again, the knowledge base of a very large and experienced team.

Well, I think, too, you have, as you just said, you ran a very similar small cap diversified value strategy for 20 years. And so there's enough track record there for people to kind of leverage. But, as you just alluded to, this fund was launched fairly recently. And you guys are newer to the ETF space. So, so far, how is talking with investors going? And really, how are you trying to position this in the overall market to try and start getting distribution? Because as we've seen, there are so many funds entering the marketplace. It's becoming very noisy and crowded. So I would love to hear how you're trying to reach advisors or investors.

Yeah. So, I think, to be honest, I think our marketing folks could answer this a little better than I could at this point. And the reality is, it's been so early. It's so early right now. It's really hard to say how things are going so far because it's been literally, months. And I believe our focus is generally on, say, large RRAs, bank trusts, broker-dealers, and really, any individual that's kind of the do-it-yourself investor. So I think time will tell what the interest level is going to be. But I think at this stage, it's really just too early to give you, clarity on that.

Well, Ryan, congratulations on the launch. I know it's, it's definitely exciting and, it's a way for the firm to kind of continue its legacy, even though it's been kind of in the SMA business for so long. It's kind of a new chapter. So it's exciting for you guys. But I really appreciate your time here with me today. But before I let you go, where can people learn more about the firm and where can they find information on your ETFs?

Yeah, the best place is our website, hwcm.com. It has a bunch of information on the ETF and our other strategies. We also have a LinkedIn page where we post content occasionally. So you just search for Hotchkiss and Wiley Capital Management on LinkedIn. All right. Well, again, Ryan, thanks so much for being with me.

Yeah, I appreciate you having me. I enjoyed it.

I enjoyed it. I enjoyed it.