One of our favorite investors at The Acquirer’s Multiple – Stock Screener is Charles Bobrinskoy.
Bobrinskoy is Vice Chairman, Head of Investment Group & Portfolio Manager at Ariel Investments LLC, a Member at Economic Club of Chicago and Member-Library Board at Duke University. He oversees Ariel’s domestic investment team and manages the focused value strategy—an all-cap, concentrated portfolio of U.S. stocks.
Prior to joining Ariel in September 2004, he spent over 21 years as an Investment Banker at Salomon Brothers and its successor company Citigroup, where he rose to Managing Director and Head of North American investment banking branch offices.
As of December 2016 Ariel Investments has $8.47 Billion in assets under management (AUM),
One of the best Bobrinskoy interviews was one he did earlier this year with The Wall Street Transcript. It’s a must read for all investors.
Here is an excerpt from that interview:
TWST: Can you explain your role in the firm and also the fund that you want to speak about today?
Mr. Bobrinskoy: I am Vice Chairman of Ariel, and I have the domestic equity investment group reporting to me. I am also the Portfolio Manager of the Ariel Focus Fund, which is our all-cap value strategy.
TWST: Can you talk a little bit about what type of investor the Ariel Focus Fund is for?
Mr. Bobrinskoy: The fund is for both institutional and high net worth clients, targeting people with a value orientation and a long-term approach. It is an independent-thinking contrarian fund with a focused strategy that invests in less than 30 stocks in any market cap. We talk about it as being the best ideas that Ariel finds across any market cap.
TWST: Is there a reason why you keep it so concentrated to, say, 30?
Mr. Bobrinskoy: It comes from something that Warren Buffett teaches, how you get better returns if you invest in your 20 best ideas rather than diversifying into 100 stocks, the average number for most mutual funds. We agree with that. We think there is a lot to be said for investing in your best ideas. Now, it does mean you have a little more concentration and a little bit more volatility, but we do think it is much easier to produce alpha in a concentrated portfolio than in a 100-stock portfolio.
TWST: And why is that?
Mr. Bobrinskoy: It comes from one of the four pillars of our investment philosophy, namely, expertise. It is very hard to be an expert in 100 names and much easier to spot the opportunity in 28 names. The danger is if you own more names, you start to look more and more like an index, and any great idea will, by simple mathematics, have less impact on the portfolio.
There is of course a trade-off; you don’t want to take this to an extreme. You could have only one stock or two stocks, and that would produce, in our judgment, too much volatility and risk. We think the sweet spot for this strategy is in 20 to 30 names where we can have real expertise on the companies, invest in our best ideas but not have the kind of volatility that would come from a nine-stock portfolio.
TWST: What are the assets under management currently?
Mr. Bobrinskoy: In the strategy it is about $170 million, while firm-wide in this style of investing that we call Buffett-style traditional value, it is about $7 billion.
TWST: Can you give us a little bit more explanation on the process you go through in order to select those 30, and as you do so, mention how often you would adjust the holdings?
Mr. Bobrinskoy: Yes. It is a low-turnover strategy with turnover of less than 40%, when the average mutual fund is more like 100%. This comes from another pillar of our investment philosophy, which is patience. We think the stock market is very efficient, but the one glaring inefficiency is excessive focus on the short term. The value of a stock is the present value of the cash flows that will be earned in perpetuity. When you do the math, you find that the cash flows from year two through 30 represent over 90% of the value. Yet, we would argue that the stock market and investors spend 90% of their time focused on the next 12 months.
Our practice is focused on finding great companies with great long-term prospects that have some kind of short-term problem. The mechanics of that are we start with a watch list of companies that we think are high-quality companies, and then we wait for some kind of short-term event. It might be a missed quarter, a regulatory problem, a trend in the industry that is producing a short-term headwind or a short-term macro factor like a strong dollar.
If that hits the stock and makes the short-term outlook appear challenged, the stock may drop abruptly, although there has been no material change in the long-term value. The stock will jump to the top of our watch list, and we will update our valuation analysis.
We are hoping to find a company with a long-term opportunity in the face of that short-term problem. The most glaring example of that might have been six months ago, when we made KKR (NYSE:KKR) our biggest holding in the Focus Fund. People were nervous about the short-term outlook for IPOs. A change in the regulatory environment might tax capital gains and carried interest on a different basis. The stock market drove KKR stock down from $24 in 2015 all the way down to $12 in July of this year.
Nobody would deny that KKR is a wonderful company with a great business and spectacular margins in a growing industry. And yet, admittedly, the short term was going to be bumpy. We made it our largest position. As often happens in value investing, a catalyst developed that we had not expected. Republicans swept the White House and Senate, and all of a sudden the out-of-favor asset management industry is now back in favor, and the stock is behaving much better, although still well below our calculation of its intrinsic value.
Another example of this process in a similar industry would be Western Union (NYSE:WU), one of our top five positions. Again, it is a great company with a network of thousands of money transfer offices around the world. The network is a clear competitive advantage producing real economies of scale. Western Union had faced concerns about new regulations from a Democratic-controlled Senate and new regulations on money transfer fees. Western Union was trading at 10 times earnings in a market trading at 17. We acknowledged the short-term headwinds, but thought this was a business that would survive any change in the political environment. That short-term headwind has gone away, and the stock has performed very, very well.
So the idea is, buy stocks trading at a big discount to their intrinsic value because of a short-term problem. Buy, be patient, wait for that short-term problem to go away, return to the normalized earnings power of a company, and
then have the market focus again on the longer term strength of the company. That, in a nutshell, is our process.
TWST: I noticed in your writing about the process that you mentioned a “devil’s advocate” step. Could you describe what that is?
Mr. Bobrinskoy: Yes, and