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
