Top Investment Shop Focuses on Quality First, Value Second

Barron’s profiles Phil Davidson of American Century Investments, a value investor who “focuses on quality first, value second.” He joined the firm in 1993 to begin a value-based approach to investing within a growth-oriented firm. “We sat on a different floor than the growth investors”, Davidson said, noting that he and Peter Zuger began with $1 million in seed capital. Now, the value team of 25 investors has $34 billion in assets spread across nine funds. The largest, American Century Equity Income outperformed 98% of its peers over the last 15 years with a 7.5% return, and was up 4.2% over the last year in which the market and most peers lost money.


Davidson described this fund as “a pure-play low-volatility fund.” Davidson’s team begins by focusing on dividend-paying stocks, convertible bonds, and preferred stocks, then “narrow down the list to 500 names based on quality, screening for such factors as return on capital, low leverage, and position in their respective industries.” After that, the team uses valuation metrics to reduce the list by half. As Davidson put it: “we start with what we think is a superior universe, but this is where the real work begins.” According to Barron’s, they “vet companies from the ground up.” No single position constitutes more than 5% of the fund, and sector weightings stray no further than 10 percentage points from the Russell 3000 index weightings. While there is interaction between the value and growth teams at American Century, they remain on separate floors and act independently. The teams are drawn largely from interns who work with the company as business students, such as Kevin Toney, who describes Davidson as “a tremendous mentor” and emphasizes his “keen ability to identify a flaw or weakness in a company that others may have not seen.” At the same time, the team is identifying companies that, as Barron’s describes, “are discounted for reasons that are manageable and understandable.” Examples of companies the value team likes are Republic Services (which, as Toney says, “is a pretty steady business” regardless of larger economic trends”) and Wal-Mart (which Davidson says has been punished more than necessary, noting that “management has a new focus on growth” and “the company is bent, not broken”).