Money manager Zachary Wydra is a lifelong New York Yankees fan. But on his office wall hangs a photograph of Boston Red Sox slugger Ted Williams. While this might be considered an abomination to some fans of the Bronx Bombers, it reminds Wydra of one of the core tenets of his investment philosophy.
Williams was one of the greatest sluggers in baseball. His secret was dividing the strike zone into 77 equal areas and swinging only at pitches in areas in which he had a history of success.
Wydra is the manager of Beck, Mack & Oliver Partners Fund, a $160 million (assets) go-anywhere value fund holding stocks ranging from $530 million (market cap) PICO Holdings to $200 billion behemoth IBM. But like Williams, Wydra swings at a select few stocks–29 currently–that are in his sweet spot. In other words, his team has done deep-dive fundamental research and believes the odds of hitting a home run far outweigh the risks.
Since its conversion to no-load mutual fund status in 2009, Wydra’s fund has logged an average annual return of 16%, besting the S&P 500 each year except 2013, when it held 17% in cash and returned only 21%. “If we aren’t finding attractive values,” says Wydra, “deviating from the benchmark is fine.”
Wydra’s approach is right out of the Benjamin Graham deep value handbook. Allowed to allocate up to 50% of assets in his top ten holdings, he seeks firms with predictable cash flows and durable businesses that can withstand competitive threats. He also targets asset bargains. It’s all about generating big returns from mispricings in the market.
About 40% of Wydra’s fund is in small caps, but his largest holding is IBM. He says IBM could buy back as much as 50% of its shares over the next ten years, doubling earnings per share. But his case for Big Blue goes beyond financial engineering. He says Wall Street is missing IBM’s potential in cloud computing.
“A bunch of cloud names are trading at huge multiples, and IPOs are flying,” says Wydra, 42. Indeed, stocks like Rally Software and Benefitfocus surged in 2013, despite being unprofitable. Meanwhile, IBM sells for just 11 times 2014 earnings expectations.
“As businesses switch to the cloud, don’t you think IBM will be involved?” says Wydra, sitting in the firm’s conference room next to a large overstuffed bookshelf of finance books ranging from Den of Thieves to The Intelligent Investor.
Though Wydra’s flagship fund is puny by industry standards, he and the other partners of the firm manage a total of $5 billion. Beck, Mack & Oliver is an old school Wall Street firm founded in 1931. However, unlike most boutiques it is under little pressure to grow. In an effort to stay nimble his fund will close when it reaches $1.5 billion in assets. As recent shareholders of Berkshire Hathaway can attest, size matters when it comes to performance, especially if your mission is finding cheap stocks. (Berkshire has a five-year total return of 85%, versus 141% for the S&P 500.)
Because of its unique culture and structure BM&O has been able to resist the urge to get bigger. The firm has only seven partners, all of whom are stock pickers. Each earns a percentage of profits, and all profits are paid out each year. In fact one reason Wydra’s tiny mutual fund has a relatively low 1% expense ratio is that the firm spends virtually nothing on marketing.
The catch for partners is that at age 65 they must give away their equity in the firm to younger partners over the course of five years. Once a partner’s stake drops to zero he no longer receives any income from the firm. This keeps the firm’s ownership in the hands of stock pickers younger than 70, with each partner’s stake based on client load and revenue generation.
By contrast, at other Wall Street firms younger partners often borrow to buy out older partners’ stakes. This puts pressure on firms to get bigger, thereby increasing asset fee revenue, profits and the payback.
“In finance everyone usually claws for the last dollar,” says Wydra, who currently owns more than 10% of the firm. Instead of spending endless hours chasing new business, partners spend most of their time either researching stocks or together in meetings debating the merits of an investment. Says Wydra, “Every time you recommend a name you’re defending it to your partners before you ever have to defend it to clients.”
Wydra’s path to deep value investing at BM&O is not typical. He was premed at Brown University, graduating in 1994. However, during medical school the sight of blood made Wydra weak in the knees.
“A guy had come in [to the emergency room] who’d been in a fight,” Wydra recalls. “My med school friend rushed over, but I was thinking, ‘I don’t want to get any of that blood on me.’ ”
So Wydra ditched doctoring and followed a friend into banking. “
He was making $80,000 a year,” Wydra says. “I didn’t know what a balance sheet was, but that sounded pretty cool.”
Eventually Wydra got an M.B.A. from Wharton and then landed an analyst job at Jacksonville, Fla. hedge fund Water Street Capital, founded by Gilchrist Berg, one of Julian Robertson’s original Tiger Cubs. At Water Street Wydra was one of the analysts behind the fund’s killing in Apple, which it bought in 2004. Wydra saw the iPod music player as a Trojan horse that would lure shoppers to Apple for bigger-ticket items like laptops. Wydra was a quick study in the rigorous discipline of buy side research, digging deep into company filings, meeting with management, customers and competitors, and dredging up every scrap of available information to check for risks.
BM&O takes a similar approach, so joining in 2005 was an easy transition. The first stock Wydra recommended at the firm was water technologies company Nalco Holding. When the financial crisis hit, the debt-laden company plunged 75% to $7.80.
Wydra knew Nalco’s customers, like oil refineries, could not operate without its products and support, so he figured its cash flow was durable enough to make necessary interest payments; in the swirl of a financial crisis it was a case of the baby being thrown out with the bathwater.
BM&O added to its Nalco position slightly above the lows. That conviction was richly rewarded when EcoLab bought the company for $38.80 per share in 2011.
Wydra has had some strikeouts. In 2008 he made an ill-fated bet on AIG, which contributed to his 42% decline that year.
These days Wydra insists that his strike zone for stocks is all about understanding the fundamentals rather than any size or sector. That’s why he’s willing to swing high for megacaps and lower for undervalued small stocks like La Jolla, Calif.’s PICO Holdings, a firm that invests in water storage and water resource management, real estate and agribusinesses. Says Wydra, “PICO management is great at aggregating misunderstood assets at low valuations and selling them at higher ones.” Proving, of course, he practices what he preaches.
Source: Forbes Apple