ETF Expert Corner

Davis Advisors’ Dodd Kittsley Spotlights Active ETFs

May 22nd, 2018 by ETF Store Staff

Dodd Kittsley, Director at Davis Advisors, spotlights their suite of actively managed ETFs and discusses what’s next for the active ETF space as a whole.



Transcript

You can listen to our interview with Dodd Kittsley by using the above media player or enjoy a full transcription of the interview below.

Nate Geraci: We're actually spotlighting a suite of ETFs this week. They're from Davis Advisors. Davis currently offers four actively managed ETFs. Joining us via phone from New York to discuss these ETFs is Dodd Kittsley, Director at Davis Advisors. Dodd, a pleasure to have you back on the program.

Dodd Kittsley: Thanks so much for having us.

Nate Geraci: Dodd, so Davis first launched actively managed ETFs back in January of 2017. As I mentioned, there are now four ETFs all together with around $500 million in assets. To begin here, just give us some background, both on Davis and this decision to move into ETFs.

Dodd Kittsley: Absolutely. Yeah, so Davis is an employee-owned independent asset manager. We were founded in 1969 and now have about $30 billion in assets under management. Think of Davis as equity specialists, and we're specialists on international equities, US equities, and financial stocks. We're a very focused, research-driven shop, and we essentially just manage five strategies: large cap, all cap, US, financials, global and international. Common among these strategies is that all have outperformed their peers and benchmarks since inception. All are focused, high conviction, best ideas portfolios that are completely benchmark-agnostic, so they look nothing like the index, which makes them pretty good candidates to pair with market cap weighted indexes in a portfolio. Also, all of the strategies have meaningfully lower fees than their peer group average of actively managed products. In each strategy, and I think this is super important, we're among the largest investors. Davis truly eats its own cooking and are aligned with investors. To answer your second question, we entered the ETF market simply because advisors asked. Certainly, we didn't head in lightly. We had to do extensive research on feasibility and came to the conclusion pretty quickly that there was no reason not to offer our strategies in an ETF wrapper. This really hinged on three things. First, as a firm, we view transparency as a virtue and we always have. We think investors have the right to know what they own, as well as the investment thesis behind each line item. Second is we manage money and the way we manage money is well-suited for the ETF structure in that we take a very long-term approach. We have relatively low turnover and invest in large liquid stocks. Then finally, and this is a little more subtle, but our existing products and mutual funds were already low cost. Actually, every dollar that we manage on the equity side of the ledger in terms of mutual funds or ETFs, we charge 55 basis points in management fee. Now, net expense ratios can be different to reflect 12b-1s and other expenses, but we're truly delivery vehicle agnostic. We're all about choice and think that investors and advisors should be able to access their strategies with the tools that best suit their clients and their business models.

Nate Geraci: Okay, so right now, the most popular Davis ETF is the Davis Select Worldwide ETF, ticker symbol DWLD. Walk us through this. What's the investment goal? What does it hold? How many holdings? Anything else noteworthy?

Dodd Kittsley: Yeah. DWLD has been extremely popular. It is now about $220 million in assets and strong volume and relatively tight spreads. The objective here is, look, this is our most unconstrained portfolio. We can select our best ideas, not constrained by geography and not constrained by market capitalization. Currently, DWLD has about 40 holdings in there. The overall net expense ratio for the fund is 65 basis points, but it is truly our portfolio that is the least constrained that allows us to deliver our best ideas. Advisors are using it as a way both to get global allocation to equities, but also as kind of an alpha generator as well.

Nate Geraci: What about the Davis Select US Equity ETF, ticker symbol DUSA? CFRA's Todd Rosenbluth actually mentioned this earlier on our program. Is this essentially the same investment philosophy as DWLD, just focused on US stocks?

Dodd Kittsley: That is absolutely correct. This is our core US equity exposure, because we recognize that while we don't look at companies or select companies by geography, we recognize that certainly investors want to build their asset allocation models that way. That's exactly why we offer both. DUSA is a concentrated US equity portfolio of our best ideas, as well as in March we just launched DINT, which is exclusively international. You could think of DWLD as kind of a wrap of those two products if you're looking for one-stop shopping. If you want just international or USA, there are those options as well. Certainly, we look at the world the way that companies compete, and that is globally. They do reflect our best ideas, just cut slightly differently.

Nate Geraci: Dodd, earlier you mentioned that you go after lower turnover in these strategies or seek lower turnover in these strategies. Give us an idea here. What's considered normal turnover?

Dodd Kittsley: Yeah. Our average holding period is anywhere between five to seven years. It's important, because it really does reflect our investment philosophy and our discipline, which is really to select companies that are durable, that can withstand different parts of the economic cycle, that are well-managed companies where management has a demonstrated capacity to allocate capital very efficiently, and we do look to buy them at value prices. But our goal is not to rent stocks and have kind of a short-term holding period. We would rather seek to own really great businesses. Again, the turnover could be anywhere, depending on the year, from 15 to 35%.

Nate Geraci: Our guest is Dodd Kittsley, Director at Davis Advisors. We're spotlighting the Davis suite of actively managed ETFs. Alright, Dodd, I have to ask you - I know you've seen all of the numbers regarding active management, whether we're talking the SPIVA Scorecard or Morningstar's Active/Passive Barometer. Look, some of this data can probably be nitpicked a bit, but the consensus out there is the majority of active managers underperform their benchmarks. Make the case for active management for us.

Dodd Kittsley: Yeah. It's really interesting for me, Nate, because as you know, I've spent almost 19 years on the indexing side of the ledger working with ETFs. I certainly see the huge value in what index-based ETFs bring to the table for investors, but my view is this conventional wisdom that you mentioned, that passive always outperforms active, is just plain wrong, and it is really dangerous for folks. Let me share a few things. The first is, if you look historically, the outperformance of passive and active over long periods of time, you can see that it is indeed a very cyclical pattern. Now, we've been through this sustained period where passive has outperformed. My view is I think that can be largely explained by the 10-year momentum-based bull market that we've been in. That's first. I think that investors really need to reserve a place within their portfolio for active management. It certainly hasn't panned out as much over the last decade, but if you look back multi-decades, it certainly can help tremendously. The second is it's just not true in all market segments. If you look at broad-based international, so this is including both developed and emerging market countries, the average manager has actually outperformed the passive benchmark, the MSCI All Country World Ex-US, and has done so actually recently over the past one, three, and five-year periods, where over the last five years, 82% of managers have outperformed the passive benchmark. The final point is I think people kind of lose the forest for the trees in just looking at active. We're the first to admit that there's a lot of bad active out there, right? There are high fee active managers. There are benchmark huggers. There are many with no alignment of interest with shareholders. But if you look and do kind of just a simple screen where you're looking at desirable characteristics in active management, it can really put the tables in your favor, if you will. Looking for portfolios that have high active share that look different than the index, I think that's first and foremost. If you got a benchmark hugger that's charging high fees, that's a recipe for disaster. Second is low costs, not rock-bottom costs, but reasonable costs for the value delivered. The last is alignment of interest. It's astonishing to me, but 88% of all active managers, all actively managed mutual funds out there, have less than a million dollars invested alongside their investors and 47% have absolutely nothing. At our firm, we really believe in this co-investment and alignment, and I think that's really, really important. In fact, Capital Group did a study last year, and they just did a simple screen in the US market of all large cap managers and screened for two things. One was only taking funds that are in the highest quartile for alignment or co-investment, and then the second screen was they looked at funds that had the lowest quartile for fees. If you take that universe, not the average universe, but the universe on those two desirable characteristics, over rolling 10-year periods over the past 20 years, that universe outperforms 89% of the time. We certainly think, with a little bit of thoughtfulness in selection of active managers, it kind of changes the whole perception of things.

Nate Geraci: Dodd, in terms of the ETF wrapper for active strategies, earlier you mentioned something. You mentioned transparency as a virtue. This is a topic we've actually covered quite a bit on the show, but I'd love to hear your perspective, because there are a number of traditional active managers who have been hesitant to put their strategies in an ETF wrapper. My sense is they're afraid of getting front run or perhaps giving away their secret sauce. Can you expand on why that's not a concern for Davis?

Dodd Kittsley: Yeah. It's a really, really good point. As I mentioned, we're uniquely suited in the way that we manage money, taking a long-term perspective and primarily investing in large liquid securities. In fact, a difference between our mutual funds and our ETFs is our mutual funds will own some private placements and less liquid securities. We do optimize out for that, but have the same investment discipline overall, whether you choose a mutual fund or an ETF. But we really think that the concepts or the concerns that you mentioned, the giving away the secret sauce and the front running, are largely overblown. It was something that we haven't had any issues with and we don't anticipate any issues with on a go-forward basis. It's something that our funds have traded very efficiently since their inception, and we expect them to do so.

Nate Geraci: Dodd, we have about two minutes left. Overall, I'm curious as to how you see the future for active ETFs. Overall, they have been a bit slow to catch on, though as Todd Rosenbluth mentioned earlier, he expects that to change fairly substantially. Do you expect to see more traditional active firms enter this space and what do you think it will take to really drive assets to active ETFs?

Dodd Kittsley: Yeah, it's a great question. I do see actively managed ETFs as the next engine for growth in the overall industry. To your point, it's growing slowly on the equity side. We're looking at just over... it's a small amount, right? I think a couple things. One is just awareness that these products exist today. We're one of the few and one of the first that has combined traditional, time-tested active management in a traditional ETF format, but I think there will be others to follow that manage money in a similar vein that we do. For the higher turnover strategies, for the investments in less liquid securities, it may take an innovation in structure, such as a non-transparent type of a version of ETFs to exist to deliver those out. In all of my peers at other asset managers, I know that every active shop is looking at this. It's part of their strategy, and they want to get into using a more efficient wrapper that ETFs offer.

Nate Geraci: Well, Dodd, with that, we'll have to leave it there. Really enjoyed the conversation today. I greatly appreciate you joining us.

Dodd Kittsley: Thanks so much for having us.

Nate Geraci: That was Dodd Kittsley, Director at Davis Advisors. You can learn more about the Davis lineup of ETFs by visiting davisetfs.com.