Herndon execs stick with process, say firm will rebound

Herndon Capital Management has been hemorrhaging clients, with several asset owners citing performance as the reason they dropped the Atlanta-based manager that largely focuses on large-cap equities.

But the company's executives say they are confident in its investment strategy of fundamental, bottom-up, stock research and are certain things will turn around. They plan to stay the course.

Herndon Capital, a minority-owned firm that is 55% owned by Atlanta Life and 45% owned by its partners, is an active long-only manager. Its flagship offering is a large-cap U.S. value equity strategy.

“We saw some downside in the performance of our flagship strategy, which has resulted in some attrition,” said Drake Craig, a principal, portfolio manager and president of Herndon Capital in a phone interview. “It's the normal part of the asset management business.”

There was a stretch where the boutique manager was on a roll. Data from Pensions & Investments Research Center data the firm's global AUM had been on the rise from year-end 2008 to year-end 2013.

“We experienced impressive (AUM) growth earlier prior to the past two years,” said Mr. Craig.

An investment banker that Pensions & Investments spoke with agreed.

“They were on a hot streak three years ago,” he said.

That hot streak came to an end in 2013. Herndon Capital's AUM has been cut in half in just two years. The manager's global assets under management totaled $5.15 billion at Dec. 31, 2015, down nearly 50% from $10.21 billion just two years earlier.

Although he hadn't been following Herndon's specific situation, one executive recruiter who asked not to be named said it is “not a good time to be an active, long-only manager” with subpar performance.

And performance for the firm's flagship strategy has been poor. Data from eVestment LLC show Herndon's large-cap U.S. value equity strategy returned -8.55% for the year ended March 31, vs. -1.54% for its benchmark, the Russell 1000 Value index. Its three-year annualized return was 4.15%, vs. 9.38% for its benchmark; its five-year annualized return was 6.81%, vs. 10.25% for its benchmark.

Examples of some recent client actions include:

• In March, the $1.2 billion Chicago Metropolitan Water Reclamation District Retirement Fund cut its allocation to large-cap equity manager Herndon in half, or roughly $20 million, because of performance concerns.


• In October, Illinois State Universities Retirement System, Champaign, terminated Herndon, which managed $159.4 million in non-U.S. developed markets equities for the $16.3 billion defined benefit fund, because of underperformance.


• Also in October, Springfield-based Illinois Teachers' Retirement System terminated Herndon, which experienced performance problems in the $272 million active U.S. large-cap core strategy it managed for the $46 billion pension fund.


• In September, the $15.2 billion Illinois State Board of Investment, Chicago, terminated the manager, which ran $118.4 million in active large-cap core equities, for performance reasons.


• In August, the $2.3 billion Oklahoma Firefighters Pension & Retirement System, Oklahoma City, terminated Herndon Capital as an active domestic large-cap value equity manager because the system disagreed with Herndon's decision to keep the system's $75 million portfolio overweight to energy.

Also, this past March, the $110 million Miramar (Fla.) Firefighters' Pension Fund began a search for an active domestic large-cap value equity manager to run $13 million because of performance-related concerns with Herndon. Herndon has not been terminated and was invited to rebid.

The same month, the $35 million Dania Beach (Fla.) Police and Fire Retirement System issued an RFP for an active domestic large-cap value equity manager to run $5 million due to the underperformance of its current manager Herndon. The firm was invited to rebid.

It could not be learned by press time if either of the Florida-based pension systems have hired managers for these allocations.

Mr. Craig explained that timing has been a factor, pointing out that several of the terminations were from recent clients who came on board just as performance was slipping.

In the same phone interview with Mr. Craig, Randell A. Cain Jr., a principal and portfolio manager, said Herndon Capital's flagship strategy started underperforming in 2014 because it was overexposed to energy and underweight to defensive positions.

“That's put us in the penalty box,” said Mr. Cain.

That said, Messrs. Craig and Cain argue that any manager with a disciplined process — which, in Herndon's case, is a bottom-up approach driven by stock analysis, will see their process fall out of favor from time to time.

Mr. Cain explained that staffers are working with client service and marketing to assure clients that “nothing is wrong with Herndon, but there will be times where some things in our portfolio will fall out of favor.”

He added that just because the firm is seeing some lean times doesn't mean it's a good idea to steer the ship in a different direction.

“If we were to change it would mean we don't have a discipline, don't have a philosophy, and don't have a strategy,” said Mr. Cain. “And that is a death knell for someone in the management industry.”