TD Epoch Non-U.S. Choice

The bedrock of our philosophy is the belief that the best predictors of long-term shareholder return are growth in free cash flow and management's skill in allocating that cash.

We prefer cash flow to earnings for three reasons. First, cash flows are more reliable than reported earnings because they are harder to manipulate under accounting rules. Second, for innovative businesses which derive much of their economic value from intangible assets, reported earnings have become increasingly less relevant as a measure of value generation compared to cash flows. Third, businesses which appear to generate reported earnings but not cash flows are more likely to run into financial distress.

Capital allocation matters because decisions on how to allocate cash flows—whether to reinvest in order to grow a company, or to return capital to shareholders—can create or destroy long-term shareholder value.

The investment process begins with a broad universe of over 6,000 non-U.S. companies in both developed and emerging markets. This investment universe is filtered down to approximately 2,000 stocks based on market cap and liquidity constraints. From this investable universe, we identify potential research candidates through meetings with companies, suppliers, customers, their peers, conferences, and trade shows. Our team complements fundamental insights with the Epoch Core Model ("ECM"), a proprietary quantitative tool that was developed in-house to systematically express our free-cash-flow investment philosophy. The Non-U.S. investment universe is large, heterogeneous, and complex, and the ECM helps reduce errors of omission by increasing the breadth of coverage and overcoming behavioral biases. The factors used in the model represent the various aspects of our investment philosophy including free cash flow yield, growth in free cash flow, and the quality of management. 

Regardless of the ECM score, all securities undergo in-depth fundamental analysis by our research team before ever being recommended for inclusions in a portfolio. For each company, our investment team scrutinizes management’s track record of allocating capital, looking for those with the discipline to use free cash flow to maximize return on investment, thereby creating shareholder value. 

As part of this process, they review the company's business model, industry dynamics, competitive positioning and strategy, free-cash-flow profile, returns on capital, and valuation. In addition, we examine management's historical track record and incentive schemes. All else equal, TD Epoch prefers management teams that are focused on measures like free cash flow, return on invested capital, and total shareholder return rather than short-term sales and EPS growth measures—which can be flattered by accounting practices but may not translate into true shareholder value creation. Once a stock has been purchased, we regularly revisit our thesis and typically sell the stock if our price target is reached, our thesis changes, or we see another investment with a better risk-reward profile.

While the portfolio is constructed from the bottom-up, we consider the macro context when making decisions. TD Epoch’s Investment Policy Group, composed of senior members of our different strategy groups, provides insight and guidance on the global market environment, as well as macroeconomic and industry trends. The end-result is a concentrated, high-conviction, and risk-controlled portfolio that represents the firm's best ideas domiciled in Non-US markets.

Risk management is integrated throughout the investment process and portfolio risk exposures are monitored and formally communicated to portfolio managers on a regular basis and are discussed at investment meetings. The strategy's portfolio construction framework is designed to minimize unintended risks and reduce volatility, producing an efficient portfolio on a risk-return basis. We employ diversification constraints across major countries and sectors. While the strategy does incorporate the top-down views of our Investment Policy Group, the portfolio's emphasis is on idiosyncratic bottom-up ideas with stock selection as the primary source of risk. Following the selection of a name for inclusion in the portfolio, our team pays careful attention to the sizing of positions. Position sizing reflects both quantitative insights and human judgment along with overall portfolio constraints, objectives, and architecture.