Today’s conversation is with Greg Powell, the Deputy Chief Investment Officer at Miller/Howard Investments – one of the largest dividend-focused investment management firms.
Greg joined Miller/Howard after a distinguished 19-year career as a portfolio manager and director of research at AllianceBernstein. Greg has a PhD in Economics from Northwestern University and today oversees Miller/Howard’s Income-Equity portfolios.
Our conversation discusses everything from Greg’s history prior to Miller/Howard, the firm’s history as an investment management firm, and the characteristics that Miller/Howard views an important when selecting individual securities.
Full Transcript Below
Nick: all right so I thought in conversations like this is always interesting to start at the beginning. So I thought a cool way to start the conversation would be to rewind back to the start of your career which was at General Motors in non-investing roles.
My understanding so I thought we could begin by talking about how that experience shaped your early career and what made you eventually make the transition to Investment Management?
Greg: well I think working for a large corporation like General Motors is very different than the roles I’ve had in the investment world. But I don’t really view it as a non-investment experience.
Essentially what I started doing I started my career there as a forecaster and I forecasted medium and heavy-duty truck markets and size of industry. And ultimately that was part of a decision my forecasts went into a much more complicated decision on whether GM should stay in the industry or divest and they ended up divesting in the late 80s.
And so everything I did there kind of went into investment decisions but it was only one piece of a much larger decision and it was not the same as sitting at a desk and buying or selling a stock but it was very much an investment decision.
My most prominent role that was in it was running a department that ran the market research prior to large capital expenditures. So every big investment in in North America went through the same process and my department did market research right at the end of the process before the go/no-go decision was made. And that research I hate to say was actually very accurate but unfortunately frequently ignored by management and we all know how the movie played out.
So I think it was very good experience it left me very skeptical of corporate management but also it gave me a big appreciation for finding businesses that had a positive tailwind. Because frankly no matter what GM management did in in the late 80s and early 90s they were dealt a very bad hand and so I don’t think it was really surprising that it ended up in bankruptcy in the financial crisis.
So that’s really what I took from it I thought was great experience the best financial decision I ever made was to leave the auto industry and go into investment management. But it was very.
Nick: and after your time at General Motors in blue can you talk a little bit about what your role was there and how it differs from your role at General Motors?
Greg: oh well the role is completely different at General Motors I was typically a manager of large departments my last department was sending out more questionnaires than the US Census it was our fun factoid.
Of course the US Census only goes out every 10 years so it’s a little bit of a faulty statistic but it gives you an idea of the level of effort.
Had general at Alliance Bernstein I was essentially starting over and learning a new skill I think I went up the learning curve pretty quickly because of my background but it was still a completely new skill.
I was recruited to be an analyst on a hedge fund they were launched in their Alliance Bernstein had it was actually Bernstein this was before the merger had the philosophy of just hiring the people they liked the best and then putting them into the jobs that were open.
So I started out actually as a healthcare analyst on a hedge fund and was promoted up to being director of research which was a portfolio manager position on that fund and I worked on it for many years.
It was long short US equities typically around one thirty so it was fully exposed to the market.
Later on I was promoted to work on or to run the large cap US value team and that ran we had large cap value we had dividend oriented funds and we also had long short funds.
Nick: so that after Alliance Bernstein you join Miller Howard and I thought we could start this section of the conversation by talking a bit about the firm’s history. To my understanding Miller Howard started as a research firm that that wasn’t necessarily focused on dividend stocks and didn’t necessarily manage outside money.
So can you explain a bit about the firm’s history and what eventually led Miller how to focus on income producing securities?
Greg: ok at the outset like you said it was essentially a sell side research firm it did institutional research for on large cap stocks for institutional clients. Then in the late 80s the firm worked on what is considered landmark study on utilities as an asset class. And basically identified the value of investing in companies have a stable business but generate dividends for shareholders.
And essentially this led to the firm’s fundamental philosophy which is best described as high quality stocks plus high dividend yield plus growth of yield equals income and opportunity. And that was really the foundation of the dividend focused strategies.
So after the paper came out there was a demand for a fund managed by the firm. It started off as a utilities only fund and that that fund has evolved into our current infrastructure strategy.
In the late 90s there was a customer demand for a fund that was broader than just utilities but used the same philosophy and that was really the genesis of the income equity product which is by far our largest product now.
Nick: so this is a nice segue to actually talk about what Miller Howard does today you guys manage investment accounts focused on generating income based on a three pronged philosophy that you referenced earlier.
So I thought an interesting way to start conversation would be to ask how you measure and quantify each aspect of the three-prong philosophy that you mentioned earlier?
Greg: well let’s start with the easy one is yield. We took the stocks that have enough liquidity for us to buy which is a very large number and put them into deciles. With the tenth decimal being the highest yield.
We really focus on decile seven through nine we do own some stocks in decile ten but we’re wary of the highest yielders a frequently if the highest yielders have a problem the markets telling you that it has a problem so we we try to focus on dial seven through nine in terms of yield.
Growth of yield is a more interesting question. Essentially you want a company that can grow earnings grow cash flow you want a company that doesn’t pay out it doesn’t have a very high payout ratio now because then there’s no room to grow.
And then also you need to find companies that have a propensity to increase the dividend. Some management teams will tell you flat-out we’re not going to increase the dividend well and that’s we take them for their work.
But other companies have both a history of paying out a dividend and also an inclination to raise the dividend. I guess the best setup is a company that has a stated dividend philosophy for example they might say we’re going to pay out between 40 and 50 percent of free cash flow as dividends.
That’s perfect for us because then if we forecast that free cash flow will grow then we’re comfortable that we’ll get a growth in dividend.
Quality is actually that’s the third prong quality is actually the most nuanced of the three. Because quality can mean different things in different sectors I would say there’s no single metric that works across sectors.
For example if you’re looking at leverage in a cyclical industry or in an industry like technology that’s subject to big swings I having no debt is probably the best way to go for a company. Where if it’s let’s say it’s a REIT that owns commercial buildings of course that’s going to have some debt now we don’t want companies in any industry that are stretching the envelope.
But we’re willing to accept some debt in in certain industries where it’s is just stable and it’s the best capital structure for that company.
We also like stable industries and this is this again is much more art than science. But if you start with utilities being a stable industry now currently were a little concerned with valuation of utilities. But in terms of stability they really check that box what’s that mean it means that you don’t have a competitor that can come in and ruin the party.
You don’t have to really worry about consumer demand fluctuating dramatically year-to-year so when we go look for other four companies and other sectors we’re really looking for that. We’re you you’re rarely going to find something as stable as a utility. But on the other hand you don’t want to have something that’s very risky in terms of either demand or competition.
A lot of times I say that stability is best defined by what it’s not it there are no existential threats to the business there’s no pending make-or-break legal cases there’s no large risk regarding a regulatory approval for a critical product and there’s no potential new competitor or technology that would completely change everything in the industry.
So really trying to avoid those in fine companies where it’s more predictable.
Nick: many of the characteristics you referenced with respect to quality are qualitative in nature like stability and the lack of existential threats. Do you apply any quantitative screens to companies when you’re looking for high-quality dividend stock?
Greg: oh sure there are leverage ratios which everybody uses and of course we would we would look at that. Something that might be more interesting for your listeners is that we do look at short interest and if this short interest is rising for a stock that can be a big red flag.
We’re looking for situations that are not controversial. in my career my favorite stocks have been stocks where the markets kind of bored with them it’s not picking the darling but I’m not picking the most controversial stock either you try to find stocks where people are kind of bored with the situation. So there’s not rising short interest but not but people we’re missing the opportunity because obviously to have a good investment to some extent the rest of the market has to miss the opportunity.
Nick: are there any examples of stocks in today’s market that you would categorize as being this kind of boring overlooked stock that’s neither very expensive nor very cheap?
Greg: yeah I would say that KLA Tencore is and the whole semi cap equipment sector is kind of boring. In the sense that in technology people are really focused on the flashiest elements of tech Netflix Facebook and so on.
But to run all that there is a demand for computer chips also to run the Internet of Things and self-driving vehicles all of those things are going to require a lot of computer chips and what KLA Tencore does is it through really in the background it makes process control equipment that’s sold to manufacturers of semiconductors and they have a very large market share there you’re not going to be displaced on that basis.
When new chip designs come out companies and these are mainly household names Samsung Intel and so on will buy their equipment to iron out the kinks in their process and raise the yield in their manufacturing process.
So KLA Tencore sells at a multiple well below the market it is its cash and debt roughly equal I think the cash might be a little bit ahead by now and it generates great free cash flow. But it’s kind of in the background it’s not something that you would hear about at a cocktail party. So that would be an example of the stock we like.
Nick: yes of course. You also mentioned earlier that the idea that different business models align themselves well to different capital structures with a commercial reaping example of a business that you’d expect to have some sort of debt.
I wanted to pivot a bit and talk about REITs and other different business legal structures like REITs and MLPs and ask about what role they play in the portfolio management strategy employed at Miller Howard?
Greg: well I would say that historically REITs and MLPs were a much larger fraction of the portfolio than they are now I think the going back to yield versus growth a yield just as a simple aside.
I think it’s important to understand that if you are a dividend investor and a stock pays a high yield it might not need as much growth to be a good investment as a stock that pays a lower yield. And so our concern right now with REITs in particular is that they’re really bond proxies you’re not going to get a lot of growth.
So as over the last eight years let’s say as investors have waded into these stocks and bid up the prices and bid down the yields they really aren’t as attractive to us as they used to be. In addition if interest rates rise since they are bond proxies, bonds are going to become a tough competitor from an investment standpoint for them and so that’s a another thing that could depress performance.
Overall we probably well I won’t say always but we do own REITs now we tried down REITs that have some growth prospects oh so we have REITs that are in what we have Digital Reality which is an example which runs data centers or owns the buildings that house data centers. So that’s something that could have actual growth to it so that we’re avoiding just being in a bond proxy.
MLPs is a much more difficult discussion essentially a lot of MLPs have these IDRs which are distribution rights that the general partner has and over time these would become more and more onerous and have taken more the cash flow from the MLP and left less for dividend investors.
So we have tried to avoid in our we can’t do this in our MLP strategy because it be too limiting. But in our income equity strategy we’ve really pivoted away from MLP s that have the IDRs.
I would say in addition the other issue with MLPs as some of them have wanted to come back to the market again and again and again for equity raises for new projects and that really doesn’t fit what we’re trying to achieve just in general with the strategy.
We really want companies that generate good cash flow can internally invest that cash flow to drive future growth. But also have some cash flow left for investors.
And if you’re constantly having to come back to the market for equity you’re really not that self-perpetuating machine that we’re looking for.
Nick: how would you say that the due diligence and research process would be different for REITs and MLPs versus traditional common equity?
Greg: well for MLPs clearly you just have to understand any of these structures that really don’t exist elsewhere in the market where there are demands on their cash flow that are that take priority over the equity holders. So that’s an issue and really understanding that.
The other thing about MLP is that difficult is that the disclosure is not very good and in fact on our website there’s a very good video done by my colleague John Cusack which is an open letter to MLP management.
And one of the points he makes is the disclosures just been terrible and the thing you really want to know as an investor is the in general these are pipelines okay and there are pipelines with long term contracts. What we really want to know is when the contracts are rolling off.
When the pipeline’s star and they’re signing up people for 10 and 20 years and you can be very comfortable like okay that’s a long time in the future when that rolls off I won’t worry about it.
Now we have to worry about it because many of these pipelines are they’re they they’ve been around for a while and contracts are rolling off. And we’ve been very frustrated with the level of disclosure across really across the board for the industry.
And so trying to figure that out is very important because once the contract rolls over it’s going to reprice and then you might may just not have what you thought you had.
In terms of the non MLPs and reads just regular stocks a lot of the due diligence is around the issue of can it grow? We’re really not looking for situations that are just stagnant because we’re not looking for bonds we’re looking for equities meaning we really want something that can grow.
And so it just completely depends on the industry what that actually means but that’s what we’re researching.
Nick: you mentioned Digital Realty as an example of a REIT with a big growth one runway and I wanted to stay on the topic of reaching MLPs and ask you if you have any favorites in those two categories today?
Greg: well we own EPD as a MLP and that would probably be our favorite they don’t have IDRs and we’re pretty comfortable they’re not going to return to the market to raise equity. And those are really the two big checkboxes we have for MLPs.
I’d like to have to answer what on REITs but yeah we’re really not really pretty shy of REITs right now in general we do own Lamar which is billboards we do know digital reality.
But REITs are problematic at the current year levels with interest rates going up.
Nick: I wanted to pivot the conversation next and talk about ESG strategies so I’m Miller how are you guys are the manager ESG strategies for more two decades far earlier than when they became popular among the investment management world so I thought we could talk a bit about how you assess the ESG characteristics of individual companies and perhaps describe some successful shareholder resolutions that your firm has been involved in over the years?
Greg: okay well first thank you for noticing that we’ve been in this for a long time. I think a lot of firms just are trying to get on the bandwagon fairly late. But this firm is has been engaged in this for a long time.
We view ESG as part of the overall risk control we provide investors. As long-term investors we really prefer forward-looking companies that are gradually adjusting to challenges rather than ones that are going to be forced by society or legally to make very abrupt expensive changes.
So that’s really well in general what we’re looking for. In terms of the mechanics if we get interested in a particular stock we asked our ESG team to investigate the stock before we do any deep research on the portfolio management team. And we will not buy stocks rejected by our ESG team.
Now their evaluation I would do I think the most important word to use is holistic it’s not any one thing it’s really a whole portrait of the company and they look at sustainability reports they look at SEC filings and look at news reports. Basically anything we can uncover on the company.
Now we do have a few exclusionary screens for instance tobacco but most of our ESG work is focused on government governance environmental practices and workplace policies.
Disclosure is a very important focal point disclosure implies both acknowledgment of a problem and the measurement of that problem. And back to working for a big company I can say that anybody’s work for a big company knows that if you if you measure it if you publicize that in general it gets better.
just as an aside I don’t know if the man a Paul O’Neill was CEO of Alcoa for many years he later became Secretary of Treasury under George W Bush and he was famous for announcing a policy on safety and everybody thought he was nuts but he they said ok we’re going to measure it and we’re going to make our aluminum plants the safest they can be and we’re going to try to improve every single year.
And they did and actually a lot of financial performance went in line with that because it’s basically if you’re running a tight ship lots of things are going to work and that was a very good thing to measure and it was a definitely in line with the ESG way of looking at the world. It was a social metric but it had good financial effects as well.
As an example of something that’s happened to me while I’ve been working here is is that I had a pharmaceutical company I don’t want to get into the name. But I found it interesting from a financial standpoint and so I asked our ESG team to take a look and they came back and told me well we’ve got to reject this idea because this company has a long history of unethical unethically compensating doctors for prescribing drugs their drugs.
And it wasn’t just one instance it was they convinced me it was a long history and so we passed on the portfolio management side and then sure enough a mini scandal ensued later on and I just thought well can they that convinced me that they were really adding value.
You asked about shareholder advocacy so what I just went through is the selection of stocks in the portfolio once the stocks in the portfolio we try to advocate for ESG policies.
I would say that the way that works is by the most successful situations are just simply dialogues. So for example Enterprise Products which is EPD the MLP. They don’t since it’s an MLP we can’t do a shareholder resolution but we contacted them nonetheless and ask them for greater disclosure on ESG topics. There was very little available on their website we had a constructive dialogue and the company responded by adding an environmental and safety section to their website.
And disclosure is quite good for instance if you go to the website you’ll see that they have a safety metric that for better or worse they disclose every year and that’s really what we’re looking for. They’ve made a commitment to do additional disclosures including emissions comparisons.
So that would be a good that was a good outcome we last year we did file nine shareholder resolutions and six were withdrawn due to successful negotiation with companies. And that’s really what we’re after is when we when we do this is trying to get companies to come around and move in this direction.
Nick: now do you guys employ ESG strapped ESG guidelines for each of your investment strategies or do you guys have dedicated ESG management accounts that investors can choose to deploy the capital into?
Greg: our strategies are denoted as ESG or not. So income equity is an ESG strategy. Okay I think there are some yeah there’s some there are some other strategies that don’t have that screen.
In general across the board we don’t have any strategies that would have tobacco stocks for example that some of them aren’t as some of them aren’t designated as the ESG strategy so they don’t have the full screen that we have.
Nick: I want to continue to talk about your portfolio construction strategy specific with respect to domestic versus international stocks. So how does another Howard think about investing internationally do on international stocks are you is the firm purely domestic?
Greg: well first let me say that I think this distinction doesn’t matter as much as it used to. That even buying US stocks you’re getting a lot of exposure to both overseas demand overseas production and currency issues.
But to answer your question very specifically we buy stocks that are we can buy stocks that are either dual listed in New York or have ADRs that’s owned in New York.
So we don’t buy anything that is not listed in the US but we will buy stocks that are let’s say have an ADR in New York but even if most of their volume is in their home market we can still buy that stock.
Nick: are there any particular international stocks that Miller Howard sees as attractive today.
Greg: well we own Total we own Aegon we own HSBC. Those are all opportunities where the yield was a little bit higher than what we could find in the US for a similar name and so we allocated some of the portfolio to them.
Nick: one of the sub sectors that we get asked about a lot at Sure Dividend and the Canadian banking sector. Do you guys have a view on the appeal of the Canadian banks right now?
Greg: we own TD it’s I would say that over the here’s how I would answer that question I think it it’s still attractive. But recently I think the US the US banks are increasingly more attractive just more as and that relates more to what’s going on the US banking system as opposed to Canada.
Canada’s it’s a little bit more of a stable situation I know there’s concern about the housing market and so on. But they look pretty good to us.
The difference is in the US banks just four years were forced to retain capital and this just went on for years and years and years. And now in the last couple years the banks have done very well in the stress test the Fed has allowed very large capital returns both dividends and share buybacks and the yields are getting very interesting.
So I think I think on a relative basis the US banks are becoming a better investment.
Nick: continuing to talk about portfolio construction and due diligence how there’s another how I think about the valuation of individual securities and assessing investment opportunities and I guess to be more specific are there any particular valuation metrics that you rely on the most or you take a holistic approach when you price securities.
Greg: well it’s holistic in that any single metric can get you in trouble. But if I had to pick one that that is a very good metric for stocks other than banks and insurance companies it would be free cash flow as a percent of market capitalization.
So that’s what that’s really telling you is how much cash flow the company’s throwing off after capital spending. And that I think is a very good measure of what’s going to be available to dividend investors.
Now there’s a host of things that can go wrong if capital spending is lower than it should be if the company’s not investing in their plants and their plants are going to deteriorate. That’s not it that’s not what you want but if you had if I had to pick one metric that would be it.
On the banks and insurance companies that’s that is trickier because really what you want to do is assess the quality of the measurement of the assets and liabilities. It would be very nice to find opportunities that where the companies are selling for less the value of their less than book value so for instance Aegon in our portfolio selling for less than Book value.
So that’s a very interesting opportunity you have to convince yourself that the assets and liabilities have been measured reasonably well and that the company can grow in the future.
So yeah I would say banks and banks and insurance companies can be a little different. For banks though I also just think a simple price earnings is that’s a very good metric for banks takes everything into account.
Nick: does Miller Howard have any steps in the investment selection process to try to avoid value traps the proverbial catching a falling knife?
Greg: yes we we’re very wary of companies that are that have negative momentum and so momentum can be defined as just the stock price movement over a period of time or can be described as an assessment of the business getting worse. and so I’m going to take it as the more general description.
If you have a company where things are getting worse the stock price is going down or revenues going down or margins are going down those are big red flags and I run a much rather wait until the controversy has subsided management started to turn the company around let somebody else pick the bottom and wade in later.
So that would be I would say there’s always an exception that’s why I’m hesitant to make it black and white but in general we’re not looking for companies that are diving into the abyss.
Nick: how does Miller Howard think about diversification in terms of how many positions you hold and how you size the positions within the portfolio?
Greg: yeah I’m not sure I’m not sure we have anything unique in that regard. We typically have roughly 40-45 stocks in the portfolio which academic studies have shown that you don’t really need much more than that to be diversified. We try to we do our research from the bottoms up so we’re not making sector calls. But we try to have a mix of sectors within the portfolio so we don’t have everything riding on one sector doing well.
We also are very aware of unintended bets so as an example let me use interest rates as an example if you’re an income equity investor you have an implicit bet in most of your portfolio that interest rates are going to go down. Because that’s what would make a bond proxy do well in terms of valuation.
So while we saw interest rates start to go up we said okay well we need some offsets you’re probably never going to get rid of that bias because that bias is just in the asset class. But you can find stocks value stocks that pay a dividend that are helped by higher interest rates.
And so the two categories that we’ve used our banks and life insurance companies and both of them should do better with higher rates and it’s not really to make a call on rates going higher is just to take that risk mitigate the risk that’s inherent in our asset class.
Nick: well I mean I’ve I’m sure utilities and other higher yielding stocks will probably decline slightly in value as interest rates rise so that’s a nice hedge against that risk and the Federal Reserve a communicative intent to raise rates a lot so it sounds like definitely some wise forecasting on behalf in the firm.
Are the last night when talking with ever suspicion on the position roughly equal weighted are you overweight based on conviction?
Greg: we have a slide overweight on conviction the other thing that that goes into it is liquidity.
I’m there’s a few things you learn doing this for many years and one is that to be very aware of how liquid stock and because when you want to get out they’re not going to be as liquid as they are typically and so that’s a little thing that goes into the calculation.
Nick: so we talked about the history of Miller Howard what the firm does today and I wanted to wrap up by just asking what does the future hold for Miller Howard is an investment firm and what are you guys currently excited about today?
Greg: even though it’s hour long even though it’s our flagship product what we’re most excited about is in fact income equity we think there’s really a demand for income by investors we think we have a good product a good history and that’s really what we’re working on every day.
In terms of the positions in the portfolio I think I’m very excited that we have we have some real growth prospects in the portfolio tech and financial stocks that really have the ability to grow much faster than some of the bond proxies that I think historically both our fund and other funds have focused on.
So we have a large weight in technology we have large weight in financials. We think both have very good prospects for growing their dividend and that’s what makes us excited about the product.
Nick: awesome well I just wanted to wrap up by saying thanks for taking some time to be on the podcast. It is a pleasure speaking with you and I know all right you’re going to learn a lot from those things in the conversation. Thanks Greg.
Greg: okay thank you Nick good day.