The global equity yield strategy delivering for investors

Epoch Investment Partners, through its portfolio managers John Tobin and Kera Van Valen, has a clear investment philosophy and portfolio objectives. 

Furthermore, the PMs have a laser focus and commitment to executing the strategy which, at its heart, involves: 

"[Finding] companies that are generating sustainable free cash flow and have management teams that are committed to consistently returning the cash to shareholders through dividends, share buybacks, and debt reduction," says Van Valen.  

The strategy also has a low turnover ratio, which runs at about 25-30% annually. That's because, as Tobin put it: 

The idea is we're looking for companies with these durable characteristics. We're looking for companies that are generating cash flow, et cetera.

When we find those companies, we are inclined to hold them as long as the company continues to generate growing cash flow. 

In this Expert Insights, I dive deeper into the Epoch investment philosophy, explore why they hold around 100 names at any one time, understand what it takes for a company to be removed from the portfolio, and explore a stock that exemplifies what they are looking for. 

Please note: This interview took place on 9 March 2023.

Edited Transcript

The portfolio holds 90-120 global companies at any one time, why that number and how do you manage so many?

Kera Van Valen: Diversification is a key element for us in minimising the risk of achieving our goals. 

We want to be diversified, not just across sectors and across countries, but also across the drivers of return. 

Income is a large part of our return within the strategy. So we actually diversify the sources of income. We limit the amount of income from any one name to 3%. That way, we can have a high degree of confidence in delivering the dividend yield that we seek to achieve in the portfolio.

This helps not only with the consistency of the income but also with the downside protection that we offer, and the lower volatility of the strategy. And it's very important to be able to have a diversified portfolio that helps us minimise the risk of achieving our goals. 

The way we do this is by being really focused. 

We want to find companies that are generating the sustainable free cash flow and have management teams that are committed to consistently returning the cash to shareholders through dividends, share buybacks, and debt reduction. 

So the structure and the focus of the strategy allow us to have roughly a hundred names across the shareholder yield strategy.

Could you talk through a portfolio company that exemplifies your holdings and shows how your investment process works in real life?

John Tobin: One stock that I could offer as an example is Novartis (NYSE: NVS). 

It's a stock that we've owned in the portfolio for several years now. It is a Swiss-based pharmaceutical company. It's a large company and has a market capitalisation of about US$200 billion. It did about US$50 billion in revenues last year. 

The company pays an attractive dividend. The dividend yield is a little over 4%. They regularly do share buybacks. The dividend has been growing year, by year, by year for more than 20 years. 

The company has demonstrated a real commitment to paying an attractive growing dividend over time.

One of the things about this business that's attractive to us is the way management has, in recent years, been focusing the business on innovative medicines. 

In 2018, they divested a joint venture interest they had in a consumer healthcare company. In 2019, they spun off Alcon, which is their eye care products company. In 2019 or 2020, they divested their joint venture interest in their cross-town rival Roche. This year in 2023, they are in the process of spinning off Sandoz, which is their generics and biosimilar company. So, it's focusing more and more narrowly on innovative medicine.

It's a company that has a clear focus, a clear strategy, and generates a lot of free cash flow. 

I think they generated about US$13 billion in free cash flow last year. And keep in mind, when we say free cash flow, this is after they paid all their expenses, after they paid all their taxes, after R&D expense, which was about US$9 billion last year, after capital expenditures, which was about a billion dollars. They had US$13 billion of free cash flow. They pay an attractive dividend with that, and they do share buybacks with that. They're also focused on smaller acquisitions, and business development... so, good capital allocation practises over time.

The last thing I'll point to about Novartis, that is attractive for us and for our strategy, is that it is a large pharmaceutical company, but it has exposure across several therapeutic areas. And to us, that's important. It implies stability to the business. They have blockbuster drugs in oncology, in immunology, in their cardiovascular business, in their neuroscience business. 

In several different verticals, they have significant blockbuster drugs generating lots of revenues and with good growth prospects. In many ways, this is an example of a company that ticks all the boxes for us.

Aside from free cash flow, what are the key characteristics that you look for in a company?

Kera Van Valen: In addition to free cash flow, capital allocation and strong balance sheets are very important. Having companies that understand that if you can earn above your cost of capital, by all means, reinvest in the business or make acquisitions. But it's about a discipline in returning any excess free cash flow to shareholders in the form of dividends, share buybacks, and debt reduction.

That capital allocation discipline is very important to us, in addition to the fact that balance sheets are what allow companies to withstand economic cycles and be able to continue to return cash to shareholders consistently. 

What does it take for a company to be removed from the portfolio and how often does that happen? 

John Tobin: The strategy tends to have a low turnover ratio. It runs about 25% to 30%. And the idea is we're looking for companies with these durable characteristics. We're looking for companies that are generating cash flow, et cetera. 

When we find those companies, we are inclined to hold them as long as the company continues to generate growing cash flow. 

As long as the company continues to adhere to good capital allocation practises, it's likely to stay in the portfolio.

So then, what makes us sell? 

Well, it's generally one of two things. It could be something bad that has happened - a whole host of things could happen that cause us to lose conviction in either the company's ability to generate cash flow or in their commitment to capital allocation practises. It could be a company-specific development. It could be sector-specific, or could be a change in management.

It could be a large acquisition that causes them to change their capital allocation policy. Those are the kinds of, if you will, negative outcomes that cause us to move away from a position and remove it from the portfolio. 

The other reason for selling a stock in the portfolio, it's the good news - if you will – scenario where the company does well, and it generates good cash flow, growing cash flow, pays a dividend, or raises the dividend.

But if the stock price appreciates faster than the dividend goes up, the dividend yield becomes compressed. And so we actively manage the portfolio to cycle out of those opportunities and redeploy capital in other opportunities that we think will be more constructive for us to achieve our overall portfolio objectives.