Like other professionals, we try to learn from compatriots across the world and we are particularly interested in other investment strategies similar to ours i.e. long-only, low churn, concentrated portfolios. In that context, we found this interview with Brian Bares to be very useful. We start with some background on Mr Bares: “Brian Bares founded Bares Capital Management in 2000. BCM manages $5.6 billion across two concentrated, qualitatively oriented strategies: Mid/LargeCap and Small-Cap. Brian is the author of The Small-Cap Advantage, published in 2011 by John Wiley & Sons. He is also an external advisor for the M.B.A. Investment Fund at The University of Texas at Austin. He graduated from the University of Nebraska with a B.S. in Mathematics (1995) and has earned the CFA designation.”
Although he grew up in Warren Buffett’s hometown, Mr Bares’ intellectual mentors extend beyond Buffett: “I started reading some newsletters and annual reports in high school and happened upon a publication called Outstanding Investor Digest, which chronicled a lot of what Buffett was doing and some of Buffett’s contemporaries.
And then, of course, I read the Berkshire Annual Letters and was pretty much hooked at that point….moved to Austin shortly after college and worked for an investment manager, who had some institutional clients and a high net worth practice. The firm was small and it was growing very quickly, and I got the privilege of having a lot of responsibility fairly early. And that gave me a great inside perspective on the various aspects of the firm….
I’ve never met David Swenson, who is the Yale CIO. But his book Pioneering Portfolio Management when it was published in 2000, was a huge catalyst for me starting the firm and growing the firm, and it was very critical in our early success, because it was essentially a guide book for where institutional allocation was headed, and where we could potentially fit into what is now known as the endowment model.
Ironically, some of my greatest mentors after starting my firm were actually institutional allocators. They helped me navigate some critical decision points along our path to success. So people like Ellen Shuman, who ran the Carnegie Corporation of New York for years and Anders Hall, who was at Duke, and now is the CIO at Vanderbilt University….”
And in the week in which the world mourns the demise of David Swenson, it is fitting that Mr Bares says that it is Mr Swenson’s landmark book, ‘Pioneering Portfolio Management’, which helped him figure out that the conventional way to build a portfolio of 50-60 stocks is nonsensical: “So my experience at the time was with a firm that was highly diversified in its portfolio implementation and almost purely quantitative, which are exactly the opposite of what we do today. And so, as I was working for this company, I noticed that institutional allocators were using a series of intermediaries, primarily investment consultants to choose 10 to 12 public equity managers each holding 100 stocks. And to me, it just didn’t make any sense at all, because everybody’s paying active fees and getting passive results. And at the time we would add a 50th, or a 60th name to the portfolio, and it was almost inconsequential in the grand scheme of things for the end client.
And so I just gravitated from first principles towards this idea of concentrated portfolios. But given the state of the industry, I didn’t know whether somebody who was 27, with very little experience, who didn’t work on Wall Street and hadn’t lived in New York could actually compete successfully for institutional allocations.
And it was that book [Swenson’s book] that gave me my “A-ha” moment where I said to myself, that the institutional allocator community will gradually adopt this endowment model, which internalized investment due diligence at the expense of relying on a lot of these third parties, institutional investment consultants and the like.
I thought that internalization of the due diligence process would allow for unconventional, younger, less tenured managers, like what I was contemplating at the time to successfully compete for large institutional allocations. And if there was any kind of a stroke of structural genius in founding the firm, it was a recognition that the endowment model would be widely adopted, and there would be a kind of categorical shift towards concentrated long-only public equity managers like Bares Capital.”
As for Mr Bares’ research process, it is old-fashioned, conventional, ground-up research on stocks done by him and his core team: “…valuing will always be a predictive endeavor. And so we want to focus on those predictive factors that should drive exceptional compounding over time. And those happen to be qualitative. They happen to be moats, or competitive advantage and the word “moat” is getting a little too overused in our business.
But competitive advantage is the first category, and the next is management, both capital allocation and strategic execution and operational implementation. And then, of course, growth, and it’s hopefully unappreciated sources of growth that drive that qualitative excellence. So we think that to make these qualitative determinations, you need to get out from behind your computer, and you need to get in rental cars and in airplanes… We’re trying to create a competitive advantage for Bares Capital by doing qualitative work that other people are either not resourced to do or unwilling to do.
A lot of people would maybe argue that visiting companies is a surefire way to introduce human bias. But in my experience, that’s just kind of an excuse not to do the work. It’s really hard to build a team and get the resources to get them on the road and to get them enough reps to the point where an analyst can truly distill exceptional from average. But the way to execute effectively is to just get them as many reps as possible. And by the way, we just don’t see a lot of our competitors out on the road doing this type of work…”
Although he grew up in Warren Buffett’s hometown, Mr Bares’ intellectual mentors extend beyond Buffett: “I started reading some newsletters and annual reports in high school and happened upon a publication called Outstanding Investor Digest, which chronicled a lot of what Buffett was doing and some of Buffett’s contemporaries.
And then, of course, I read the Berkshire Annual Letters and was pretty much hooked at that point….moved to Austin shortly after college and worked for an investment manager, who had some institutional clients and a high net worth practice. The firm was small and it was growing very quickly, and I got the privilege of having a lot of responsibility fairly early. And that gave me a great inside perspective on the various aspects of the firm….
I’ve never met David Swenson, who is the Yale CIO. But his book Pioneering Portfolio Management when it was published in 2000, was a huge catalyst for me starting the firm and growing the firm, and it was very critical in our early success, because it was essentially a guide book for where institutional allocation was headed, and where we could potentially fit into what is now known as the endowment model.
Ironically, some of my greatest mentors after starting my firm were actually institutional allocators. They helped me navigate some critical decision points along our path to success. So people like Ellen Shuman, who ran the Carnegie Corporation of New York for years and Anders Hall, who was at Duke, and now is the CIO at Vanderbilt University….”
And in the week in which the world mourns the demise of David Swenson, it is fitting that Mr Bares says that it is Mr Swenson’s landmark book, ‘Pioneering Portfolio Management’, which helped him figure out that the conventional way to build a portfolio of 50-60 stocks is nonsensical: “So my experience at the time was with a firm that was highly diversified in its portfolio implementation and almost purely quantitative, which are exactly the opposite of what we do today. And so, as I was working for this company, I noticed that institutional allocators were using a series of intermediaries, primarily investment consultants to choose 10 to 12 public equity managers each holding 100 stocks. And to me, it just didn’t make any sense at all, because everybody’s paying active fees and getting passive results. And at the time we would add a 50th, or a 60th name to the portfolio, and it was almost inconsequential in the grand scheme of things for the end client.
And so I just gravitated from first principles towards this idea of concentrated portfolios. But given the state of the industry, I didn’t know whether somebody who was 27, with very little experience, who didn’t work on Wall Street and hadn’t lived in New York could actually compete successfully for institutional allocations.
And it was that book [Swenson’s book] that gave me my “A-ha” moment where I said to myself, that the institutional allocator community will gradually adopt this endowment model, which internalized investment due diligence at the expense of relying on a lot of these third parties, institutional investment consultants and the like.
I thought that internalization of the due diligence process would allow for unconventional, younger, less tenured managers, like what I was contemplating at the time to successfully compete for large institutional allocations. And if there was any kind of a stroke of structural genius in founding the firm, it was a recognition that the endowment model would be widely adopted, and there would be a kind of categorical shift towards concentrated long-only public equity managers like Bares Capital.”
As for Mr Bares’ research process, it is old-fashioned, conventional, ground-up research on stocks done by him and his core team: “…valuing will always be a predictive endeavor. And so we want to focus on those predictive factors that should drive exceptional compounding over time. And those happen to be qualitative. They happen to be moats, or competitive advantage and the word “moat” is getting a little too overused in our business.
But competitive advantage is the first category, and the next is management, both capital allocation and strategic execution and operational implementation. And then, of course, growth, and it’s hopefully unappreciated sources of growth that drive that qualitative excellence. So we think that to make these qualitative determinations, you need to get out from behind your computer, and you need to get in rental cars and in airplanes… We’re trying to create a competitive advantage for Bares Capital by doing qualitative work that other people are either not resourced to do or unwilling to do.
A lot of people would maybe argue that visiting companies is a surefire way to introduce human bias. But in my experience, that’s just kind of an excuse not to do the work. It’s really hard to build a team and get the resources to get them on the road and to get them enough reps to the point where an analyst can truly distill exceptional from average. But the way to execute effectively is to just get them as many reps as possible. And by the way, we just don’t see a lot of our competitors out on the road doing this type of work…”
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Note: The above material is neither investment research, nor financial advice. Marcellus does not seek payment for or business from this publication in any shape or form. The information provided is intended for educational purposes only. Marcellus Investment Managers is regulated by the Securities and Exchange Board of India (SEBI) and is also an FME (Non-Retail) with the International Financial Services Centres Authority (IFSCA) as a provider of Portfolio Management Services. Additionally, Marcellus is also registered with US Securities and Exchange Commission (“US SEC”) as an Investment Advisor.
