Equity and Fixed Income Methodology
Davis Capital Management’s (DCM) core investment philosophy is preservation of capital with a value and income bias. Our investment process is designed to manage risk by way of portfolio diversification and disciplined active management. We use mostly large-capital equities in an effort to supply short-term preservation of capital and long-term growth of assets. For suitable clients, we also capitalize on the use of a “buy and write” covered call strategy, which provides further risk management and more consistent returns.
Equity Investment Philosophy
Our equity investment philosophy is best described as a core-and-satellite approach. At the core, we may use mega-cap companies or indexed Exchange-Traded Funds (ETFs) in order to capture general market performance. For our satellite positions we try to find companies that may be undervalued or in sectors that we find favorable in order to outperform or seek safety.
We are long-term investors and, therefore, do not give much consideration to short-term market trends. We use an aggregate of third-party analysis in order to narrow our list of potential investments and then do our own analysis to select those companies that fit our requirements for investment. This analysis is crucial in maintaining DCM’s philosophy of capital preservation, risk management and asset appreciation.
Before we recommend any client strategy, we interview the client(s) to ascertain their specific financial goals, time frame and risk tolerance. Based on these factors we craft the client portfolio, indicating what percentage will be allocated to equity, fixed income and cash. We believe that individual stocks and bonds are the best tools in portfolio construction, and they comprise our signature Equity Builder accounts. For those individuals who may have smaller accounts, we use ETF’s in order to best represent sectors hallmarked by the companies we invest in.
All equity portfolios under our management are diversified and sector weighted. Chief considerations while exploring an investment are company growth and economic sentiment, though risk reduction through diversification remains the overall focus. In line with this philosophy, DCM discipline mandates that investments in an individual sector shall not exceed 25 percent of the total portfolio and investments in an individual security shall not exceed 5 percent of the total assets. Once fully invested, equity portfolios typically contain between 30 and 35 positions to further diminish individual security risk. ETF-based portfolios generally will have fewer than 15 equity issues, due to their diversified nature. DCM constantly reviews both price target and sector performance in order to fulfill both defensive and opportunistic investment strategies.
When We Buy
We buy companies, not stocks. Before DCM even considers purchasing a security, we conduct a rigorous due diligence review. We begin with a top-down analysis of market conditions, which includes predictions of growth for the world’s major economies, commodity price forecasts, interest rates, wage pressure, job growth, Producer Price Index, Consumer Price Index, Gross Domestic Product and other indicators. We follow that with a bottom-up approach to individual companies, gathering and evaluating SEC filings and disclosures, listening to conference calls, reviewing industry research and trade publications, and cross-checking with third party analysts’ research. Selection criteria include consistent and predictable earnings, solid fundamentals, strong management and reasonable valuations.
When We Sell
Exiting a security is just as important as buying a security. We may sell all or part of a position for various reasons. We will exit the position if the stock reaches its intrinsic value or our set target price. If there is significant stock appreciation in a short period of time we will decrease our position in order to maintain our margin of safety and lock in gains. We will liquidate a position if our investment thesis no longer remains intact due to business deterioration or company strategy change. If a stock significantly underperforms its peer group or industry by 20 percent, we will exit the position.
DCM primarily defines risk as the loss of principal, and, secondarily, as underperformance relative to our benchmark (S&P 500 index). If DCM believes that the market has more downside risk than upside opportunity, we will lower the overall beta of the portfolio and shift to sectors that historically outperform when the market declines. Our short-term focus is on capital preservation and, with that in mind, we rotate between sectors based on the firm’s overall risk/reward assessment.
Fixed-Income Investment Philosophy
In DCM’s view, fixed-income investment should represent safety in the portfolio. With this in mind, the best way to limit risk and optimize yield is through the use of individual bonds placed in a bond ladder. We believe that this method of fixed-income portfolio construction will provide our clients with current income, while reducing credit risk and controlling the timing of interest payments to meet client needs.
In portfolio construction, we predominantly use government issues and higher-quality corporate issues, as well as FDIC-insured certificates of deposit. The percentages used will vary depending on the economic analysis at the time of purchase. DCM evaluates liquidity and call protection of a security when considering any corporate issues. DCM also is able to use tax-advantaged issues such as municipal bonds if they meet a client’s objectives and after-tax yields are greater.