Cheswold Lane International High Dividend Yield Strategy

Transcription

1 R E P R I N T E D F R O M J A N U A R Y 2 2, Cheswold Lane International High Dividend Yield Strategy COLLEEN QUINN SCHARPF is President and Chief Operating Officer of Cheswold Lane Asset Management, LLC. Prior to co-founding the firm in 2006, she was the Director of Investments for the Board of Pensions of the Presbyterian Church (U.S.A.) from Ms. Scharpf managed the international equity and global bond portfolios for the $6 billion defined benefit pension plan. Before joining the Board of Pensions, she held several positions at Putnam Investments. She was a senior member of the Strategic Relationship Team (SRT), providing custom research and investment solutions to the firm s largest institutional clients. Prior to joining the SRT, Ms. Scharpf conducted monthly 3P internal reviews (Philosophy, Process and Performance) for Putnam s Head of Investments. She began her career at Putnam as a quantitative analyst in the Fixed Income division. Previous employment includes HSBC and Chase Manhattan Bank. Ms. Scharpf earned a Bachelor s degree in Finance from Rutgers College and received an MBA from The Wharton School at the University of Pennsylvania. She has earned the right to use the Chartered Financial Analyst designation and is a member of the Financial Analysts of Philadelphia. ERIC F. SCHARPF is Managing Partner and Portfolio Manager at Cheswold Lane Asset Management, LLC. Prior to co-founding the firm in 2006, Mr. Scharpf was a Partner and Senior Portfolio Manager at Chartwell Investment Partners from At Chartwell, he managed US and international large cap value equity portfolios. From 1997 to 2003, he was a Portfolio Manager and Research Analyst for Miller Anderson & Sherrerd, an institutional asset management division of Morgan Stanley & Co. He was a member of the portfolio management team that managed over $12 billion in large cap equity portfolios including the Morgan Stanley Institutional Value Trust, Morgan Stanley Institutional Equity Fund, and Morgan Stanley Dividend Growth Fund. Prior to joining Morgan Stanley, Mr. Scharpf worked as an investment banker for Salomon Brothers in the energy and chemicals group. Previous employment includes Fidelity Investments and Chase Manhattan Bank. He currently serves as a member of the Board of Directors of the Amboy Bancorporation, the holding company of Amboy National Bank. Mr. Scharpf earned a Bachelor s degree in Finance from the University of Notre Dame and received an MBA from The Wharton School at the University of Pennsylvania. MATTHEW H. TAYLOR is a Partner and Portfolio Manager at Cheswold Lane Asset Management, LLC. Prior to co-founding the firm in 2006, Mr. Taylor was a Partner and Portfolio Manager at Chartwell Investment Partners from At Chartwell, he managed US large cap value equity portfolios, including the Chartwell Dividend Income Fund, a closed-end high dividend fund. Before joining Chartwell, Mr. Taylor worked for Miller Anderson & Sherrerd, an institutional asset management division of Morgan Stanley & Co., from 2000 to 2003, as a member of the portfolio management team of the Morgan Stanley Dividend Growth Fund and as a Research Analyst on the Morgan Stanley Institutional Value Trust. He worked for Prudential Investments and Prudential International Investments prior to joining Morgan Stanley. Previous employment includes UMS Group and Fidelity Investments. Mr. Taylor earned a Bachelor s degree in Economics from Swarthmore College and received an MBA from The Wharton School at the University of Pennsylvania. M O N E Y M A N A G E R I N T E R V I E W

2 TWST: Colleen, would you start by telling us about Cheswold Lane Asset Management. Ms. Quinn Scharpf: I founded the firm with my two partners, Eric Scharpf and Matt Taylor, in February We are located just outside of Philadelphia in West Conshohocken, Pennsylvania. We have one investment strategy and one focus it is a large cap, international high dividend strategy that holds only foreign ordinary securities and no emerging markets. We manage an institutional mutual fund, the Cheswold Lane International High Dividend Fund (CLIDX) and separate accounts. Cheswold Lane is 100% employee-owned and we have approximately $30 million in assets under management. Mr. Scharpf: It starts with our investment philosophy. We believe that a portfolio of stocks with high dividend yields and low valuation will deliver superior risk-adjusted returns over time, and that, historically, high dividend yield portfolios have had lower volatility, as measured by standard deviation, and lower risk of capital loss. But we don t view high dividend yields simply as a valuation metric. We think about yield in terms of specific characteristics of a stock or portfolio that we find very appealing. For example, the high dividend yield companies we invest in tend to be large, well-established businesses with leading market share positions. They earn high returns on capital, generate significant and stable cash flows and require modest capital reinvestment. Most of these companies are underleveraged. Mr. Scharpf: The portfolio s largest overweight on a sector basis is the telecom industry, which definitely fits our portfolio s characterization of quality businesses, at good prices. In fact, we believe they are extremely good prices. The telecom stocks have high returns on invested capital, generate significant free cash flow, and are trading at very attractive valuations on a firm value to cash flow basis, which is our primary valuation metric. TWST: What made you decide on this asset class and investment strategy, as opposed to the other strategies available? Ms. Quinn Scharpf: In my prior business life as a plan sponsor, I spent over two years looking for institutional large cap international managers, and I found it very challenging. Many of the large institutional players had performance, retirement and even reputation issues. The mid-sized players, some of which were very good, had either closed or were struggling under the weight of large asset inflows. It became clear to me that there was a great market opportunity for new firms focused on the international marketplace. Mr. Scharpf: At the same time, Matthew Taylor and I were developing an international high dividend yield strategy at our prior firm. We had spent more than 18 months researching and developing an institutional investment philosophy and process for our international high dividend strategy. Our experience, combined with Colleen s knowledge of the institutional marketplace, ultimately led to the formation of Cheswold Lane Asset Management. TWST: Would you tell us more about the investment process and what characteristics you are looking for in potential holdings? We also believe that they are predisposed to have better corporate governance and capital discipline, because management and their Boards have made an implicit commitment to shareholders with respect to dividends and their future rate of growth. Admittedly, reinvestment opportunities are finite and thus growth is average relative to the market. As Portfolio Managers, Matt and I focus our fundamental research effort on analyzing companies and industries investment capital cycles. We believe future marginal returns on capital drive stock valuations in the intermediate and long run. We are fond of describing the stocks in our portfolio as a collection of quality businesses, at good prices. TWST: Are you investing only in international stocks, or is the United States included? Mr. Scharpf: We only invest in developed countries outside the US; we do not invest in emerging markets. Our benchmark is the MSCI EAFE Index. We expect our investment strategy to be used as an asset allocation tool for clients and their advisers. We don t believe it s in our clients interests for us to adopt a go-anywhere investment philosophy or mandate. We consider emerging markets to be a different and specialized asset class.

3 TWST: What are the rewards and risks of looking for international stocks with a high dividend yield? Mr. Scharpf: For a US investor, the two primary benefits to international investing are diversification and an expanded investment opportunity set. They benefit from more opportunities to find inefficiencies in the global marketplace, as well as the diversification benefits of investing outside of the US. International markets and economies are often on different cycles. Foreign currency exposure is an additional diversification benefit. The bottom line is our product provides international market exposure, capital loss protection and the opportunity to exploit less efficient markets relative to the US. TWST: How do you attempt to control investment risk? Mr. Scharpf: Risk management is a strong point for our Fund, because historically a high dividend yield strategy has provided significant capital loss protection. We use two third-party quantitative models to analyze our Fund, which highlight unintended bets from a risk management perspective, and also act as a guideline TWST: What are some of your holdings that you can tell us about that are representative of your strategy, and the reasons why you found them attractive? Mr. Scharpf: The portfolio s largest overweight on a sector basis is the telecom industry, which definitely fits our portfolio s characterization of quality businesses, at good prices. In fact, we believe they are extremely good prices. The telecom stocks have high returns on invested capital, generate significant free cash flow, and are trading at very attractive valuations on a firm value to cash flow basis, which is our primary valuation metric. Telecom has been out of favor in the market for quite a number of years, but we believe the telecom market is curing itself through consolidation, reduced capital expenditures and better pricing discipline. Our largest holding in the portfolio is in the telecom sector, and that s Vodafone (VOD), the world s premier wireless company. It s a UK-based company with wireless operations around the world. The stock has a dividend yield of 4.6% and trades at 5.5 to Mr. Scharpf: Vodafone is the world s premier wireless company. It s a UKbased company with wireless operations around the world. The stock has a dividend yield of 4.6% and trades at 5.5 to 6 times 2007 cash flow. Vodafone recently has suffered through brutal wireless pricing competition in several major European markets. However, management appears to have seen the light in terms of capital investment; they actually paid out 15% of the company s capital to shareholders this past summer in the form of a special dividend. for managing our portfolio s volatility, tracking error and overall factor risks. TWST: How many holdings generally would you have in the portfolio? Is it a fluctuating number? Mr. Scharpf: Our guidelines limit the number of holdings in the portfolio to a range of We don t expect these numbers to change. TWST: Do your screens have a country allocation? How do your holdings fall into different areas? Mr. Scharpf: We are broadly diversified within the 21 countries of the MSCI EAFE Index. We have limitations on both sector and country weights for risk management purposes. On a sector basis, our holdings will be plus or minus 10% of the MSCI EAFE Index, and plus or minus 15% of the MSCI EAFE Index on a country basis. 1-Year Daily Chart of Vodafone Chart provided by

4 TWST: What other large sectors have you been finding good holdings in? Mr. Scharpf: We have a very large weight almost 30% of the portfolio in financials, where we have been primarily focused on the capital markets sensitive stocks. In Europe, many of the major banks generate significant revenues from investment banking, private banking and asset management businesses. We expect the capital markets environment to remain robust in 2007, so we have increased our exposure to capitalize on this theme in the market. Our top holdings in this space are Credit Suisse (CS) and Deutsche Bank (DB). These are very attractively priced stocks on a p/e basis, with excellent fundamentals and accelerating returns on equity right now. Each company also has an underlying restructuring story, which should drive incremental returns higher in the next two to three years. Mr. Scharpf: If you look at the last 12 to 18 months, everything that could go wrong at BP, from a management perspective and from a public relations perspective, has gone against them. As a result, BP s stock has significantly underperformed its peers. But we think it represents excellent value within the energy space, which is the cheapest sector in the entire market, on a forward p/e basis. 6 times 2007 cash flow. Vodafone was the poster child for overinvestment during the TMT bubble, and more recently has suffered through brutal wireless pricing competition in several major European markets. However, management appears to have seen the light in terms of capital investment; they actually paid out 15% of the company s capital to shareholders this past summer in the form of a special dividend. Additionally, Vodafone recently sold several non-core assets in order to focus future capital expenditures on larger, higher growth markets such as India and Eastern Europe. Finally, Vodafone owns 45% of the premier wireless asset in the world, Verizon Wireless. For strategic reasons related to Verizon s (VZ) core fixed line and broadband (fiber to the home) strategy, we believe Verizon will be compelled to buy Vodafone s stake in Verizon Wireless. We don t believe Vodafone s current valuation reflects the significant premium Verizon will be forced to pay Vodafone for this critical asset. TWST: Are the telecom companies that you are interested in broadly wireless? Mr. Scharpf: No, not necessarily. Our telecom holdings include both incumbent service providers and wireless companies. By incumbents, we mean the former state controlled telecom monopolies. They have fixed line, broadband and wireless networks that service consumers and corporations. France Telecom (FTE), a large holding in our portfolio, is a good example of a major incumbent telecom player in Europe. Most incumbents have been experiencing declining revenues in their fixed line business due to voice over IP competition and wireless substitution. This has been buffered by growth in broadband and wireless revenues. However, very recently, we have seen the rate of decline in the fixed line business slow, which is a critical factor to enable these companies to drive overall top-line revenue growth. 1-Year Daily Chart of BP Chart provided by TWST: Have you been taking advantage of the energy boom over the past year? Mr. Scharpf: We have; our second largest overweight is the energy sector. Our largest holding in that space is BP (BP). We

5 tend to be contrarians, and BP fits that description as a contrarian investment within the energy sector. If you look at the last 12 to 18 months, everything that could go wrong at BP, from a management perspective and from a public relations perspective, has gone against them. They ve had major pipeline issues at Prudhoe Bay in Alaska. Their Texas City, Texas, refinery had a catastrophic fire resulting in 15 fatalities. Over the summer, their US natural gas trading division was accused of bid rigging. And most recently, the Russian government has threatened to revoke their ownership rights to TNK-BP, the company s large Russian joint venture business. As a result, BP s stock has significantly underperformed its peers. But we think it represents excellent value within the energy space, which is the cheapest sector in the entire market, on a forward p/e basis. TWST: What about the industrials? Have they been benefiting from the world economies doing better? Mr. Scharpf: Yes, the industrial market has benefited significantly from the strong global economies. However, this is an area of the market that we have been reducing our exposure to over the last six to nine months. This decision is driven more by the valuation side of the investment equation than the fundamental. The fundamentals remain strong; however, the margins and the valuations appear to be peaking, in our estimation. TWST: Do you have any examples of industrials that are in your holdings right now? Mr. Taylor: One industrial area that we find attractive is the Japanese auto sector. We own both Honda Motor (HMC) and Nissan Motor (NSANY). In contrast to what Eric was saying about the industrial cyclicals peaking, the global auto industry has already softened. However, both Honda and Nissan have significant new product launches scheduled for 2007, which should bolster their performance this cycle. Honda in particular has gained market share in North America, and has opened new production facilities, which will drive higher returns on capital. Within the broader industrial sector, Japanese autos have lower margins. However, we believe they have a clear path to improvement. TWST: Is Japan the largest Asian country that you have holdings in? Mr. Taylor: Yes, Japan, at about 16% of our portfolio, is our largest country weight in Asia, followed by Australia and Hong Kong. Taylor: One industrial area that we find attractive is the Japanese auto sector. We own both Honda Motor and Nissan Motor. The global auto industry has already softened. However, both Honda and Nissan have significant new product launches scheduled for 2007, which should bolster their performance this cycle. Honda in particular has gained market share in North America, and has opened new production facilities, which will drive higher returns on capital. 1-Year Daily Chart of Honda Motor Chart provided by TWST: What is the sell process that you have in place? Mr. Scharpf: As a value investor, I am convinced that the key to successful portfolio management is not what you do with your winners, but rather what you do with your losers. How does one decide to sell an underperforming stock, or buy more? In my opinion, the results of these investment decisions ultimately determine whether a value portfolio manager is successful or not. For us, quality written research is the critical tool allowing us to be more consistent and disciplined in these buy more or sell-out situations. Our internal research reports lay out the investment thesis, future events, catalysts, valuation parameters and potential risks.

6 This record helps us avoid the psychological traps many portfolio managers fall into. Dealing with adversely performing stocks is challenging. However, by putting your investment thesis in writing, you are laying the foundation for future decisions, which are often required to manage a successful investment holding. As Cheswold Lane s lead Portfolio Manager, I want to know before I purchase a stock, If a stock is underperforming, under what circumstances am I gladly going to buy more of it, and under what circumstances am I going to sell it and take the loss? Without this knowledge, I think it s difficult to have a rigorous buy/sell discipline. Mr. Scharpf: We think our international high dividend yield strategy is a disciplined, repeatable investment approach that has proven effective in the past and that we believe will continue to generate consistent, strong returns for our clients. It s a differentiated strategy within the foreign large cap value peer group, with a bias toward lower risk, rather than higher risk. Finally, it s well suited to be the primary international strategy for most institutional and high net worth clients because the product offers versatility as a total return product, but can also be used as a high income producing vehicle with a consistent, above inflation rate of growth. Mr. Scharpf: Our international high dividend yield strategy is a disciplined, repeatable investment approach that has proven effective in the past and that we believe will continue to generate consistent, strong returns for our clients. It s a differentiated strategy within the foreign large cap value peer group, with a bias toward lower risk, rather than higher risk. Human nature tells you it s always difficult to buy more of a stock when things are going against you, and it s easy to hold on too long when they are going higher. At Cheswold Lane, we sell stocks based on valuation. If a stock is no longer attractive versus other alternatives on our core candidate list, it will be sold. We also sell stocks when we ve made a mistake in our investment thesis. If the dynamics for improvement in the business are not turning or management has disappointed us with their actions, we sell the stock. But we will buy more of a stock, especially if it has underperformed and is even more attractively priced, if the core investment thesis remains intact. TWST: Do you sell outright or do you prefer to reduce holdings by trimming them? Mr. Taylor: It depends. If a stock is performing very well but we decide the valuation is starting to get extended, then we will trim the stock and let it continue to run and trim some more, until we eventually sell the position. Having said that, we don t have positions that linger too long we adhere to our stock-holding range. However, we want to do it in a prudent manner. When it comes to selling a stock because of a negative fundamental event or management disappointment, we sell the entire position immediately. TWST: What do you think differentiates or distinguishes your investment approach at Cheswold Lane from that at other firms? TWST: Are most of your clients institutional? Mr. Scharpf: The majority of our assets, more than 80%, are institutional. The remaining assets are from high net worth clients. TWST: What advice would you give to investors about looking at international stocks, particularly those with a high dividend yield? Mr. Scharpf: The first thing I would say is to be careful in the international marketplace there is no free lunch. Because we are a low risk strategy, we do not own any emerging market stocks, even though many emerging market countries have very high dividend-yielding stocks within their indices. Just because a stock has a low valuation or a high dividend yield does not mean it is a good investment, especially if your investment objective is lower risk. TWST: Is there anything else that you d like to bring out about your work or views for 2007? Mr. Scharpf: What s really interesting to us as we enter 2007 is how well our investment philosophy and process match up with the current major force in the global financial markets, private equity. During the last three years, private equity funds have raised $750 plus billion to buy public companies and divisions of public companies around the world. This is equity capital that will be levered 5-6 times with debt, so the true buying power of these firms increases to several trillion dollars. I ve never seen a time in my

7 investment career when a small group of investors have accumulated such vast sums of capital that they have the ability to change the dynamics of an industry or company. And the phenomenon is global! Our portfolio should benefit from this trend because private equity firms are attracted to the same characteristics of companies found in the Cheswold Lane International High Dividend Strategy. Private equity firms want to buy businesses that generate significant and stable cash flows, are underleveraged, have modest capital expenditure requirements and can be purchased at reasonable valuations. Historically, the only difference between our investment criteria and private equity s was the market capitalization size. Cheswold Lane invests in medium to large capitalization companies while private equity firms have tended to buy small to medium-sized companies. But today, the financial markets have shifted, and the most attractively priced companies in the global markets are large capitalization stocks, not small or mid-caps. Because there has been so much private equity money raised, and there have been low interest rates and tight credit spreads, private equity firms are starting to buy larger and larger targets. In fact, for the first time, during 2006, private equity firms started pooling equity together to jointly buy several $10- $20 billion companies, in what has become known as Club Deals. The most obvious and direct positive impact private equity can have on Cheswold Lane s portfolio is to acquire one or more of our holdings at a significant premium to its current market price. However, another powerful outcome from the influence of large private equity funds is a renewed responsiveness of management and Boards to create shareholder value. CEOs will be pressured to make important strategic decisions to increase their companies share prices. For example, they might be more willing to increase their dividends or share repurchases, sell non-core assets or even sell out to a strategic competitor promises to be a very exciting time for mergers and acquisitions. We expect to see bigger deals in Europe and Asia than we ve ever seen before with respect to private equity firms. This will be a major theme in 2007, and the Cheswold Lane International High Dividend Strategy fits very nicely with it. TWST: Is there anything that you want to add? Ms. Quinn Scharpf: Cheswold Lane is off to a great start. We ve had strong responses from the institutional marketplace and we re excited about our investment strategy s prospects in 2007 following a stellar TWST: Thank you. Note: Opinions and recommendations are as of 1/11/07. COLLEEN QUINN SCHARPF ERIC F. SCHARPF MATTHEW H. TAYLOR Cheswold Lane Asset Management, LLC 100 Front Street, Suite 960 West Conshohocken, PA (610) The Wall Street Transcript, 48 West 37th Street, NYC Tel: (212) Fax: (212) Website: