& Results

U.S. Quality Capital Reinvestment

Seeks superior total and risk-adjusted returns by investing in companies that reinvest in their business to grow free cash flow.

At a Glance

Our U.S. Quality Capital Reinvestment strategy focuses on companies that reinvest in their businesses to grow free cash flow. We seek companies that are good capital allocators, and that use capital effectively to fund internal projects or to make acquisitions. Our research indicates that companies that make investments, internally or externally, that generate a marginal return on invested capital that exceeds their marginal cost of capital will increase in value. The U.S. Quality Capital Reinvestment strategy pursues attractive total returns by investing in a diversified portfolio of these companies with persistent, high return on invested capital (ROIC) which is achieved through their allocation to the growth-oriented uses of free cash flow, namely investment in internal projects and acquisitions. The portfolio generally holds between 75 and 120 stocks from equity markets worldwide, with risk controls to diversify the sources of growth and reduce volatility.

The U.S. Quality Capital Reinvestment Opportunity

  • Access to a portfolio of high-quality global companies with attractive capital appreciation potential
  • Portfolio holdings generate strong free cash flow and use their cash to reinvest in their business through internal projects and acquisitions
  • Invests in companies with a persistently high spread between ROIC and weighted average cost of capital (WACC)
  • Active management by an investment team with an average of over 20 years’ experience
  • Risk management integrated with the investment process

Epoch’s Distinct Investment Philosophy and Approach

Epoch believes that the key to understanding a company requires a focus on the cash generation drivers of the business — not a focus on accounting terms like earnings or book value. How does the business generate its free cash flow, and how does management allocate that cash for the betterment of the owners of the business; i.e., the shareholders? It is the ability to generate free cash flow that makes a business worth anything to begin with, and it is the ability of management to allocate that cash flow properly that determines whether the value of the business rises or falls.

There are only five things that management can do with a company’s free cash flow: pay a cash dividend, buy back stock, pay down debt, make an acquisition, or invest in internal projects. If a company can invest, either internally or in an acquisition, and generate a marginal return on invested capital that is greater than its marginal cost of capital, then making that investment will increase the value of the business. But if the return is going to be less than the cost of capital, making the investment reduces the value of the business, and management should return the capital to the shareholders. Accrual-based accounting measures such as earnings, and valuation metrics based on earnings, simply do not provide the relevant information as to whether a company is successfully generating free cash flow and whether management is allocating that cash flow properly.

This strategy uses proprietary quantitative research to identify potential investments. We look for factors including ROIC greater than WACC, growth in cash flow from operations over the last five years, expected revenue growth greater than expected global GDP growth and high or expanding margins. Stocks are then subject to rigorous fundamental research which is designed to assess the sustainability of the competitive advantages that has enabled each company to achieve its level of ROIC. Risk management is integrated throughout the process with a focus on avoiding unintended risks. Portfolio risk exposures are monitored and formally communicated to portfolio managers on a regular basis and are discussed at investment meetings.

The team performs a portfolio rebalance on a quarterly basis that incorporates the results of a risk optimization analysis as well as the latest results of the quantitative screens. Positions can also be added or removed at any time based on input from our fundamental analysts or in reaction to new information. There are no absolute or bench-mark relative sector or regional constraints. The maximum premium on WACC contribution per security is 3.0% so that the portfolio’s aggregate ROIC – WACC is not dependent on any single security. Additional risk measures include maximum contributions to cash flow growth per security, revenue growth per security and cash flow margin per security. Position size is generally 0.25% to 2.0% and determined by the portfolio managers with input from the analyst and our Quantitative Research and Risk Management Team. Position weights are inversely related to the risk presented by the security within the context of the overall portfolio. Stocks are generally held as long as they continue to display the sustainable growth characteristics we seek, specifically ROIC well above WACC. Stocks are reduced or sold if a company’s fundamentals change, there are more attractive alternatives with a better risk-reward outcome or if there is deterioration in the investment criteria.

Disclosures and Fees »

Our Perspectives

The transition to net-zero emissions (NZE) involves a fundamental change in the structure of the economy, and will likely be messy, implying periodic supply shortages and even more volatile energy prices. Further, inflation and nominal interest rates will probably be higher and more volatile, especially relative to the levels of the last two decades. This has not yet been priced into markets.

China has launched a new policy framework, “Common Prosperity,” which escalates government steerage of the economy and features two critical initiatives. First, Beijing is taking action to tame the country’s real estate obsession. Second, the “summer blizzard” of regulatory actions has targeted a wide range of tech-related sectors including fintech, social media, online tutoring and gaming. Here, we examine the implications for investors of the pendulum swinging ever further in favor of the state.

The recent surge in start-ups and unicorns reflects the broadening of the digital revolution across industries, and suggests improving productivity and free cash flow. Further, although the digitization of the economy is still in early earnings, we expect digital platforms to represent the majority of market cap by 2025, with tech, health care and communications the most promising sectors.

Inflation risks are at a four-decade high due to today’s combination of a generous Treasury, an overly tolerant Fed, and a reopening economy. While our base-case scenario assumes only a brief period of above-target inflation, investors should brace themselves for more inflation scares, which will likely remain a key driver of equity markets well into 2022.

During the past two years, CBDC has progressed from a bold speculative concept to a seeming inevitability and will soon be a core feature of our financial ecosystem. The rollout of CBDCs will further accelerate the digitization of the economy, which is the key defining feature of markets over the past decade. This paper explores the implications for monetary policy, the FinTech and payments sectors, and the potential disintermediation of significant swaths of the commercial banking system.

The Cambrian explosion of exciting breakthroughs in AI, autonomous driving, 5G, and cloud computing will drive double-digit growth in semiconductor revenues for the foreseeable future. Superstar firms have come to dominate all subsectors of the increasingly concentrated semiconductor industry, which implies pricing power and explains the sector’s attractive operating margins and return on capital. Valuations are reasonable, and we have a constructive view on the semiconductor sector and believe it possesses considerable upside.

Both sides of the political spectrum have been increasing their calls for regulatory action on the Big Tech companies. Here we explain why tech will continue to be the most dynamic sector of the economy, and why we expect greater breadth in tech market leadership and the emergence of entirely new sub-sectors.