A third-generation family-run asset manager founded on the principles of 19th-century Scottish saving associations is an unlikely hotbed for innovation.
The firm in question, Davis Advisors, is a long-only equity shop run by a wealthy dynasty and based in the building of another: the Rockefeller Center in Midtown Manhattan.
On paper, it is about as conventional as an asset manager can get. It should – theoretically, at least – be facing some kind of existential crisis too, as passives become ever-more pervasive.
Instead, the firm is busy planning for the next 30 years based on a strategy of embracing the new world of asset management. It is offering its strategies as actively managed ETFs, while also sticking to what it has been doing since the 1960s: running high-conviction portfolios of stocks with underappreciated earnings potential.
It offers five main strategies today, the most famous and oldest of which is the $11.7 billion Davis New York Venture fund. It is run by Danton Goei and Chris Davis, whose grandfather – Shelby Cullom Davis, known as the ‘dean of insurance stocks’ – started the family investing habit by turning $100,000 into $800 million over the course of his career, largely by investing in financials. This particular legacy lives on in the $1.4 billion Davis Financial fund, also run by Davis.
Since January last year these two strategies, as well as the firm’s global equity offering, have been available as fully transparent, fully active ETFs.
‘People say true active managers can’t run an ETF, that that’s a different business, a different product. But our view is: Why not?’ Davis says.
‘We have all of the characteristics that are suitable. We have low turnover, we have true active management, a culture of transparency and low costs. Why can’t we offer our services in the format of an ETF, in the same way we do the format of a mutual fund?’
Transparency is everything
Many active managers have resisted offering ETF versions of their mutual funds for two main reasons: cost and competition. They stand to lose their margins as investors flock to the cheaper offerings and will lose out too as rivals steal their strategies, made available under the structure’s daily disclosure rules.
Neither of these are a concern for Davis.
‘We are relatively small in the scheme of the universe. It would be hard for a trillion-dollar manager to do what we’re doing because of the market impact,’ he says. ‘We have a culture of transparency. We want our clients to know what we own. If a client has an SMA [separately managed account] with us today, they know what we own, so we didn’t feel there was anything inconsistent with being transparent.’
On charges, he adds: ‘Our fees were already quite low. I felt how I felt with iTunes. When it was created people said, “Why won’t people keep stealing music?” And the answer is: If you make it easy and relatively cheap, people don’t want to steal.
‘If somebody wants to arbitrage our expense ratio they would have to lever it 20:1 to get a double-digit return. I don’t see how that would work.
‘It’s been a long evolution, but this evolution is not driven by the way companies change. It’s driven by understanding the needs of clients and what suits them.’
Passive’s gift to active
The firm’s move to offer ETFs should not be seen as a shift toward a more index-centric, passive style of investing though.
Davis, like many active equity managers, has suffered significant outflows over the course of the US bull run as investors flocked to the cheap S&P 500 passives. His new ETFs are yet to change that in a meaningful way, but he argues that the rise of passive investing has in some ways been a boon for a shop such as his.
‘The big trend of flows to passive is really a gift to a firm like ours,’ he says. ‘We no longer get the questions about being different. [People used to say,] “You look so different to the index, isn’t that risky?”
‘Now what we find is that the people who want active managers – which is admittedly fewer and fewer people – but those that do, they want true active management. So all of a sudden the fact that we look different is no longer a source of concern to clients.
‘Also, the more money that goes into passive, which is essentially a momentum strategy, the more opportunities there will be for true active managers. It’s not good for an active manager’s business, but it is good for them in terms of the value creation they can get.’
However, he admits that the continued success of passives has made things hard, and the end may not yet be in sight. ‘This is a difficult period,’ he says.
‘You can be doing great things that don’t show up for a while, a bit like the late ’90s. A lot of good managers started capitulating. We are in that sort of environment, but it could go on for a long time. We don’t think we’re in the ninth inning of that. Where we are finding value is by being very stock-specific.’
While he sees problems with passives, he is by no means blind to the faults of active managers.
‘There’s this view that the average manager doesn’t outperform,’ he says. ‘Well, the average manager has high fees, high turnover, is inexperienced in portfolio management, looks a lot like the index, is overdiversified and doesn’t have any of their own skin in the game. Of course they are going to underperform. I wouldn’t make a case defending the average active manager.
‘But it’s like saying the average person couldn’t dunk a basketball. It doesn’t mean there aren’t characteristics that make it more likely somebody could dunk a basketball.’
The learning curve
Davis’s candor and criticism are not reserved for his peers. He also turns them on himself. On the wall of his offices are framed certificates of all the mistakes he and his co-managers have made over the years.
He says these have evolved with him. His early mistakes are errors of commission, buying value traps such as AT&T. But his more recent missteps have been errors of omission – not owning stocks due to perceived overvaluations, only to watch them soar from the sidelines, as he did with Apple and Amazon. He has since corrected that latter oversight.
‘We were late and we were slow,’ he says of getting back into the online retailer. ‘We owned it from 2002 to 2005, sold it and then we bought it back about four years ago.’
Davis says Amazon is a good example of his firm’s investment preference and has parallels with the life insurance companies his grandfather first bought in the 1950s.
Despite selling plenty of contracts, earnings for the new insurance firms looked meager, as for the first year of the contracts the sales commissions outweighed the premiums. But over time, an aggressive and seemingly expensive growth strategy paid off as commissions went down and profits went up. Amazon has similarly reinvested its earnings aggressively in a bid to boost sales.
‘We have to hold to unchanging principles but adapt to changing times,’ Davis says. ‘The principles are the same but where and how value manifests itself changes as the economy changes.
‘One of those unchanging principles has been the requirement to constantly adapt. What worked in the ’50s didn’t work in the ’60s and so on. We have moved from Main Street to shopping malls, shopping malls to Walmart, Walmart to the internet. At every stage what worked in retail for one generation has not worked for the next. You have to evolve.’
Head of investment research, Citywire
Over the course of Chris Davis’s lengthy career he has managed to outperform the market. However, like many of his peers, he has lagged the momentum rally that has characterized the post-credit crisis period.
Over the past five years, the portfolio sits in the top quartile on a risk-adjusted basis and has outperformed over the past couple of years. Investors will hope that as the drivers of markets shift from central bank intervention to growth and fundamentals Davis can maintain that form.