I am pleased to interview Mark Feinberg, General Partner of Feinberg Capital Partners LP (www.feinbergcapital.com) a value oriented investment partnership. From 2006-2009 Feinberg served as portfolio manager for Feinberg Investment Group a group of separately managed accounts that using a true valuation orientation beat the S&P during that time period by an estimated ~5% per year and in the twelve (12) months prior to shifting to a fund structure generated over 100% return and beat the S&P by over 70%. Mark also held senior level strategy and consulting roles with Ernst & Young and the IBM Corporation and also started multiple commercial real estate firms (one of which was sold in 2009) and a software company in the early part of the decade.
I wrote in a previous article how hard it is to find a good fund. Most good funds attract too many assets and are therefore are limited to only the largest cap stocks. Dodge and Cox is a good example of this they have spectacular managers but now manager over $40 billion. If they find a net net that has a market cap of $10 million they cannot waste their time investing in it as any investment would not move the proverbial return needle (as Buffett would say) plus they are likely to end up taking a controlling stake which doesn’t necessarily have its advantages. On the other hand there are certain smaller funds and/or newer funds with no track record. In your case its almost the best of both worlds as you have a track record and since you are transitioning your structure and starting a new fund your deployable assets are still manageable and you are not handcuffed to the larger dollar amount. How big of an advantage do you have over even the best value investors due to this?
It’s been studied and shown that investing in smaller cap companies over time leads to greater returns Feinberg Capital’s flexibility to invest in smaller cap companies is a huge advantage over many other funds. I try not to beat the Warren Buffett drum over and over again but he often says things that crystallize a specific point. He said it best in his recent annual report. His having to invest large dollars has and will continue to crimp returns. Feinberg Capital does not have this issue and at least for the very foreseeable future I don’t expect to have this issue as my plan isn’t to grow so big where this becomes an issue. If this does happen I will be thinking long and hard as to how to handle this, but I stress this shouldn’t be an issue any time soon.
Take a company like Acme United Corporation (ACU) which is based in Massachusetts and has been in business since 1865 in one form or another. Its core products include school scissors, pencil sharpeners, compasses, protractors and other in classroom items as well as other cutting type tools. The company as far back as history will take you has had positive owners earning, free cash flow and has consistently grown revenues. The company also has very little debt and a generally pristine balance sheet. Their total market cap is just under $35M. The company sells for just around $10.50 yet based on a very conservative owners earnings cash flow analysis I feel the company is worth somewhere between $16-$19 per share. There is also about $2 per share in cash on the balance sheet and the company is paying about a 2% dividend which is rare for such a small company.
Here is the issue for larger funds and money managers to come close to making an impact to their portfolio they would have to take a controlling stake in the company and would come close to having to buy the entire company to truly move the return needle. Neither are attractive cases to a majority of the value funds out there. Feinberg Capital does not have this issue so this is a tremendous advantage over the larger funds and money managers.
Do you focus strictly on micro and nano caps?
No I don’t. Whereas there is nothing keeping me from fishing in the smallest of ponds there is also nothing that keeps me from fishing in the big ocean either. At the end of the day it comes down to being able to understand the company, being able to buy at a discount to what its worth and the intangibles. By intangibles I mean I need to trust the management and I need to feel comfortable they are doing the right thing for shareholders. They need to have proven this over a long period of time. So if all these things add up and it happens to be a larger company then I would consider an investment in the company.
I’ve borrowed a bit from Buffett (post meeting Munger) in the fact if I see something that is a good company at a fair price and not necessarily deeply discounted price then I will think long and hard about making an investment.
Are you limited by fund rules by how much you can invest in micro-nano caps?
No not at all. Our partners view this as a large advantage that Fienberg Capital has over larger funds. Many of the larger funds are handcuffed by fund limit rules. Those who have invested with me in the past recognize that there are opportunities in many of the smaller cap names and so when I set up the fund I ensured maximum flexibility. Those that invest in Feinberg Capital understand that while there are at times additional risks with smaller cap names if you stick with companies that are not speculative in nature and companies that have a proven long term business model and/or assets that justify a higher price than it’s intrinsic value, than having the added flexibility to buy these stocks are a huge advantage. I think it would be doing my partners an injustice if I limited what the fund can look at for no other reason than to fit a “specific fund arrangement”.
The other key advantage along these lines is many of the small cap funds are limited to investing in only small cap funds. Feinberg Capital does not have this limitation nor does the fund have to sell a quality small cap firm when it no longer classifies as a small cap or in another words once it has grown up to a point of not being a small cap any longer. Having this flexibility even though I may not encounter the situation that often, allows to the fund to hold something I don’t want to sell ifthe situation were to arise. Flexibility is the theme and a huge advantage.
You don’t have any concentration limits either, isn’t that correct?
That is true. The fund typically holds on average 15-20 holdings at any given time. However, there is nothing in the fund rules that would keep the fund from holding less. There are certain situations where this could happen such as if I didn’t see enough investments meriting investment. Peter Lynch who used to have 1000s of holdings recently came out in an interview in support of concentrated portfolios. I feel the same way as long as the homework is done on the few bets made.
Are you at liberty to discuss your current holdings?
I am a bit of a traditionalist when it comes to discussing holdings and except for at times in quarterly and annual letters I tend not to get into specifics. This isn’t an issue of me wanting to hide anything I just find it causes a lot of noise and on some levels is a form of manipulation. Perhaps I’m giving myself too much credit by thinking anyone is paying attention but call me old fashioned. With that said I can say that at this time I am in a a lot of cash at the moment.
So you think the market is fairly valued then?
I am a stock picker so I try not to get to macro but at this point I am not seeing a whole lot of the type of value that I tend to look for before I make a purchase.
We talked a bit about the huge advantages your fund has, I would like to discuss another point regarding your advantage as a fund manager. You have a great background in that in addition to managing money you’ve started and run multiple companies, and you’ve worked and consulted for many of the world’s largest and most respected organizations (ie. IBM, Ernst & Young, Marriott, Spring and the list goes on). It seems to me that your background could prove very advantageous as a fund manager. Would you agree?
I would agree. It’s not something I think about everyday as a lot of what I learned is second nature at this point. Starting with having worked for many of the largest and most respected companies part of the question. As a former consultant my job was basically to parachute into a company and either figure out what was wrong and/or figure out how to do something better. The first part of this was to figure out what they were doing the day I got there and identify areas of improvement and then rank the impact if they didn’t improve.
I think too many money managers focus so much on what the financials say that sometimes they lose sight of the fact there is a living, breathing company behind those financials. It’s inherent in me to find out what part of the living, breathing company is about to stop breathing or in some cases already stopped. The fact that for me its 2nd nature to view a company like this gives me a huge advantage over other managers plus I think having been inside a company I have a better feel for what really is going on vs. what one may think is going on from talking to people at the company or what a document happens to say. There are so many dynamics many of which are intangible in nature that at unless you’ve been on the inside its hard to understand and make sense of all of the dynamics yet those dynamics (good or bad) are often what determines whether a company is a good (or not so good) investment.
Shifting to the entrepreneurial part of the question. There are so many skills I’ve learned as an entrepreneur but for the sake of the question I will focus on what I think is one of the bigger ones. Being an entrepreneur like with investing, capital allocation is paramount. As an entrepreneur financial resources are often limited so how you spend and manage those resources is absolutely critical. You learn when to spend and when not to spend and you are always looking for the biggest bang for your buck. You have to choose what to spend your money on as you don’t have enough to spend on everything. Not that this wasn’t the case at the larger companies but as an entrepreneur its life or death. So as a result of these experiences I tend to look at investing the same way and before I would even consider making the investment I want to ensure I am getting a good deal but also that it is the wisest use of funds that will bring the biggest bang for the buck. I view every investment of a dollar as if its my last dollar and as an entrepreneur that’s very often the case. It’s a return on your investment equation but having had to do it under survival or no survival conditions it makes the process all the more focused. There are so many other skills developed from being an entrepreneur but I feel this is probably the most relevant for the discussion we are having today.
There are different types of value investing so I am always curious to ask a value investor which Value Investor has had the greatest influence on your investment Style?
Well I’ll start with Benjamin Graham, Warren Buffett and Charlie Munger. Warren was influenced by Benjamin Graham, and then Charlie Munger and as a result his style changed over time. I also respect Walter Schloss a lot as any man who works from another company’s conference room his whole life is someone I can respect. I am a pretty frugal guy so I like that about Walter Schloss. I’ve taken bits and pieces from them and others as well. I don’t like to think of myself as one vs. another. Value investors and investors in general all have their own little quirks and what I tend to do is if there is something that one does that works for me then I adopt it or morph it into my own version. I’ll continue to do that as well and don’t expect that ten years from now my style today will be the same as it was.
Where do you find your investment ideas and what is your investment process?
I will answer the investment idea question first. It’s multifaceted for me. I’m forever looking for ideas in the house, when I go out to eat, when I drive down the street. Life is a breeding ground for investment ideas. For example I have a 15 month old son and inevitably products started making their way into my household. My thought is that if they made it into my household without me knowing about it first then that’s a good sign that it’s a product worth looking into, this is similar to what Peter Lynch used to do. The first thing I would do is look at the label regardless of what the product was. I found a small cap company that provides diaper linings to a large number of the larger diaper makers this way. That company delivered close to 170% return for me yet wasn’t followed by any analysts.
In addition to what I call “life research” I read about 4-5 newspapers and/or magazines a day whether online or in print, peruse the 52 week low lists every day, have screens set up looking for companies with solid balance sheets, large amounts of free cash flow and solid operating metrics and I listen and pay attention to what is going on around me.
I try not to get too caught up in what everyone else is investing in although unlike a lot of other fund managers who say they don’t pay attention to what others are buying I do pay attention not as necessarily to follow their moves but as another idea source. My view is not to rule out any stock, anyone’s suggestion, and/or any place for ideas. As long as you do additional due diligence and make your own decisions then the more ideas the better. With that said I can make a first pass decision on a company within a minute or two. I do think its important to be able to at least on first pass make a quick decision.
To address the process question in particular. At any given time I typically track about 250 companies that fit the criteria in which I look for when investing in a company. These are all companies that generally have solid balance sheet, large amounts of free cash flow, and are in industries I understand, have solid management teams, solid operating history and/or have other distinguishing value characteristics. From there it becomes a wait for the right time to strike exercise.
I have a simple model that tracks these companies in three columns; in one column is what I think the company is worth, in another column is what I would pay factoring in a significant margin of safety, and then in another column the actual trading price. When a company turns green then it’s time to get even more serious about additional due diligence and I try to break our thesis about the company. What I mean by that is I start to really get serious about worst case. If the company still looks cheap after this process, then and only then would I make an investment. If this sounds familiar its probably because Bruce Berkowitz comes at this the same way. I think most value investors do, Bruce just has done a great job of talking about it.
Along these lines how do you determine intrinsic value?
At my core I am a DCF (Discounted Cash Flow) believer and more specifically owners earnings free cash flow. I also pay attention to a company’s liquidation value and where as I don’t put a lot of weight on earnings driven valuations due to the ability for earnings to be manipulated I do at least pay some attention to them. What I’ve found is when a company is underpriced on a cash flow basis if the earnings valuation is not also undervalued then there is less of a chance or it takes a lot longer for that company to reach its intrinsic cash flow basis valuation. That doesn’t mean I don’t invest its just something else I pay attention to.
There are some value investors who meet with management and others who don’t where do you fall in this?
I don’t go out of our way to meet with management. I do listen to what they have to say in conference calls, quarterlies, annual reports, releases but I don’t marry myself to their words. They are often there as salespeople for their company so one needs to be careful what you attach yourself to. With that said there is a lot you can pick up as far as tonality and for me I want to hear the truth and I want to hear the tone of complete frankness in their voice. Sugar coating is not what I am looking for and I’ll tend to stay away from the sugar coaters.
Back to the fund structure, why did you decide to shift to a fund structure now vs. any other point?
Well to be honest it was a twofold decision. The first reason is the structure that was in place as Feinberg Investment Group, while an easy structure to manage when limited to a handful of investors, when the demand started to outgrow the infrastructure that was in place it was time to change. I’m better able to serve my previous investor/partners but now I can also expand as well.
The second part of the decision stems from seeing a void in the marketplace for a value oriented manager that has yet to be swayed by the need to be close to 100% invested most of the time. It seems the larger a fund grows the more pressure they have to deploy funds. I feel strongly that having a lot of cash on hand at the right times is the smartest move you can make. I know Seth Klarman feels the same way but the more investors one has breathing on them I think this becomes harder and harder to stick to.
Well that answers part of what my next question was going to be. What is your differentiation and competitive advantages over other funds that are out there? So the cash strategy and limiting to only those investments considered your best are a couple, is there anything else you want to add?
Well being able to remain in cash is certainly a big one as is limiting investments to only the best ideas. If a partner isn’t ok with this then Feinberg Capital is probably not the fund for them. This concentration and this focus has proven itself throughout history as one of the most successful ways to invest and being able to stay true to that is very important.
I also think there are other advantages as well. Like Buffett in Omaha, me working in Dunwoody Georgia I feel is a large advantage. I am not coerced by the noise of Wall Street and I am able to stay true to the value investing thesis while not being influenced by others.
People also like our fee structure as compared to other funds.
So that is actually a good lead in to my next question. Can you talk a bit more about the structure of your fund and the types of investors that you are looking for?
Sure. As alluded to, the fee structure is unique as compared to other funds in general but for the value community it’s a very recognizable structure. Whereas most funds charge an asset management fee and a performance fee I only charge a performance fee with no asset management fee. In addition, I have to exceed a certain performance threshold each year. If I don’t meet that number then I don’t get paid. Frankly, I could not have done it any other way without feeling as though I was taking advantage of someone. I was a bit tired of watching people turn over their money to other people to manage only to lose a portion but still the manager was still making off with a solid payday. That model just never really made sense to me for any business. I think without getting too theoretical that model has created many of the issues we are seeing out there today as the compensation models are severely flawed and they lead to conflicting and non-fiduciary type of behavior.
So with my fee structure there is certainly risk that I may be eating Ramaan noodles for awhile but I’d rather eat Ramaan noodles then dine at some fancy restaurant while my partners aren’t making a dime.
As far as the type of investors I am looking for. Very similar to other value investors and much in line with Warren Buffett’s comments and trying not to just beat the Buffett drum, I do believe that investors are and should be considered long term partners. I really want people who understand that investing is a long term proposition and whereas one could get rich in the short term that is often an accident and not often based on hard work and fundamentals. People do get lucky but that is not what Feinberg Capital is all about and the types of people who become our partners should know this going into it.
In addition I want to really like the people who become partners. I’ve run enough businesses and worked with enough people at this point that one bad apple can make for a terrible apple pie. I am not going to risk my apple pie. I want people who are excited to be part of the fund. If you wake up every morning and either consciously or sub- consciously are asking yourself who you can take advantage of that day by playing the market then you certainly aren’t the right fit. However, if you wake up every day about how to move the ball forward, take care of someone, and ask what am I going to learn today then those are the types of people I am looking to attract.
Your Fund structure sounds very similar to Warren Buffett’s early partnership; can you elaborate more on this?
Well with regards to the fee Feinberg Capital is different than the larger publically traded funds but similar to a handful of other private value funds in that Feinberg Capital modeled it as other value investors do after Warren Buffett’s early 1950s partnerships. As mentioned there is no assets under management fee and only a performance fee. Most funds charge 2% just to hold an investor’s assets and to underperform index funds. In addition many mutual funds are charging in the mid 2s and fees are going up not down. This has been the case with almost every fund family lately including Vanguard. In many cases the investors do not even know their fees are going up.
I cannot get into the specific details due to certain SEC guidelines but the basic premise is if the fund generates returns above a certain threshold then the general partner gets paid. If the fund does not generate returns above the threshold then the general partner does not get paid. Frankly it’s the only way to structure fees that make sense to me. I say this as if you don’t structure it this way there is a reward mechanism in place for volume vs. quality and focus on performance. Those who charge a fee would argue they get paid more when they have more of someone’s money to manage so they are motivated to keep values up. However, many funds are just looking for assets and they get paid a set fee even if their performance is awful. My goal isn’t simply to build up my asset level as that does me no good. My fund fees are structured to make sure I try to perform really, really hard otherwise I will be eating Ramaan noodles for dinner every night.
How long have you been working to put the fund together and what has been the hardest part in establishing your fund?
To address the first part of the question I truly feel that everything I have done to date and in my career has culminated in this. So on some levels this fund has been in the works my entire life. I’ve been lucky in that I’ve had the opportunity to work for and with many of the world’s best companies such as Ernst & Young, Sprint, Coca-Cola, ING Insurance, Marriott, IBM Corporation so Ive had the chance to see from the inside and work with many of the great companies both from an operational standpoint as well as management standpoint. I’ve also seen what the not so great companies look like so I have perspective on that as well. I’ve also run my own businesses and managed money so the combination of running businesses, serving as a consultant to others and being in strategic roles and managing money has led me to this point.
To address the specific question and perhaps the question you were asking is, I’ve been working on the nuts and bolts of the fund for about 18 months.
The hardest part without a doubt is finding the right team to support you. Everyone is different and brings a certain style to the equation. There are a lot of good folks who are very good at what they do whether it be accounting, legal, fund administration, brokerage, marketing and everything in between.
For me I wanted to surround myself with people who were good at what they did but also in addition to being good I wanted to be around genuinely good people who understood at its core what it meant to be ethical. Plus I am not one for a lot of noise (as alluded to) so I preferred people who valued their morals over people who favored getting more clients.
My investment thesis isn’t as complicated as many of the other ones out there, nor do I or would I want it to ever get complicated. So I wanted the people around me to understand this that simple is very often the best approach.
The team I have in place right now is amazing. They are good at what they do; passionate about what they do and at their core are great people. Plus they are as excited about what I’m doing as I am. For me that’s an imperative otherwise I just don’t think the model works long term. So while it took 18 months to get here I am very pleased.
Do you have a rate of return that you expect the fund to achieve?
The goal of the fund is to beat the S&P each year. With that said since the fund wont be measuring long-term success by a year by year metric its possible and even probable that the fund would pace the index only to have a breakout year every couple of years. Such is the case of my most recent 4 year performance where I paced the market for 2, missed one but then beat the market by over 70 percent. Sometimes it just takes a little time to unlock value so whereas I would like to beat the index year over year, I am not concerned if it doesn’t happen.
How will you measure success?
I will know the fund is a success if those who become partners in the fund end up becoming partners for life. That would tell me that we did what we said we were going to do and did it consistently.
Well, I want to thank you very much for your time.
Your welcome. I enjoyed it.
Mark Feinberg is General Partner of Feinberg Capital Partners LP (www.feinbergcapital.com) a value oriented investment partnership modeled after Warren Buffett’s 1950s partnerships. Feinberg also serves as Managing Member of Feinberg Capital Advisors LLC a registered investment advisory firm in the State of Georgia and manager of the fund. He can be reached at firstname.lastname@example.org.