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Why Innovative Companies Should Outperform Over Time

Christopher Franz, CFA

Christopher Franz: Hello, I'm Chris Franz with Morningstar. I'm here today with Amy Zhang, portfolio manager of the Alger Small Cap Focus Fund.

Amy, thanks for joining me.

Amy Zhang: Chris, it's great to be here.

Franz: So, equity markets are nearing record highs again and kind of rebounding from the late 2018 sell-off. You are a bottom-up small-cap investor. What's your take on markets right now?

Zhang: Well, as bottom-up benchmark-agnostic long-term investors, we're very cognizant of macro events. We do not make sector calls or top-down calls, nor do we try to predict the direction of the market. We simply focus on fundamentals and intrinsic value of a company. At Alger, we spend the bulk of our time identifying and investing in exceptional small companies undergoing positive dynamic change that have the potential to become exceptional large companies.

Having said that, it's always good to have a tailwind. In the current environment, interest rates are still very low with the dovish Fed. So, that's a huge positive for growth stocks. And the small-cap space is still very inefficient. So, I think it will continue to be a very fertile ground for active management. But in terms of economic expansion, we're in the late cycle. So, growth is going to be scarce. So, I think the best way to outgrow the economy will be through innovation. And as you know, innovation is a common theme of our portfolio. We own a collection of innovative small companies with powerful secular and company-specific drivers that will triumph over economic cycle. So, I definitely believe that innovation will continue to be the engine to sustained value creation. And regardless of market gyrations, stock prices usually track value creation over the long term.

Franz: Sure. So, obviously, you are being pretty picky with your portfolio. But as you look at the market, is there anything--perhaps valuations or leverage levels--that you think are kind of concerning right now?

Zhang: Well, I think, you know, in terms of the market--in terms of valuation, we are very long-term. So, we really open--we really invest in those open-ended opportunities, companies with a very strong and wide moat that the value will compound over time as they expand the addressable market to sustain durable growth and profitability. But in terms of leverage, I think overall at index level, probably the leverage is not that low. But we invest in very low leverage companies. For us, it's very important to have very high financial quality. So, our leverage ratio is significantly lower than the benchmark. So, I think, that will serve us well over the long term.

Franz: Great. Amy, thanks for your insight.

Zhang: Thanks for having me.

Franz: For Morningstar, I'm Chris Franz. Thanks for watching.