- Epoch Investment Partners
Eric Sappenfield is a portfolio manager for Epoch’s Global Equity Shareholder Yield strategy. Prior to joining Epoch in 2006, he was a research analyst at Spear Leeds & Kellogg where he was responsible for credit/risk assessment.?
Previously, he was a senior analyst at Steinberg Priest & Sloane Capital Management, LLC focusing on high yield bonds and equities of leveraged companies. Eric’s additional experience includes senior analytical roles at The Carlyle Group, Travelers, and Bankers Trust. Eric holds a BA degree from Stanford University and an MBA from UCLA Anderson School of Management.?
We believe that growth and applications of free cash flow represent the best predictor of long-term shareholder return. As a result, our security selection process is focused on free-cash-flow metrics and capital allocation as opposed to traditional accounting-based metrics such as price-to-book and price-to-earnings. We look for a consistent, straightforward ability to generate free cash flow and to allocate it effectively. An essential factor is the evaluation of each company’s management team to confirm their commitment to transparency and building shareholder value. The companies uncovered by this process have inherently less volatility due to their ability to generate cash flow.
This strategy uses proprietary quantitative research to identify potential investments. We look for factors including high current dividend yield, growth in cash flow, cash from operations that exceeds dividends and no dividend cancellations. Stocks are then subject to rigorous fundamental research. We develop an investment thesis as we assess the sources of the company’s long-term value creation and management’s ability to nurture it. Management’s track record of allocating capital is scrutinized as we look for those with the discipline to return cash to shareholders if the expected return for other uses of cash does not exceed the firm’s cost of capital. We select stocks that can meet our 6% shareholder yield requirements, with 4.5% coming from dividends and 1.5% coming from share buybacks and debt repayments. We also look for a 3% minimum growth rate of cash flow. We continually revisit our thesis on each stock and sell if it appears the company will no longer be able to provide the required level of shareholder yield (dividends, share buybacks and debt reduction) or if we see another investment with the characteristics we are looking for with less risk.
We analyze risk as part of the portfolio construction process to monitor portfolio volatility and better ensure the delivery of the strategy’s goals. Our chief risk officer is a co-portfolio manager on all our strategies so that portfolio managers are aware of unintended biases and the effect individual securities may have on the portfolio. The portfolio is diversified across sectors and sources of yield so that no single stock is relied on too heavily to achieve the portfolio’s yield targets.
Public debt in the developed world has ballooned, with debt obligations of OECD countries now exceeding their combined GDP. This debt overhang will restrain economic growth, keeping it below its potential. With growth subdued, volatility elevated and interest rates having little room to move lower, it seems unlikely that valuation multiples have much room to expand from here. So buying stocks on the thesis of a rerating is not likely to be a winning strategy. And while there have been periods where expanding P/E multiples have powered equity market returns, over the long term the expansion and contraction of valuation multiples has been a wash. Similarly, earnings growth will be subdued in a world where economic growth is weak. With that in mind, we expect dividends, share buybacks and debt reduction to account for a larger portion of equity returns for years to come.
While my entrance into this industry was serendipitous, I believe investment management suits me. I have a curious nature and enjoy the “puzzle solving” aspect of finance and investing. My cumulative experience in commercial and investment banking, sales and trading, and private equity are a natural fit with Epoch’s investment philosophy and the Global Equity Shareholder Yield strategy.
The biggest risks in my view are higher volatility, sustained low interest rates and overly enthusiastic investor expectations. The operating environment for many companies remains difficult. With much of the developed world in recession and with economic growth in emerging markets slower than in the recent past, many companies will find it challenging to grow revenues. With that as a backdrop, it will be increasingly important to understand which companies can grow their free cash flow despite the difficult environment, enabling them to sustain or improve their shareholder yield characteristics.
I believe the majority of equity returns come from capturing dividend income from growing companies. To execute on that belief, we seek to provide strong risk-adjusted returns by investing in companies we have thoroughly researched, with growing free cash flow and the discipline to return cash to shareholders. We then assemble a diversified portfolio of companies that possess these characteristics. We avoid buying companies on the expectation of a rising P/E ratio. We also do not attempt to achieve the portfolio’s yield targets by having an excessively large position in any single security. We hope that we never mislead clients, particularly in terms of the expectations for this strategy. We believe we can provide a portfolio of stocks with growing shareholder yield, which should deliver an attractive return with less volatility than the market in a variety of environments. It is not a capital appreciation strategy and it will likely lag the market and other strategies when market returns are very strong and characterized by expanding valuation multiples of more speculative companies.
I believe the best way to protect client assets is to be disciplined in how we carry out the strategy and to continuously review the strategy’s results and process. We perform thorough fundamental research on each company in which we invest on the client’s behalf. We focus on companies that can growth their free cash flow and increase their dividends, share buybacks and debt reduction. Companies with these characteristics tend to have less volatility. The portfolio is well diversified in terms of sectors and sources of shareholder yield. Risk management is integrated throughout the investment process with a focus on avoiding unintended risks. Portfolio risk exposures are monitored and formally communicated to portfolio managers on a regular basis and are discussed at investment meetings. Michael Welhoelter, the head of our Quantitative Research and Risk Management team, is a co-portfolio manager on every strategy managed by Epoch. We use Barra risk models to evaluate the total risk and tracking error risk in the portfolio. In addition, Barra risk models are used to report on the level of specific and systematic risks. We reevaluate any position that represents a significant percentage of a portfolio’s specific risk.
I have two. The first is the classic “Security Analysis” by Benjamin Graham and David Dodd. It provides a disciplined way for investors to evaluate companies and their risks and potential rewards. It is a framework that has survived the test of time and continues to serve me well. The second is “The Essays of Warren Buffett: lessons for corporate America,” edited by Lawrence Cunningham. It is a compendium of Mr. Buffet’s annual letters that reveals real-life investment challenges and a true value investor’s approach to understanding them.
I regularly read the Financial Times and The Economist, and I source a great deal of information from Bloomberg.
This article originally appeared on June 24, 2013. Any views presented in this article are as of such date and are subject to change.
This article and the information provided therein are not a recommendation to purchase or sell any security, nor are they intended to constitute the marketing of, or a solicitation for investment in, any investment product.
Epoch Investment Partners is a global asset management firm that provides U.S., non-U.S. and global equity strategies for institutional clients. Our investment approach is based on fundamental research, seeking companies that can grow free cash flow and allocate it allocate it intelligently for the benefit of shareholders. In our view, the growth of free cash flow, and the intelligent use of that cash flow, represents the best predictor of long-term shareholder return. We look for strong company management with a commitment to financial transparency and a track record of delivering returns to shareholders. We have a risk management process that is integrated within the investment process focusing on avoiding unintended risks.
We have a highly experienced team of investment professionals, with an average of over 20 years of experience, that work within a collaborative and client-focused culture. Our purpose is to help our clients achieve their investment objectives. If our clients win, we win.?
Our Global Equity Shareholder Yield strategy pursues attractive total returns with an above-average level of income by investing in a diversified portfolio of global companies with strong and growing free cash flow. Companies in the portfolio possess managements that focus on creating value for shareholders through consistent and rational capital allocation policies with an emphasis on cash dividends, share repurchases and debt reduction ? the key components of shareholder yield. The portfolio generally holds between 90 and 120 stocks from equity markets worldwide, with risk controls to diversify the sources of shareholder yield and minimize volatility.?
March 21, 2013
by Investment in Japan