Poor Contrarian Picks Contribute to This Fund's Downgrade
Recent blunders have eroded American Century Value's previously strong long-term record and altered its risk profile.
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American Century Value’s seasoned manager still employs a solid approach, but recent struggles, analyst turnover, and a hefty price tag lead to a Morningstar Analyst downgrade to Bronze from Silver.
Lead manager Michael Liss adds a contrarian bent to American Century’s proven quality-driven process. Liss and the American Century value team start by screening for quality names, which they define as firms with robust balance sheets and strong competitive advantages. From there, Liss determines whether a firm’s valuation and risk/reward profile merit investment. He’ll add to names with uncertainty, such as General Electric (GE), if he believes the issues are transitory.
This contrarian tilt, however, can lead to value traps if Liss’ thesis fails to materialize. For instance, Liss swapped quality for cheap valuations during oil’s 2014-16 price collapse, leading to an overweight to the volatile energy sector. The share prices of picks such as EQT (EQT) and Cimarex Energy (XEC) have since cratered.
Recent blunders have eroded the fund’s previously strong long-term record and altered its risk profile. In Liss’ first seven years on the job, the strategy edged the Russell 1000 Value Index and most large-value Morningstar Category peers, including on a risk-adjusted basis. However, Liss’ poor contrarian picks during the past four years have sunk returns and steadily increased the fund’s standard deviation, a measure of volatility. It’s also unsettling that the fund lagged in 2018’s 11-month peak-to-trough correction since it had lost less than the index in the prior four market corrections. The team’s recent analyst churn, with seven of nine supporting analysts joining in the past four years, and the fund’s above-average price tag also curb the strategy’s outlook.
Yet there’s reason for optimism. The core management team is stable and accomplished. Liss is an experienced investor who has previously navigated the strategy through team changes and bouts of underperformance. To be sure, there’s reason for caution. But Liss’ continued use of an established process makes this strategy a solid long-term holding.
Performance | Neutral | by Tom Nations, CFP® Aug 9, 2019
Continued struggles have flattened the strategy’s previously superior absolute and risk-adjusted returns, warranting a Performance downgrade to Neutral from Positive. Michael Liss has comanaged this fund since 2004 and took the lead role in September 2008. From the latter date through July 2019, the fund’s 8.5% annualized return lagged its Russell 1000 Value benchmark by 5 basis points but beat 60% of category peers. The fund’s below-average volatility over Liss’ tenure has led to its Morningstar Risk-Adjusted Return besting the index and 71% of competitors.
Yet the strategy has struggled lately. The fund’s one-, three-, five-, and 10-year returns through July 2019 all fit in the category's second-worst quintile. Its 19.8% peak-to-trough loss from Jan. 29-Dec. 24, 2018, lagged the index by 1.5 percentage points. This underperformance is noteworthy because Liss’ quality-value focus previously provided ballast in downturns--the fund outperformed the bogy by an average of 3.1 percentage points in the index’s four previous corrections. Furthermore, its standard deviation has steadily risen relative to the index and category peers.
Liss’ contrarian selections have been out of favor. He piled into cheaper energy names during oil’s 2014-16 price collapse, which especially hurt in 2018’s fourth quarter. Holdings General Electric (GE) and Teva Pharmaceutical (TEVA) have also shed two thirds of their value over the past three years.
Price | Negative | by Tom Nations, CFP® Aug 9, 2019
This fund’s fees are rising relative to its competition, warranting a Price rating downgrade to Negative from Neutral. The Investor and Institutional shares hold the bulk of assets and land in the second-most-expensive quintile among similarly distributed peers. Trading costs are middling despite manager Michael Liss’ relatively higher turnover approach. The fund’s brokerage commissions as a percentage of net assets, at 3 basis points, were in line with the large value trailing 12-month peer median.
Higher turnover has, however, generated sizable tax distributions. Over the past five years, the investor shares’ capital gains distributions have averaged 6% of the shares’ pre-distribution net asset value.
Process | Positive | by Tom Nations, CFP® Aug 9, 2019
The strategy maintains a Positive Process rating because lead manager Michael Liss effectively adds a contrarian aspect to a sound quality approach.
This strategy’s investment process begins much as it does at the team’s other charges. The American Century value team starts by trimming a universe of about 6,000 stocks to approximately 550 firms that meet criteria on such quality factors as improving returns on capital, low leverage, and strong competitive positioning. This limited universe doesn't change much over time and contributes to an efficient research workload. The team then estimates a risk/reward ratio based on its in-depth fundamental analysis of each company. From there, Liss selects from the least-expensive third based on at least two of five valuation measures, including price/earnings, price/free cash flow, and dividend yield.
Yet Liss’ contrarian tilt means he’s more comfortable trading quality for valuation. He’ll pursue companies with negative sentiment and cheap valuation if he believes their issues are temporary. This does, however, invite risk and increase portfolio volatility. These riskier names typically fill out the back end of the portfolio as Liss holds more names than the average large value Morningstar Category peer. He also frequently moves in and out of smaller positions. Indeed, portfolio turnover has averaged 45% over the last five years, slightly higher than that of the category median.
Since lead manager Michael Liss took over in September 2008, he’s kept the portfolio diversified in 100-140 names. Liss can invest in smaller-cap names, but overall the portfolio’s average market cap has been in line with the Russell 1000 Value benchmark and category peers. He’s comfortable holding foreign names, such as Total (FP) and IMI (IMI) , and has invested up to 8% of assets overseas. Liss also typically keeps weightings within five percentage points of the benchmark while consistently underweighting the debt-laden utilities and real estate sectors.
Cheap valuations made several energy names attractive following the 2014-16 oil price collapse. From September 2015 through June 2019, the strategy’s average energy stake stood 5.7 percentage points above the index. Moreover, this overweight has been concentrated in the exploration and production and equipment and services industries, which typically are more sensitive to oil price volatility than the larger integrated majors. This positioning has noticeably affected the portfolio. As oil prices have seesawed back and forth over the past five years, the portfolio’s standard deviation, a measure of volatility, has increased. Furthermore, while not a deep-value strategy, the portfolio has shifted further into the value category over the past three years as Liss piled into cheaper names.
People | Neutral | by Tom Nations, CFP® Aug 9, 2019
A solid management team supports veteran lead manager Michael Liss. But analyst turnover and Liss’ recent missteps lead to a People rating downgrade to Neutral from Positive.
Churn on American Century’s value team is concerning. Todd Peters, the firm’s longtime technology sector analyst, recently retired. Then, Dan Gruemmer, a comanager on this fund for five years, left the firm in April 2019. And although the team’s size hasn’t shrunk, eight of the nine supporting analysts have joined the firm in the past five years. To prepare for such departures, the team has established a junior analyst bench from which they can pull in the future.
That said, the management team is proven and experienced. Liss boasts 28 years of industry experience and took over the fund’s lead manager responsibilities in September 2008 after serving as a comanager for four years. He works in a collaborative fashion with the American Century value managers and analysts as the team runs six funds using the same general philosophy. Phil Davidson, the team’s standard-bearer and lead manager on Silver-rated American Century Equity Income (TWEIX) , is the longest-serving comanager as his tenure began in 1993. Kevin Toney has also served as a comanager on the fund since 2008. He steers Silver-rated American Century Mid Cap Value (ACMVX) and took over the firm’s value CIO responsibilities from Davidson last year.
Parent | Neutral Jan 2, 2019
Personnel and process issues limit American Century's Parent rating to Neutral.
The firm's ownership structure is unusual. The Stowers Institute for Medical Research owns 45% of the firm and holds 70% of the equity voting rights. Nomura bought CIBC's 41% share of American Century in mid-2016; that partnership has helped increase distribution globally. Employees own the rest, and their stake has increased significantly over the past decade.
The firm uses a boutique structure. There are pockets of strength, most notably the U.S. value team that manages about one fourth of the firm's assets. But much of the remainder of the investment team lacks an edge versus the competition in terms of personnel, process, or both. For example, the U.S. growth team has seen personnel turnover as it moves away from the firm's legacy earnings-momentum approach (which is still employed by the international growth team despite modest results). Also concerning is depth and continuity among the taxable- and municipal-bond teams and the multi-asset team.
There are other stewardship concerns, including turnover at the executive level. Fixed-income CIO Dave MacEwen recently retired, and Scott Wittman, CIO of the quant equity and multi-asset teams, departed in 2017. A commitment to fostering top investment talent and differentiated investment processes would be welcome developments here.
Tom Nations does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.