00:00:14
Speaker 1: Welcome to Inside Active, a podcast about active managers that goes beyond soundbites and headlines and looks deeper into the processes, challenges, and philosophies in security selection. I'm David Cohn. I lead mutual fund and active research at Bloomberg Intelligence. Some of the market's biggest companies started out much smaller, but investing in small and mid-cap growth companies isn't simply about trying to find the next company. They'll become a household name. These businesses can be earlier in their growth trajectories with less established track records and greater uncertainty about what their business may ultimately become. That can create opportunities for active managers, but that also puts a premium on determining which companies can sustain their growth and, just as importantly, what the market already expects from them. So today, I wanted to explore how an active manager approaches that challenge, how potential investments are identified in research, how sustainable growth is separated from short-term momentum, and how expectations and valuation factor into security selection and how those individual ideas come together in a portfolio. Joining me to discuss that is Brandon Nelson, Senior Vice President and Portfolio Manager at Calamos Investments, including the Calamos-Tapani Small Cap Growth Mutual Fund, ticker CTSIX, and the Calamos-Tapani Active SMID Growth Strategy, which just actually converted from a mutual fund to an ETF this week with the ticker CTAG, or C-T-A-G, and is actually the first active mutual fund ETF conversion on the Texas Stock Exchange. Brandon, thanks for joining me.
00:01:46
Speaker 2: Yeah, thanks for having me.
00:01:48
Speaker 1: So, you know, your investment philosophy is kind of described as fundamental momentum. What does that mean to you? And what does a company with fundamental momentum look like? Right.
00:01:59
Speaker 2: It's really got two components to it. So the first component is sustainable growth. So companies that aren't just growing for a quarter or two, but have the sort of profile that they can sustain growth for many quarters and hopefully many years. That's part one of fundamental momentum. And part two is very importantly, companies that know how to manage expectations. So we're looking for underestimated growth as well. We want to invest in management teams that know what it's like to be in the public limelight. And it's very important to be able to Do what you say you're going to do. And we find that managing expectations is sometimes just as important as running the business and the operational side of things. So fast growth and underestimated growth equals fundamental momentum. Okay.
00:02:52
Speaker 1: And out of those two, what do you think is harder to identify and kind of what gives you the confidence that you're right when the market might be wrong?
00:03:00
Speaker 2: I think of the two underestimated growth is more difficult to find. Yeah. I think it's easier to identify, you know, open-ended fast growth situations, but it's a whole nother thing to execute on that and to, you know, again, do what you say you're going to do. And that I think is really, that's where our research comes into play. And we, we meet with a lot of management teams and we try to, sort of get inside their head and try to understand what's important to them so that we're looking for favorable setups where that sustainable growth profile is there, but also where management teams seem to have a sensitivity to managing expectations. And it's really when you get those two things together, that's where kind of the magic happens. The market really likes those characteristics, fast growth and underestimated growth. And it'll pay a premium for companies that have that profile. So we're all about trying to find companies that are in the early stages of demonstrating that profile and then riding that wave of them getting re-rated from maybe, let's say, a 14 times PE ratio when that process started. Fast forward seven, eight, nine quarters, and maybe you're trading at a PE ratio of 35 times. And that's where you really find the big winners.
00:04:22
Speaker 1: Okay. You know, I've always heard a great company doesn't always turn out to be a great stock. How do you distinguish between the two when you're evaluating a potential company?
00:04:32
Speaker 2: Yeah, I agree with that completely. Yeah, sometimes great companies are slow growing, not exceeding expectations. That doesn't mean you're a bad company if you're not showing fundamental momentum. But what we think drives stock prices the most, and at the end of the day, that's really what we care about as portfolio managers, is really what I said before. It's that fundamental momentum profile. And it's that fast growth and underestimated growth profile. And if you don't have it, you still might be a great company, but you're just not great for our portfolios. And you might be kind of a mediocre stock if you're not showing those characteristics.
00:05:14
Speaker 1: Okay. You know, you've been managing or investing in small and in SMID cap growth companies for a while. I don't want to age you, so I won't guess the year. But you've used essentially the similar philosophy throughout that period. What have you learned over that time about where the market is most likely to misprice growth?
00:05:37
Speaker 2: I think the most important maybe lesson I've learned in investing all those years, I don't know if it really answers your question directly about mispriced growth, but I think the, one of the first things I learned about investing, especially with this sort of investment process is sell discipline is really important and falling in love with your stocks is can be the kiss of death. And it's so easy to do. Just as humans, we have this tendency to get emotionally attached to stocks and we sort of lose our objectivity and we make bad decisions as a result. And we try to be unemotional and very objective. And we have this set of rules that relate to fundamental momentum. And when the companies violate those rules, you have to have an open mind and a willingness to reduce exposure to those stocks. Again, they might still be great companies, but they're possibly no longer going to be great stocks going forward. And it's important to distinguish between those two things. So biggest lesson learned is don't fall in love with your companies and have an open mind and a willingness to recognize the thesis may have changed from when you first purchased the stock and had success with the stock. And you have to just acknowledge that and know that, you know, going forward, it may not be wise to keep that investment in the portfolio.
00:07:03
Speaker 1: Okay. No, it makes a lot of sense. And, you know, we've kind of gone over the philosophy a little bit and set the stage. But, you know, one of the things I'd love to do on this podcast is kind of get into the whole process. So if you could kind of take us through your investment process from the beginning, you know, with thousands of small companies you could potentially invest in, you know, how do you narrow that new universe down to companies that deserve deeper research? Yeah. Yeah.
00:07:26
Speaker 2: And I'm glad you mentioned that because I think there's a perception that there really aren't many stocks available to choose from. You know, private equity has really become a big asset class over the years and it's legit, not knocking it, but there seems to be this narrative that, you know, companies, they're just, there's so few stocks for folks like me to even choose from. How could you possibly come up with a portfolio of stocks that could appreciate and value. And I can tell you again, from a 30-year perspective, there's no issue from where I sit. We're finding great ideas all over the place. Maybe there's fewer stocks public today than there were 10, 20 years ago, but there are still hundreds and hundreds of publicly traded stocks. And we're not dependent on IPOs, for instance, to come up with new ideas for our portfolio. So that's just kind of a side note, I guess, on what I'll tell you about our specific process. But yeah, you know, we start with a large opportunity set, call it 1500 plus stocks in the small cap and mid cap growth space. We have, you know, this tier one criteria. I mentioned this fundamental momentum criteria. We're really picky about the stocks we're choosing, you know, really only maybe about 10% of that universe of stocks. checks the boxes for what potentially could go in the portfolio. And it's from that sort of subset of, call it 150 to 200 stocks, where we really sort of roll up our sleeves and do much more in-depth research, myself and my teammates, to come up with a portfolio of 80 to 120 stocks. And so it's the fundamental momentum characteristics I mentioned, fast growth, underestimated growth, We also want to make sure the market is embracing the idea too. So we do pay attention to sort of the stocks, how the stock is being received in the marketplace. And we want to make sure the market is in a place where it's embracing that fundamental momentum that we're identifying. And it's really where you get the fundamental momentum marrying up with a market that's willing to embrace the idea. That's when you find the big winners. And so we're very much honed in on trying to find all those stars to sort of align. And we're good at finding big winners. And very importantly, we're good at letting them run. That's a big mistake investors make is they sell their winners too soon. And on the flip side, they keep their losers too long. Bad investment, you're hanging on to it, just hoping to get back to even someday. We look at it the other way. We say, wrong stock, wrong time. We run into trouble too, just like everybody else. But the way we handle it is sort of cut losses quickly, let it be a scratch or a bruise on the portfolio, but don't let it ruin the whole year. and double down and triple down on the exposure on a losing situation. So find big winners, let them run and cut your losers quickly. That's really the name of the game. And that's how we approach investing, you know, day to day. I'm covering a lot of ground with you just on, you know, investment process. Some of that is investment process and some of that is almost a investment philosophy, but it all kind of comes in together and intertwines on a day to day basis. So hopefully that helps explain. No, definitely.
00:10:49
Speaker 1: It, You alluded to management earlier, and I'm going to ask you about that next. But, you know, is there once these companies have your attention, you know, what exactly are you looking at to kind of give you those answers that you might not get just from looking at financial statements?
00:11:03
Speaker 2: Yeah, as it relates to management teams, especially in the small cap space, you know, management teams are a really big deal. They tend to move the needle a lot in terms of how the stock is actually going to ultimately perform. And it really relates, I'd say the most to that idea of underestimated growth, you know, management teams, there's some management teams and I've seen it all over the years where on one extreme, they'll say, you know, we have, we don't really care what the market looks at. We don't, we don't care if our growth is underestimated or not. We're just going to do what we're going to do. And if it's better than people think, so be it. If it's worse than people expect, so be it. We don't care. Like that's, red flags all over the place for us if we're hearing that. If instead they're like, okay, we've got a conservative philosophical approach, we've given guidance, but we've not included a new product that we're rolling out next year because we don't know how good that product is going to be and therefore just out of conservatism, let's just not include it. And so they're very cognizant of sort of this idea of managing expectations and making sure they don't fall short of whatever the expectations are that are out there. So that's where the management team, I think, probably shows itself the most in the importance of management teams. And that ripples through to the sell side analyst estimates too. Let's face it, a lot of these analysts that are publishing research are using management's sort of guidance to determine where their models should end up being. And so there's this sort of domino effect of, You know, management teams that are conservative and have sensitivity to managing expectations, they tend to be, you know, just very important on a lot of levels, I guess, in terms of, you know, checking the box of fundamental momentum.
00:12:55
Speaker 1: With the, you know, underestimated growth, how do you measure what the market already expects from a company? And, you know, how large, I guess, is the gap between your expectations and the market needs or what the market expects, you know, for it to actually become interesting?
00:13:10
Speaker 2: No, that's a good point because if it's just a minor upside situation, let's say the company is expected to grow 10% and we think they're really going to do 11%, I don't know if that's enough to get us excited. But if it's 10% growth expected, but we think they're going to do 23%, okay, now that's much more meaningful. And I'm talking like over the course of a year. that's likely to result in that valuation multiple expansion that I mentioned earlier, where if the company's growing fast and exceeding expectations meaningfully, that's going to have a direct result in terms of the magnitude of that re-rating that the stock is likely to see. So it is important. We look for fast growth, but we also look for underestimated growth. And just to really bring the point home, You know, we would actually pass on a faster growth situation where there's minimal upside. So I would not buy a stock that's growing where the company's growing 40%, but they're likely to do, you know, actually put up 37% growth. I would pass on that stock. I'd rather buy a stock where growth is expected to be 18% and they're going to do 25% growth, lower growth rates in that example. but underestimated growth. And so that's really, again, where kind of the magic happens. So you have to have a growth rate above a minimum for in sort of a normalized economy. We like to see at least 10% revenue growth, at least 15% earnings per share growth. Averages are much higher than that, but that's kind of what we're thinking for a minimum growth rate. And then for revision potential, I'd say at least 10% revision, positive revision potential over the course of the four or 12 months.
00:15:07
Speaker 1: That's interesting. How does valuation fit into the equation? I mean, can you have a company that has exactly what you're looking for, but might just be simply too expensive to own?
00:15:17
Speaker 2: We do pay attention to valuation, but it is not a tier one sort of consideration. We don't let valuation sort of drive the bus on our decision making. A lot of stocks that look expensive are stud performers, right? They end up being monster performers despite looking expensive. And part of the issue is, yeah, they might look expensive on the consensus estimates, but they reported way more than the consensus estimates. And so what looked to be a high valuation multiple at the time you were looking at it ended up not really being that high when you plugged in what they really ended up doing in earnings. These are stocks that get valued on forward earnings and forward EBITDA. expectations, forward sales. And so to the extent there's upside to all those metrics, there's downside to the valuation. So evaluation can be kind of tricky. Again, we pay attention to it. We get most nervous about stocks where we're sensing fatigue in the fundamental momentum profile at the same time that we're seeing elevated valuation multiples. So maybe it's already gone through that re-rating process, that positive re-rating process. And now we're starting to see some fatigue and maybe a little weakness in that fundamental momentum profile. It's time to reduce exposure when we see those characteristics all kind of come into play. So again, we use it, but we don't let it trick us. Valuation, that is, we don't let it trick us into not buying stocks that look expensive up front. At the same time, sometimes valuation tricks people into not selling their losers. They say, oh, I can't sell this stock It's so cheap. Well, maybe it's not as cheap as it looks because that company is going to miss estimates in the multiples a lot higher than it looks. So it can go the other way, too. So I think valuation just I just don't think it should be a sort of decision. I don't think it should drive by and to sell. And I don't think it should drive by or sell decisions. There we go.
00:17:27
Speaker 1: Okay, no, makes sense. You know, I mean, smaller companies, I think, can, you know, they obviously have tremendous growth opportunities, but, you know, some of them also can have, you know, greater business or financing risk. How do you kind of distinguish between a company that's, you know, early in, you know, say a durable growth trajectory versus one that, you know, where the numbers simply look good temporarily?
00:17:47
Speaker 2: Yeah, as far as like financing goes, you know, most of the stocks we invest in, a lot of them are self-funding their growth. And that's important. And for the ones that aren't able to self-fund their growth, maybe their earlier stage, they're still building out their infrastructure, let's say, they've got something special, at least the ones we invested. And investors are very willing to get capital to them in order for them to build their business. These aren't just like plain vanilla, you know, small companies and mid-sized companies. These are up and coming companies. companies that have something special, some unique good or service that they're selling. And investors are excited to give them capital to build their business. And so I find that it's not usually an issue. Well, first of all, our companies that we invest in do tend to be much more profitable than the average small cap company. So that's something I probably should have said right off the bat. And they also tend to have less financial leverage. But in cases where they need capital, They usually don't have a problem getting it because they're very exciting, sort of sexy growth stocks where investors are seeing a really positive potential return on that capital. Okay.
00:19:03
Speaker 1: Once you have a company that meets all of your criteria, how do you determine the position size in a portfolio? What would earn a stock a large position?
00:19:13
Speaker 2: Great question. It does depend on, you know, maybe the history we have with the stock. If we've owned it before and we're more familiar with it, there's a willingness to maybe make it a bigger position faster. But I'd say for most situations, you know, we'll start at maybe a 50 basis point position in the portfolio and then we'll watch it closely. We'll, you know, we have our finger on the pulse of these companies and, you know, we're paying attention to all the data points. We're scrubbing the quarterly earnings reports, and we're just going from there. At the same time, we're also monitoring the market reception to those stocks too. And we're monitoring those data points on a daily basis. And so if maybe it starts at 50 basis points and we see a great quarter of execution, let's say it's growing fast, beating expectations, there's very much a willingness to take it up to maybe a 1% or 1.3% position in the portfolio and then go from there. Hopefully it's appreciating at the same time. And so you end up seeing this sort of natural lift of weight in the portfolio as a company, as the quarters go by and the execution is there and the company is being embraced by the market, that 50 basis point position evolves between the market appreciation and us buying more. Before you know it, sometimes it's, you know, 2% plus position, you know, within six months. And so that's very common for it to sort of play out that way. And then, of course, you know, very, again, cannot emphasize enough the importance of sell discipline and just, you know, monitoring the portfolio constantly. One thing I didn't mention before, which is really important, everybody probably always says, you know, they're great at buying stocks and great at selling stocks. We actually took it another level when we're talking about our sell discipline. The thesis was, or the theory was, hey, if we're so great at selling stocks, they probably should be poor performers after we sell them. Well, the data supports that. We ran all that. We've been running that data for years. And sure enough, stocks we sell out of our portfolio persist as losers in the six months after we sell it, 12 months after we sell it, and not just by a little bit. They end up being you know, meaningful losers relative to our benchmark. So there's just to add some meat to the bones, I guess, to say the sell discipline adds a lot of value. I think we're really good at buying stocks and letting them run, but I think we're exceptionally good at selling stocks and, you know, avoiding trouble or lessening trouble.
00:21:52
Speaker 1: I'm not hearing, you're not planning on adding a short component, are you? Like a shorting component?
00:21:56
Speaker 2: No, we've been asked that. We have been asked that many times over the years.
00:22:00
Speaker 1: Yeah.
00:22:01
Speaker 2: We maybe should have done that a long time ago, but no, we're long only. But yeah, it's a logical follow-up question. We probably should be shorting those stocks that we're selling because again, if they're falling later.
00:22:15
Speaker 1: That's pretty cool. I mean, that's obviously a different type of skill, but it's cool that it works that way. When I was going through the documentation of the two strategies, one of the things that kind of struck out or struck out for me or that I noticed was kind of in the SPID strategy, it said you expect roughly 90% of the value added to come from security selection rather than sector kind of allocations. So I guess my question is, how do you keep a bottom-up portfolio like this from unintentionally becoming a large bet on a particular sector or even a factor?
00:22:48
Speaker 2: It's always a mixture of sector, or sorry, selection and sector allocation. exposures and factor exposures, of course, where we spend our time is on and where we think we add the most value is on the bottom up, you know, company interactions and just having our finger on the pulse. We're intentionally trying to find stocks that aren't that sensitive to the Fed's next move or GDP being, you know, plus one or plus three percent. You know, it's just it's we want to find stocks that are really in their own bull market and you know, have that profile where they're going to grow fast. They're going to likely beat and raise. And the macro is just kind of a rounding error on what, what that outcome is going to be. It's, it's not that they're immune from the macro, but maybe the macro, a bad macro knocks the 25% growth down to 23%. But it doesn't derail the growth profile meaningfully. So that's where we spend our time. I think that's where we add the most value. The sector exposures are really just a fallout of that bottom-up effort. And we're not afraid to have deviation from our benchmarks as far as sector exposure. So that inevitably does result in some value add or value subtraction at the sector level. But it's really the portfolio decisions are driven mostly by bottom-up research and really the outlook for these company-specific situations. But, you know, we do have themes. You know, AI infrastructure has been a pretty big theme for us the last three years. That shows up in some of the technology exposure and industrial exposure. So that's definitely elevated the sector weights in those two sectors over the last three years or so. But it's, you know, it also, it doesn't have to be thematic either. You know, our financial services exposure right now is, higher than it normally would be and it's just because we happen to have found a few kind of one-off financial services stocks that meet the fundamental momentum growth profile and that's taken the sector weight up and so you know to some extent financials as at the sector level is going to be showing up as a value adder detractor within our sector sector attribution but It's not the primary focus. It's really, again, more of the company specific bottom up focus that drives the value add.
00:25:29
Speaker 1: So, you know, I did want to also ask kind of the difference between the portfolios, obviously you have a small cap and then the SMID. And, you know, how does expanding the opportunity set from small caps into mid caps kind of change the types of companies you find and the way you construct that portfolio?
00:25:44
Speaker 2: Yeah. And we've had mid cap, you know, we've invested in mid caps for most of my career. Um, I think mid caps inherently, because they're a little bit more mature than the small cap companies, they, they sometimes aren't growing as fast. You know, they tend to have more analyst coverage. Um, and so there's probably less inefficiency, uh, in terms of, you know, where those stocks are priced, but there, I, you know, my career, we have found some huge mid cap winners as well. So, um, I think what we do works really well in small growth and mid-growth. And that's, yeah, it's just more of a matter of sort of how extreme is the sort of inefficiency at the mid-cap level versus small cap level. And it's still extreme enough where I think there's opportunities to exploit. So I think it makes a lot of sense to have exposure to both. And we've had a lot of success. investing in Bullock over the years.
00:26:51
Speaker 1: Makes sense. You know, one of the things I've been observing and, you know, my colleagues have as well, and I've actually written about it a little bit is, you know, small caps really have spent much of the past decade lagging their large cap peers. And, you know, but the relative performance has kind of changed a bit, you know, over the last few months and this year. And, you know, from the perspective of a stock picker, do you think the, has the quality of the opportunity set in small cap growth changed? recently?
00:27:18
Speaker 2: I don't think so. I guess that touches a little bit maybe on the earlier conversation of perception that there's a scarcity of ideas. You're right though. Small caps have lagged large caps for, it's actually been nine years in a row. If you can believe it, the Russell 2000 has lagged the Russell 1000. I don't know if that's so much that small caps have been bad as so much as the mega caps have been just sensational. But you're right. Things have changed. Really, you could almost pinpoint it to a day specifically last year in 2025. It was, you know, I think it was April 9th or something like that is when small caps started to take more of a leadership role. And this is just I'm speaking relative now. It's not that large caps have gone down. But, you know, looking back like 100 years or so, you'll see small caps will lead over large caps for decades. multiple years in a row and then large caps will lead over small caps for multiple years in a row and they take turns. So this could be, you know, early days of a big up cycle for small caps, you know, probably a little bit too soon to say, but very importantly, the earnings are there and everyone's probably, you know, we've heard a lot of talk in recent months about this is a very strong earnings environment. It's been strong for small caps as well as large caps and mid caps. But the difference, I guess, and maybe what's finally happening here is, you know, small caps have looked really inexpensive relative to large caps for many years, but they didn't have the earnings momentum. And that was kind of the missing piece. And that's why they stayed cheap for so long. They're still cheap. They're not quite as cheap as they were relative to large caps, but importantly, they have tremendous earnings momentum. They're scheduled to grow, and these numbers change all the time, but small caps are scheduled to grow about 15% in 2026 and are poised to accelerate to about 17% last I looked in 2027. So those are great growth rates, and to actually see an acceleration of growth expected at least in 2027, it might cause small caps to close the gap even further with large caps in terms of the valuation. And it could lead to a sustained... leadership in small caps but what I like about what we do is you know we're not dependent on that happening for us to win again we're all about bottom up stock picking and positioning and you know small caps lagged large caps big time in 2024 in 2025 and we put up big time points on the board. Despite that, you know, we didn't need small caps to beat large caps for us to do well. And this year we're doing very well and small caps are beating large caps. And so it's, it's, it doesn't determine necessarily what, how we're going to do, but I think it would, you know, it would probably be a tailwind overall if small caps sustained a leadership role going forward, but it's tough to predict that. And I'm glad we're not living and dying with, with that happening.
00:30:31
Speaker 1: I mean, it's definitely a good point. I think it's just from outside looking in, it's kind of interesting for me as a, you know, as I cover managers to watch, but probably doesn't make as big of a deal for the actual managers. So it's definitely good. And I know you kind of alluded to this earlier where, you know, the lack of IPOs has kind of created the sentiment of, you know, at least in the media and I think with some other folks where, you know, there's just a lack of small cap companies to choose from and But beyond that, is there anything else you think that investors misunderstand most about investing in small cap growth?
00:31:07
Speaker 2: I think they just underestimate the potential. Small cap as an asset class is littered with future big winners. And yes, there are big losers waiting in the wings as well. And so the opportunity is just enormous. But you have to be careful. You have to pick your spots. You have to have a really strict sell discipline. So if you're going to traffic in those types of stocks that have big upside and big downside potential, you better have a strict sell discipline where you're managing risk. And we have all that. But I just think in general, people are just, it seems like they're very dismissive of small caps in general. And they find all sorts of reasons to just ignore the asset class and you know, oh, you know, interest rates are rising. That means, you know, small caps are going to zero, right? Like, no, there's no IPOs anymore. That must mean you have zero ideas, right? Because you're completely dependent on the IPO market. Completely wrong, barely at all, even dependent on the IPO market for new idea generation. It's a rounding error on new idea generation potential. So I just think there's maybe some lazy thinking out there that, it's almost like they want to dismiss the small cap asset class, but I just think it's a huge mistake because again, that's where your big winners, the likelihood of finding a big winner is so much higher in the small cap space than it is in the large cap space. And so it's an asset class is very much worth paying attention to. And I put my money where my mouth is too. I've got substantial personal capital exposed to the funds we manage in small and mid cap stocks. possibly, you know, uh, too much, but, but it's, uh, I just see it like, you know, it doesn't matter what interest rates are doing. In my opinion, it's just about like, these are inefficiently priced stocks and there's just home run potential all over the place, but it's, you know, it's, it is a tricky asset class to navigate. Got to know what you're doing. And, um, you know, like I believe in what we're doing. It's a proven, repeatable process that we've been implementing now over 30 years. And the results, I think, show that.
00:33:30
Speaker 1: No, that's great. I think that's a great place to end here. This was a lot of fun, though, Brandon. I really appreciate you joining me today.
00:33:37
Speaker 2: Yeah, my pleasure.
00:33:39
Speaker 1: I also want to thank our listeners. If you liked the episode, please share, subscribe, and leave a review. And if you'd like to see more of our research on The Terminal, Please go to BIFundGo for U.S. fund and active research. Until our next episode, this is David Cohn with Inside Active.
Speaker 1: Welcome to Inside Active, a podcast about active managers that goes beyond soundbites and headlines and looks deeper into the processes, challenges, and philosophies in security selection. I'm David Cohn. I lead mutual fund and active research at Bloomberg Intelligence. Some of the market's biggest companies started out much smaller, but investing in small and mid-cap growth companies isn't simply about trying to find the next company. They'll become a household name. These businesses can be earlier in their growth trajectories with less established track records and greater uncertainty about what their business may ultimately become. That can create opportunities for active managers, but that also puts a premium on determining which companies can sustain their growth and, just as importantly, what the market already expects from them. So today, I wanted to explore how an active manager approaches that challenge, how potential investments are identified in research, how sustainable growth is separated from short-term momentum, and how expectations and valuation factor into security selection and how those individual ideas come together in a portfolio. Joining me to discuss that is Brandon Nelson, Senior Vice President and Portfolio Manager at Calamos Investments, including the Calamos-Tapani Small Cap Growth Mutual Fund, ticker CTSIX, and the Calamos-Tapani Active SMID Growth Strategy, which just actually converted from a mutual fund to an ETF this week with the ticker CTAG, or C-T-A-G, and is actually the first active mutual fund ETF conversion on the Texas Stock Exchange. Brandon, thanks for joining me.
00:01:46
Speaker 2: Yeah, thanks for having me.
00:01:48
Speaker 1: So, you know, your investment philosophy is kind of described as fundamental momentum. What does that mean to you? And what does a company with fundamental momentum look like? Right.
00:01:59
Speaker 2: It's really got two components to it. So the first component is sustainable growth. So companies that aren't just growing for a quarter or two, but have the sort of profile that they can sustain growth for many quarters and hopefully many years. That's part one of fundamental momentum. And part two is very importantly, companies that know how to manage expectations. So we're looking for underestimated growth as well. We want to invest in management teams that know what it's like to be in the public limelight. And it's very important to be able to Do what you say you're going to do. And we find that managing expectations is sometimes just as important as running the business and the operational side of things. So fast growth and underestimated growth equals fundamental momentum. Okay.
00:02:52
Speaker 1: And out of those two, what do you think is harder to identify and kind of what gives you the confidence that you're right when the market might be wrong?
00:03:00
Speaker 2: I think of the two underestimated growth is more difficult to find. Yeah. I think it's easier to identify, you know, open-ended fast growth situations, but it's a whole nother thing to execute on that and to, you know, again, do what you say you're going to do. And that I think is really, that's where our research comes into play. And we, we meet with a lot of management teams and we try to, sort of get inside their head and try to understand what's important to them so that we're looking for favorable setups where that sustainable growth profile is there, but also where management teams seem to have a sensitivity to managing expectations. And it's really when you get those two things together, that's where kind of the magic happens. The market really likes those characteristics, fast growth and underestimated growth. And it'll pay a premium for companies that have that profile. So we're all about trying to find companies that are in the early stages of demonstrating that profile and then riding that wave of them getting re-rated from maybe, let's say, a 14 times PE ratio when that process started. Fast forward seven, eight, nine quarters, and maybe you're trading at a PE ratio of 35 times. And that's where you really find the big winners.
00:04:22
Speaker 1: Okay. You know, I've always heard a great company doesn't always turn out to be a great stock. How do you distinguish between the two when you're evaluating a potential company?
00:04:32
Speaker 2: Yeah, I agree with that completely. Yeah, sometimes great companies are slow growing, not exceeding expectations. That doesn't mean you're a bad company if you're not showing fundamental momentum. But what we think drives stock prices the most, and at the end of the day, that's really what we care about as portfolio managers, is really what I said before. It's that fundamental momentum profile. And it's that fast growth and underestimated growth profile. And if you don't have it, you still might be a great company, but you're just not great for our portfolios. And you might be kind of a mediocre stock if you're not showing those characteristics.
00:05:14
Speaker 1: Okay. You know, you've been managing or investing in small and in SMID cap growth companies for a while. I don't want to age you, so I won't guess the year. But you've used essentially the similar philosophy throughout that period. What have you learned over that time about where the market is most likely to misprice growth?
00:05:37
Speaker 2: I think the most important maybe lesson I've learned in investing all those years, I don't know if it really answers your question directly about mispriced growth, but I think the, one of the first things I learned about investing, especially with this sort of investment process is sell discipline is really important and falling in love with your stocks is can be the kiss of death. And it's so easy to do. Just as humans, we have this tendency to get emotionally attached to stocks and we sort of lose our objectivity and we make bad decisions as a result. And we try to be unemotional and very objective. And we have this set of rules that relate to fundamental momentum. And when the companies violate those rules, you have to have an open mind and a willingness to reduce exposure to those stocks. Again, they might still be great companies, but they're possibly no longer going to be great stocks going forward. And it's important to distinguish between those two things. So biggest lesson learned is don't fall in love with your companies and have an open mind and a willingness to recognize the thesis may have changed from when you first purchased the stock and had success with the stock. And you have to just acknowledge that and know that, you know, going forward, it may not be wise to keep that investment in the portfolio.
00:07:03
Speaker 1: Okay. No, it makes a lot of sense. And, you know, we've kind of gone over the philosophy a little bit and set the stage. But, you know, one of the things I'd love to do on this podcast is kind of get into the whole process. So if you could kind of take us through your investment process from the beginning, you know, with thousands of small companies you could potentially invest in, you know, how do you narrow that new universe down to companies that deserve deeper research? Yeah. Yeah.
00:07:26
Speaker 2: And I'm glad you mentioned that because I think there's a perception that there really aren't many stocks available to choose from. You know, private equity has really become a big asset class over the years and it's legit, not knocking it, but there seems to be this narrative that, you know, companies, they're just, there's so few stocks for folks like me to even choose from. How could you possibly come up with a portfolio of stocks that could appreciate and value. And I can tell you again, from a 30-year perspective, there's no issue from where I sit. We're finding great ideas all over the place. Maybe there's fewer stocks public today than there were 10, 20 years ago, but there are still hundreds and hundreds of publicly traded stocks. And we're not dependent on IPOs, for instance, to come up with new ideas for our portfolio. So that's just kind of a side note, I guess, on what I'll tell you about our specific process. But yeah, you know, we start with a large opportunity set, call it 1500 plus stocks in the small cap and mid cap growth space. We have, you know, this tier one criteria. I mentioned this fundamental momentum criteria. We're really picky about the stocks we're choosing, you know, really only maybe about 10% of that universe of stocks. checks the boxes for what potentially could go in the portfolio. And it's from that sort of subset of, call it 150 to 200 stocks, where we really sort of roll up our sleeves and do much more in-depth research, myself and my teammates, to come up with a portfolio of 80 to 120 stocks. And so it's the fundamental momentum characteristics I mentioned, fast growth, underestimated growth, We also want to make sure the market is embracing the idea too. So we do pay attention to sort of the stocks, how the stock is being received in the marketplace. And we want to make sure the market is in a place where it's embracing that fundamental momentum that we're identifying. And it's really where you get the fundamental momentum marrying up with a market that's willing to embrace the idea. That's when you find the big winners. And so we're very much honed in on trying to find all those stars to sort of align. And we're good at finding big winners. And very importantly, we're good at letting them run. That's a big mistake investors make is they sell their winners too soon. And on the flip side, they keep their losers too long. Bad investment, you're hanging on to it, just hoping to get back to even someday. We look at it the other way. We say, wrong stock, wrong time. We run into trouble too, just like everybody else. But the way we handle it is sort of cut losses quickly, let it be a scratch or a bruise on the portfolio, but don't let it ruin the whole year. and double down and triple down on the exposure on a losing situation. So find big winners, let them run and cut your losers quickly. That's really the name of the game. And that's how we approach investing, you know, day to day. I'm covering a lot of ground with you just on, you know, investment process. Some of that is investment process and some of that is almost a investment philosophy, but it all kind of comes in together and intertwines on a day to day basis. So hopefully that helps explain. No, definitely.
00:10:49
Speaker 1: It, You alluded to management earlier, and I'm going to ask you about that next. But, you know, is there once these companies have your attention, you know, what exactly are you looking at to kind of give you those answers that you might not get just from looking at financial statements?
00:11:03
Speaker 2: Yeah, as it relates to management teams, especially in the small cap space, you know, management teams are a really big deal. They tend to move the needle a lot in terms of how the stock is actually going to ultimately perform. And it really relates, I'd say the most to that idea of underestimated growth, you know, management teams, there's some management teams and I've seen it all over the years where on one extreme, they'll say, you know, we have, we don't really care what the market looks at. We don't, we don't care if our growth is underestimated or not. We're just going to do what we're going to do. And if it's better than people think, so be it. If it's worse than people expect, so be it. We don't care. Like that's, red flags all over the place for us if we're hearing that. If instead they're like, okay, we've got a conservative philosophical approach, we've given guidance, but we've not included a new product that we're rolling out next year because we don't know how good that product is going to be and therefore just out of conservatism, let's just not include it. And so they're very cognizant of sort of this idea of managing expectations and making sure they don't fall short of whatever the expectations are that are out there. So that's where the management team, I think, probably shows itself the most in the importance of management teams. And that ripples through to the sell side analyst estimates too. Let's face it, a lot of these analysts that are publishing research are using management's sort of guidance to determine where their models should end up being. And so there's this sort of domino effect of, You know, management teams that are conservative and have sensitivity to managing expectations, they tend to be, you know, just very important on a lot of levels, I guess, in terms of, you know, checking the box of fundamental momentum.
00:12:55
Speaker 1: With the, you know, underestimated growth, how do you measure what the market already expects from a company? And, you know, how large, I guess, is the gap between your expectations and the market needs or what the market expects, you know, for it to actually become interesting?
00:13:10
Speaker 2: No, that's a good point because if it's just a minor upside situation, let's say the company is expected to grow 10% and we think they're really going to do 11%, I don't know if that's enough to get us excited. But if it's 10% growth expected, but we think they're going to do 23%, okay, now that's much more meaningful. And I'm talking like over the course of a year. that's likely to result in that valuation multiple expansion that I mentioned earlier, where if the company's growing fast and exceeding expectations meaningfully, that's going to have a direct result in terms of the magnitude of that re-rating that the stock is likely to see. So it is important. We look for fast growth, but we also look for underestimated growth. And just to really bring the point home, You know, we would actually pass on a faster growth situation where there's minimal upside. So I would not buy a stock that's growing where the company's growing 40%, but they're likely to do, you know, actually put up 37% growth. I would pass on that stock. I'd rather buy a stock where growth is expected to be 18% and they're going to do 25% growth, lower growth rates in that example. but underestimated growth. And so that's really, again, where kind of the magic happens. So you have to have a growth rate above a minimum for in sort of a normalized economy. We like to see at least 10% revenue growth, at least 15% earnings per share growth. Averages are much higher than that, but that's kind of what we're thinking for a minimum growth rate. And then for revision potential, I'd say at least 10% revision, positive revision potential over the course of the four or 12 months.
00:15:07
Speaker 1: That's interesting. How does valuation fit into the equation? I mean, can you have a company that has exactly what you're looking for, but might just be simply too expensive to own?
00:15:17
Speaker 2: We do pay attention to valuation, but it is not a tier one sort of consideration. We don't let valuation sort of drive the bus on our decision making. A lot of stocks that look expensive are stud performers, right? They end up being monster performers despite looking expensive. And part of the issue is, yeah, they might look expensive on the consensus estimates, but they reported way more than the consensus estimates. And so what looked to be a high valuation multiple at the time you were looking at it ended up not really being that high when you plugged in what they really ended up doing in earnings. These are stocks that get valued on forward earnings and forward EBITDA. expectations, forward sales. And so to the extent there's upside to all those metrics, there's downside to the valuation. So evaluation can be kind of tricky. Again, we pay attention to it. We get most nervous about stocks where we're sensing fatigue in the fundamental momentum profile at the same time that we're seeing elevated valuation multiples. So maybe it's already gone through that re-rating process, that positive re-rating process. And now we're starting to see some fatigue and maybe a little weakness in that fundamental momentum profile. It's time to reduce exposure when we see those characteristics all kind of come into play. So again, we use it, but we don't let it trick us. Valuation, that is, we don't let it trick us into not buying stocks that look expensive up front. At the same time, sometimes valuation tricks people into not selling their losers. They say, oh, I can't sell this stock It's so cheap. Well, maybe it's not as cheap as it looks because that company is going to miss estimates in the multiples a lot higher than it looks. So it can go the other way, too. So I think valuation just I just don't think it should be a sort of decision. I don't think it should drive by and to sell. And I don't think it should drive by or sell decisions. There we go.
00:17:27
Speaker 1: Okay, no, makes sense. You know, I mean, smaller companies, I think, can, you know, they obviously have tremendous growth opportunities, but, you know, some of them also can have, you know, greater business or financing risk. How do you kind of distinguish between a company that's, you know, early in, you know, say a durable growth trajectory versus one that, you know, where the numbers simply look good temporarily?
00:17:47
Speaker 2: Yeah, as far as like financing goes, you know, most of the stocks we invest in, a lot of them are self-funding their growth. And that's important. And for the ones that aren't able to self-fund their growth, maybe their earlier stage, they're still building out their infrastructure, let's say, they've got something special, at least the ones we invested. And investors are very willing to get capital to them in order for them to build their business. These aren't just like plain vanilla, you know, small companies and mid-sized companies. These are up and coming companies. companies that have something special, some unique good or service that they're selling. And investors are excited to give them capital to build their business. And so I find that it's not usually an issue. Well, first of all, our companies that we invest in do tend to be much more profitable than the average small cap company. So that's something I probably should have said right off the bat. And they also tend to have less financial leverage. But in cases where they need capital, They usually don't have a problem getting it because they're very exciting, sort of sexy growth stocks where investors are seeing a really positive potential return on that capital. Okay.
00:19:03
Speaker 1: Once you have a company that meets all of your criteria, how do you determine the position size in a portfolio? What would earn a stock a large position?
00:19:13
Speaker 2: Great question. It does depend on, you know, maybe the history we have with the stock. If we've owned it before and we're more familiar with it, there's a willingness to maybe make it a bigger position faster. But I'd say for most situations, you know, we'll start at maybe a 50 basis point position in the portfolio and then we'll watch it closely. We'll, you know, we have our finger on the pulse of these companies and, you know, we're paying attention to all the data points. We're scrubbing the quarterly earnings reports, and we're just going from there. At the same time, we're also monitoring the market reception to those stocks too. And we're monitoring those data points on a daily basis. And so if maybe it starts at 50 basis points and we see a great quarter of execution, let's say it's growing fast, beating expectations, there's very much a willingness to take it up to maybe a 1% or 1.3% position in the portfolio and then go from there. Hopefully it's appreciating at the same time. And so you end up seeing this sort of natural lift of weight in the portfolio as a company, as the quarters go by and the execution is there and the company is being embraced by the market, that 50 basis point position evolves between the market appreciation and us buying more. Before you know it, sometimes it's, you know, 2% plus position, you know, within six months. And so that's very common for it to sort of play out that way. And then, of course, you know, very, again, cannot emphasize enough the importance of sell discipline and just, you know, monitoring the portfolio constantly. One thing I didn't mention before, which is really important, everybody probably always says, you know, they're great at buying stocks and great at selling stocks. We actually took it another level when we're talking about our sell discipline. The thesis was, or the theory was, hey, if we're so great at selling stocks, they probably should be poor performers after we sell them. Well, the data supports that. We ran all that. We've been running that data for years. And sure enough, stocks we sell out of our portfolio persist as losers in the six months after we sell it, 12 months after we sell it, and not just by a little bit. They end up being you know, meaningful losers relative to our benchmark. So there's just to add some meat to the bones, I guess, to say the sell discipline adds a lot of value. I think we're really good at buying stocks and letting them run, but I think we're exceptionally good at selling stocks and, you know, avoiding trouble or lessening trouble.
00:21:52
Speaker 1: I'm not hearing, you're not planning on adding a short component, are you? Like a shorting component?
00:21:56
Speaker 2: No, we've been asked that. We have been asked that many times over the years.
00:22:00
Speaker 1: Yeah.
00:22:01
Speaker 2: We maybe should have done that a long time ago, but no, we're long only. But yeah, it's a logical follow-up question. We probably should be shorting those stocks that we're selling because again, if they're falling later.
00:22:15
Speaker 1: That's pretty cool. I mean, that's obviously a different type of skill, but it's cool that it works that way. When I was going through the documentation of the two strategies, one of the things that kind of struck out or struck out for me or that I noticed was kind of in the SPID strategy, it said you expect roughly 90% of the value added to come from security selection rather than sector kind of allocations. So I guess my question is, how do you keep a bottom-up portfolio like this from unintentionally becoming a large bet on a particular sector or even a factor?
00:22:48
Speaker 2: It's always a mixture of sector, or sorry, selection and sector allocation. exposures and factor exposures, of course, where we spend our time is on and where we think we add the most value is on the bottom up, you know, company interactions and just having our finger on the pulse. We're intentionally trying to find stocks that aren't that sensitive to the Fed's next move or GDP being, you know, plus one or plus three percent. You know, it's just it's we want to find stocks that are really in their own bull market and you know, have that profile where they're going to grow fast. They're going to likely beat and raise. And the macro is just kind of a rounding error on what, what that outcome is going to be. It's, it's not that they're immune from the macro, but maybe the macro, a bad macro knocks the 25% growth down to 23%. But it doesn't derail the growth profile meaningfully. So that's where we spend our time. I think that's where we add the most value. The sector exposures are really just a fallout of that bottom-up effort. And we're not afraid to have deviation from our benchmarks as far as sector exposure. So that inevitably does result in some value add or value subtraction at the sector level. But it's really the portfolio decisions are driven mostly by bottom-up research and really the outlook for these company-specific situations. But, you know, we do have themes. You know, AI infrastructure has been a pretty big theme for us the last three years. That shows up in some of the technology exposure and industrial exposure. So that's definitely elevated the sector weights in those two sectors over the last three years or so. But it's, you know, it also, it doesn't have to be thematic either. You know, our financial services exposure right now is, higher than it normally would be and it's just because we happen to have found a few kind of one-off financial services stocks that meet the fundamental momentum growth profile and that's taken the sector weight up and so you know to some extent financials as at the sector level is going to be showing up as a value adder detractor within our sector sector attribution but It's not the primary focus. It's really, again, more of the company specific bottom up focus that drives the value add.
00:25:29
Speaker 1: So, you know, I did want to also ask kind of the difference between the portfolios, obviously you have a small cap and then the SMID. And, you know, how does expanding the opportunity set from small caps into mid caps kind of change the types of companies you find and the way you construct that portfolio?
00:25:44
Speaker 2: Yeah. And we've had mid cap, you know, we've invested in mid caps for most of my career. Um, I think mid caps inherently, because they're a little bit more mature than the small cap companies, they, they sometimes aren't growing as fast. You know, they tend to have more analyst coverage. Um, and so there's probably less inefficiency, uh, in terms of, you know, where those stocks are priced, but there, I, you know, my career, we have found some huge mid cap winners as well. So, um, I think what we do works really well in small growth and mid-growth. And that's, yeah, it's just more of a matter of sort of how extreme is the sort of inefficiency at the mid-cap level versus small cap level. And it's still extreme enough where I think there's opportunities to exploit. So I think it makes a lot of sense to have exposure to both. And we've had a lot of success. investing in Bullock over the years.
00:26:51
Speaker 1: Makes sense. You know, one of the things I've been observing and, you know, my colleagues have as well, and I've actually written about it a little bit is, you know, small caps really have spent much of the past decade lagging their large cap peers. And, you know, but the relative performance has kind of changed a bit, you know, over the last few months and this year. And, you know, from the perspective of a stock picker, do you think the, has the quality of the opportunity set in small cap growth changed? recently?
00:27:18
Speaker 2: I don't think so. I guess that touches a little bit maybe on the earlier conversation of perception that there's a scarcity of ideas. You're right though. Small caps have lagged large caps for, it's actually been nine years in a row. If you can believe it, the Russell 2000 has lagged the Russell 1000. I don't know if that's so much that small caps have been bad as so much as the mega caps have been just sensational. But you're right. Things have changed. Really, you could almost pinpoint it to a day specifically last year in 2025. It was, you know, I think it was April 9th or something like that is when small caps started to take more of a leadership role. And this is just I'm speaking relative now. It's not that large caps have gone down. But, you know, looking back like 100 years or so, you'll see small caps will lead over large caps for decades. multiple years in a row and then large caps will lead over small caps for multiple years in a row and they take turns. So this could be, you know, early days of a big up cycle for small caps, you know, probably a little bit too soon to say, but very importantly, the earnings are there and everyone's probably, you know, we've heard a lot of talk in recent months about this is a very strong earnings environment. It's been strong for small caps as well as large caps and mid caps. But the difference, I guess, and maybe what's finally happening here is, you know, small caps have looked really inexpensive relative to large caps for many years, but they didn't have the earnings momentum. And that was kind of the missing piece. And that's why they stayed cheap for so long. They're still cheap. They're not quite as cheap as they were relative to large caps, but importantly, they have tremendous earnings momentum. They're scheduled to grow, and these numbers change all the time, but small caps are scheduled to grow about 15% in 2026 and are poised to accelerate to about 17% last I looked in 2027. So those are great growth rates, and to actually see an acceleration of growth expected at least in 2027, it might cause small caps to close the gap even further with large caps in terms of the valuation. And it could lead to a sustained... leadership in small caps but what I like about what we do is you know we're not dependent on that happening for us to win again we're all about bottom up stock picking and positioning and you know small caps lagged large caps big time in 2024 in 2025 and we put up big time points on the board. Despite that, you know, we didn't need small caps to beat large caps for us to do well. And this year we're doing very well and small caps are beating large caps. And so it's, it's, it doesn't determine necessarily what, how we're going to do, but I think it would, you know, it would probably be a tailwind overall if small caps sustained a leadership role going forward, but it's tough to predict that. And I'm glad we're not living and dying with, with that happening.
00:30:31
Speaker 1: I mean, it's definitely a good point. I think it's just from outside looking in, it's kind of interesting for me as a, you know, as I cover managers to watch, but probably doesn't make as big of a deal for the actual managers. So it's definitely good. And I know you kind of alluded to this earlier where, you know, the lack of IPOs has kind of created the sentiment of, you know, at least in the media and I think with some other folks where, you know, there's just a lack of small cap companies to choose from and But beyond that, is there anything else you think that investors misunderstand most about investing in small cap growth?
00:31:07
Speaker 2: I think they just underestimate the potential. Small cap as an asset class is littered with future big winners. And yes, there are big losers waiting in the wings as well. And so the opportunity is just enormous. But you have to be careful. You have to pick your spots. You have to have a really strict sell discipline. So if you're going to traffic in those types of stocks that have big upside and big downside potential, you better have a strict sell discipline where you're managing risk. And we have all that. But I just think in general, people are just, it seems like they're very dismissive of small caps in general. And they find all sorts of reasons to just ignore the asset class and you know, oh, you know, interest rates are rising. That means, you know, small caps are going to zero, right? Like, no, there's no IPOs anymore. That must mean you have zero ideas, right? Because you're completely dependent on the IPO market. Completely wrong, barely at all, even dependent on the IPO market for new idea generation. It's a rounding error on new idea generation potential. So I just think there's maybe some lazy thinking out there that, it's almost like they want to dismiss the small cap asset class, but I just think it's a huge mistake because again, that's where your big winners, the likelihood of finding a big winner is so much higher in the small cap space than it is in the large cap space. And so it's an asset class is very much worth paying attention to. And I put my money where my mouth is too. I've got substantial personal capital exposed to the funds we manage in small and mid cap stocks. possibly, you know, uh, too much, but, but it's, uh, I just see it like, you know, it doesn't matter what interest rates are doing. In my opinion, it's just about like, these are inefficiently priced stocks and there's just home run potential all over the place, but it's, you know, it's, it is a tricky asset class to navigate. Got to know what you're doing. And, um, you know, like I believe in what we're doing. It's a proven, repeatable process that we've been implementing now over 30 years. And the results, I think, show that.
00:33:30
Speaker 1: No, that's great. I think that's a great place to end here. This was a lot of fun, though, Brandon. I really appreciate you joining me today.
00:33:37
Speaker 2: Yeah, my pleasure.
00:33:39
Speaker 1: I also want to thank our listeners. If you liked the episode, please share, subscribe, and leave a review. And if you'd like to see more of our research on The Terminal, Please go to BIFundGo for U.S. fund and active research. Until our next episode, this is David Cohn with Inside Active.
