In these volatile times many investors are risk averse and shy away from uncertainty, but Daniel O’Keefe revels in it.
As other people panic when the stock price plunges, the Citywire + rated manager (pictured above right) rubs his hands and starts hunting for bargains.
‘We love volatility. Volatility is what creates opportunity. It is the lack of volatility that eliminates opportunity. We were very excited in the back half of last year when stocks were going down, and at the beginning of this year when the markets were falling. We are not so excited now that prices have recovered.
‘Our greatest investments have always been made during periods of volatility. Everybody knows that this is a ‘buy low, sell high’ business but people get worried when things fall, which is one of the fascinating conundrums of investing. When stock prices go down, people should be happy if they are buyers,’ he says.
These discounted stocks go into the Artisan Global Value fund, which O’Keefe manages with Citywire A-rated David Samra (pictured above left). The strategy was launched in December 2007 for US investors and the $923 million Ucits mirror was unveiled in March 2011.
O’Keefe’s approach is clearly paying off: over five years his personal performance has notched up a 54.8% total return against 14.6% from his average peer in the sector.
During the most recent bout of market instability, O’Keefe purchased a small holding in an education firm which helps students get into universities in the US.
‘The volatility in emerging markets over the last year allowed us to buy a company called New Oriental Education, which is a Chinese business. The sell-off in emerging markets sent that stock down to a very attractive valuation.
‘There were fears that when the Chinese economy was slowing down, the business would fall back. As it turns out, it has held up very well and the stock price has recovered dramatically,’ he says.
This story is typical of O’Keefe’s value approach to investing, which involves buying businesses at a discount to their long-term intrinsic worth.
‘We define value by assessing the business and all its characteristics. A higher quality, more rapidly growing business would be worth a higher multiple, and we would buy that at a discount to what we estimate is its long-term worth. That is our framework for value investing,’ he says.
Five-year total return figures in focus
One of O’Keefe’s better-known bargains is consumer healthcare company Johnson & Johnson, in which he has a 3.6% holding.
‘Price is the gate and we bought Johnson & Johnson because it was a very attractive price. We don’t hold it because we view it as safe, we are not hiding in the stock, we had an investment case based on all the characteristics of the company and a price at which we thought we could generate a good return.
‘If there’s a great firm, that is safe, well known, respected and available at a great price, I’m going to take that all day long. You seize those opportunities. However, we don’t focus on things like that to the exclusion of other companies that might not be household names.’
O’Keefe says a good bargain is not the only thing he looks for. He likes to look beyond the numbers to quality.
‘We try to avoid the common pitfalls of value investing by not being drawn into a low multiple that is attached to a very challenged business model or a highly leveraged business. That is why we also gravitate towards higher quality businesses and those with strong balance sheets.
‘We are very cautious of highly leveraged propositions because if something goes wrong, that low multiple becomes a high one as there is so much leverage that cascades through the earnings. Earnings can very quickly disappear,’ he says.
O’Keefe generally invests in 30-50 stocks in the portfolio and holds 40 at present. There is a low turnover of names in the strategy and O’Keefe is very picky about the ones that make the cut.
‘We are in the rejection business. It is very hard to find things that are both undervalued and good businesses. It is a demanding set of criteria, so most of your time is spent studying and rejecting,’ he says.
It is not a lack of liquidity that is preventing O’Keefe from stocking up. He currently has the money to buy more stocks if he wishes, as cash levels are at around 10%. This has dropped from record levels of 14% shortly before the fund was soft closed, see box-out below.
‘We would love to be fully invested because it means there are opportunities for a significant compounding. We hold cash reluctantly. It is a result of our valuation discipline. In other words we are selling more than we are buying and we are selling because valuations are better for sellers than for buyers.’
A risk too far
O'Keefe has outstripped the average manager
When it comes to investing this cash O’Keefe has the whole world to choose from. The US accounts for the largest region in the fund at 55.3%, while the UK is the second largest holding at 13.3%. To highlight diversity he also has a 1.3% exposure to Norway.
However, there are many areas where O’Keefe is unable to find companies that fit his strict criteria. He currently has 3.9% of the fund positioned in China, which makes up part of the 11.8% he devotes to emerging markets.
‘Our investments aren’t guided by a top-down view on countries but what I can say is that there are countries where it is very difficult to for us to find things that we are comfortable with.
‘Russia is a kleptocracy run by criminals and the corporate governance is horrific. Its legal environment is also questionable and our rights as minority owners are very low on the priority list. So it is very difficult to find businesses that you can invest in and feel like you are an owner.
‘That is an extreme example. Venezuela, Argentina, Russia – there are plenty of countries where, if you are valuing a business and expecting to participate in value creation, the economies and legal structures make it difficult to make that assumption.’
Warming to financials
O'Keefe takes less risk than his average peer
On a sector basis O’Keefe takes an indiscriminate stance but there are some industries where he can find more companies that make the grade. The largest allocation in the fund is to financials at 36.6%, which is overweight against the benchmark’s 20.7% allocation.
O’Keefe says the sector includes a good range of companies including credit card processing firm American Express, insurance brokers and property casualty businesses. Financial holdings in the fund include a 4.2% stake in BNY Mellon and a 3.4% position in Citigroup.
‘The valuations are very low. The industry has gone through a revolution since the financial crisis in terms of recapitalisation. The banking industry in the US is in its best capital position since right after the great depression,’ he says.
Around 15% of the fund is devoted to banks, which is the largest holding that O’Keefe has had in the sector. From 2003 until the financial crisis he did not hold any banks, then started to increase his weighting in them.
‘The banking system has been deleveraging and purging itself of bad loans that were originated prior to the financial crisis. So we look at them and we see cheap valuations, good franchises, strong capital levels and plenty of liquidity, and that looks like a compelling opportunity for long-term compounding,’ he says.
Away from financials, the second largest sector in the fund is information technology at 26.1%, versus the benchmark’s 14.8%. Holdings in the sector include software company Oracle, which is the fund’s largest single position at 4.9% and technology giant Microsoft at 3.8%. He also has smaller holdings in Korean manufacturer Samsung. They all share common attributes.
‘It is not like we woke up one day and thought that information technology is the place to be. By researching companies we came across businesses we liked and the right price, so we accumulated these positions.
‘They are all highly cash generative, have net cash and really good margins. They all generate returns and most of them are buying back stock and returning cash to shareholders in the form of dividends. To top it all, the valuations are attractive.’
With so many companies to choose from, O’Keefe is wary of the many traps that await value investors.
‘I’ve made so many mistakes. Investing is one of the few business where you are confronted with your mistakes in real time. Every day you come in and you look at the screen and there are dozens of “woulda, shoulda, couldas.”’
While O’Keefe remains strong in his convictions, he is humble enough to realise that sometimes his views need to be challenged and is keen to foster a culture of intellectual honesty and adaptability in his team.
‘One of the keys to our success as a team and as partners, is that we are both very comfortable operating in that environment, challenging each other and being challenged,’ he says.
‘It is a very odd business, you need to have two opposing psychological characteristics. On the one hand you have to be absolutely thick headed – willing to go against the grain, and act on that conviction without backing down. On the other hand, you need to be extremely open to changing your mind.
‘When new information comes in you have to be ready to utterly abandon your conviction if it is appropriate and the facts warrant it. You need to be an oak tree, but also you need to be a blade of grass that moves and shifts with the winds.’
This article originally appeared in the July/August edition of Citywire Selector magazine.