‘Shareholder yield’ is king

NEW YORK — After focusing on how companies employ their free cash flow throughout a four-decade career in investing, William W. Priest says for the first time in a long time market trends are putting the wind at his back.

In recent months, Epoch Investment Partners, the New York-based firm Mr. Priest launched with three colleagues in 2004, has seen that wind blowing institutional money their way — with $1 billion in new mandates since April 1 set to lift assets under management to $3.5 billion.

In an interview, Mr. Priest said the price-earnings expansion that drove the bulk of investment gains during the 1980s and 1990s, when interest rates were trending lower, is dead. The new king is "shareholder yield," broadly defined as dividend payouts, debt reduction and stock repurchase programs, he said.

Dividend payouts as a percentage of free cash flow are at a 30-year low, and firms that allow cash to languish on their balance sheets will increasingly become the targets of private equity firms, eager to deploy their multibillion-dollar buyout funds. In that environment, listed companies will face growing pressure to put their cash to shareholder-friendly use, Mr. Priest predicts.

Focusing stock selection on companies that will return cash to shareholders if they can't find profitable ways to use it results in portfolios that can make money for investors no matter what's happening to price-earnings ratios — an absolute-return orientation in tune with current market trends, Mr. Priest said.

The 38-person firm offers eight strategies, all built around the same free cash flow-focused research process.

According to Atlanta-based research firm eVestment Alliance, Epoch's U.S. All Cap Value strategy, with more than $1 billion in assets, has trailed its Russell 3000 benchmark by 1.6 percentage points on a one-year basis, while beating it by 3.5 percentage points and 7.3 percentage points a year respectively on a three- and five-year basis. All figures are for time periods ending June 30.

The firm's U.S. Value strategy, its next biggest at more than $800 million, trailed its Russell 1000 benchmark by 1.2 percentage points on a one-year basis, while beating it by just less than 3.0 percentage points a year annually since its launch four years ago, according to eVestment Alliance.

Meanwhile, Epoch's U.S. Small Cap Value strategy, with just less than $500 million in assets, has gained an annualized 23.7% since its inception three years ago, trailing its Russell 2000 benchmark by just less than 6 percentage points a year. David N. Pearl, a managing director and Epoch's head of U.S. equities executives, said the firm's portfolios underperform in speculative markets — such as the one small-cap stocks have enjoyed in recent years — while holding up relatively well when stocks are retreating.

Its most recent strategy, Global Dividend Yield, with $250 million, was launched 6%BD; months ago and funded with an initial undisclosed mandate from GE Private Asset Management. "We thought we could put together a fund that earned a 5% cash yield," another 150 basis points from share buybacks and debt pay downs and perhaps 3% growth in cash flow for a 9.5% return in a market likely to be yielding between 6% and 8%, Mr. Priest said. So far it has worked according to plan, he added.

J. Philip Clark, the 17-year Sanford C. Bernstein & Co. veteran who is a managing director and Epoch's executive vice president, client relations, said his team is focusing on two areas: pursuing institutional clients, with a big effort to tell Epoch's story to the consultants who serve them, and looking to gain subadvisory business.

Within the past month or so, a few big pension plans have hired the firm. On July 11, the firm's listed parent, Epoch Holding Corp., announced in an SEC filing that it had won $750 million in new mandates since March 31 — including $400 million from Los Angeles-based Northrop Grumman Corp. — all for the firm's U.S. All Cap Value strategy.

That figure doesn't include another $250 million all-cap mandate from the $7 billion Teachers' Retirement System of Oklahoma, Oklahoma City.

Gregory W. Weaver, the president of Tulsa, Okla.-based gregory.w.group, Oklahoma Teachers' general consultant, said he likes finding emerging managers that can generate alpha, and he was impressed with both Epoch's all-cap strategy and the firm's experienced team.

Along with Messrs. Priest, Clark and Pearl, Epoch's fourth co-founder, President and COO Timothy T. Taussig, had been a colleague of Mr. Priest's at BEA Associates, the firm Mr. Priest helped establish in 1972.

The fact that Epoch had listed itself on a stock exchange was another factor that made it stand out among smaller asset managers, Mr. Weaver said.

While constrained, as an executive of a listed company, in what he can say publicly, Mr. Priest conceded Epoch is looking for "another quarter of strong asset growth."