From MicroCap to LargeCap with Brian Bares

[Music] but uh brian thanks for being with us today thank you and appreciate you inviting me to be part of an event and um i have a soft spot in my heart for microcap it's where we started and and uh look forward to talking with you excellent uh maybe for people that don't know you maybe give a little bit about your background and how you got started investing sure so i mean going all the way back i started uh you know the the sort of long road to becoming an investor you know in high school opened up a self-directed brokerage account my father was an eye surgeon in the u.s air force stationed in omaha nebraska the nebraska connection is only interesting to people because you know i happened upon the berkshire hathaway annual letters and the writings of warren buffett fairly early and uh was very fortunate to feel like you know this was in the early 90s late late 1980s sort of felt some discovery value for having you know found somebody that locally that was you know on his way to becoming a superstar um and then you know the discovery value sort of brought out a little bit of a elicited and emotional response in me where i sort of liked the uh you know the the game and the treasure hunt and common stocks generally and that naturally gravitated me towards the smaller end of the market cap spectrum and so you know the first stocks that i put in my personal portfolio were these you know unknown smallish companies and i was kind of hooked i became a junkie at that point like a lot of people that you know sort of catch the bug uh studied math and actuarial science at the university of nebraska and then migrated to austin texas the year after college and started working in the business and you know interesting part of my origin story is that you know typically uh people that are following a similar path to the one that i laid out for myself um you know they they'll sort of emulate the buffett model where they'll start a fund uh you know one in 20 fund with a hard hurdle or something like that before they have uh you know a lot of industry experience and so i made the correct and retrospect uh decision to actually work in industry for about three or four years to try and really understand the infrastructure around being a professional investment manager before ultimately starting bears capital at 27 and so i think uh you know to the extent that there's you know emerging managers in your audience that are you know thinking about this or contemplating this i found that uh it really accelerated our success once i did start various capital to have had you know the understanding of what you know the 40 act fund world is like what the you know the wealth management world is like what the institutional world is like you know looking at third party marketers and you know whether you structure a separate accounts versus a fund and these types of things all those questions were answered for me because of my experience at my prior firm and then so ultimately started in 2000 bears capital uh after kind of noticing a a tectonic shift in institutional asset management that was allowing large allocators to internalize their due diligence efforts and ultimately seek out unique managers that were you know doing things like the the the the strategy that i was contemplating when i launched the firm highly concentrated um you know uh pressing on our very perception and inefficient markets and that sort of thing and so ultimately we launched bears capital in 2000 and as you alluded to highly concentrated uh almost exclusively qualitative in our uh in our process and vetting ideas and adding them to the portfolio and we have stayed uh primarily institutional in our asset base for a whole host of reasons we can get into if you'd like um and then you know we have the three separate strategies as you alluded to we follow followed our success in microcap into small cap and then ultimately in mid-large and so today bears capital covers the waterfront of market cap uh in the u.s you started as a micro-cap strategy you know i'm curious how you got started in microcap was it where you kind of saw that the endowment they were looking for a concentrated micro cab approach and you created one or was it something that you had a passion for that you know you had a certain skill set and you launched the firm yeah there are a couple of reasons one one is very practical which is when i started um you know despite having some industry experience for a couple of years i didn't peel out of a large you know hedge fund complex with uh you know stable of backers both financial and prospective client backers i really started from scratch with zero clients and so there was a a very uh acute feeling of financial scarcity that was you know i was feeling every single day and fighting to try and you know drive revenue to my firm while you know spending as little as possible but there's this time scarcity thing that that uh is probably even more important where you know i'm balancing account statements you know processing management fees i'm doing you know uh client prospecting and all the things that an emerging manager might be doing while still trying to run the research process you know research companies go you know get on airplanes and go meet with people and try and find great investments so i just didn't have time to you know to be the best analyst on microsoft for example i mean i could have spent my entire you know waking existence studying microsoft and and still not have been the 50th best analyst on the company and so um you know microcap afforded an opportunity for variant perception in a time scarce world for me and so that's a very practical reason investment reasons are probably patently obvious to your audience which are that the you know the exploitation of variant perception is just much more available in microcap and um sort of going back to this concept of the emotional connection to the discovery value you know like actual treasure hunters feel this every day of their life you know they wake up thinking today could be the day where i find you know find the the sunken spanish galleon you know gold or whatever this is you know this is the feeling that drew me to the business in the first place that you know got me excited about reading about buffett and other you know fantastic investors and what drives you know what drives me every day to continue you know doing what i do and and in micro cap that's the sort of the most intense intense emotional connection for discovery value for an investor and so you know having um having a process that transcends my market cap has been very useful as we've grown the firm because our varying perception in micro cap isn't probably what many of your audience is used to we're not we're not in micro cap because you know we're looking for that undervalued piece of real estate you know in the footnotes of a 10k um it's the discovery of you know people that have a strategy to win in a large and growing market that are great capital allocators it's studying the competitive aspects of these businesses and the potential for the you know competitive advantage to manifest and continue and then ultimately studying the industry and the growth prospects of the business and and you know fortunately for us that that works across market cap um but that that discovery value is pretty intense in microcap and so starting there was you know there's a whole host of reasons we did that it was an easier sell at the time because we were unusual and still to some extent are i think your your audience may think that there's you know there are thousands of microcap managers out there pining for institutional capital but the fact is is there really aren't um especially concentrated microcap is still relatively unusual in the mainstream institutional world and so you know smart allocators that are looking for differentiation in process philosophy and you know a scarce capital base that they can be a part of um that's something that's still in my opinion very appealing to to them so so when you launched in 2000 i mean did you have you know checks from endowments just pouring in as soon as you opened up like what was that what was that first few years like and when did you feel like you had the confidence that okay we can make a go with this it was not raining money back then uh so the the the real part of the origin story that um that strategically is is really important is that the tectonic shift in institutional asset management started probably in the mid 90s and was popularized by the yale endowment manager at the time his name is david swenson and there's a book published in 2000 which is sort of coincidental for me starting the firm called pioneering portfolio management written by david that architected essentially the new approach to institutional asset management and so the 60 40 stocks and bonds of yesteryear was falling away to uh in in favor of a multi-asset class implementation where you know perpetual time horizon non-taxable endowments were engaging in sort of new uncorrelated equity-like return streams and that would include of course venture capital and private equity but also things like timber and infrastructure and other areas and so if you think about it you get a smoother line up and to the right if you add um equity-like return streams that are uncorrelated or anti-correlated to uh to common stocks so so that's interesting for institutional allocators but it's really interesting for public equity managers because it meant that there was a massive outflow in the category which doesn't seem like an opportunity until you dig a little bit further and you realize that the 1 100 stock managers were getting fired and in their place where these more unconventional more hedge fund like uh high active share you know highly concentrated managers uh were becoming populated in the public uh pie piece if you will for these institutional allocators so that provided an opportunity so the book architected this overall tectonic shift and institutional asset allocation and in my opinion provided a window of opportunity for a firm like i was contemplating to actually go direct to these large allocators into and to get a check and you know up until that point i would have had to go pitch to one of these large institutional gatekeepers who would have said you're too young you have your subscale you don't have assets you don't have a track record um and so you know we can't risk our capital on you and we're certainly not going to recommend our clients do the same so there are too many agency issues that would have prevented a firm like ours from growing in say the 1980s but with the advent of the endowment model all of a sudden these in these due diligence efforts on public managers were internalized and so i could actually go to the for example the yale investment office and they never gave us money but you know i went and pitched them with six hundred thousand dollars in composite assets and you know i wasn't laughed out of the room you know it was one of those things where they said this is actually the type of thing that we're really interested in and so we sort of shook the ex yale tree where these people started going and running other large endowments and foundations and we finally got about two and a half years in our first check which was eight million bucks and then they ramped that up significantly and that was followed by a couple of other university endowments and similar-minded type of investors and so um you know once that social proof started to kick in then the acceleration of fundraising was was was pretty rapid um so there's a time window where lots of lots of new money was coming towards managers like us um is is that opportunity you know available today is probably at the top of mind of a lot of your listeners and the answer is it is but it's not categorical inflows as much anymore it's sort of replacement inflows so if you know somebody's out there saying well i've got to concentrate a micro cap strategy i'm going to go you know talk to yale and get a get an allocation it's possible but they're probably going gonna have to fire somebody to first you know to um you know to add where you know they were firing pretty much all of these you know large diversified asset managers without you know ready stable of ideas to allocate the capital to uh back in 2000 when i was having these conversations and so we were a little bit more successful i think than somebody would be now in terms of just the number of interactions before an actual check it's still definitely possible and i talk to people all the time that are that are seeing that type of success but it's just probably a slightly harder road to hoe today i appreciate the color on that but kind of in my opening remarks i mentioned sort of your two pillars which are concentrating and qualitative kind of those two things and it's something that's been around since you started the firm and you know i'm curious uh who got you started down that path of concentrating and you know was focusing on the qualitative and what was it like that then to scale that up and out of bikercap so the good news and the bad news is i didn't really have a mentor from a process standpoint you know it would have been a lot better if somebody would have just sat me down and said look this is the way you should invest but my old firm was actually highly quantitative and highly diversified and so my process is basically built on first principles and using occam's razor to take away what doesn't work and so you know i i looked at the highly diversified portfolio in the institutional context and i said this makes absolutely no sense everyone is way too diversified if you think about our institutional client base maybe having a hundred managers across all all asset classes uh in the public book maybe they have i don't know half a dozen or ten uh let's say you had ten you know investment managers each holding a hundred stocks i mean paying one percent you're owning the market but you're paying active fees for the privilege they might as well give them money to vanguard and so i just thought this was ridiculous and then i thought about our own portfolio where you know we're adding our 70th favorite name and that 70th position is a you know five or eight basis point you know position i was like this thing could 10x and it would be meaningless to our long-term performance to say nothing about the ultimate institutional allocators portfolio performance and so you know i just sort of said this doesn't make any sense and then marry that with having studied buffett and some of buffett's contemporaries where most of the great long-term track records appeared to me to come from a fair amount of investment concentration then you had emerging research at that time that was showing that high active share managers tended to perform low active share managers and you had a manager's best ideas out performing their worst ideas and then you had a seminal paper in 1970 that was written that showed that you're 80 diversified after eight stocks and so i'm thinking to myself all this is leading to one very obvious conclusion which is you ought to concentrate and it works especially well when you're a sub manager for an institutional portfolio because you know we're not more than a three four five percent position in any one large allocator's portfolio we don't have the suitability issue that probably a lot of your audience has where i'm gonna start a concentrated microcap fund and then i'm gonna go down the street and i'm gonna try and find uh you know my my parents friends to give me a couple hundred grand well they have to sort of match a traditional you know cfp style suitability issue where you know i shouldn't have too much of somebody's money especially an older person's money and a portfolio of concentrated microcaps right so what i was contemplating works particularly well in the institutional context so so concentration was was sort of an obvious first principles um a part of anything that i was contemplating and then the qualitative approach to research i sort of again took occam's razor and said look what what what are the you know what are we trying to achieve here we're trying to achieve stock price out performance okay well what are stock prices they're simply pieces of businesses and reflect over the long term the underlying compounding of business value per share and so if we want above average stock price performance we should necessarily be looking for above average business compounding okay where does above average business compounding come from and as you deconstruct that problem the answer is a handful of qualitative buckets right it's you know you can't have above average business performance over time from a commodity business that's in a very competitive you know industry and so you know your you and i are going to compete on price until we whittle away our economic margin and we're both rendered uh um you know averaged by the the gods of the economy um we you know if we're both average managers we're probably not going to re-plow the capital back into the business in optimal ways if the businesses that we have don't you know have long runways for growth we're going to be rendered even more average or below average and so there are all these things that inform uh the ability of a business to compound at above average rates that are qualitative descriptors and it just so happens that if you come into qualitative analysis you typically are getting the conclusions for future compounders before the numbers have manifested itself especially in microcap and so it worked particularly well there so marrying this qualitative aspect of the research process with a highly concentrated portfolio came up with uh you know it sort of produced something that was relatively new and interesting at the time and i i've said this on a recent podcast but i love the tim urban blog uh wait but why and there's this you know this sort of concept that he articulated a mental model if you will it's chefs versus cooks you know a cook is somebody that follows a recipe takes a table full of ingredients and makes a delicious dish a chef is somebody that doesn't have a recipe he's got a table full of ingredients and creates something new and interesting and you know we didn't invent the concept of concentration we didn't invent the concept of qualitative research or being in microcap or pitching two endowments or any of these sorts of structural strategic or process related elements we just sort of put them together in a way that is relatively new and interesting i don't think we're completely unique but i mean there were only a handful of us doing the sorts of things that we were contemplating but the common thread through all this is that i built it through sort of first principles i didn't take you know i didn't you know peel off of tiger and take their process and philosophy and their way of running their business and and just sort of glom it on to us a smaller asset base you know i didn't peel out of a large value investor and take their formulas or their you know their way of running businesses or or pull people from you know other places to implement best practices we really just sort of thought through every single step of an investment advisor and tried to do what seemed to be logical uh you know the best for our ultimate client compounding the best for the long-term strategic vision of the people running our business et cetera et cetera you've said before that your your research team your research process is your mode at the firm and i think you have maybe 15 research analysts now there at the firm you know i was wondering if you could kind of just run us through the process from start to finish like you know how long does it take to research an idea like is it is it you bellowing from the heavens i want you to look at this company or do you let them kind of explore their own curiosities so they have ownership of an idea through that process you know and what happens yeah that's a great question so the great the great thing about our research team is that everybody's a generalist and so we don't hire you know the precision instruments analyst and the software analyst and the you know the industrial analyst everybody's a generalist and we're trying to contrast the entire opportunity set and the entire process is designed to distill exceptional from average that's really what we're doing if you think about what we get paid for by our clients it's really two things it's the discernment between exceptional and average in these qualitative buckets that can drive future compounding and then it's ultimately the decisions that we make about what to add to the portfolio and and how much to weight them and so it's really the portfolio management piece and the research piece i mean that's what we're paid for and so we want to design the research team which as you alluded to is a part i think of a constellation of things that provides a competitive advantage for bears capital we want to structure that research team in a way that optimizes uh in this case the former the distil the distillation of exceptional from average and so how do you do that well you really need reps i guess is the short answer i mean you need to get out and start meeting companies and if anybody that's a listener of your you know in your audience has met with a company you'll know the very first thing that happens is the very first company visit you go on you meet with a you know microcap ceo cfo or you know investor relations person and you walk away going wow that's a really cool company this is really interesting and there's this immediacy bias there's all these sorts of things that come in your head and then you meet with 10 and you look back on that first meeting and you say okay maybe that wasn't such an exceptional company maybe that wasn't so impressive and then you meet with a hundred and you go back to the first one you go okay now i can tell you that was an average company or below average or exceptional and so it's this it's this constant repetition of interactions meetings that starts to give you clues about whether something has a really interesting competitive advantage whether a team of people is really talented and likely to succeed or whether the growth prospects of the business are really really fantastic and so it's that distillation between um you know between exceptional and average that i think makes our search relatively unique and what that requires is if you're a junior analyst for us you come on board and you you know you excuse the french but you work your ass off for six months to get up to speed when and then you're finally productive after a half of a year because you need to get these reps in and obviously covet has changed everything to virtual but we are just recently getting back out on the road i mean it's sort of core to our process to have this constellation of interactions with people so that we can build this mosaic around the qualitative aspects in these three buckets and so um i i really like this you know this additional field work that we do too and so we encourage our analysts to get out and go to trade shows and talk to people is you know is the product that the company is touting really going to have a receptive audience among its users is the you know is this company just sort of producing vaporware or is it really you know starting to see traction in the in the um in the marketplace and so we have all these questions that that we continually mine and try and answer and the whole goal is you know are we looking at one of the 30 best companies in the space and so 30 is not a hard and fast number it's just kind of a mental model because we have roughly 10 stocks per portfolio we're sort of looking for 30 names that we can manageably follow and stay really close to and have a really good assessment of their qualitative characteristics that represent the best distillation of exceptional from average and then our portfolio were conviction weighting basically from that 30 names in a 10 stock portfolio so that's kind of the process it's all of this messy field work there's i mean if you go pitch an institutional allocator they're used to seeing this kind of triangle where it's like filter one filter two filter three portfolio right and we always have this slide in our deck it's like much messier than that right we're doing all this work and we're constantly trying to upgrade our focus list of ideas that represent these you know 30 exceptional names and then we pull from there uh once we've approved a focus name we do appraisal work pull from there and conviction await the portfolio but we don't have this perfect you know triangle or trapezoid sort of uh visual representation of our process in our in our slide deck because it's not that easy i mean we're not quantitative and so we don't have you know screen on low price to book low low priced earnings you know low ebd vita or high roe or something like a lot of a lot of people do we just say we want to pre-qualify best businesses run by the best people with the best prospects for growth and if we can find those 30 names we can be a little bit wrong in the price but we're going to conviction weight them with both quantitative and qualitative analysis uh to to make really big swings of the bad uh in a 10 stock portfolio given your concentrated kind of low turnover approach like how do you view cash in the portfolio you know what do you think is the appropriate amount for you yeah sort of back to the suitability question you know we have a very wonderful uh structural element of our business which is that we're not 100 of anybody's money and so we don't need to use cash tactically if a large institution allocates a two percent or three percent position in their portfolio to us then what happens is they typically have a tertiary level cash allocation and they don't want us taking unintended um you know cash bets with the portfolio they're expecting you know we just want you to buy the 10 best small cap names we can find in full stop and so we don't use cash tactically we try to stay as fully invested as possible we don't want to compound the problem of the fact that the type of companies that we look for tend to be very cash generative to begin with and and many of them have large excess cash balances on their balance sheet and so on a look through basis we're probably holding more cash than we probably ideally should anyway and so holding cash in the portfolio becomes a you know just sort of a compounding problem for both the client and for us and so we want as much of the capital in their in our fine accounts allocated to the forceful you know business growth that's happening at the fundamental level i'll ask one more question just as a reminder of the audience if you have questions put them in the q a click the q a button at your bottom of your zoom screen and we'll get to them after i ask this one last question to brian uh maybe the last question i have for you is i know you don't necessarily look at valuation when you're doing your analysis of a business but what role does valuation play in your buy and sell decisions so yeah with all this qualitative talk i don't want to intimate that we don't do any valuation work we certainly do we have dcfs in every single company that we follow the important point here is that we don't use price as an input to our process so a mistake in my opinion that many investors make is that they use a screen especially in the micro cap space where the you know there's so many so many opportunities i mean we've got 1500 companies or whatever realistic companies or whatever you're wanting however you want to categorize that number it's a lot and so you're looking at all these companies and the natural thing to do in a time scarce world is to apply some quantitative screen or filter and typically if you're a student of buffett or you view stocks as businesses you're looking for cheap first you're looking for a price based input you're looking for low p e for low price to book low price to cash flow low ebd and i think that's a mistake in an increasingly efficient market a low price in relation to fundamental business value is typically an indication of a business that's under earning on its capital base and probably an economic decline rather than a contrarian indicator of investment value and i think that has been borne out by the the failure of price to book and the fama french three factor model for the last 15 to 20 years and so our contention is that to avoid those value traps especially in a concentrated portfolio you don't want a value trap we just want best businesses run by best people with the best runways for growth full stop and so we want to we want to look for those companies pre-qualify them independent of price and then once we have our focus list of 30 names at that point we're going to do appraisal work on those names but and importantly even in the selection from that list to the ultimate portfolio appraisal is a part of the decision but it is not uh solely determine it we're not just ranking or rank ordering our focus list from you know most expensive to cheapest you know buying the bottom selling the top wash rinse repeat what we're doing is we're saying well you know xyz at 80 cents on the dollar is not the same as abc at 80 cents on the dollar they're different businesses there's no qualitative equivalence among these positions that's a huge mistake what we need to do is discern uh you know how is the management what's their plan for winning what's the runway for growth what's the competitive advantage look like could it potentially deteriorate what's the embedded optionality all these sorts of qualitative assessments of these and then use price to appraisal as kind of a guide but not but not wholly determined in terms of what gets into the portfolio and how much it's weighted so we do appraisal work we think we're pretty good at appraisal work but ultimately it's the weakest part of any manager's process in my opinion um you know having a sharper pencil or getting out to you know microsoft excel you know cell ae 26 or whatever you know if you're getting that level of detail to be determinant on whether you buy or sell position i think you've sort of lost the force for the trees what you really should be doing is saying i just want the very best business i could find because the longer you hold a great business the more determinant the underlying compounding is over the starting multiple with one huge caveat we're not buying companies for 50 times sales right i mean there's a price you pay at which it doesn't matter how great the business up is you will lose money so we want to buy things for less than they're worth we want to be disciplined about that but um we're not we're not getting too heavy into the end of the math okay yeah go ahead mike i think you could we have a few questions that came in yeah brian the first question uh from the audience is uh if you weren't running the amount of money that you're running how would you think about the risk return trade-off as you go down the market cap uh spectrum considering exceptional returns generated by larger companies in the last decade yeah there's a couple couple embedded questions here that um that are very interesting to think about the first is um you know i don't pat myself in the back very often because it's a very very difficult business that's very humbling and the second you do that you're going to get whipsawed but we've had really good performance without owning even in our mid-large strategy without owning the you know netflix google apple microsoft amazons of the world and those businesses are remarkable and how quickly they are growing for how large they are and with without utilizing a significant amount of assets internally within the businesses and so they're fantastic companies we haven't owned them and we've still done well and so i sort of feel okay about that but it's been a real headwind in terms of relative performance for managers including us to to try and overcome strong index returns that are largely powered by these these large names so that's been very difficult um you know managing large amounts of money typically is correlated with um you know a degradation in your alpha potential and what we have tried to do is stay on the front end of that emerging manager life cycle where you know managers start out they have great performance they get asset floats and then they start to disappear and i sort of said how can we structure our firm to where we stay on the front end of that emerging manager life cycle and the way we have done that is by um having a scarce amount of of assets in each strategy that is to say capping the assets that we'll take and so for you know for all of our strategies we have either closed or have articulated a cap on those assets that allow us to stay flexible for each opportunity set and so i'd say just generally speaking you know the that the absolute level of assets doesn't matter what matters is you know do you have you limited your assets in the strategy that you're managing uh to stay sized flexibly for the opportunity set so that you don't have to increase con your your the level of concentration simply to accommodate a larger uh fee paying asset base we're not going to do that we could be a much more profitable organization if we went from 10 stocks to 50 stocks like without a doubt and we could ride this bow wave of extreme profitability as an investment manager we could watch our performance go to hell and we'd die you know a slow and then quick death as a manager but we've opted to stay sized appropriately for the opportunity set to sort of forego the obvious economic opportunities for us in um in pursuit of optimally compounding client capital uh thank you so um what has been your most memorable uh trade or position oh gosh too many too many to count both good and bad um i think i think one the one that sort of interesting that might come to mind uh just given the forum here is that we owned a our record for holding a stock is 18 years and so one of the very first positions we bought in our micro cap strategy was utah medical products which is sort of a very small utah-based niche you know medical device manufacturing company and uh we rode that you know to i think that the the compounded annualized returns were 17 or 18 or something like that for for 18 years and we just sort of bought it and hung onto it and it did what it was supposed to do and you know it's very rare in common stocks that things do exactly what they're supposed to do but but this one did and so um yeah i suppose that's an inspirational story for you know the people listening that you know those types of names are out there so uh uh is your style similar to buffett's um in that uh you don't have an extra strategy if the company continues to exit execute yes with uh with a couple caveats um you know buffett has the the you know he's got the headline issue where you know he buys gary let's say he sold coca-cola that would be a huge issue for lots of people but he also has a tax issue too and so we have a largely non-taxable client base and so we have a little bit more flexibility i think than he has both in terms of the amount of capital that we run the opportunity set that's available to us and then the tax implications of our uh of our trades so you know our turnover has a has actually averaged about 30 percent which is you know in a in a that's you know three new positions in a ten stock portfolio it's an interesting uh statistic because we're not managing to it it's just sort of happened that way and i think it's just being having the luxury of being in the public markets and having opportunities be served up to us sometimes um the things that we buy work out way quicker than we would have anticipated we'll sell and move on sometimes we make mistakes we got to sell and move on i think if i would have guessed what our turnover number would have been 21 years ago when i started the business i thought it would be lower but that's just the way it works out that being said you know we try and we try and buy with the intent of holding for a long time but i never lose sight of the fact that we're in the public markets and we have the luxury of taking advantage of the public markets and the opportunities that they serve all right just scrolling through questions here um how has the firm's on the ground research evolved over time well it's evolved from me doing it all to now instead of having people that are a lot smarter than me that are executing on the process and so um i think one of the important evolutions that i um i sort of came to over time was i you know i'm a states i'm a state school person i had a fair amount and still to some extent to have a fair amount of imposter syndrome where i always think everybody else knows so much more about everything than i do and so i compensatory mechanism is just to work harder and so we had a period probably 15 years ago where you know we just felt like we needed to know literally everything about the businesses that uh we were we were researching and so it just got really really in the weeds with lots of minutiae that you know quite candidly is completely irrelevant to the long-term um sort of compounding of the business and so i think the pendulum has sort of swung from we started out we had this sort of gritty uh research effort where it's like we're gonna know more about this company than anyone else does and that sort of swung to this area where you know from not knowing anything to knowing too much to sort of getting in this happy medium to where we're like let's figure out what's important to the investment thesis let's know everything about that but you know the shoe size of the ceo and you know what kind of car they drive and that sort of stuff you know that that's become you know the irrelevant pieces of information that are just sort of immaterial to the to the thesis so we we try to chase down what's important but um i think we've we've happily settled into this kind of rhythm of we know what we're trying to find out okay for those of us scaling or bootstrapping are firms similar to bears capital running out of your condo when you first went on your own could you talk a little bit about your efforts to scale particularly as it related to the balance between early stage marketing versus focusing on the investment activities like research and portfolio management yeah you know we've gotten to about six billion in assets without having a formal marketing effort um and i you know it's not a it's not a humble brag or anything like that it's it's really um in in institutional ally out for institutional allocators um you know you can't be a used car salesperson you have to you have to sell people philosophy process so you just need to get in front of them and talk to them about it so kind of what i did was if i were researching a company in you know in in san francisco i would drop in on the university investment offices and just tell them what i was doing and i said i know this may not be right for you now but maybe it will be one day and just laying the groundwork for um for who you know for the future relationship who we are what we're doing um you know keep them updated with quarterly letters and that sort of thing and all that fieldwork sort of paid off and once you get client one two three then all of a sudden all these people kind of move in concerts and they all talk to each other and and you know if if we would have spent a bunch of money on institutional sales people i'm not sure we would necessarily accelerated that effort that much and so it's a real conundrum because as i said before i sort of benefited from you know the the categorical inflows that were happening for concentrated managers but i think that you know my read on the situation is that is still very much um the attitude for most large allocators is they want to allocate to high active share concentrated um fundamental investment managers and so i think that there's some optimism for those of you that are out there that are that are trying to scale their firm um in terms of the actual time balance um i i'm probably a little bit unique and this is not something that's probably that widely known but you know i think that that i probably spent a little bit more time prospecting new business um than than probably my peers and i say that because a lot of people that are attracted to this business i think have the personality where they're a little bit introverted they like finance they like numbers they like um you know company analysis they like staying behind the computer it feels like their comfort zone going and you know trying to advocate for yourself uh to what looks like a scary meeting with an allocator um is overcoming some amount of fear and i would just say that you know i was probably a little bit more equipped to go do that than most of my peers that i was noticing trying to launch their firms and so i think that if you can sort of bridge that gap in your mind and say this is a necessary skill for our business and it is absolutely a necessary skill for our business if you want to scale the business um as i've said many times in the past if you've compounded 30 annually the world will be the path to your door and you know you never have to leave the office if you don't want to but if you're you know reasonably successful and just in the in the universe of managers that has good numbers um you need to differentiate yourself by making sure that your your what you're doing is visible to other people and i think with you know i didn't grow up in a world with twitter and and all this other stuff so there are new mechanisms and platforms to you know to raise your profile and to increase your visibility among all these people but i've always felt like a personal face-to-face connection is typically the best chance that i've had of getting an allocation from an institution and so i made it a point to try and travel as much as possible not eat lunch alone you know to get out there and to meet people and just tell people what i'm doing and 90 to 95 of that effort is wasted motion and you just have to get used to that and you know no one likes to be told no no one likes to be shot down no one likes to be criticized but you just sort of grate your teeth and say this is part of the process and i'm just gonna go do this and so i think that's why one of the reasons why we're successful in raising money what is a piece of advice or pieces of advice you would share with your 20 year old or 22 year old version of yourself right out of college oh man um i try not to be too hard on myself in retrospect but um but i was probably a workaholic that's another piece of all this too i mean you know i just watched the firm when i was 27 i was still single at the time uh had just gotten out of a long-term relationship but you know there's a lot of casualties in your life health relationships you know friends lots of things if you're just making the absolute commitment to launch a firm and be successful and i was probably uh you know had a little bit of a screw loose back then in terms of the intensity uh with which i pursued the you know the launch and ultimate success of bears capital and i'm you know have a very happily married with three kids right now and so have toned it down a little bit and and one of the one of the things that i probably should have done is recruited some people to my cause that could have diversified that workload a little bit so that i could have been a little bit more balanced probably in my late 20s early 30s but you know all this is kind of nitpicking nitpicking in retrospect i've been very fortunate there's a lot of a lot of luck and timing and and hard work and everything came together and and even that isn't a guarantee of success i have good friends that are you know trying to make a go of of a business like this and sometimes our timing is wrong sometimes they you know catch an unfortunate streak of performance sometimes you know they get the wrong clients and you know there's just a lot of things that could have gone wrong in retrospect and so you replay my story a thousand times and probably 90 of the time it turns out worse and so i'm not going to be too hard on myself in retrospect so are there particular industries that you focus on and your investments yeah that's a great question so um we're all generalists here uh we don't have we don't try to have two of everything i think buffett famously called it the noah's ark version of investing where you just buy two of everything um that's that's not our our thing obviously the concentrated portfolio we want to focus on the types of businesses that have um you know that score highly on our qualitative uh sort of framework and and those tend to kind of coalesce around a handful of buckets um you know precision instruments where you have a lot of product differentiation can allow for super normal pricing opportunities for those participants um and so they qualify quite a bit information services companies where they're selling a non-rival good which you know build once so many times subscription model recurring revenue etc those tend to you know score pretty highly software sas model software companies are fantastic for all the obvious reasons um and so you know anything that that uh that that gives us an indication that they would have this qualitative excellence is something that's interesting to us and those have just sort of sorted out in a handful of of categories that uh that we we tend to focus on um but that being said you know if if there's a commodity industry but there's one participant that's you know maximizing or minimizing some variable within the business that allows them some competitive differentiation that becomes interesting to us and we'll take a look but if you look at our historical uh holdings you know they they they are in information services software precision instruments lots of product differentiation razor razor blade models you know sell build once so many times non-rival goods that type of thing brian i have a question you know a lot of investing in microcap or at least a decent part of it more so than the other market cap classes is investing in the right management and the leadership and you know when you think about trying to evaluate or discern the difference between exceptional and average and some of these small micro caps you don't have the luxury of a history or a track record to go back and see okay well this is how this person thought or allocated or things like that you know so kind of under the lens of just microcap and discerning exceptional from average you know what are some of the two or three things that kind of stick out to you that that help you discern that you know from smaller companies that might not have the history of you know a mid cap company that you're looking at sure yeah there's a bunch of emergent patterns that happen here too they're a little bit more subtle and judging human character is always a difficult task but um the basic thing that everybody already knows on this call that is is still very important to us is you need the right alignment of interest i mean we're outside passive minority shareholders and therefore you want to you know an ideal situation is to have a founder owner operator that's a little bit selfless in terms of their compensation and their you know their overreach and and how you know they issue themselves stock and things like that so if you've got this sort of buffett archetype there where you know there's some kind of you know signaling low base salary with a you know limited or no option grant and they've got a large you know economic stake in the business you know you're reasonably protected uh from that standpoint so that's that's you know that's kind of table stakes though and i don't think i'm saying anything that's earth shattering to the people on this call there's some other you know sort of emergent patterns that are interesting to us there's an idea that we've sort of coined an encore performance where you know microcap companies are actually kind of often times the recipient of talented management from larger companies and so say you know somebody's kind of either frustrated or maybe an activist gets involved or a founder is leaving or something like that and they may be recruited to a seasoned executive or executive team from you know from a honeywell or a ge or something like that all of a sudden that gets really interesting to us because you know you know big league talent in the in the in the farm leagues is is something that can be a really powerful uh differentiator for a business long term so this encore performance theme has been something that has been um very successful for us in the past um you know we we we extend this idea of great capital allocator a little bit i think people read a bunch of buffett and they think well i'm looking for the next henry singleton right and i the next person that's sitting there making decisions about buybacks versus dividends and and doing m a uh private equity has made the m a game incredibly difficult unless it's a really you know targeted strategic roll-up strategy in a particular fragmented industry it's just hard to be better at acquisitions especially when you're not doing anything i mean i'm friendly with lots of private equity you know guys and they're you know many they get a bad reputation but many of them are incredibly good business people operationally strategically uh and it's the ripam and shreddam you know no holds barred type of uh um business implementation and so it's hard for me to think of a henry singleton these days that can sort of make a passive acquisition like buffett used to do and just leave the business alone and get super normal returns and so you know that that henry singleton archetype is important in terms of the the mental model we want people that are they're careful with capital that that reinvest it internally with you know a rational approach and with an expectation for super normal returns we want people that you know pay dividends rationally that buy back stock rationally all those sorts of things but we really want people that are strategic operators that know how to win that have a long-term vision for future compounding that are stepping on the gas in terms of increasing their competitive advantage these are the other industry participants that understand the growth potential of the business that can cultivate and incubate tangential growth opportunities all these sorts of things so i think there's more more to this great management than just sort of checking the box for the next warren buffett we're bumping up almost against our time constraint but maybe one last question you know i'm curious you know when you look back over the last 10 years maybe not the last 20 years but let's just say the last 10 years you know where do you think are the areas that you've kind of evolved the most um as an investor or as a firm yeah um i mean there's a lot of evolution that's happening i think you know the the neat hindsight is 2020 version of our history is is pretty revisionist i mean this has not been a smooth line up into the right for bears capital for me personally it's been this really squiggly line all over the place that's gotten us here um you know i think people like to you know sort of sprinkle the fairy dust on on the revisionist history and and articulate this you know almost inevitable uh you know apparent success that we have had um but we we've evolved i mean we've gotten better at research we've gotten better at portfolio management we've gotten better at all these things and we're adapting to the market conditions i mean it i i look at a lot of the the heroes that i have in investing that have had struggled with performance uh over the last 15 20 years in part because you know they've just adhered to a statistical value framework that in an increasingly efficient market um has not produced the sort of relative results that they have wanted and so you know similar to i'm an american college football fan i'm a nebraskan and so that's just sort of in my dna but you know you think about you know oklahoma running the wishbone or you know in the 70s or nebraska running the you know triple option offense and you know that has given way to pro style offenses in the 2000s and ultimately the rpo and all these sorts of things and and defenses have to adapt it's like it's a complex adaptive system and the stock market is a complex adaptive system as well and so if price to book is working for a while there's no guarantees that it's going to continue to work and so you have to stay attuned to what other people are looking for as well and stay in front of and hopefully peering around corners seeing what's coming next so that you can constantly adapt and change and so you know the 13f if you look at our you know top holdings they're probably not you know what ben graham would have thought of when he wrote security analysis right i mean these are not net nets they're not low price to book they're you know they're you know optically very high multiple stocks but we have adapted to to try and understand um in some newer frameworks and understanding you know network effects and software and all these sorts of things and what what proper valuation should be for these businesses and so i'd like to think that we're trying to stay abreast is that the best we can and the qualitative elements of our process means they're not quantitatively boxing ourselves into a process that we have articulated to clients that we subsequently cannot change because the worst thing in the world with an institutional investor is you start style drifting from what you have articulated we have intentionally left it a little bit open with this qualitative analysis to say you know we're going to adapt and change with the times and so you know i think you would if you looked at you know snapshots every year of our holdings you would see that evolution over time so hopefully that was a good enough answer that was very helpful well brian thanks for being with us this morning really appreciate the time and um thank you i enjoyed the conversation and congrats on your success thank you

Channel: MicroCapClub

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Keywords: microcap, microcaps, MicroCapClub, stocks, investing, microchip leadership summit, 2021

Id: daf22jRsXdI

Length: 53min 3sec (3183 seconds)

Published: Mon Sep 27 2021