TWST: Colleen, would you start by telling us about Cheswold Lane Asset
Management.Ms. Quinn Scharpf: I founded the firm with my two partners, Eric Scharpf and
Matt Taylor, in February 2006. We are located just outside of Philadelphia in
West Conshohocken, Pennsylvania. We have one investment strategy and one focus -
it is a large cap, international high dividend strategy that holds only foreign
ordinary securities and no emerging markets. We manage an institutional mutual
fund, the Cheswold Lane International High Dividend Fund (CLIDX) and separate
accounts. Cheswold Lane is 100% employee-owned and we have approximately $30
million in assets under management.TWST: What made you decide on this asset class and investment strategy, as
opposed to the other strategies available?Ms. Quinn Scharpf: In my prior business life as a plan sponsor, I spent over two
years looking for institutional large cap international managers, and I found it
very challenging. Many of the large institutional players had performance,
retirement and even reputation issues. The mid-sized players, some of which were
very good, had either closed or were struggling under the weight of large asset
inflows. It became clear to me that there was a great market opportunity for new
firms focused on the international marketplace.Mr. Scharpf: At the same time, Matthew Taylor and I were developing an
international high dividend yield strategy at our prior firm. We had spent more
than 18 months researching and developing an institutional investment philosophy
and process for our international high dividend strategy. Our experience,
combined with Colleen's knowledge of the institutional marketplace, ultimately
led to the formation of Cheswold Lane Asset Management.TWST: Would you tell us more about the investment process and what
characteristics you are looking for in potential holdings?Mr. Scharpf: It starts with our investment philosophy. We believe that a
portfolio of stocks with high dividend yields and low valuation will deliver
superior risk-adjusted returns over time, and that, historically, high dividend
yield portfolios have had lower volatility, as measured by standard deviation,
and lower risk of capital loss.
But we don't view high dividend yields simply as a valuation metric. We think
about yield in terms of specific characteristics of a stock or portfolio that we
find very appealing. For example, the high dividend yield companies we invest in
tend to be large, well-established businesses with leading market share
positions. They earn high returns on capital, generate significant and stable
cash flows and require modest capital reinvestment. Most of these companies are
underleveraged. We also believe that they are predisposed to have better
corporate governance and capital discipline, because management and their Boards
have made an implicit commitment to shareholders with respect to dividends and
their future rate of growth. Admittedly, reinvestment opportunities are finite
and thus growth is average relative to the market.
As Portfolio Managers, Matt and I focus our fundamental research effort on
analyzing companies' and industries' investment capital cycles. We believe
future marginal returns on capital drive stock valuations in the intermediate
and long run. We are fond of describing the stocks in our portfolio as a
collection of "quality businesses, at good prices."TWST: Are you investing only in international stocks, or is the United States
included?Mr. Scharpf: We only invest in developed countries outside the US; we do not
invest in emerging markets. Our benchmark is the MSCI EAFE Index. We expect our
investment strategy to be used as an asset allocation tool for clients and their
advisers. We don't believe it's in our clients' interests for us to adopt a "go-
anywhere" investment philosophy or mandate. We consider emerging markets to be a
different and specialized asset class. TWST: What are the rewards and risks of looking for international stocks with a
high dividend yield?Mr. Scharpf: For a US investor, the two primary benefits to international
investing are diversification and an expanded investment opportunity set. They
benefit from more opportunities to find inefficiencies in the global
marketplace, as well as the diversification benefits of investing outside of the
US. International markets and economies are often on different cycles. Foreign
currency exposure is an additional diversification benefit. The bottom line is
our product provides international market exposure, capital loss protection and
the opportunity to exploit less efficient markets relative to the US. TWST: How do you attempt to control investment risk?Mr. Scharpf: Risk management is a strong point for our Fund, because
historically a high dividend yield strategy has provided significant capital
loss protection. We use two third-party quantitative products to analyze our
Fund, which highlight unintended bets from a risk management perspective, and
also act as a guideline for managing our portfolio's volatility, tracking error
and overall factor risks.TWST: How many holdings generally would you have in the portfolio? Is it a
fluctuating number?Mr. Scharpf: Our guidelines limit the number of holdings in the portfolio to a
range of 45-60. We don't expect these numbers to change. TWST: Do your screens have a country allocation? How do your holdings fall into
different areas?Mr. Scharpf: We are broadly diversified within the 21 countries of the MSCI EAFE
Index. We have limitations on both sector and country weights for risk
management purposes. On a sector basis, our holdings will be plus or minus 10%
of the MSCI EAFE Index, and plus or minus 15% of the MSCI EAFE Index on a
country basis.TWST: What are some of your holdings that you can tell us about that are
representative of your strategy, and the reasons why you found them attractive?Mr. Scharpf: The portfolio's largest overweight on a sector basis is the telecom
industry, which definitely fits our portfolio's characterization of "quality
businesses, at good prices." In fact, we believe they are extremely good prices.
The telecom stocks have high returns on invested capital, generate significant
free cash flow, and are trading at very attractive valuations on a firm value to
cash flow basis, which is our primary valuation metric. Telecom has been out of
favor in the market for quite a number of years, but we believe the telecom
market is curing itself through consolidation, reduced capital expenditures and
better pricing discipline.
Our largest holding in the portfolio is in the telecom sector, and that's
Vodafone (VOD), the world's premier wireless company. It's a UK-based company
with wireless operations around the world. The stock has a dividend yield of
4.6% and trades at 5.5 to 6 times 2007 cash flow. Vodafone was the poster child
for over-investment during the TMT bubble, and more recently has suffered
through brutal wireless pricing competition in several major European markets.
However, management appears to have seen the light in terms of capital
investment; they actually paid out 15% of the company's capital to shareholders
this past summer in the form of a special dividend.
Additionally, Vodafone recently sold several non-core assets in order to focus
future capital expenditures on larger, higher growth markets such as India and
Eastern Europe. Finally, Vodafone owns 45% of the premier wireless asset in the
world, Verizon Wireless. For strategic reasons related to Verizon's (VZ) core
fixed line and broadband (fiber to the home) strategy, we believe Verizon will
be compelled to buy Vodafone's stake in Verizon Wireless. We don't believe
Vodafone's current valuation reflects the significant premium Verizon will be
forced to pay Vodafone for this critical asset.TWST: Are the telecom companies that you are interested in broadly wireless?Mr. Scharpf: No, not necessarily. Our telecom holdings include both incumbent
service providers and wireless companies. By incumbents, we mean the former
state controlled telecom monopolies. They have fixed line, broadband and
wireless networks that service consumers and corporations. France Telecom (FTE),
a large holding in our portfolio, is a good example of a major incumbent telecom
player in Europe. Most incumbents have been experiencing declining revenues in
their fixed line business due to voice over IP competition and wireless
substitution. This has been buffered by growth in broadband and wireless
revenues. However, very recently, we have seen the rate of decline in the fixed
line business slow, which is a critical factor to enable these companies to
drive overall top-line revenue growth. TWST: What other large sectors have you been finding good holdings in?Mr. Scharpf: We have a very large weight - almost 30% of the portfolio - in
financials, where we have been primarily focused on the capital markets
sensitive stocks. In Europe, many of the major banks generate significant
revenues from investment banking, private banking and asset management
businesses. We expect the capital markets environment to remain robust in 2007,
so we have increased our exposure to capitalize on this theme in the market. Our
top holdings in this space are Credit Suisse (CS) and Deutsche Bank (DB). These
are very attractively priced stocks on a p/e basis, with excellent fundamentals
and accelerating returns on equity right now. Each company also has an
underlying restructuring story, which should drive incremental returns higher in
the next two to three years.TWST: Have you been taking advantage of the energy boom over the past year?Mr. Scharpf: We have; our second largest overweight is the energy sector. Our
largest holding in that space is BP (BP). We tend to be contrarians, and BP fits
that description as a contrarian investment within the energy sector. If you
look at the last 12 to 18 months, everything that could go wrong at BP, from a
management perspective and from a public relations perspective, has gone against
them. They've had major pipeline issues at Prudhoe Bay in Alaska. Their Texas
City, Texas, refinery had a catastrophic fire resulting in 15 fatalities. Over
the summer, their US natural gas trading division was accused of bid rigging.
And most recently, the Russian government is threatening to revoke their
ownership rights to TNK-BP, the company's large Russian joint venture business.
As a result, BP's stock has significantly underperformed its peers. But we think
it represents excellent value within the energy space, which is the cheapest
sector in the entire market, on a forward p/e basis.TWST: What about the industrials? Have they been benefiting from the world
economies doing better?Mr. Scharpf: Yes, the industrial market has benefited significantly from the
strong global economies. However, this is an area of the market that we have
been reducing our exposure to over the last six to nine months. This decision is
driven more by the valuation side of the investment equation than the
fundamental. The fundamentals remain strong; however, the margins and the
valuation appear to be peaking, in our estimation.TWST: Do you have any examples of industrials that are in your holdings right
now?Mr. Taylor: One industrial area that we find attractive is the Japanese auto
sector. We own both Honda Motor (HMC) and Nissan Motor (NSANY). In contrast to
what Eric was saying about the industrial cyclicals peaking, the global auto
industry has already softened. However, both Honda and Nissan have significant
new product launches scheduled for 2007, which should bolster their performance
this cycle. Honda in particular has gained market share in North America, and
has opened new production facilities, which will drive higher returns on
capital. Within the broader industrial sector, Japanese autos have lower
margins. However, we believe they have a clear path to improvement.TWST: Is Japan the largest Asian country that you have holdings in?Mr. Taylor: Yes, Japan, at about 16% of our portfolio, is our largest country
weight in Asia, followed by Australia and Hong Kong.TWST: What is the sell process that you have in place?Mr. Scharpf: As a value investor, I am convinced that the key to successful
portfolio management is not what you do with your winners, but rather what you
do with your losers. How does one decide to sell an underperforming stock, or
buy more? In my opinion, the results of these investment decisions ultimately
determine whether a value portfolio manager is successful or not. For us,
quality written research is the critical tool allowing us to be more consistent
and disciplined in these "buy more or sell-out" situations.
Our internal research reports lay out the investment thesis, future events,
catalysts, valuation parameters and potential risks. This record helps us avoid
the psychological traps many portfolio managers fall into. Dealing with
adversely performing stocks is challenging. However, by putting your investment
thesis in writing, you are laying the foundation for future decisions, which are
often required to manage a successful investment holding.
As Cheswold Lane's lead Portfolio Manager, I want to know before I purchase a
stock, "If a stock is underperforming, under what circumstances am I gladly
going to buy more of it, and under what circumstances am I going to sell it and
take the loss?" Without this knowledge, I think it's difficult to have a
rigorous buy/sell discipline.
Human nature tells you it's always difficult to buy more of a stock when things
are going against you, and it's easy to hold on too long when they are going
higher. At Cheswold Lane, we sell stocks based on valuation. If a stock is no
longer attractive versus other alternatives on our core candidate list, it will
be sold. We also sell stocks when we've made a mistake in our investment thesis.
If the dynamics for improvement in the business are not turning or management
has disappointed us with their actions, we sell the stock. But we will buy more
of a stock, especially if it has underperformed and is even more attractively
priced, if the core investment thesis remains intact. TWST: Do you sell outright or do you prefer to reduce holdings by trimming them?Mr. Taylor: It depends. If a stock is performing very well but we decide the
valuation is starting to get extended, then we will trim the stock and let it
continue to run and trim some more, until we eventually sell the position.
Having said that, we don't have positions that linger too long - we adhere to
our 45-60 stock-holding range. However, we want to do it in a prudent manner.
When it comes to selling a stock because of a negative fundamental event or
management disappointment, we sell the entire position immediately.TWST: What do you think differentiates or distinguishes your investment approach
at Cheswold Lane from that at other firms?Mr. Scharpf: We think our international high dividend yield strategy is a
disciplined, repeatable investment approach that has proven effective in the
past and that we believe will continue to generate consistent, strong returns
for our clients. It's a differentiated strategy within the foreign large cap
value peer group, with a bias toward lower risk, rather than higher risk.
Finally, it's well suited to be the primary international strategy for most
institutional and high net worth clients because the product offers versatility
as a total return product, but can also be used as a high income producing
vehicle with a consistent, above inflation rate of growth. TWST: Are most of your clients institutional?Mr. Scharpf: The majority of our assets, more than 80%, are institutional. The
remaining assets are from high net worth clients. TWST: What advice would you give to investors about looking at international
stocks, particularly those with a high dividend yield?Mr. Scharpf: The first thing I would say is to be careful in the international
marketplace - there is no free lunch. Because we are a low risk strategy, we do
not own any emerging market stocks, even though many emerging market countries
have very high dividend-yielding stocks within their indices. Just because a
stock has a low valuation or a high dividend yield does not mean it is a good
investment, especially if your investment objective is lower risk. TWST: Is there anything else that you'd like to bring out about your work or
views for 2007?Mr. Scharpf: What's really interesting to us as we enter 2007 is how well our
investment philosophy and process match up with the current major force in the
global financial markets, private equity. During the last three years, private
equity funds have raised $750 plus billion to buy public companies and divisions
of public companies around the world. This is equity capital that will be
levered 5-6 times with debt, so the true buying power of these firms increases
to several trillion dollars. I've never seen a time in my investment career when
a small group of investors have accumulated such vast sums of capital that they
have the ability to change the dynamics of an industry or company. And the
phenomenon is global!
Our portfolio should benefit from this trend because private equity firms are
attracted to the same characteristics of companies found in the Cheswold Lane
International High Dividend strategy. Private equity firms want to buy
businesses that generate significant and stable cash flows, are underleveraged,
have modest capital expenditure requirements and can be purchased at reasonable
valuations. Historically, the only difference between our investment criteria
and private equity's was the market capitalization size. Cheswold Lane invests
in medium to large capitalization companies while private equity firms have
tended to buy small to medium-sized companies. But today, the financial markets
have shifted, and the most attractively priced companies in the global markets
are large capitalization stocks, not small or mid-caps. Because there has been
so much private equity money raised, and there have been low interest rates and
tight credit spreads, private equity firms are starting to buy larger and larger
targets. In fact, for the first time, during 2006, private equity firms started
pooling equity together to jointly buy several $10-$20 billion companies, in
what has become known as "Club Deals."
The most obvious and direct positive impact private equity can have on Cheswold
Lane's portfolio is to acquire one or more of our holdings at a significant
premium to its current market price. However, another powerful outcome from the
influence of large private equity funds is a renewed responsiveness of
management and Boards to create shareholder value. CEOs will be pressured to
make important strategic decisions to increase their companies' share prices.
For example, they might be more willing to increase their dividends or share
repurchases, sell non-core assets or even sell out to a strategic competitor.
2007 promises to be a very exciting time for mergers and acquisitions. We expect
to see bigger deals in Europe and Asia than we've ever seen before with respect
to private equity firms. This will be a major theme in 2007, and the Cheswold
Lane high dividend investment strategy fits very nicely with it.TWST: Is there anything that you want to add?Ms. Quinn Scharpf: Cheswold Lane is off to a great start. We've had strong
responses from the institutional marketplace and we're excited about our
investment strategies' prospects in 2007 following a stellar 2006.TWST: Thank you. (PS)Note: Opinions and recommendations are as of 1/11/07.COLLEEN QUINN SCHARPF
ERIC F. SCHARPF
MATTHEW H. TAYLOR
Cheswold Lane Asset Management, LLC
100 Front Street
Suite 960
West Conshohocken, PA 19428
(610) 940-5330
General Investing >> Money Manager Interview >> January 22, 2007
International High Dividend Yield Strategy
Colleen Quinn Scharpf, Eric F. Scharpf & Matthew H. Taylor
COLLEEN QUINN SCHARPF is President and Chief Operating Officer of Cheswold Lane
Asset Management, LLC. Prior to co-founding the firm in 2006, she was the
Director of Investments for the Board of Pensions of the Presbyterian Church
(U.S.A.) from 2003. Ms. Scharpf managed the international equity and global bond
portfolios for the $6 billion defined benefit pension plan... More










