Taking the Cap off Large Caps

After I. P. “Kip” Knelman retired as CEO of Minneapolis-based Investment Advisers, Inc. (IAI), in 1998, he spent a year considering other business opportunities. But he recognized that investment management was still his true calling and set up shop as Knelman Asset Management, not far from IAI’s former headquarters. Teaming with Jim Tatera (former chief equity strategist for Advantus Capital Management in St. Paul) and Aaron Walters, Knelman built his firm’s asset base to more than $300 million by 2004.

Then Lazard, the New York financial-advisory and asset-management giant, came calling. Lazard was mulling the expansion of its already prodigious investment offerings—the firm currently has more than $93 billion in assets under management—to include large- and small-capitalization growth stocks, Knelman’s investment specialty. After lengthy discussions, Knelman’s firm was acquired and folded into Lazard in February 2005, greatly expanding its reach, technology platform, and potential asset base.

We asked Knelman how the current market is affecting his specialty.

{Q} Large-cap growth stocks have been lackluster. What do you think will trigger a resurgence?

{A} I think what we saw in the last three months was some recognition that there is significant risk in a number of the asset classes that have been extremely popular and have provided strong performance over the past few years. At some point, investors are going to recognize that there is significant risk in some of these investments and are going to look at asset classes that have underperformed and that are cheap on a relative basis. We are believers in regression to the mean, and sooner or later, large companies outperform small- and mid-cap stocks.

{Q} Has much money been funneled into alternative assets, such as gold, other metals, and real estate?

{A} There has been a significant amount of money moving into alternative asset classes and nondirectional asset classes—hedge funds, which are meant to capture excess return regardless of the direction of the market. Not only has the emergence of hedge funds had an impact, but so have exchange-traded funds, or ETFs, which buy baskets of stocks in a given sector, industry, or market. That’s good if you own the underlying securities that the ETFs are buying. However, if we should experience a downturn in the market, those securities are going to be sold.

{Q} How have you positioned your portfolio to capture whatever excess return is available?

{A} First of all, we consider ourselves opportunistic investors. When we look at the market—whether that’s measured as the Russell 1000 Growth Index or the Russell 2000 Growth Index; we’re agnostic to our benchmark—we don’t look at the weightings in those indices and try to replicate a portion of that index to control our variability. We try to add value by finding companies we believe are going to be growing their top and bottom line through what we call operating momentum. We’ve been able to do that. One of the differentiators that we have relative to other growth managers is that we approach those opportunities with a clean slate. Many managers start by screening for traditional growth companies—technology, communications, and health care. We think we can find that strong top and bottom line in other sectors.