Less Is More For This Active Global ETF

August 15, 2018

The Davis Select Worldwide ETF (DWLD) is a global equity ETF described as “high conviction active.” This is a go-anywhere, best-ideas-type strategy serving up a concentrated portfolio of global stocks that, in 2017—its debut year—notably outperformed passive giants in the segment, such as the iShares MSCI ACWI ETF (ACWI) and the Vanguard Total World Stock ETF (VT).

 

Chart courtesy of StockCharts.com

 

So far in 2018, DWLD, with $254 million in assets under management, has lagged a bit, but the fund’s construct and performance speak to the importance of security selection, of finding good value, and of having conviction in long-term themes when you are truly steering clear of an index. Davis Funds’ portfolio manager Danton Goei gives us a glimpse at the legwork that goes into an active ETF such as DWLD.

 

ETF.com: DWLD owns only about 35 holdings; it accesses at least three countries at a time, and the positions are ideally held for at least three to five years. This is a concentrated portfolio that holds on to its bets for a good length of time. Why is this the way to go in global equities?

Danton Goei: It's a globally diversified fund, actively managed, index-agnostic. We think that's one of the big benefits. It's a go-anywhere fund based on bottom-up research. Our view is that, in the global space where the index comparison, the MSCI All-Country Weighted Index (ACWI), has 2,500 names in it, we’re pretty sure there aren’t 2,500 good companies out there. We do the legwork and choose what we think are 35 great investments and build a portfolio around that.

ETF.com: Performance of this fund is highly dependent on individual securities. In the past, allocations to Amazon and Google drove most of the outperformance DWLD had against funds like the iShares MSCI ACWI ETF (ACWI) and the Vanguard Total World Stock ETF (VT). What company-specific metrics are you considering when picking stocks in a global pool?

Goei: It’s a concentrated portfolio, and at different points, different names will drive the performance. Our overall investment philosophy is long term—a three- to five-year investment horizon. We're looking for companies with great competitive advantages, with high return on investment.

We try to invest in what we call “compounding machines”—names where time is your friend, companies that, over time, have great investment opportunities in their own businesses.

We also spend a lot of time with management. If you only own a stock for five weeks, like a lot of funds do, it’s not going to matter. But if you own it for five years, then management matters hugely. We spend a lot of time with management talking about capital allocation.

Finally, we're very valuation-sensitive. In our mind, there's no such thing as must-own. It's all depending on the price that you get relative to the opportunity.

If you look at the portfolio, it’s pretty eclectic. You have names like Google (GOOG) next to names like Wells Fargo (WFC). You don't often see portfolios that have those names side by side, but we think about the multiples we're paying now relative to the growth rate over time. Wells Fargo is trading at 11 or 12 times earnings, so that's 8% or 9% current earnings yield. It's a great starting point. We think those earnings will continue to grow.

But then you look at Google and you've got something that's trading double the multiple, 23 times earnings. But their earnings and revenues are growing in the 15-20% range. A 15% growth rate would mean a doubling of earnings in five years, so the multiple’s halving in five years. That’s also very attractive, and we have a lot of confidence that's going to happen. It's bottom-up, valuation-focused analysis.

ETF.com: People seem to love factors. In DWLD, you’ve favored larger-cap growth names and smaller-cap value names. You also seem to avoid value stocks that have higher yields. But it sounds like the underlying factor here is value.

Goei: Correct. We focus on value. But you bring up a good point: What you own is just as important as what you don't own. We don't own a lot of these high-dividend yielders—a lot of the consumer product companies that have been seen as either safe or attractive because they have a high dividend. People are wrong on both ends.

There are a lot of things happening in the consumer space that makes a lot of these companies less attractive than they were 10 years ago—online retailers, stronger competition in emerging markets, which has been a big growth area for them.

But the idea that just because you have a 3% or 4% dividend yield you're an attractive company, and I'm willing to pay 20-25 times earnings even though those earnings are only growing 0-5%, low single digits is a dangerous place to be. Even though they're global, multinational, well-established companies, we think they actually make for risky investments.

ETF.com: Outside the U.S., DWLD has a big allocation to China. That’s paid off in the past. It's not doing so well this year. What's your view on China going forward?

Goei: I just returned from six weeks in China meeting with companies there. Part of our research effort is going to meet with companies and talk to management, as well as to their competitors, suppliers and customers. China is an area we’re very interested in. But we don't invest in a country. We have a very focused approach, and only own names we find interesting, and that’s in the consumer space.

Even though historically China's been driven by commodity, industrial and construction companies, the consumer space is faster-growing. Chinese net exports as a percentage of GDP in 2007 was 9%. That’s fallen to 2% last year because the economy in China has been pivoting toward much more of a consumer-led, domestically driven economy. Just like ours, the U.S. is driven by how the U.S. consumer does.

You can find some great businesses in the consumer space, where there are high barriers to entry, real competitive advantages, high-free-cash-generation-type of businesses, whether you have economies of scale or brand.

But right now, China’s been struggling a bit, mainly because of macro fears around trade disputes. That said, a trade war would have some impact on the Chinese economy, but it would be limited due to its growing consumer focus. The companies we invest in have very little exposure to exports; they’re domestically driven.

ETF.com: DWLD is still pretty young, but you have a lot of experience in this space. Have you ever picked a stock that turned out to be a complete sour apple? How did you manage that?

Goei: Yes, we've certainly had our misses in the past. Even though the ETF is a year-and-a-half old, our global strategy is almost 15 years old. So, we have a long track record there with lots of winners, but also our share of misses.

We want to be long term. But we assess every holding we have on a daily basis relative to the opportunity costs that are out there. If something is amiss for whatever reason—we were wrong about management, or about the market opportunity or competition or regulatory environments—and we now think the risk/reward is poor from here on, we'll certainly sell. We're not tied to the idea that we have to hold it for at least three to five years.

ETF.com: Active management gets a pretty bad rap for often underperforming benchmarks, failing to deliver consistent performance year after year and for being expensive. You’re out there pitching a high-conviction, concentrated global active ETF at 0.65% when you have funds like ACWI at 0.32% and VT at 0.10%; that can’t be easy. Are there any misconceptions people have about what an active ETF like DWLD can offer at the end of the day?

Goei: We realize the competition is funds like ACWI. But we think our rates are very competitive, and that's one of the reasons we started the ETF. We were already low rate relative to other active managers, so we thought we were a great candidate to do ETFs. But we realize the passive manager is even lower. Still, we can add a lot of value. We talked about ACWI and its 2,500 names—it’s way overdiversified.

And it’s not just the number of names, but the list is chock-full of state-owned enterprises, like banks, industrials, insurance companies, telecom. A lot of these companies, outside the index, investors would never dream of investing in—a Chinese state-owned bank or an Indian telecom company run by the government? They aren’t well run and they’re not run for the benefit of shareholders.

An active manager in the global space can really add a lot of value by avoiding those types of companies, and focusing on the right ones.

Contact Cinthia Murphy at [email protected]

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