Morningstar Magazine - April/May 2018 - 62

Investors

Active Endeavor
Davis Advisors puts fundamental stockpicking in an ETF package.

UNDISCOV ERED M ANAGER

Tom Lauricella

In every issue, Undiscovered Manager profiles
a noteworthy strategy that hasn't yet been
rated by Morningstar Research Services' manager
research group.
As a third-generation money manager,
Christopher Davis is hardly an unknown quantity.
But the exchange-traded funds introduced
by Davis Advisors last year are a rarity: classic
bottom-up stock-picking strategies in
an ETF landscape dominated by beta plays.
The initial ETF lineup from the 49-year-old firm
launched in January 2017 and includes
the $120 million Davis Select U.S. Equity ETF DUSA,
the $105 million Davis Select Financial ETF
DFNL, and the $180 million Davis Select
Worldwide ETF DWLD. All are benchmark-agnostic,
long-term strategies based on buying
competitively advantaged companies trading
at attractive valuations.
Each follows a strategy used by an established
Davis-advised open-end fund. The Select U.S.
Equity ETF echoes Clipper CFIMX; the Select
Worldwide ETF follows the strategy behind Davis
Global DGFAX, and the Select Financial ETF mirrors
the investment approach used at Davis Financial
RPFGX. Just as this article was going to
press, the firm launched a fourth ETF, Davis Select
International ETF DINT, which is similar to
Davis International DILAX.
The open-end funds behind the original three
ETFs have earned Morningstar Analyst Ratings

62

Morningstar April/May 2018

of Bronze. (Davis International is not rated.) That
said, the ETFs are not clones of these
funds. As Davis notes, the ETFs are "not identical;
they are analogous." The ETFs do not hold
private placement investments, for example, and
Worldwide does not yet have regulatory
permission in India to hold stocks domiciled
in that country. Whether such differences
will cause significant performance divergence
is an open issue.
Why create new twists on established success
stories? Chris Davis likens the decision to
launch ETFs to his father's decision back in 1969
to move into the retail mutual fund business
after having been solely an institutional money
manager. Whether it's an open-end fund,
separate account, or ETF, "it's about what's the
best end vehicle for the client," Davis says.
"It's a natural evolution."
This push into ETFs may not be a revolution,
but the firm is nevertheless moving into largely
uncharted waters for an established actively
managed stock-fund shop, says Ben Johnson,
director of global passive strategies with
Morningstar's manager research group. While a
few brand-name, active managers have
rolled out ETFs, thus far it's been limited to
fixed-income shops such as PIMCO and DoubleLine.
Equity ETFs, in contrast, have been the domain
of index-tracking offerings.
Davis began seriously considering launching
active equity ETFs about two years ago,
after hearing interest from both advisors who
already had money with Davis Advisors
and advisors who use ETF-only strategies and
hadn't been clients. Davis says they approached
the question much the same way as they

would a contrarian investment: "There's the
presumption that ETFs are passive and
the more we looked at that presumption, we felt
there was no reason for them to be that way."
Rusty Vanneman, chief investment officer
at CLS Investments, is one example of the kind
of advisor Davis hoped to attract. The Omahabased firm, which has $9 billion in assets, primarily
runs managed ETF portfolios. Its strategies are
more strategic than tactical, and CLS has
taken positions in Davis Select Financial ETF as
a longer-term bet on financials.
"We're not making beta bets, so we have to
pick ETFs that will add some excess returns like the
Davis funds," Vanneman says. "If we want
a large-cap value-oriented manager, the Davis
funds have always been strong in that
space, and it's really cool for them to have come
out with the ETFs."
Headwinds

The skepticism many investors are showing
toward active stock managers-evident
in net outflows in 2017-is, however, a potential
hurdle to widespread adoption.
"The biggest challenge that active managers face
in the ETF space is that they are active managers,"
Morningstar's Johnson says. "Many ETF
investors have either thrown in the towel on active
managers or are active managers themselves-
trying to generate alpha by creating their own
homespun [ETF] combinations."
Davis relishes the opportunity to compete directly
in the ETF space.
"We have been in a time where there have
been huge headwinds for active managers, and
we think that the average active manager
isn't so great," Davis says. "The average active
manager has high fees, is inexperienced, has very
little investment in their own fund, has high
turnover, and looks a lot like the index. We are
planting our flag in the ground in an area where
we will add value."
With the launch of the ETFs, Davis Advisors
has taken a step that other active managers



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Morningstar Magazine - April/May 2018 - 1
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Morningstar Magazine - April/May 2018 - Contents
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