One of our favorite investors at The Acquirer’s Multiple is Allan Mecham.

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Arlington Value Capital 2015 Annual Letter: First Losses

Arlington Value’s Allan Mecham On Value Investment …

Mecham is a value investing legend that flies under the radar.

You’re probably asking, Who is Allan Mecham? Forbes wrote an article about him called, Is This The Next Warren Buffett? Marketwatch wrote an article about him titled, The 400% Man, but most investors have never heard of him.

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In the 2012 Marketwatch article, Brett Arends writes a short description about the college dropout from Utah:

Over a 12-year stretch, through the end of 2011, Mecham, now a mere 34 years old, has earned an astounding cumulative return of more than 400 percent by investing in the stock of U.S. companies — many of them larger ones like Philip Morris, AutoZone and PepsiCo. That investment performance leaves the stock market indexes and most mutual funds trailing far in the dust. Of the thousands of mutual funds in America, only a smattering of stock-oriented funds have done better, according to Lipper. Arlington, which is structured like a hedge fund, has put most firms in that category deep in the shade as well. It even managed to turn a profit during the crash of 2008, when Standard & Poor’s 500-stock index fell nearly 40 percent. And Mecham has done this mostly while sitting in an armchair, in an office above a taco shop, in downtown Salt Lake City.

One of my favorite Mecham interviews is one he did with The Manual of Ideas, it’s a must read for all investors. Here’s an extract:

The Manual of Ideas: Over the ten years ended December 31st, 2009, the S&P 500 delivered an underwhelming return of negative 9.1%, equaling a 1.0% annual loss. Bruce Berkowitz’s Fairholme Fund achieved a net annualized return of 13.2% during the same period, while your fund returned 15.5% annually net of fees. Berkowitz’s record has made him somewhat of a “rock star” in the investment business. How come you are still flying below the radar?

Allan Mecham: Ha! Good question… I’m eagerly awaiting The Little Book on Becoming a Hedge Fund Rock- Star. In all seriousness, it’s likely a combination of factors (Salt Lake City-based LLC, only $10+ million under management for the first five years with no serious marketing), but certainly my limitations marketing Arlington are partly to blame. Additionally, and probably the biggest reason for our obscurity, stems from our fanaticism about accepting the “right” capital. Maintaining a culture that’s conducive to rational thinking and investment success has been the top priority since inception.

We have turned down significant sums of money on many occasions because of this stubborn commitment. As I said in my most recent letter, we get far more satisfaction from producing top returns than from the size of our paycheck… though we’re hopeful this distinction won’t need to be highlighted for much longer! Many potential investors require monthly transparency into the portfolio and are overly focused on short-term results. Accepting “hot” money would endanger the culture and my ability to perform.

My partner Ben [Raybould] considers it his most critical job to cultivate and maintain a culture that minimizes emotional noise and short-term performance pressures, to which I must say he has done a fantastic job. We believe patience and discipline are critically important to investment success. Taking emotion out of the equation, or at least minimizing it as much as possible, is vitally important and difficult to do if you have investors peering over your shoulder in real time, questioning ideas. That’s like telling someone what’s wrong with their golf game in the middle of their backswing — it’s the last thing you need when you’re trying to concentrate and execute a shot.

Allan Mecham's Arlington Value Capital 2014 Annual Letter

MOI: We could conduct this entire interview simply by revisiting quotes from your past letters, which are a tour de force. You recently didn’t hold back on your view of certain types of institutional investors: “Many times these gatekeepers of capital have expressed admiration for our results. Yet for them to invest we would need to not only continue to find undervalued stocks, we’d need to find more of them; additionally, we would need to identify overvalued stocks – and short them – as well as find ideas across the globe in both large and obscure markets.

Such comments are flattering, yet we see nothing but wild-eyed hubris attempting to outsmart people, more often, in more ways, and in more markets, as opposed to sticking with what produced top-tier results in the first place.” Clearly, the proliferation of investment vehicles whose partners’ interests are at odds with those of the ultimate owners of capital has resulted in misallocation of capital. Do you see owners waking up to this inherent conflict and demanding a more sensible approach to investment? Is it feasible for a fund like yours to bypass the agents and go directly to the owners of capital?

Mecham: I think it’s possible to gain traction but I’m not optimistic about change on a large scale as there are multiple factors at play. Bypassing the agents is a laborious process that’s difficult for a two-man shop like ours. The fees throughout the financial system are crazy and make no sense when thinking about the industry as a whole.

A lot of financial intermediaries and hedge funds operate using a form of the “Veblen” principle — where status is attached to the high cost and exclusivity of the product. The financial middlemen satisfy the clients’ emotional needs more than the financial needs. The comfort of crowds is strongly at play throughout the system. At the end of the day I think managers are giving clients what they want — peace of mind and smoother returns, albeit at the expense of long-term results.

MOI: Short-term thinking seems to be alive and well in the investment industry despite overwhelming evidence that a longer-term perspective yields better results. You have alluded to the fact that good ol’ career risk may be the culprit: “Non-activity in the face of short-term underperformance is simply not tolerated, even though realistic assumptions (you can’t outsmart other smart people all the time) and basic math (lower frictional costs) confirm its worth.

Most fund managers’ capital would not stick around long enough so they simply comply with more standard methods of operation in the spirit of keeping their jobs.” Incentives are one of the most powerful forces driving behavior, so it’s little surprise investment managers have adjusted to the prevailing industry incentives. What could be done to better align career risk with investment risk?

Mecham: I am a strong believer in the power of incentives. That being said, I’m not sure I have a silver bullet on how to solve the problem. You need investors to think and act like owners, rather than short-term renters, and to judge performance over longer time frames. I remember reading a talk that Mark Sellers gave at Harvard a few years back. He basically said good investors have the right temperament by age 15, and there’s not much one can do

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