Performance through specialisation
The Dutch private bank Kempen & Co created something of a stir last year when it executed what were effectively two ‘lift-outs’: the hiring of a three-man European and global equities team from ING Investment Management, and the recruitment of two of the architects of fiduciary management at Mn Services.
The year before a management buy-out had extracted Kempen from the Dexia Group, where it was positioned uncomfortably as a niche player in a volume business. The hirings were part of Kempen’s strategy to develop KCM into a leading investment boutique for institutional investors. Much of this strategy was sketched out by Lars Dijkstra, the former chief investment officer at Philips Pension Fund, who moved to become CIO of KCM early in 2005.
The main features of the strategy were a focus on performance rather than asset gathering, and an emphasis on excelling in particular areas of investment rather than replicating the range of activities of other asset managers – an approach which KCM describes as ‘performance through specialisation’.
KCM already had a few areas of excellence like Dutch and European small caps, real estate and hedge fund selection. It now wanted to add another one – a dividend-based approach to global and European equity investment that was unique to KCM.
It found this approach in the equities team at ING IM, which included Jorik van den Bos and his colleagues, Joris Franssen and Joost de Graaf. Van den Bos, head of value and responsible for all the value strategies, had built a global equities operation from scratch that had grown from zero assets in 1999 to around €7bn in 2005. However, he was less interested in asset gathering than in performance.
“As a portfolio manager responsible for performance, I like to be in an environment where there is more focus on the performance. Of course there have to be some assets to manage, but the performance is key. And Kempen provided us with this vision and this view,” he says.
Van den Bos also liked the approach of Kempen as an active stock-picking boutique. “What was very helpful to us was that Kempen really believed in a bottom up process and also likes a value approach. There is an understanding and an underlying belief that value works in the long run.”
There was no need to build an operation from scratch, since KCM already had global and European equity funds. What was needed was the incorporation of a particular approach that would give KCM a competitive edge.
Van den Bos, Franssen and De Graaf offered a disciplined approach to European and global equity investment which uses dividend yield as the valuation tool. “Other value managers use price earnings, price to book or whatever. We have chosen dividend yields as our valuation tool and as our starting point,” van den Bos says.
The attraction of dividend yield
is that it is a solid measure of value: “A dividend is real cash. A profit is an opinion. And if you search long enough for the profit number you are looking for you will find it. But you cannot manipulate dividend. It is real cash that you receive in your bank account. There’s no discussion about it.”
Dividend yield also provides the asset manager with clear signals about how a company is performing, he says. “If the management of a company decides to increase the dividend, that gives a positive signal because then they have to be very certain that they can pay the dividend not only this year but also the year after. If they decide to lower or pass the dividend and they don’t have a good story behind it, the stock price can react negatively.”
This process is now being applied to KCM’s global and European equity funds. “For the European universe we limit ourselves to companies with a dividend yield above 2% and for our global universe we limit ourselves to companies with yields above 3%.”
The targets for the funds are the same: to outperform a broad-based benchmark over a rolling three to five-year period, says van den Bos.
“Everyone wants to outperform but we want to do it with lower volatility and lower downside risk. To guarantee that we will stay in this corner of the market the average yield for the portfolio has to be at least 100 basis points higher than the yield of the benchmark. That target is on top of the 2% and 3% yields.”
The process requires a strong sell discipline, he says. “If the share price of a European equity goes up 30%, the yield drops below 2% and we have to sell it, although we can collect a capital gain off the 30% price increase.
“The other side of the coin is that if a company lowers its dividend or passes its dividend altogether, then we have to sell it. So it is our task to avoid investing in companies where the dividend is at risk. It is perhaps a rather rigid sell discipline but it enables us to be strict with our style and take profits where possible.”
Yet only part of the investment process is quant-driven. The other part is fundamental. “We speak to management and one of the first questions we ask is about the dividend policy. We want to have some feeling about whether earnings are increasing or declining, and what the revisions are doing. If the dividend cover is close to one and revisions are down, that makes us a little bit worried about the dividends,” Van den Bos says.
The next step is to check Bloomberg data on a company’s yield, cover and earnings per share outlook. The final step is to use HOLT, a system which enables comparison of the underlying fundamentals of companies, to calculate cash flow return on investments (CFROI) and real asset growth. “So you are looking for companies with CFROI’s above their discount rate and then hopefully with rising assets,” he says.
The European dividend strategy enables KCM to select a portfolio of names from a universe of 10,000 equities. The dividend yield filter reduces some 1,000 companies screened for liquidity to between 200 and 400 companies. Quantitative screening and fundamental analysis whittles this figure down in the range of 60 to 90 equities.
Dividend strategies based on this selection have consistently outperformed, van den Bos says. One way of looking at this performance is to separate the months when the index goes up from the months when the index goes down.
This shows that over the last five years the dividend strategy outperformed the index in 21 out of 30 months in falling markets and 22 out of 39 months in rising markets.
“The dividend strategy is a strategy that will perform differently in different market environments,” Van den Bos says. “In a rising market we are happy if we can match the performance of the benchmark, but if the market drops as it did in 2001 and 2002, we are confident that our relative performance will be positive. So investors have much better downside protection.”
Dividend strategy funds will be one of the products on offer within KCM’s fiduciary management proposal. Kempen will initially not include its own funds unless at the request of the client and if it fits the mandate.
Fiduciary management is a new specialisation for KCM, although Kempen already provides a multi-manager service to its private wealth clients. The impetus was the appointment of Hans Rademaker as director fiduciary management and Jan Bertus Molenkamp, senior manager fiduciary management at KCM. Both men spent eight years developing the concept of fiduciary within the pension fund manager Mn Services.
As a business line, fiduciary management fits into KCM’s aim of ‘performance through specialisation’. “What is important is that you have to be focused. You need people who are aware of the integral problem of pension funds,” says Molenkamp.
“If a pension fund changes its strategy you don’t merely sell some equities and buy some bonds. There is a whole range of other things you have to do. You have to manage the risks and return within the time frame in which this change takes place.
“Tracking what risk you can run at what time can only be done in one fashion. It’s what we call an integral process, and one of the characteristics of a good fiduciary manager is that he has these processes in place.”
The new FTK regulations, which come into effect next year, have given a fillip to fiduciary management, says Molenkamp. “The debate in the Netherlands has been fuelled by regulatory changes. This is to the good, in the sense that pension funds should be focused on managing liabilities.”
Yet fiduciary management means much more than matching liabilities. “The first question pension funds should ask is not how do we match our liabilities but what is our ambition? What inflation indexation do we want to generate? What can we promise our members?”
The starting point for fiduciary management should be establishing the profile of the pension fund, he says. “Once you establish your profile, it is easier to see what tools will be needed, such as liabilities matching and asset diversification.”
Although KCM is currently focusing on the Dutch market for fiduciary management mandates, Molenkamp sees no reason why, in time, it should not move into other European markets. “Because of the approach taken in fiduciary management, most markets are suitable for this approach. Of course, every market has its own environment and conditions, but nobody will become poorer from an integral management perspective.”
KCM will win mandates, he suggests, because fiduciary management is a business where ideas count. “We position ourselves as the smart alternative. Like all fiduciary managers and asset managers we want to do the best for our clients, but we want to do it just a little bit smarter than the competition.”