Winning at Active Management

WILLIAM W. PRIEST is Chief Executive Officer, Co-Chief Investment Officer, and a co-founder of Epoch Investment Partners, and a long-time advocate of free cash flow investing. His other books include Free Cash Flow and Shareholder Yield and The Financial Reality of Pension Funding Under ERISA. STEVEN D. BLEIBERG is a Managing Director and Global Portfolio Manager at Epoch Investment Partners. MICHAEL A. WELHOELTER is a Managing Director, Portfolio Manager, and Head of Quantitative Research and Risk Management at Epoch Investment Partners.

• Preface xiActive Management is Not Dead YetPart I CultureChapter 1 Culture at The Core 3The Original Organizational Culture: Command-and-Control 5An Alternative Culture for Knowledge Businesses 8The Partnership Culture Model 10Justice and Fairness 17Chapter 2 Culture in Investment Management 21Values 22Integrity 26Trust 28Culture and Clients 32Firm Culture under Stress 34Culture in Recruiting 35Acquisitions 38Evolution of Culture 41Part II Philosophy and MethodologyChapter 3 The Nature of Equity Returns 49Linkages: The Real Economy and the Financial Economy 49Components of Stock Returns 51Price-Earnings Ratios 53The Historical Makeup of Stock Returns 59Chapter 4 The Great Investment Debate: Active or Passive Management? 63The Debate Is Timeless 65An Elegant Theory: The Capital Asset Pricing Model 66Further Elegance: The Efficient Market Hypothesis 68Reality Intrudes 69The Problem with MPT 71Chapter 5 A More Human Description of Investors and Markets: Behavioral Finance 73Loss Aversion 74Mental Accounting 75Minimizing Regret 76Overconfidence 77Extrapolation and Reversal 78Investor Behavior in Action 78MPT Still Lives 80Chapter 6 Active Versus Passive Management: The Empirical Case 85Market Regimes 87Correlation and Dispersion 87Company Quality 89The Weight of Cash 90Luck versus Skill 91Investors Voting with Their Dollars 96Chapter 7 The Case for Active Management 101April 2015: Investment Giants Square Off in New York City 101An Active-Passive Equilibrium 103The Case for Active Management 105Chapter 8 Debates On Active Managers’ Styles and Methods 109Manager Style 110Free Cash Flow Is the Measure of Value 112Depreciation 113Accruals 114Research and Development Costs 118The CFO Perspective 120Chapter 9 The Jump from Company Earnings to Stock Prices 125Flaws in Traditional Valuation Measures 125Accounting versus Finance: A Case Study 128Chapter 10 Epoch’s Investment Philosophy 133The Starting Point: Generating Free Cash Flow 134Choosing to Reinvest 135Capital Investment: Returns and Capital Costs 136Once More: Cash Flow-Based Measures Are Superior 139Trends in Capital Allocation 142Dividends 143Share Repurchases 145Debt Buydowns 150Capital Allocation: What’s the Right Mix? 151Part III TechnologyChapter 11 High-Speed Technology 159Information Technology: Three Relentless Forces 162Chapter 12 Technology in Investing 171Information at Work 172Order from Chaos: Applying Scientific Frameworks 172Computers to the Rescue 174A Virtuous Circle 176Expansion of Index Funds 177Betting Against the CAPM 177Concurrent Developments 179The Spread of Quant 181Computing and Data, Neck and Neck 181Big Data—Beyond Bloomberg 183Artificial Intelligence 187Chapter 13 The Epoch Core Model 191Factors in the Epoch Core Model 192Results of the Epoch Core Model 196Chapter 14 Racing with The Machine 201Investing Is Too Important for Robots Alone 201Racing with the Machine 202Seeking High Return on Capital 204A More Practical Study 206Is Persistence Contradictory? 208An ROIC Strategy 211The Value of Judgment 214Epilogue 219Appendix A: Selected Articles and White Papers of Epoch Investment Partners 223Appendix B: Financial Asset Valuation 273Appendix C: Feathered Feast: A Case 285Acknowledgements 295About the Authors 297Index 299