Dear friends,
I spoke for about an hour on Wednesday evening with Zac Wydra of BMPEX. There were about 30 other participants on the call. I've elsewhere analogized Beck, Mack to Dodge & Cox: an old money, white shoe firm whose core business is helping the rich stay rich. In general, you need a $3 million minimum investment to engage with them. Partners was created in 1991 as a limited partnership to accommodate the grandkids or staff of their clients, folks who might only have a few hundred thousand to commit. (Insert about here: "Snowball gulps") The "limited" in limited partnership signals a maximum number of investors, 100. The partnership filled up and prospered. When the managing partner retired, Zac made a pitch to convert the partnership to a '40 Act fund and make it more widely available. He argued that he thought there was a wider audience for a disciplined, concentrated fund.
He was made the fund's inaugural manager. He's 41 and anticipates running BMPEX for about the next quarter century, at which point he'll be required - as all partners are - to move into retirement and undertake a phased five year divestment of his economic stake in the firm. His then-former ownership stake will be available to help attract and retain the best cadre of younger professionals that they can find. Between now and retirement he will (1) not run any other pooled investment vehicle, (2) not allow BMPEX to get noticeably bigger than $1.5 billion - he'll return capital to investors first - and (3) will, over a period of years, train and oversee a potential successor.
In the interim, the discipline is simple:
1. never hold more than 30 securities - he
can hold bonds but hasn't found any that offer a better risk/return profile than the stocks he's found.
2. only invest in firms with great management teams, a criterion that's met when the team demonstrates superior capital allocation decisions over a period of years
3. invest only in firms whose cash flows are consistent and predictable. Some fine firms come with high variable flows and some are in industries whose drivers are particularly hard to decipher; he avoids those altogether.
4. only buy when stocks sell at a sufficient discount to fair value that you've got a margin of safety, a patience that was illustrated by his decision to watch Bed, Bath & Beyond for over two and a half years before a short-term stumble triggered a panicky price drop and he could move in. In general, he is targeting stocks which have the prospect of gaining at least 50% over the next three years and which will not lose value over that time.
5. ignore the question of whether it's a "high turnover" or "low turnover" strategy. His argument is that the market determines the turnover rate. If his holdings become overpriced, he'll sell them quickly. If the market collapses, he'll look for stocks with even better risk/return profiles than those currently in the portfolio. In general, it would be common for him to turn over three to five names in the portfolio each year, though occasionally that's just recycling: he'll sell a good firm whose stock becomes overvalued then buy it back again once it becomes undervalued.
There were three questioners:
Kevin asked
what Zac's "edge" was. A focus on cash, rather than earnings, seemed to be the core of it. Businesses exist to generate cash, not earnings, and so BM&O's valuations were driven by discounted cash flow models. Those models were meaningful only if it were possible to calculate the durability of cash flows over 5 years. In industries where cash flows have volatile, it's hard to assign a meaningful multiple and so he avoids them.
In follow up:
how do you set your discount rate. He uses a uniform 10% because that reflects consistent investor expectations.
Seth asked
what mistakes have you made and what did you learn from them? Zac hearkened back to the days when the fund was still a private partnership. They'd invested in AIG which subsequently turned into a bloody mess. Ummm, "not an enjoyable experience" was his phrase. He learned from that that "independent" was not always the same as "contrary." AIG was selling at what appeared to be a lunatic discount, so BM&O bought in a contrarian move. Out of the resulting debacle, Zac learned a bit more respect for the market's occasionally unexplainable pricings of an asset. At base, if the market says a stock is worth twenty cents a share, you'd better have remarkably strong evidence in order to act on an internal valuation of twenty dollars a share.
Andy asked how Zac established
valuations on firms with lots of physical resources. Very cautiously. Their cash flows tend to be unpredictable. That said, BMPEX was overweight energy service companies because things like deep water oil rig counts weren't all that sensitive to fluctuations in the price of oil.
A number of other contributors to the discussion board were there and I'd be delighted to get their take on the evening. Folks interested in listening in can get the .mp3 at
http://78449.choruscall.com/dataconf/productusers/mfo/media/mfo131016.mp3.
As ever,
David
Comments
Other things I remember:
...will hold cash, 2-30% at times
...all-cap, but portfolio skews toward high quality, except when "special situations" are identified
...high quality means a firm possesses competitive advantage that leads to sustainable creation of cash, which at the end of the day is all that matters
...volatility leads to opportunity, which can create higher turn-over, but normally, expect rotation of only 3-6 names per year
....will wait years, if necessary, before good company is selling at discounted prices, like Bed Bath & Beyond after Best Buy tanked..."time has a way of creating opportunities"
...he remains on look-out for daily dips of good companies on bad news, as often these stocks recover by end of day...he will add to his holdings on such dips
..."compouding vehicle" (influence Charles Akre, apparently)
..."30 stocks that represent best ideas" (influence Bruce Berkowitz, apparently)
...appears extremely sensitive to permanent loss of capital...he believes he is the fund's largest individual shareholder
...he's captain and commander of the portfolio, but "leverages a strategy channeled through years of collaborative research"
...like D&C, once a BM&O employee, always a BM&O employee
...he's currently performing due diligence of ADT, including a visit today by an ADT salesman to sell him and his wife an alarm system
..."for better for worse" has never owned Apple because he's wary of predicting its earnings five years out: "Five years ago, would any of us thought Blackberry would be where it is today?"
...he's currently overweight oil/energy, particularly servicers, which are less dependent on commodity pricing
I thought he was terrific!
Very much appreciate David.
As usual, you've helped introduce us to yet another top money manager, not covered by Morningstar.
Thanks again.
I admit that I find this argument fascinating. BM&O was founded in 1931. In the last 82 years, exactly two partners (that is, the folks who manage the money as well as own the firm) have voluntarily departed -- and one of those eventually returned.
But that's also true of the support staff, he says. Their office manager has been around 32 years and their jack-of-all-trades guy (perhaps "executive assistant"?) has been on-board for 30. Zac argued that such stability offers them a competitive advantage: the investment folks simply don't need to divert time and attention to the day-to-day operations of the firm. They have equally-seasoned professionals on that end of the business who can be trusted to get it consistently right and to anticipate needs and problems without hand-holding.
The one person they don't have? An in-house marketer. They have, so far as Zac knows, never had an employee whose job it was to promote the firm or solicit assets. They do have an external partner, Lyndhurst Investment Partners, who are helping to educate the advisor community about the BM&O funds - but that's largely in pursuit of advisors who are going to have the sort of understanding and long-term loyalty that their private account clients do.
David
I was at a campus interviewing student candidates that were seeking permanent or internship positions in Software Engineering positions at the company I work.
I'll listen to the recording when it is available.