Aegis Funds

Scott Barbee’s bio

Scott founded the Aegis Value Fund (AVALX) and has served as Portfolio Manager since its inception in 1998.  He is also the owner of Aegis Financial Corporation and the Portfolio Manager for the Aegis High Yield Fund (AHYFX). Prior to Aegis, Scott worked as an analyst with Simmons & Company, and later Donald Smith & Company.  He received his M.B.A. from The Wharton School at the University of Pennsylvania in 1997 and holds undergraduate degrees in Mechanical Engineering and Economics from Rice University.

Aegis High Yield Fund has beat the Barclays Capital High Yield Index since its inception in January 2004. The fund recently won the Lipper Award for having the highest risk adjusted return for the 5-year period ending December 31, 2009, ranking best out of the 337 funds in the high current yield category as measured by Lipper over the period.

The Aegis Value Fund was started in 1998 as a small cap value fund. It has crushed its index, producing a 10.5% return per annum versus 6.4% for the Russell 2000 value index.

Mr. Barbee was king enough to answer several questions I had for him below is our interview:

I like starting off an interview with the following question. Value investing is contrary to human nature, how did you get started in value investing?

I first became seriously interested in value investing while working at Simmons & Company, an oil-service investment banking boutique that was my first employer out of school.   I had first started working in the Securities Group in 1993 and was supporting the sell-side analysts after graduating from Rice University with degrees in Mechanical Engineering and Economics.  At the time, I remember Simmons was still ordering 10-Ks and 10-Qs from an overnight delivery service.  One of my jobs was to aggregate the news, accounting and valuation statistics for the oil-service universe for a monthly oil service overview we were publishing.  That’s the first time I remember becoming interested in investing in stocks that were statistically cheap on historical metrics.  Looking for cheap stocks based on historically-based attributes particularly appealed to my contrarian, engineering-focused mindset.  I ordered a public company statistical database and began running screens for cheaply valued stocks in the broader market, and remember buying Advanced Marketing Services, a book distributor that was a Benjamin Graham net-net.  As my investment in Advanced Marketing started to make money, I began reading everything about value investing I could get my hands on.  In 1995, I went to Wharton, where I was able to take a class from John Neff, who successfully managed the Vanguard Windsor fund for many years.  During this time, I also met Donald Smith, Rich Greenberg and Alan Kahn, three talented deep-value investors who helped me get into the business.

On a similar note how did you get started specifically in small cap value investing and high yield investing?

While at Wharton, I became interested in the academic research of Eugene Fama and Kenneth French, which seemed to demonstrate that very small companies trading at big discounts to book-value were delivering impressive historical returns.  The research dove-tailed well with my own findings that deeply undervalued companies with the most interesting stories tended to be smaller market-caps.  Small-caps were also easier to study, as they typically had only one or two business lines, and regulatory disclosures seemed more granular and comprehensive.  So when I started the Aegis Value Fund in 1998, I focused on small-cap, deep value stocks.  Later, we realized that the companies that we were looking at, which were typically going through periods of fundamental stress, also often had high-yield debt issues outstanding that traded at attractively discounted levels.  We started the Aegis High Yield Fund at the beginning of 2004 in order to take advantage of these kinds of situations.

There are many different schools of value investing, which school would you say you adhere to the most? Who has had the greatest influence on your investment philosophy?

We consider ourselves to be deep-value investors, and typically focus on buying companies at prices under tangible book value.  In this respect we are probably closer to the old-school, deep-value investment style that Benjamin Graham himself applied in his own work, as opposed to the new-school, Bill Miller-type approach.  We have a contrarian nature, so deep value seems to work better for us.  In terms of who has had the greatest influence on my own investment philosophy, it’s difficult to pick just one.  Certainly books by Benjamin Graham, Seth Klarman, Joel Greenblatt, and Louis Lowenstein have all made deep impressions on my thinking, as did my class with John Neff.  I’ve also picked-up significant experience vicariously over the years in conversations with Rich Greenberg, Donald Smith, Alan Kahn, Walter & Edwin Schloss, Bill Berno, and many others.

How do you manage risk?

First, I describe risk as falling in two general categories.  The first is the risk of permanent capital loss, which occurs when the fundamentals underlying a company’s intrinsic value are initially too optimistically assessed or deteriorate post investment.  We focus the vast amount of our own effort on this first category of risk, looking very carefully at the fundamentals of the companies in which we invest.  By doing substantive due diligence work and monitoring our investment carefully, we hope to mitigate the potential for a breakdown in investment thesis or an erroneous assessment of intrinsic value.  The second general category is the risk of temporary capital loss due to a quotational decline stock price that is not materially indicative of a deterioration of company fundamentals.  This kind of investment illiquidity or quotational risk can be very difficult to guard against as a deep value investor, as it has more to do with the financial condition of other shareholders than with the subject company itself.  Perhaps the only way this illiquidity risk can be addressed is by holding additional liquidity when the Mr. Market gets too keyed-up and putting the liquidity to work when Mr. Market is sober and depressed.

Do you ever meet with management?

Sure.  We spend a lot of time talking with management, either in person or over the phone, typically after fleshing out the fundamental issues over several hours of deskwork.  We think interaction with management is an important part of the investment process and one that can lead to a better understanding of the various businesses in which we invest.

How do you go about finding stocks? Do you look at the 52 week low list? Do you use a screener for stocks with high dividends and low payout ratios?  Do you favor stocks with higher dividend yields? What percentage of your returns comes from dividends as opposed to increases in the price of the stock?

Our process begins with a quantitative overlay, screening for companies trading at discounts to tangible book value.  We also tend to look for less levered situations, as a levered discount to book can easily evaporate with a small erosion in asset value, which can certainly happen during times of distress.  Additionally, we look for either current cash flow, or evidence of better future cash flow.  Corporate share repurchases, insider share repurchases, restructurings, and other potentially impactful corporate events also

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