Chantal Brennan talks stock selection, Mifid II and Brexit
Continuing our regular series of interviews with fund managers, IR Magazine recently caught up with Chantal Brennan, chief investment officer at Davy Asset Management, which manages more than $4 bn across equity, fixed income, multi-manager and alternative investment strategies. Davy’s investment arm is relatively new: it was launched in 2012 and opened a second office in London this year as it looks to expand its team and product range.
Chantal Brennan, Davey Asset Management |
Brennan has more than 20 years’ experience in the industry managing European and global equity portfolios, including stints at AIG and later PineBridge Investments. She holds degrees in investment and treasury from Dublin City University and economics from University College, Dublin.
Can you give me a brief overview of the asset management industry in Dublin and where Davy fits in?
It is dominated by large global index managers such as State Street as well as some boutique managers such as Davy Asset Management. All of the other players are owned by large global or Italian banks; Davy Asset Management is wholly owned by management and staff.
What proportion of assets under management is in equities?
Equities represent more than 30 percent of our assets under management. All our strategies are global equities.
Your investment style is both value-oriented and growth-oriented with a quality overlay – can you elaborate?
We believe companies that are long-term winners exhibit common identifiable characteristics that we refer to as quality pillars. We believe the market systematically misprices companies demonstrating these characteristics and an investment process focused on identifying quality companies, at an appropriate valuation, will deliver superior performance for our clients over the long term.
Our conviction regarding quality is supported by our own extensive back-testing, which has proven that high-quality companies – as per our definition – outperformed both low-quality companies and the broader market consistently over time.
What’s your average holding period?
Usually around three years, sometimes longer.
Do you have a target price when you buy a stock?
Yes, we use our proprietary valuation model to assess the value of a security, then we forecast five years of earnings and cash flows. We also forecast best and worst-case scenarios to give a range around our base case. The output from the forecasts is used in two separate valuation models: a discounted cash flow model and an exit multiple-based model.
For each stock we calculate a quality score (Q-Score), which is based on a series of 31 fundamental questions each fund manager must answer about the stock he or she is analyzing; the higher the Q-Score, the higher the quality. We incorporate the Q-Score directly into the cost of equity that we use to value the company and a company with a lower Q-Score will have a penalty attached to its cost of equity. This ensures our valuation reflects the risk of the stock relative to others in the portfolio or research universe.
Do you have any market cap cut-off restrictions on stocks?
The Davy Discovery Fund, which focuses on small and mid-cap equities, has a minimum market cap threshold of $200 mn and can hold stocks up to $15 bn. The large-cap strategies focus on stocks with market caps above $10 bn.
Are there any sectors or themes you don’t favor?
A quality-oriented philosophy tends to perform across the market cycle because businesses with higher returns, growing margins and lower leverage tend to have share prices that are less volatile as their businesses are less affected by the economic cycle. This phenomenon is based on our experience and has been confirmed by the back-testing of our proprietary four-factor quality model.
We expect a global small and mid-capitalization strategy to perform in the early to mid-stages of a business cycle but performance may moderate toward the later stages of the cycle as growth moderates and earnings come under pressure. We focus on investing in quality businesses as we wish to minimize the effects of this. When an economy slips into recession, liquidity and earnings growth tend to dry up and low-quality stocks such as turnaround situations, low-margin cyclicals and/or asset plays perform. As we don’t invest in these types of businesses we would expect our performance to lag the market in the short term.
Does a company need to pay a dividend?
It depends on the strategy. Not all growth-oriented small and mid-cap companies pay dividends as they tend to be focused on growing their business; with more mature large-cap stocks, we prefer them to pay dividends as it demonstrates good capital discipline.
What’s your view on share buybacks?
Positive, as it demonstrates good capital discipline but you need to ensure the firm is not increasing leverage in order to buy back shares.
Do you have any ethical constraints?
Only our strategies where it is appropriate have ethical constraints but all of our strategies have an environmental and social governance rank within our investment universe.
Do you vote your proxy of foreign holdings?
Only in certain appropriate cases.
What size are your typical US and European holdings, and your largest US and European positions?
Active position sizes range from 1 percent to 3.5 percent, depending on their volatility or expected risk-return characteristics. Depending on the size of the fund, positions can be between €500,000 and €2 mn ($550,000 and $2.2 mn) in the case of the Davy Discovery Fund.
Examples of our largest US equity holdings in our global small and mid-cap equity strategy are MSCI, Xylem, Ulta Beauty and Panera Bread, while in Europe it’s Teleperformance, Micro Focus, Playtech, DCC and ALTEN.
Cadence is a recent addition to your portfolio. Why did you buy it?
Cadence is a leading provider of electronic design automation (EDA) and semiconductor internet protocol. It is the number two provider of EDA software globally. The EDA industry is oligopolistic with more than 80 percent of the market in the hands of just three companies, and Cadence has a 26 percent share. The firm has double-digit operating margins and returns and these returns should continue given key secular trends: mobility, cloud computing and the internet of things. Around 90 percent of Cadence’s revenues are recurring and the business is debt-free. Accretive acquisitions have enabled Cadence to grow market share and its revenues at a faster pace than its competitors over the last five years.
What about Henry Schein?
Henry Schein is the world’s largest distributor of medical products and value-added services to office-based healthcare practitioners. It operates in dental, medical and animal health and has a global market share of 20 percent-25 percent. The healthcare products distribution industry is worth around $45 bn globally. Henry Schein’s businesses carry next-to-no product risk or ‘patient cliffs’; even in adverse economic climates the company has generated top and bottom line growth.
Margins are improving due to improvements in the selling, general and administrative line as a result of scaling and integration of recent acquisitions. The company generates significant levels of free cash flow and plans to allocate around $400 mn to share repurchases and $200 mn-$300 mn to M&A. Management’s ability to balance short-term profitability and cash flow with medium and long-term priorities has for decades delivered consistent financial results.
What about your recent investment in European stock Sika?
Sika is a market leader in construction chemicals and fourth in the adhesive and sealants sector. In spite of its leadership position the firm has outgrown all peers in recent years and this is expected to continue. Revenue is above the sector average and margins have been improving since 2012. This trend looks set to continue as the company exploits economies of scale, pricing power and favorable raw material costs. It has a strong balance sheet with a net cash position. We also like the capable management coupled with capital discipline.
Do you have to meet with management before you buy a stock?
Yes. We gather fundamental company information through direct company contacts, analyst meetings, sector conferences and official company filings. We would seek to meet with all company managements within a 12-month cycle. As a team, we attend more than 400 company meetings per year.
How do you prefer to meet management teams: in your offices, at conferences, at their HQ, in groups?
We interact with portfolio companies at least once a year, if not quarterly. Meetings take place at our offices or via site visits to the company. If time is a constraint, we will conduct a conference call.
How is the changing regulation around corporate access affecting you?
Given the introduction of Mifid II [in 2018], we decided to separate our commission into execution and research. This has resulted in a more concentrated list of execution and research counterparties. We allocate commissions on a quarterly basis depending on the relevance of it toward making our investments decisions.
Why should corporates target Davy Asset Management?
Davy is a long-term, low turnover investor that operates a consistent investment style. It’s also a relatively ‘new’ investment firm with an experienced fundamental research-driven investment team.
How has Brexit affected you?
Although the collapse of the pound post-Brexit was a positive for UK large-cap stocks whose revenues are generated internationally (75 percent overseas), the effects in the UK small and mid-cap space have been more acute. Our UK holdings have less than 4 percent of their revenues coming from the UK and we are already seeing earnings upgrades happening for those stocks in our portfolios. We have used this volatility as a buying opportunity.
In the aftermath of Brexit, many of our funds experienced a strong rebound in July. In fact, we had recovered most of our drawdown within six business days. We are relatively defensively positioned, focused on preserving capital by investing in securities with good earnings visibility that we believe have the ability to withstand periods of market volatility. This is the cornerstone of our quality investment philosophy.
Davy’s different strategies
Strategy | Benchmark | Factor | Active share | Style |
Davy Global Brands | MSCI World | Brands | 86% | Growth |
Davy Ethical Equity | MSCI World | Ethical/ESG | 80% | Core/value |
Davy Discovery | MSCI World Small and Mid-Cap | Small and mid-cap | 96% | Growth |
Davy Global High Yield | MSCI World | Dividend yield | 80% | Core/value |
Defensive Equity Income | MSCI World | Dividend yield with downside protection | 80% | Core/value |
Source: Davy
Davy Asset Management, by asset class Equity 30% Fixed income 39% Balanced 16% Multi-manager 13% Other 1% |
Source: Davy
This article appeared in the Fall 2016 issue of IR Magazine