Phil Davidson of American Century Investments takes a slow and steady approach to value investing, stressing avoiding losers as he has built nearly $33 billion in assets under management in nine mutual funds. His numbers tell the story, having delivered an annualized net return of 8 percent over the past 15 years vs. just 4.6 percent for the S&P 500 (INDEXSP:.INX).
Phil Davidson on the different styles of value investing
“There are different styles of value investing, with different outcomes in terms of volatility,” Davidson noted in a recent issue of Value Investor Insight. “We consider ourselves more at the quality end of the spectrum, trying to buy good businesses at attractive valuations as opposed to buying statistically cheap stocks of often damaged businesses and hoping they turn around.”
Although Phil Davidson apparently takes a swipe at statistically driven investment decision making, he sure talks like an algorithmic trader as he looks to buy on a drawdown (loss) and looks for a good company to revert back to its historical mean.
“Right down the middle of the plate for us is a company under earning relative to its more normal returns on capital and whose stock is trading at what we consider a below-normal valuation,” Davidson said, outlining a buy after negative drawdown strategy. “We’re looking to make money on the mean reversion of both returns and of valuations. Buying decent companies when they’re out of favor typically produces a return pattern with lower volatility, which we consider congruent with growing wealth over time.”
Extending the algorithmic trader’s mentality
Phil Davidson extends the algorithmic trader’s mentality when he looks at cyclicality and how they played an investment in a tech industry hot shot leader. “In a somewhat different way we took advantage of cyclicality to increase our stake in Applied Materials, Inc. (NASDAQ:AMAT) last year. It is one of the leading players in semiconductor manufacturing equipment, with a history of higher and less-volatile returns than peers in what still can be a fairly volatile industry,” said the value investor who has successfully avoided volatility. “We were buying during a down period for earnings as end customers cut back on capital spending. Maybe we got a bit lucky that the company announced later in the year a transformational merger with Tokyo Electron, which we expect will be highly accretive for Applied Materials shareholders. But that’s another byproduct of investing in higher-quality businesses with good managements and good balance sheets: they tend to do the right thing for shareholders over time,” he said, explaining a fundamental tactic in a mean reversion strategy.
Phil Davidson then moved to explain his mathematical scoring system for determining value. “We have set broad ranges to be plus or minus 1000 basis points relative to our benchmark at the sector level and plus or minus 500 basis points at the security level,” he said. “At the stock level we tend to be within 300 basis points over and under the benchmark and pay particular attention to our biggest variances.”
Phil Davidson talks quant
Then speaking like a quantitative manager he talks about his win percentage and size of win. “You want to have good batting averages on those – swinging and missing on your top 10 overweights would make it hard to outperform,” he says.
“Over time if we have skill in ranking by value a reasonably diversified portfolio, we believe that wins out over trying to move in and out of the market,” Phil Davidson said, which, in the end, is a classic statement for a value investor.