ValueWalk is pleased to present an interview with Dan Miller, Portfolio Manager of the Gabelli Focus Five Fund. Dan was kind enough to respond to our questions about his fund and its concentrated value philosophy.
Can you give us a little information on your background?
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I was born on Long Island, but grew up in Lakeland, FL, a small town in the center of the state. In April 2002, when I was a senior at the University of Miami, where I majored in Finance, and the student representative to the Board of Trustees, I was fortunate to be in attendance at a presentation by two of the money managers that handled a portion of the University’s endowment. Donna Shalala, the President of the University, introduced me to Mario Gabelli and told him I was one of her top business students. Two months later, my car was packed and I was on my way to GAMCO’s office in Rye, NY. I initially joined Gabelli & Company, Inc. in the operations department. After demonstrating success working with institutional investors at the firm’s aerospace conference that fall, Mario asked me to build a team of institutional salespeople. This team grew to 10 individuals over the next several years. I became Head of the Institutional Equities business in 2006, President of Gabelli & Company in 2011, and Chairman of Gabelli & Company in 2012. I am also a Managing Director of GAMCO Asset Management, where I am responsible for relationships that approach $500 million in assets.
The fund has an interesting history; can you give readers some color on the topic?
In January 2006, I wanted to draw more attention to the very high quality research ideas that we were generating and we came up with the concept of the Gabelli Focus Five, a quarterly publication of our best ideas. Over the six years we have published this report, our picks are up 210%, while the S&P was down 4.5%. This got a lot of attention from the media, clients, and most importantly, financial advisors. As a result of the significant interest we received in these reports, we decided to take the brand that was established over six years, and the concentrated “best ideas approach” that appeared to work so well, and offer an open-end fund. The easiest option was to repurpose an existing Gabelli Fund, the Woodland Small Cap Value and on January 1, 2012, I became the portfolio manager of the re-named Gabelli Focus Five Fund. To ensure compliance with IRS regulations, we designed the portfolio to be comprised of 25-35 investments, with up to 50% in our five highest conviction ideas.
Why do you favor concentration versus diversification?
According to Morningstar, the average equity fund has 160 positions, and many funds own up to 500 individual investments. In my view, an investor is better off owning a low-cost ETF at that level of diversification. There is strong evidence that demonstrates that portfolios outperform the broader market when a manager is able to invest in fewer but higher conviction ideas. This makes a lot of sense. I’ve learned as an institutional salesman that money managers tend to dabble. They will attend a conference, read a magazine, or watch CNBC, finding ideas that are compelling, or at least interesting enough to take a 10-15 bps position. Then over time, they will follow it, and it might even work out to be a solid investment. I, however, favor an approach that says every investment I make counts. We invest in businesses, not stocks, and thus must want to own, or be comfortable owning the entire company if we have the necessary capital.We must also have an open line of communication with the management team, and understand their strategy for enhancing shareholder value. We will only make an investment when a stock is trading at a significant discount to intrinsic value (30% +), and importantly, there must be the potential for a near-term (3-18 month) catalyst that will help surface that discount. Catalysts could include a financial restructuring, sale of an asset, sale of the company, change in management, or transformative acquisition.
How has Mario Gabelli influenced your investment strategy? Has anyone else influenced you?
Mario is a legend in the world of value investing. He hasn’t just influenced my approach, but that of thousands of investors. Textbooks credit him with developing the notion of Private Market Value (PMV), which we define as the price that an informed industrialist would pay to acquire an entire business. He is a consistent and incredibly valuable source of ideas, and molds our team of analysts on a daily basis so that we are thorough and think through scenarios that might often be ignored. His tremendous experience through various market cycles allows us to take advantage of market opportunities to both buy and sell into irrational prices.
Do you think that a concentrated portfolio is more risky, and while we are on that question, can we ask what you define as risk?
Risk is losing money, both on a relative and absolute basis. I strongly believe that our concentrated fund is less risky than the market in general as our intensive research allows us to identify and invest in great businesses with a substantial margin of safety. This may not mean that we will outperform on a daily basis, but over time our portfolio will deliver a much better return while assuming less risk.
What are your top five picks? Can you briefly tell us the pitch for each stock? What are the catalysts for these five companies, and which can unlock shareholder value?
Our three largest investments as of September 30, 2012 were:
We also think CIT Group Inc. (NYSE:CIT) could be very attractive to a larger financial services company given its niche focus on the small- and middle-market business customer, an area that many of the big banks have been forced to neglect in recent years. Selling the company to a larger firm would also allow John Thain to become the chief executive of a larger business, something we believe he will seek in the coming years.
Holding most of a portfolio in five companies takes a lot of conviction. How much research/determination do you need to do before deciding to buy a stock?
We have a very high level of conviction in every single investment in the Fund, although the market sometimes gives us opportunities to overweight positions. Given that the Fund has grown assets under management by almost 900% since its launch in January, the relative weighting of certain positions has changed while our conviction hasn’t. In other words, we opportunistically allocate every new dollar of capital rather than maintain arbitrary weightings.
When do you sell?
We sell when a stock trades at or near our estimated PMV, the catalyst materializes but doesn’t have the anticipated impact, or our investment thesis changes. Two examples – one gain and one loss – come to mind. On March 28, we initiated a position in Barnes & Noble, Inc. (NYSE:BKS). While we knew the legacy brick-and-mortar business had its challenges, its 600+ bookstores on college campuses are a terrific cash generator, and the online/e-reader segment seemed poised to gain market share. Importantly, we didn’t believe the current share price was attributing any value to the Nook. Our estimated private market value was $30 per share. We identified a number of catalysts related to the Nook, and thought that a large technology firm like Google might even be interested in acquiring the retail footprint. Over the next three weeks, we built a sizable position in Barnes & Noble at an average cost of approximately $12.50 a share. On April 30, Microsoft announced an investment in the Nook business. We sold our entire position in pre-market trading at $27.21 for a gain of over 120%. Shares of Barnes & Noble, Inc. (NYSE:BKS) closed June 30 at $16.46.
While we do not anticipate to be rewarded so quickly on future investments, I think this example will serve to illustrate our view that the stock market provides us unusual opportunities to buy and sell securities on occasion. Although our approach is tax sensitive, we will not hesitate to book a gain when a position trades at or near our estimated private market value or when we believe shares are temporarily overpriced.
Likewise, we will not hesitate to take a loss on a position when we believe our investment thesis has changed. For example, we initiated a position in Clear Channel Outdoor Holdings, Inc. (NYSE:CCO) on May 4. CCO is an outdoor advertising company operating billboards, posters, street furniture, transit displays, mall installations and spectaculars. Approximately 45% of their revenues are derived in the Americas, with 55% classified as International. The stock traded almost 10% lower on May 4 after the company reported quarterly earnings that were below expectations as margins compressed and expenses grew faster than previously anticipated. Nevertheless, we thought the underlying outdoor advertising business was strong and continuing to gain share from the total advertising pie. Moreover, shares were trading at more than a 50% discount to our estimated private market value of $15, and the potential for a buy-in from the parent company Clear Channel (radio) seemed possible given shareholder concerns about a cash-sweep arrangement. We bought shares during the month of May at prices from $6.85 to $6.33. On May 30, we attended an investor meeting with the senior management team of Clear Channel Outdoor Holdings, Inc. (NYSE:CCO) to discuss the current state of the business and strategic outlook. Our view on the company’s prospects, and importantly, the potential for a catalyst, materially changed after that meeting. As a result, we sold our shares opportunistically during June at prices from $6.25 to $6.08 for a small loss.
Can you tell us about the non-top five holdings? Additionally, do you like to hold cash?
The Focus Five Fund (GWSIX) is +20.95% YTD (through Nov 6, 2012), while carrying significant amounts of cash at times. We don’t “like” to hold cash, but we find it prudent to manage cash flows so that we can invest when the market presents the best opportunity. In January, as I repositioned the former Woodland Small Cap Value Fund, cash started to come in and we averaged 31% of assets in cash. The Fund averaged 24% in cash in February, although this percentage has since declined.
My top 15 holdings are:
Dana Holding Corporation (NYSE:DAN)
CIT Group Inc. (NYSE:CIT)
Are you having trouble finding value in this market?
We feel better about our portfolio today than at any other point this year. There also may be an upcoming resolution to the “fiscal cliff,” which has created an enormous amount of uncertainty in the market.
65% of your portfolio is in small caps, and the rest is almost entirely in mid caps. Is that intentional or are you now finding more value in companies with smaller market caps?
We own companies like Walgreens ($32 billion market cap), Tyco ($12.7 billion), and just last week initiated a position in Mead Johnson ($21.4 billion). That said, we own some very small caps, and don’t take size into consideration when constructing the portfolio.
It has been a tough year for many money managers, but your fund has produced great returns. What do you attribute this to?
Our very strict, high conviction investment process allows us to identify investment ideas from a team of over 45 investment professionals in the Gabelli organization. This process should allow us to continue making money for our shareholders over a long period of time.