Dundas: An unusually simple - and successful - strategy

James Marlay

Livewire Markets

If you had to focus on just one metric to succeed in investing, what would it be? It's a hypothetical question, of course. However, in a world filled with shiny new things designed to make life 'easier', it can often feel like the opposite is true. 

For Alan McFarlane and the team at Edinburgh-based Dundas Global Investors the answer to this question could not be clearer: find and buy dividend and capital growth then hold it for a long time. McFarlane says the strategy is unusual in its simplicity, and while the concept of compounding is well understood it can be hard to execute against the backdrop of noisy markets.

We haven't discovered anything. What we've done is ... focused on what is commonly understood but it's so hard to execute because of the drumbeat in Mr. Market.

The 14-person team at Dundas apply what they describe as a 'sifting' process to find just 60-70 stocks, from a universe of over 3,400, that they believe can consistently grow their dividends and consequently also grow their capital over time.

It is a substantial undertaking to conduct this level of research and McFarlane explains how the firm has embraced the age of information to complement 'shoe leather' research. 

But there are no shortcuts. In fact, it took the firm 10 years to find, research and eventually pull the trigger on the most recent addition to their global portfolio, detailed below. This painstaking process puts a spotlight on the level of care taken by the firm when determining which stocks make it into their portfolio and those that don't.

"We have a 66-67 stock portfolio but it is equally possible to say we have 3,440 stocks and that the most important decision is to not own them. Those decisions have equal value."

The 'sifting' process has the added benefit of reducing portfolio turnover, helping to facilitate the low 0.90% management fee and there is no performance fee. The Dundas portfolio turned over by just 13.48% in the past 12 months. For context, recent research conducted on over 3,500 long-only equity managers found an average portfolio turnover of 58%. The fact that Dundas is independently owned allows them to think for the long term and aligns the investment team with this strategy, and, importantly, with other investors in the fund, according to McFarlane.

The Apostle Dundas Global Equity Fund has outperformed its benchmark, returning 11.34% after fees over the past 12 months, and 15.50% per annum after fees since inception in August 2012.

I recently fired up the Zoom account to speak with Alan McFarlane, senior partner at Dundas Global Investors, to hear about the firm, the strategy and a recent portfolio addition in more detail.

You can access the full interview by clicking on the player or via an edited transcript below.

Topics discussed

  • Background and philosophy
  • Why it is important to focus on dividends and growth
  • Australia vs Global for dividends
  • The difference between 'sifting' and 'filtering' for stocks
  • A recent addition that took 10 years to uncover
  • An incredible statistic for Livewire readers


Edited Transcript

Could you tell us about Dundas Global Investors and explain what is unique about your investment philosophy?

The firm is easy to describe: There are 14 of us and we operate from Edinburgh. 9 of the 14 are partners. We've managed global equity portfolios for Australians since 2012. Looking at what sets it apart, the first is that it's completely independent - it's owned by the people in the firm. There's no external investors so what we're doing is exercising our independent judgement about what is going to deliver the best investment returns over the long-term for the firm.

The background of the founding members was in funding pension funds and superannuation assets. We tilt to the long-term and that is the way the firm is organised. 

We only have one strategy, the strategy of dividend and capital growth that we will be exploring today. 

I won't dwell but perhaps where it starts to really be particular, is that we only have one strategy. 

In having conversations like this and talking about the fund to Australians, we're not seeking clients. If people join us, they become co-investors. You'll be familiar with the problem of the principal and the agent. Well, we've just taken that away. We're fellow principals. 

From day one, we've done our own research. You'll be familiar with the struggles inside the investment banking industry and the research industry globally. The tying of that together with brokerage was something to be separated in our opinion. We started the firm at the point where we entered the age of information abundance through investor relations websites, online systems, trade associations and the like. 

We do our own original research on the companies that we are considering but the key feature in all of that is we've sought to have the simplest possible structure. When we come to work, we're thinking about, "Will this company enhance the portfolio? Will this one detract from it?" There are no other questions. 

Perhaps the best way to illustrate that is if you think of any medium-sized global equity and fixed income shop nowadays of a few hundred billion dollars, there are usually 10, 15, 20 strategies, lots of people, very robust systems. But when an idea gets in the building, how does it get to the right place? The management of that internal complexity can become the complete preoccupation of those organisations. I'm not saying they're bad. I'm just saying that they have a big headache before they even get looking at the stocks.

The information management problem in complex organisations, multiple sites, multiple strategies, multiple objectives. Firms that are built by acquisition can lack in a single common purpose, other than shareholder return. Our view is if we invest our own money well and invest well for our co-investors, things will take the natural course. 

We have stripped the unnecessary internal noise and focused exclusively on writing a single strategy. There are three and a half thousand stocks in the world that we could invest in based on their size, which is a minimum of $2 billion market cap. We invest in 67 of them. It's a very simple firm.

The last thing, when we set it up we could see the pressure on fees that were coming from around the world, which I welcome. For far too long intermediation has captured client savings, not enough to the client. We set up a low fee model that is future proof. 

You said unique which is a very strong word. I'll take very unusual because of its simplicity.

Why is it so important to focus on capital and dividend growth?

Because both are important, and the most pertinent part is that it can be easy to lose sight of this because the one with the biggest drum beat every day is the movement in share prices. They're in our face every single day. Mr. Market has a big, loud instrument that he likes to smash very hard and we're all experiencing some of that at the moment. The noise from that part of the orchestra can drown out the other parts.

We know that the key components of long-term returns are compounding, compounding inside companies and compounding dividends. In the last few years it has become even clearer that dividend growth is the key component and that's supported by research by academics and index firms. 

That's a longer, lower part of the noise of markets. We don't have a special insight here. We haven't discovered anything. What we've done is we've focused on what is commonly understood but it's so hard to execute because of the drumbeat in Mr. Market.

The focus is on the key component of long-term return, which is dividend growth, which is why we have honed in on it. Starting the firm with our own savings and our own capital enabled us to cut away everything else and discover that dividend and capital growth were priorities. We didn't decide it - We discovered it. Having made the discovery, the thing was then to discipline ourselves around the pursuit of what really matters in the long-term.

For Australian investors, there's a perception they should be fishing in local waters for income and looking abroad for that capital growth. Can you share some compelling reasons that investors should look more globally for income opportunities?

Let's start with the first part of it, staying at home for income. There are really strong reasons for doing that but if you look a little deeper, the problem becomes more obvious. Yield and dividends are not identities. Some of the places we've talked about growth but what people have heard is yield, which is the relationship between dividends and capital. 

It's dividend growth that drives return, not yield. Yield is very important but in the longer run, dividend growth drives returns. 

Now, Australia's dividends rely on two industries principally. A very mature banking system, which really has one asset, residential property, and commodities from coal to iron ore. Long-term investors have to prioritise dividend growth. In one sense, by focusing at home for dividends, we've answered that part but in terms of focusing on dividend growth, that's a bet on those industries, plus CSL, plus Seek, plus some of the other companies that are available to you.

Dividend growth depends on industries and companies, not domicile. Easy money from a favourable tax system is a very poor substitute for hard analysis.

Last year showed the perils of relying on a small group of companies for high current income. Set in a wider context, we look at banks around the world and the Big Four in Australia, they have struggled through our sifting to even get to the intermediate rounds in terms of the underlying challenges they have.

Going back to the couplet, I think the answer is this: Home for income and overseas for growth, there is no question that the dividend advantage for Australians means that they should fully take advantage of it, but remember that the real underlying powerhouse for your return is dividend growth, not current yield. And on that test, pick the best of Australia but also pick the best in the world. There is 50 times the opportunity outside of Australia.

Could you talk through how you find those companies that you want to invest in? What is special about your process of sifting rather than filtering? 

The sift versus screening discussion is pretty simple, it's intended to paint a picture. The picture it evokes for me would be somebody panning for gold or sifting the material in their garden and putting it through the grid. That's what we do. 

We first started in an age of information abundance. What that meant was that the shoe leather and air miles remain important to finding stocks, but a long time ago when I got started in the business they were the only way you could find stocks. That's not true anymore. When we sift, we're sifting through that three and a half thousand stock universe. 

What we're able to do is look at industry groups (retail, car companies, pharmaceuticals etc.) and sift through them, by which we mean looking at each individual company. We look at financial record, look at products. We look at the possibilities.

We are unashamedly back casters. Forecasting is important but we like back casting as it tells you how people have coped with the circumstances they face that we both understand, which tells you something about resilience and continuity. 

Having sifted, we discard the ones that we think don't cut the mustard and we focus in on a smaller group. We look at them individually and then we discuss them as a team. That's it.

What's the advantage of that? Well, we've never owned a telecom stock but we've written about Vodafone, we've researched Telstra, we've looked at Singapore Telecom and Bharti Airtel time after time after time. Why? Because you learn about that industry. You learn about its supply chain. You learn about how that interacts with app stores. You learn about the relative pricing power between them. You learn about the shift from print media to digital media and so on. The way I describe sifting that you're addressing the world as it is, not as you would wish it to be. It's possible to do that even in a firm of our size because of the extraordinary access to data and information that we have today compared to the past.

Plenty of ideas emerge from the sifts and what we are looking for are the ones that stand tallest. The first part of our sift is discarding - letting things go. 

We have a 66-67 stock portfolio but it is equally possible to say we have 3,440 stocks and that the most important decision is to not own them. Those decisions have equal value. 

Sifting is about understanding those two things and what you learn from the process of doing it. The best way to illustrate this is to think of the opposite side. Let's say we were talking about a European small cap value fund and you had the three and a half thousand stocks. Well, first thing is, you take out all the non-European stocks, and then you screen by market signs and then you've got some criteria for valuation. Your criteria, pre-decided, takes you to that group of stocks. And there'll be 300 of them.

What have you learned by starting this? Nothing. If you went to Sunday school when you were younger, seek and you shall find is one of the things that you have heard discussed. If you've put the glasses on of that tint, that is all you will find, so we think sifting is a far more robust, far simpler method.

It's more perspiration than the inspiration of the screening criteria. We sift because we are looking for the things that emerge, rather than the things that we've decided in advance will be better. Let the facts tell us, it's not the other way around.

Can you talk through a live example of something in the portfolio, a really high-quality dividend grower that exhibits the traits that you're sifting for?

I'll share the most recent one we bought because it's the most vivid in memory. When we started in this process of repetitive search, search, search, sift, sift, sift approach, some of the points that emerged were about the transformation of factories around the world. Transformations of productivity, the role of computerised design and computerised manufacturer. At an earlier stage in my career, I met a few CAD cam companies in the 1980s and they tended to operate in silos, where they produced material that then went to the design people who would transform that into drawings and material that would help people build cars, planes, boats, other devices. That has moved on enormously and in all the work that we've done, speaking to industrial companies around the world, speaking to manufacturers, we've learned a great deal more about the integration of the supply chains, the integration of computer aided design and manufacturing; and ultimately the growing integration of the semiconductor industry into much wider walks of life.

You'll have seen in the press recently, the global automotive business is being held up and it is having a problem, the semiconductor industry is a big part of its supply chain yet they really lived as two separate groups for a long time. The more we delved into and sifted through the industrial companies and their suppliers, one group that came up time and time again were industrial test and measurement businesses, with the standout being Keysight (NYSE: KEYS).

What's attractive about it? It all goes back to the sifting. We can see from our work that test and measurement is now becoming ever more deeply embedded in a design procurement. Manufacture and test are a single continuum, as opposed to a series of discrete functions. Keysight has 32,000 customers built up over 80 years of Hewlett-Packard's operations. 55% of those customers are served directly and the rest are distributed, but the key insight is that if you think back to the engineers, Disney and Fantasia, guys in the white shirt, they would read from the device, write something down and then use it elsewhere in the building.

Keysight's products and its peers' products are now software-enabled and built into units, so data is taken without human intervention and used at different parts of the manufacturing process. This is a company with over 60% gross margins. We think it's in a very important place in the future of manufacturing. There's been a lot of talk about reassurance. Donald Trump talked about it. The Brexiteers talked about it. Just because it comes from mildly disreputable sources doesn't mean the point is badly made, but as manufacturing activity is being spread around the world again, the labour content is less and less the most important factor. More important content is eliminating error, flaw and bad products that can't be sold, and it is test and measurement that are deeply embedded into this.

Keysight is very strong in electronics and in communications. Its products are associated with what is happening in 5G. How long did it take us to find Keysight? 10 years. How many stocks did we sift through to be convinced that the demand for its products and services is strong? Hundreds. How many in the end did we sit down and compare and contrast before we bought Keysight? Four or five. That is sifting. That is why I'm optimistic that it's a robust process and philosophy.

We've started running a series called Stats Incredible on Livewire, so could you blow our hair back with an incredible statistic that highlights the global opportunity for Australian investors?

It's a very simple one. The challenges facing all of us as long-term savers, who will eventually consume those savings, is to beat inflation and the corrosion of our wealth by being in the wrong industries.

 If you restrict yourself to investing only in Australia, you're buying 2.9% of the world's dividends and a lower number than that, of the world's dividend growth. Opportunities elsewhere are multiples of what's available at home.

Interested in learning more?

The Apostle Dundas Global Equity ETF is listed and available for investment, for more information on the Fund and to review a copy of the PDS click here

James Marlay
Co Founder
Livewire Markets

Livewire is Australia’s #1 website for expert investment analysis. We work with leading investment professionals to deliver curated content that helps investors make confident and informed decisions. Safe investing and thanks for reading Livewire.

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