Disciplined in Global Selection
MainStay Epoch Global Choice Fund
Author: Ticker Magazine
Last Update: Oct 09, 8:42 AM EDT
|Finding investable companies is hard enough in any one region of the world, and doing it around the globe calls for a rigorous process and strict discipline. William J. Booth, portfolio manager of the MainStay Epoch Global Choice Fund, and his team of analysts look for companies with operations generating free cash flow, management with capital allocation discipline, and attractive valuation.
“The Epoch Core Model, a quantitative tool, ranks securities by focusing on free cash flow, earnings quality, and metrics analyzing balance sheet strength. It’s an efficient and effective way to review an investable universe of over 10,000 securities.”
Q: What is the history of the fund?
The MainStay Epoch Global Choice Fund is an open-end mutual fund that was launched on July 25, 2005 with Epoch Investment Partners as its subadvisor.
With an investment philosophy rooted in a free-cash-flow approach, Epoch offers traditional, diversified, and geographic-focused strategies to both institutional and retail clients. Our global, concentrated portfolio consists of 20 to 35 high-conviction securities chosen from the broader research efforts of Epoch.
Many global funds are significantly more diversified with far more holdings. In contrast, in addition to being highly concentrated, our portfolio’s holdings include companies that don’t necessarily fit more conventional descriptions of growth or value.
Currently, the Global Choice strategy has $4.7 billion of assets under management with the open-end mutual fund being a small piece of that. I became a portfolio manager in 2014.
Q: What core beliefs drive your investment philosophy?
We firmly believe that our free-cash-flow approach, which is rooted in the fundamental principles of finance, does a better job of representing the true economic health of a business. As free-cash-flow investors, it is our belief that a company’s ability to generate free cash flow is what makes it worth something to begin with. How management allocates free cash flow is equally important, as this determines whether the business’s value will rise or fall.
We look for management teams that allocate free cash flow in one of two broad ways: by reinvesting it on behalf of their investors or by returning to investors who can then decide for themselves where to reinvest.
In the first case, management may reinvest free cash flow either internally in new production facilities or research and development, or externally through mergers and acquisitions. We are happy when they reinvest in projects that will earn a return that exceeds their cost of capital, because that is the fastest way to grow shareholder value. However, we also appreciate management teams with the discipline to give back to investors through a dividend, share repurchase, or by paying down debt.
Q: How do you transform this philosophy into your investment process?
We rely on our fundamental investment team as the primary source of ideas that are consistent with our free-cash-flow philosophy. Our analysts average over 22 years of experience and are largely organized on geographical and/or sector lines. Epoch’s investment culture is collaborative, allowing us to share and leverage insights across the firm, portfolios, and strategies.
Beginning with these well-researched, bottom-up ideas, we then marry in our top-down thinking to identify where the best risk-reward opportunities are globally. But, because we realize that sometimes we miss opportunities, a secondary source of idea generation is also used.
The Epoch Core Model, a quantitative tool, ranks securities by focusing on free cash flow, earnings quality, and metrics analyzing balance sheet strength. It’s an efficient and effective way to review an investable universe of over 10,000 securities.
Q: In what other ways do you narrow your investment universe?
To make it more manageable, we begin with a technical exclusion by liquidity and market cap. Although Epoch does have small-cap strategies, some of those stocks wouldn’t be appropriate for us; they’re too small for our concentrated global portfolio.
Primarily, though, our focus is winnowed down to the key stocks followed by each analyst. Epoch actually requires that they flag their three best ideas at all times in our research management system. This way, I and the other portfolio managers can follow up on a specific name with an individual analyst.
Finally, because price targets are also required of analysts, we can use them to narrow the list further. Every security in the portfolio is analyzed in terms of its upside/downside ratio to assess the relative attractiveness of the various opportunities available to us.
Q: What steps are involved in your research process?
Regardless of how an idea is sourced, our process involves a bottom-up, deep-dive research analysis which focuses on understanding three main areas of a business: its free-cash-flow profile, capital allocation, and valuation.
We begin by developing a company’s free-cash-flow profile; we need to understand whether it can sustain and hopefully grow free cash flow over time. This involves a thorough examination of the business and industry, and addresses competitive advantage, industry structure, and corporate strategy.
Next comes capital allocation. We look at management’s track record, their key performance indicators and incentives, and whether there is significant insider ownership or alignment from a shareholder perspective.
In addition to understanding management’s framework for allocating free cash flow and whether they will be good stewards of it, we try to get a sense of whether they really care about creating shareholder value, and also consider trust and integrity factors.
The final step is valuation, during which we estimate the intrinsic value of a business based on our expectations for future free-cash-flow generation and look for a disconnect between our estimate and the security’s current market price. With at least a three-year time horizon, we tie intrinsic value to some measure of free cash flow: it could be free-cash-flow yield or its inverse, the price-to-free-cash-flow multiple; in some industries, a full-blown discounted cash flow analysis will be done.
Even though we are more fundamental bottom-up investors, our research process is layered with top-down context. An investment policy group meets quarterly to discuss significant risks and opportunities around the world which ultimately may influence portfolio construction.
These might include issues like central banking policies, global elections, China, the geopolitical risk related to North Korea, or what’s happening in commodity markets.