TD Epoch U.S. Equity Shareholder Yield
At a glance
The U.S. Equity Shareholder Yield strategy pursues attractive total returns with an above-average level of income by investing in a diversified portfolio of U.S.-domiciled companies with strong and growing free cash flow. We pursue this through a portfolio of securities with a cash dividend yield of 3%, an additional return from share buy-backs and debt reduction of 2%, and operating cash flow growth of at least 3%. The portfolio generally holds between 75 and 120 stocks from U.S. equity markets, with risk controls to diversify the sources of shareholder yield and reduce volatility.
The U.S. Equity Shareholder Yield Opportunity
A significant portion of total returns from shareholder yield - dividends (The most stable component of returns), Share repurchases and debt paydowns.
Defensive characteristics: less-than-market volatility, low downside capture.
Abundant income with persistent dividend growth.
Low correlations with traditional equity styles.
Style consistency with factor attributes that have been stable over time.
Strong exposure to yield factor, tilt to quality.
Philosophy and approach
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 universe of approximately 3,000–4,000 U.S. equity securities. We deploy a proprietary quantitative screen that helps narrow the universe to an opportunity set of 150–250 stocks that meet the basic criteria for the strategy. We screen for items including a minimum current recurring cash dividend yield of greater than 2%, consistent dividend growth, operating cash flow coverage of the dividend, and minimum market capitalization with sufficient trading liquidity. This screen serves as an aid in identifying companies worthy of further research and allows our analysts to dive more deeply into the fundamentals of a smaller set of potential investments.
Stocks that have been identified as potential investments are subjected to rigorous bottom-up fundamental analysis, which includes an evaluation of the business, financial strength, capital allocation policy, quality of management, as well as external factors, to select stocks for inclusion in the portfolio. Each company we analyze is subject to an extensive review of historical performance, as well as a detailed two to three-year forecast of key operating and financial metrics. We are not looking for mispriced securities, but rather companies where we have a high degree of confidence that we will collect a growing stream of shareholder yield.
We perform sensitivity analysis around the key drivers of cash flow and management's allocation of it over a two-to three-year horizon to develop an expected shareholder yield and our confidence level that the company will meet our expectations. Both the screen and the fundamental analysis seek to identify companies that can produce excess cash flows and whose managements are committed to delivering shareholder yield by paying above average and growing dividends, buying back shares and/or paying down debt without taking undue risks.
All members of the investment team, including the portfolio managers, conduct fundamental research for the strategy. Investment ideas are discussed during formal and informal team meetings. Analysts are responsible for developing and presenting an investment thesis, and it is up to the portfolio manager to determine, within the strategy's portfolio construction process and risk controls, the names to include and their weights in the portfolio. Stocks are generally held as long as they continue to produce the shareholder yield characteristics we seek. Positions may be sold due to changes in a company's fundamentals or its capital allocation policy. We may also exit or trim a position if price appreciation has exceeded growth in the dividend to such a degree that the dividend yield is no longer considered constructive in reaching our overall portfolio objectives.
We seek to constrain the extent to which any one security could compromise the portfolio’s ability to deliver our goals in terms of yield or growth in underlying cash flows. In other words, if a security has a very high yield, we will assign it a relatively low weighting so that the portfolio is not dependent upon it to achieve its dividend yield objective. No one security can contribute more than 3% to the overall yield of the strategy, and no one security can contribute more than 5% to the overall cash-flow growth of the strategy. Individual positions are limited to 2.5% of the portfolio and sectors are generally limited to 25%.
Risk management is integrated throughout the process with a focus on avoiding unintended risks—TD Epoch's Chief Risk Officer serves as a co-portfolio manager on the strategy, who actively monitors portfolio risk exposures, and formally communicates them to other portfolio managers on a regular basis.