Business, Value Investing

Brian Bares – Finding An Edge; Creating A Moat Around An Investment Process

Brian Bares founded Bares Capital Management. an investment advisory firm, in 2000. Mr. Bares is known for his strategy of focusing on small- and micro-cap companies, a strategy which led to 53% gross returns in 2010.

H/T Value Investing World

Get The Timeless Reading eBook in PDF

Get the entire 10-part series on Timeless Reading in PDF. Save it to your desktop, read it on your tablet, or email to your colleagues.

Q1 hedge fund letters, conference, scoops etc, Also read Lear Capital: Financial Products You Should Avoid?

Brian Bares
Image source: YouTube Video Screenshot

Mr. Bares has a degree in Mathematics and has authored a book titled “The Small Cap Advantage: How Top Endowments and Foundations Turn Small Stocks into Big Returns”.

Mr. Bares spoke with the Bulldog Investment Company as well as the TLU and Seguin communities.

Texas Lutheran University students experience a challenging academic environment that sets a path for life-long learning. Our students engage in high-impact educational experiences that include civic engagement, aesthetic expression, critical thinking, and a focus on intercultural and global knowledge in a community that welcomes the interplay of faith and reason.

Brian Bares - Finding An Edge; Creating A Moat Around An Investment Process


Texas Lutheran university our speaker today is behind bars. And Brian in a seat here Your Honor right levels. Yes the person I know are from Omaha Nebraska and every one of them is just off the shore smart successful investor the old 3 guy Wally wanted to be here. Being Charlie Munger Warren Buffett and now Ryan bears. So there must be something in the water up in Omaha. Additionally Brian Nally is in Austin and runs the firm came here. After graduating from University of Nebraska has a degree in mathematics. I will encourage you to ask him how that plays into the world he lives in the day. But it's a very very young age. He set out on his own after working for another investment manager and hosted by age 27 was able to start his own firm probably with a whole lot of holidays and maybe a little bit of it hurts so bad when you're don't have that combination is a wonderful blessing. Today brined manages a verb that is not going to north of three billion dollars and one of the things I always noticed about fund managers other managers is how often they are marketing and advertising. I never see how advertising which means that he had built up three billion dollar firms straight on reputation and performance which is extremely unusual. So that tells me that he is probably a whole lot more of the real deal as opposed to just the very shining suit.

Instead of being right on all they'd be a whole lot more enjoyable if you guys got to hear from Brian so why don't we hear from bears have you feel you welcome when you hit 3 billion enough to wear a suit anymore. I'm going to talk a little bit today about creating a moat around investment process. This could be pretty dry for those of you who are required to be here. So if and when you leave don't worry about it. If you have questions feel free to pepper me while I'm doing the presentation. There's nothing really super formal about this. It's kind of a derivative presentation on just kind of how I got to where I am and why we do what we do. But Yamana dive right in there's probably 30 slides or so and then afterwards it's just going to be a hopefully a long Q and A and you guys can fire fire away. I will say first thanks to Dave. This is a pretty unique program that he set up and I think it's probably worth taking taken just a minute to acknowledge the fact that like there are very few schools of this size in a location like Seguin that have this sort of program and that are getting guys like Wally whites and Pat Dorsey to come down and speak and so you know kudos to Dave and the team for punching above their weight because this is a pretty pretty awesome deal and you get a guy like me to speak. That's pretty tough. OK so who am I. As Dave said we're actually above 3 billion now which is great. We have three strategies that we run for those in the back.

Strategies are just portfolios of stock so we have a microcap strategy that's been close since 2006 the small cap strategy that's been closed since 2012. The only thing that we're selling right now and we don't do much selling as Dave said is our mid large cap strategy and we're going to close that at 6 billion. And so we'll talk about the differentiators in my firm but basically we're unusual because our approach is highly qualitative despite my math background we do almost no computer screening or quantitative filtering and we're very concentrated so we have between 8 to 12 stocks in each portfolio that we run. My story starts in the great state of Nebraska as Dave alluded to I was a math major in the university Nebraska I studied math and actuarial science. It was the path of least resistance for me. I always knew I was going to be an entrepreneur and in business somehow. But I got bored with college and got out in four years which was a rarity in my fraternity. I started working in Austin. I followed a girl to Austin actually and married a different one. But I started my my firm in in 2000 after working at a small cap manager and kind of learning the business and that's pretty informative if people have questions about that kind of how to crack into the business. I've kind of a unique story around that is probably worth telling to you guys at some point. But Bare's capital is the focus of the presentation. I've been running the firm for almost 18 years and it's been a slog. This was the world headquarters when I started. That's my condo in Westlake which is a suburb of Boston.

All the money that's ever been put into my firm is twenty one thousand one hundred ninety five dollars and 14 cents that is came straight on my checking account. I'd saved up that money working at my previous firm and the point of putting this here is not to sort of show the Horatio Alger story you know rags to riches. It's really that there is no moat in investment management that is to say the financial barriers to entry are nonexistent. I mean you can have a laptop and file a registration with the state of Texas without using a lawyer which is what I did. And you can be very easily off and running if you have the proper licensing to manage other people's money and it can be lucrative if you scale so just to sort of reiterate barriers to entry or moats in the investment manager business are actually non-existent. So you have to have to think about it in non-financial terms and start looking at the qualitative aspects of the structural aspects of the firm and the strategy to sort of say how to build a firm that's actually differentiated and can keep competition at bay. So what are the barriers to entry if you wanted to run out and start an investment management firm and start stock picking for other people. Well most people say What's your track record. How can I trust you. Well you need three or five years to sort of put up some numbers and show the world that you're any good. There are these categorization issues which in the industry sort of lag well what are you. Are you a value manager you growth manager are you a smallcap manager.

And so you sort of say well I've got to sort of commit to something but I don't know if there's going to be a receptive audience for what I'm pitching euthanasia experience. I was 27 had a baby face no beard and no gray hair. And you know at that age you know you're competing against every you know Goldman Sachs person and Harvard graduate and it's really really tough to convince people to give you money. I didn't have a team and the assets under management is the real issue. And so in our business if you have three billion dollars it's a lot easier to get the next 3 billion if you have zero dollars. It's really hard to get to even one million this sort of chicken and egg problem we need the assets to get the assets and you know hard work was you know my recipe for overcoming that. So we went from our single forty thousand dollar account in August of 2000 to almost three billion dollars today. And we didn't do it by getting individual money or focusing on individuals as clients which is what 90 percent of the investment management world is. And so when you see your regional you know Raymond James office or whatever you know they're primarily catering to you know rich people on the right side of town or whatever or money managers can scale to 3 billion pretty easily if you have a hot mutual fund that's sold through other brokers or financial advisors. We opted not to go that route and instead grew with institutional clients. What does institutional client mean. It means like for example the Texas Lutheran university endowment or the University of Texas endowment.

Neither of those are clients of ours but those are the types of clients that we were pitching in our early days. So these large institutional clients will slice up their portfolio and they'll give money to venture capital to give it to real estate. They'll give it to equity managers public equity managers like us. And so we compete for a small slice of this multibillion dollar pool of capital and we found a receptive audience in that client base and if people want a little bit more color on that afterwards in the Q and A happy too happy to do that. But along the way we trying to figure out what's our little secret sauce. What can differentiate us you know coming from this condo in Westlake and competing against all these people in midtown Manhattan how can we structure a process to where not only we're different but it will provide us with a sustainable edge in investing and produce good results. And so if you walk away from this presentation with sort of two points of of remembrance you should remember that we are concentrated in qualitative that is 10 stock portfolios eight to 12 is sort of the real boundaries but typically there's 10 stocks in the portfolio that's incredibly concentrated for a typical institutional money manager. You put money with Fidelity you know there probably 150 to 250 stocks in the portfolio. We know we step up to the plate watch a lot of balls go by and swing hard when we see something like that 60 to 65 percent of the way to the portfolio in the top five names.

So if we fall in love with the name it may be you know 20 30 percent of the portfolio by weight low turnover which means we don't buy and sell very often. So typically we're holding stocks for five to seven years and then we're qualitative. So as I alluded to despite my math background we don't do any computer screening or filtering. This is shoe leather research we get on airplanes and in real cars we go visit factories we go talk to management teams go to trade shows user conferences etc. with a hope of finding and honing in on unique ideas. So notice what's not on here. Trading ideas with friends you know sell side brokers pitching us ideas that sort of thing. So we do things the hard way. I listened to a lot of podcasts lately I don't know if anybody else is into these personal improvement podcasts. There's Tim Ferris and all these guys out there. I think it was the Tim Ferriss podcast where he was interviewing this guy that is his personal trainer and his personal trainer has this great line and he says you know hard choices easy life easy choices hard life. So we sort of went let's make the hard choices let's do things the hard way because it's more likely to produce the results that we want. It's more likely that other people are not going to make those choices and try and surmount these hurdles and start competing with us and whittle away our advantage. And so by doing things the hard way concentration is hard. Why is it hard. Because it's really embarrassing when it doesn't work. You buy a bunch of stocks they go down and the market is flat.

And like we had in our small cap strategy in 2015 we were down 28 percent. The market was flat and my phone is ringing off the hook. You guys are. You have lost your touch your terrible bubble blah. Now we have a 38 percent year the following year and we're heroes and we're getting all these cudos and so there's this huge disparity in our performance of the index but over time that rocky path has led to extreme outperformance and all of our strategies and it's because we're doing the things that other people won't. There are all these incentives to diversify. The primary incentive is to have more stocks in the portfolio so that you can have more asset based fees. I mean we're trying to make money bears capital as a profit making enterprise and if we went from 10 stocks to 20 stocks we could double the amount of assets we could take and we could double my profitability. But we're not going to do that. Why. Because the more we look like the index the more names we add to the portfolio the more likely it will be that we'll match that the performance of the index and we're not trying to match it we're trying to outperform. And so we're doing these accommodative things structurally that make us different and that get the attention of large allocators that end up giving us money. So more diversity can be good if you want to keep your job and just barely deviate from the benchmark and have consultants fall in love with you and all of these large institutions not really pay attention to you.

But if you want to put up the numbers and you want to have a career in investment management where you look back and say hey that you know I wanted to be one of the best concentration is the way to go but it's really hard qualitative is also hard. Who wants to get on airplanes and go to Sioux Falls South Dakota and meet with Raven Industries or go to Greenville Tennessee and meet with forward air and talk to management teams and the guys in midtown Manhattan are trading ideas with their friends and they're not getting on airplanes and replicating the sort of work that we're doing. It's much easier to say hey there's 5000 publicly traded stocks. I'm going take a computer and I'm going to identify characteristics that Buffett likes low EVC of it. Why are we going to screen on that. Now I've got a manageable universe of 100 names and then we'll do some work around that much more difficult to start with a and work to Z in 5000 companies and that's what we've done over 18 years. And then of course it's really easy in our business especially at 3 billion to generate a ton of trading activity for this for Wall Street and then have them sell you ideas. And so we're a horrible customer for the mainline Wall Street firms because we don't like the research. We don't take their research we rarely look at their research and that's bad news for them but it keeps us intellectually honest. OK so little tidbit about structure and building a moat around the firm. How do we build a moat around the investment process itself.

Well let's start by sort of flipping it and saying how do we build something that everybody else has. How do we build something that's totally undifferentiated. Well let's try with you know start with something that's easy to execute. How about you know screening on high ROV. All right. Something that's available to everybody. Identify Buffett like characteristics. You know it's probably a higher return on capital business probably got good margins probably got a little moat around it. That's great. Everybody's doing that and I can tell you right now that there is zero Alpha there zero excess return available and an approach like that. How about just relying on industry standard tools. Bloomberg FactSet Compu stat turned CNBC on everyone's doing that. We don't have any of those tools. We don't have any TVs in the office excessively diversified hugging the benchmark. I talked about the increased assets under management that give us more and more fees. You know everyone's doing that too and that how about being a lacking so much confidence in yourself that you need others to confirm what you're doing all the time. That's super common even with really smart people from Harvard that have worked at Goldman Sachs. They're constantly calling and saying Hey I know you're a big holder of X Y Z. Can I talk to you about why you own it. And I know what they're really looking for is confirmatory evidence that tells me that they're not confident enough in their own work and their own in their own frankly intellectual honesty to truly make the big decisions with confidence. So here's your typical no moat process and some pictures.

You know you got the you know eight flat screens up there is probably a trading window open. There there's some Bloomberg and then you've got a mechanistic process that shows your potential clients you've got filter one filter to filter three and then here's your portfolio which leads to 100 stocks in the portfolio and you've got CNBC and the fast money crowd you know shouting at you and you're tugging at your little emotional heartstrings every time you hear your ticker symbol talked about and it incites you to action. And all this excess excess activity activity that's you know that's deleterious to your returns. So another point here too is that your investors if you are investing money for other people in particular institutions they want repeatability they say OK you're smart guy Bryan and I like this idea that you're pitching me. But how do I know that you can keep coming back and give me idea after idea after idea and produce returns over time. That's what they care about is repeatability of your investment edge. And it's funny you know you have these movies these movies like The Big Short and they have these one this one big thematic idea that one big thematic idea pays off huge for you know a Palsson or Kyle Bass or whatever. But relying on those macro calls you have to ask yourself are those people you know equipped to make that next call and then that next call and then that next call. And I find that you know guessing quarterly earnings doing these macro calls you know sharing ideas with friends and outsourcing it to the sell side. These are things that are not repeatable over time.

In my opinion and I've seen some evidence that you know the the best coin flip or one day you know it ends up tails the next. So how we built a differentiated process you can really go one or two directions you can go this quantitative process which will give you repeatability and that's why a lot of investors invest with quantitative managers and unique hey I've got my own little recipe. I got low EBD a low price to book low price to earnings I've got all these factors and they backed hest well and I just get to keep you know running this process over and over again and let the computer do the work. And that way I don't have to hire a team full of people that want to be the next Warren Buffett. That's a great byproduct of a quantitative process. The problem is is you end up with misplaced confidence in the outcome. The very idea of it being quantitative you start to think wow you know the computer's not wrong but unfortunately I've seen quantitative processes go awry. My old firm was a quant firm and I saw it spit out all these weird results where you're like wow we're buying Western Digital at 42. And you know my teenage son could read the annual report and see that it's a totally different company in the future than it was in the past. We're investing on all these historical ratios and data points. We're driving by looking through the rearview mirror and this is this is not the way in my opinion to produce good investment results. Plus they're subject to competitive arbitrage. What does that mean.

It means I've come across my little recipe for success and in stock in the stock market and I'm in the computer run it. And then one day somebody that I don't know commits a significant amount of money to that exact same strategy and its value nullifies through competitive arbitrage in the marketplace and I don't know until it's too late and once it's too late I don't know what's wrong. We opted obviously for qualitative. It can be repeatable harder to be repeatable that it can be you can generate unique ideas you can go do a bunch of work and you can find these little companies in faraway places that people aren't going to visit and you can do unique work on them. It incorporates non-financial analysis. This is very important to you guys talk a lot about Moat's in this in this group and and you know Moat's at the company level are critically important for us because we believe that the moat allows a business to continue to compound in excess of what microeconomic theory would dictate. The problem with the qualitative strategy is it's hard to communicate. It's even harder to execute and it requires cumulative experience. So in the early days we were putting our reps in. We didn't see the entire market. We were sort of starting at a and working for our best ideas the best we could with what we had. But it was like drinking through a fire hose every day. And I don't think we really got good at it frankly until probably year 8 or 9 but we have to do the hard work ourselves. We can't rely on other people to do it.

So obviously we've gone with the qualitative and we've committed to formalizing this process. So our fundamental premise and it's often forgotten despite its simplicity is that stock prices over time should mimic per share business value. So when you buy a stock you're really buying a piece of the business and that price of that stock will over time that's the distributions of dividends and multiple expansions and contractions approximate the underlying compounding of a of intrinsic value per share. Exceptional share prices performance comes from exceptional compounding. Just remember that and we believe that exceptional intrinsic value compounding can come from three sources Moat's management and under or unappreciated sources of growth. You guys know all about Moat's management. Harder exercise to evaluate management. I think it sort of comes from Reps doing a lot of pattern recognition meeting tons and tons of companies over time and trying to understand who is a charlatan and who's legitimate and then trying to use your analysis to figure out how a company can potentially grow that perhaps other market participants aren't focusing on. But the important thing here is that these three factors are qualitative which is why we're qualitative or qualitative because the determinants of value over time are qualitative. So our moat around our investment process is a team we have 15 people in Austin. They have the company credit card and they're on airplanes and wrong cars and they're meeting companies and they're doing that 24/7 and we AAPs people that let them do that and then we focus we focus on those three things exclusively and then have the discipline to structure our strategies so that other people have a difficult time replicating it. And why do I sort of keep harping on that.

Well if you're Goldman Sachs or your fidelity you're not going to open a 10 stock microcap strategy. Why. Because you're gonna raise a couple of hundred million dollars and you're going to cap it because you can't jam billions of dollars into 10 microcap stocks. And so when you run the math on the fees that that generates it's just frankly not enough for Wall Street to pay attention. And what's left in its wake is this vacuum of professional participation that we can exploit. And again a final point cumulative knowledge will widen our moat over time. If we're doing the right things. So this is our productivity over the last three years. So we've looked at 1100 companies ruled out 722 of them as a team we've done 567 site visits about 60 presentations and it's not important to go over our in-depth process here but a presentation is sort of a formal pitch of an idea which has resulted in six portfolio additions. So a hornet's nest of activity happening but very little is happening on the account statements of our clients. Six new positions in three years that's not very many. So we want the funnel as wide as possible on the top is narrowing on the bottom. I think it's important to remind everybody too that a moat doesn't necessarily mean an edge. What do I mean by that. Well a moat is you know your how hard it is to replicate what you're doing but just because it's hard to replicate doesn't mean it's any good. The edge is actually producing the variant perception which leads to the performance. So what is an investment edge.

It's a repeatable sourcing a very perception that leads to sustained outperformance. It's a mouthful. It's perception. It can be a different take than the market has in any of these three buckets different amount of information analyzing the information you have differently or behavioral difference and all talk about each of these. Most people think even a micro-cap stocks that information is not widely disseminated the market and that's incorrect. Even in microcap stocks is very very rare. Information about a company that no one else has and if you do it's probably illegal and you can't trade on it. It's more common in a smaller market caps every now and then I remember we were researching a company in Fort Worth and you know we thought that it had undervalued real estate in their headquarters or whatever but we realized that even after all this analysis is like okay it's a ten dollar stock. They get two extra dollars of real estate on the books. You know this is not a repeatable way to outperformance for us so we buy it 10 and cross our fingers and hope that they sell the real estate or someone else notices. It's not really our thing. Our thing is buying these long term compounders and so you know the informational quote unquote legal informational edge is that we've come across in our careers have always had almost never been a true source of investment performance for us. It's really hard to have a repetitive process that exploits this. This is the big bucket right here. Analytical so you have probably the same information that everybody else has or hopefully more competitive qualitative information.

And it's putting that together and trying to make a prediction about the future that's better or more accurate than everybody else's. And this is very difficult but this is you know the majority of our job and why we're paid a lot of money to you know to fly aircraft. And then finally behavioral this is pretty pretty intense focus of the finance literature a couple of years ago the sort of behavioral finance stuff where you know well there's overreactions in the markets and you know loss avoidance and all these decision making here mistakes that cause people to do irrational things. I've seen people brag about this in sales literature. I've actually in my 20 years never come across an investment manager that has repeatedly used this stuff in any successful way despite the fact that I believe in all of it. So maybe there's somebody out there and you know maybe somebody knows somebody but I haven't come across it. But it is definitely a occasional source of edge for people. We don't go around bragging about this or looking for it explicitly if we happen to happen upon it and we could take advantage of it. Great. So here are two pillars of a successful investment process. Just building something that's hard to replicate and then creating these sources of perception that lead outperformance. So it's really about that note and edge. So that's it. That's 33 slides less than 30 minutes and I'll talk about what ever anyone wants to talk about congratulations on your extra credit. Yup. Yeah good question. OK. So most managers use price as an input to their process. What do I mean by that.

Well let's look for cheap stocks and then let's convince ourself of the quality of those names. Let's start with low P E your low EBD bet. And you know rank order or securities or whatever whatever they do we think that especially with a concentrated portfolio that's a huge mistake and it's taken me a long time to just sort of harden this conclusion. And it's not obvious. Price is the last thing we look at because we don't want to make a mistake in the business quality or the management quality because that is going to be the determinant of your success. If you think back to Coca-Cola trading at forty five times earnings or whatever in the 1960s had you paid that forty five times and is held onto it your return would gravitate towards that. Are we of the business. The longer you held it's over for decades you'd probably still be compounding in the high teens or low 20s. So make sense. So we're going to make a mistake. I want to make a mistake on the price. I don't want to make a mistake on the quality. And so that's why we do pricing last. Now we do appraise every single company that we have. We've been doing appraisals for a long time and I'm not here to brag about the precision of those appraisals. We don't have sharper pencils and everybody else or looking for intrinsic value estimate that gives us a feel as to whether something is expensive cheaper or appropriately priced. That's a great question. We can do everything from nothing to get very alarmed and sell.

And so each business has a different reliance on those kind of Sliders. You know some some business we buy the moat is so big it can sort of overwhelm a mediocre management in some cases we buy businesses where the management was so good that that was the big slider to the right. And if there were a change in management at that point it probably caused us to sell. So I'd say that moat management growth there's kind of a slider you know sort of zero to 10 score type of thing on each of those and we want them all to be tens. But the reality is is no investment idea has you know perfect scores in each of those categories and the more reliant we are on management the more that's a concern for us. But there are some businesses that the moat is so great or their culture is so strong that you know it's sort of plug and play at the top. You know based on you know people come and go in the culture just continues to serve up you know fantastic people. Yeah yeah. Ukraine because like you know if they were friends if you had a really excellent management still good growth was fantastic. That's a super heady question because something hasn't abated internally at our firm a lot. I will say that we don't rank order them per se but it's hard for a great manager to overcome a bad moat. Right. It happens all the time but it's just harder.

It's usually better to bet on a really big moat you know a great network effects business with you know an okay manager than it is to invest in a great manager with a commodity business. So that's usually the right but not always but usually then again had you bet on Warren Buffett when he had a commodity insurance company you would have done pretty well. So yeah when you first started what would you say was the hardest part. Yeah. Yes it's super hard. I mean it's just super hard. I was a little I had had a screw loose like I was just full of confidence when I was 27 and like you know at the expense of everything else my life. My wife likes to say when she met me I had a block of Velveeta cheese and a six pack of Coors Light in my fridge. That was it. I mean it was like I ate every meal like close to the office lived up there. I got my car broken into three consecutive Friday nights because I had this seedy office in South Congress in Austin and it was above a bar and I park my jeep down there and like three consecutive Friday nights I got the stereo stolen like the glove window broken the stereo stolen because I was at work at 2:00 in the morning I was again I was a little had kind of a screw loose and I think as part of bringing my dad was an eye surgeon but he was he was a good surgeon but he's a really good businessman and brought my brothers and I to the lake some of his business meetings early on and we kind of have. That's right kind of got my love for business and started reading the stock pages.

And you know I'm from Omaha I got obsessed with Warren Buffett at a young age. And so I just had a real passion for this and I'm like the rare person you'll meet that kind of knew exactly what I wanted to do. And I was like 14 or 15 years old. And so breaking into the business is really hard because 99 percent of the jobs in this business are sales jobs and you sort of look down your nose at that because you're a finance major business student whatever and you're like I want to be in sales. And then you realize that's mostly my job. It's everyone's job selling yourself selling yourself declined selling yourself to them you know to your co-workers to your boss to everybody. So I think I've kind of come full circle to appreciate that everything is sales. That being said you don't want to be the person that's just smiling and dialing for money unless that's your strong suit and you really like it. So I actually when I started the business I thought OK I want to raise 130 million dollars and micro-cap money and I don't want to smile and dial and look for that money. I just want to like picking stocks like that's the fun part for me. And what I realized is like everyone that would give you any significant sum of money wants to talk to you. And so you're going to have to get good at this or you're not going to go anywhere.

And what I've come to increasingly realize is that the difference between the people like me with 3 billion under management and the person that's got 3 million under management is their inability and and to sell and their dislike of the sales process. I mean at some point you have to get out there and build the team around yourself and convince other people and use your powers of persuasion to to bring money in the door. And that is a huge differentiator if you can do it well and I was terrible at it. I remember our first big institutional investor invited me to give a presentation at the board. And excuse my French but I just shit the bed. I just I mean I could not put two words together. I was just terrible at it. My knees were knocking I was scared I was like in the room with all these Harvard guys and these Goldman guys and I was so embarrassed. I went back to the hotel in New York and I was like looked at myself and there was like I have to get good at this like I have to get good at this if I want to go anywhere in this business I have to be good at this and that that's the truth. You have to get good at that. So if you're sitting here going I just want to pick stocks for a living is like a five jobs in the world where somebody will just let you pick stocks and not talk to anybody. You know it's like you have to get good at that. And the higher the stakes the more important that is. And so when you see Bill Ackman on CNBC or you see these guys they're unbelievable communicators and they're so persuasive.

I went to the Texas Teachers Retirement System the event they put on a Texas hedge fund conference and a couple years ago Bill Ackman was a speaker and whatever you think of Blackman the guy was so smooth so smooth I mean everyone was eating out of the palm of his hand. He just had the greatest stories he was able to communicate effectively. His process the stock ideas you were just like Man this guy is so good you know and he has gray hair which I like but but that's what you got. You got to go. You've got to get good at that. And so that's critical to launching the firm. I mean you know if you truly are the next Warren Buffett you compound it 30 percent a year like the world will beat a path to your door. Right. There are those people that are just savant like intelligence and can do that. But if you're a high teens compound like me you still need this other part of this sort of talent stack to succeed and then you know the final pieces back to original question say you need entrepreneurial drive to make it happen to a lot of people I see make the mistake of saying you know I'm not that confident myself so I'm going to get my buddy or go 50/50 and then we'll sort of share the insecurity among ourselves and that never goes anywhere. For me it was like live or die by my own sword like plan a stake in the ground and move forward and just assume it's going to work.

Because if you come across as insecure like no one is going to give you any money you just got to say I'm going from here to there and I'm getting there regardless of you know you come along or not. And that will recruit people to your cause. So yeah managing your well we charge more and micro-cap than large but we have a larger U.N. base in mind large. The game is a bit more I won't say professional and large and that if we're analyzing a company and the Mullard Space for typically talking to an investor relations person and our microcaps strategy we'll get a call from the CEO on their way home from work on their cell phone or whatever. And so it's just a different level of sort of interaction. The mid large space is also full of more Moat's. I would say it's like there's a couple of thousand microcap companies and the disparity between exceptional and poor is pretty wide. Whereas you know small cap and then mid large you get them enlarged you've probably gotten there because you have some interesting competitive differentiation. And so the game is a bit harder and larger which is one reason one of the reasons why we charge less in fees qualitative Yeah. Yeah. Yeah. There's a quote I think tributed Charlie Munger where he says you know a man with a hammer every problem looks like a nail. And I think you know equipped with the math actuarial science background it's very seductive to want to rank order your stocks on price to intrinsic value you sell a top by the bottom. That sort of thing.

I think I sort of operated from first principles and just said how do I compound optimally and all of the background I just gave about how intrinsic value per share matches you know share price or drive share price over time just deconstructing those principles. I just kind of came to conclusion there was almost nothing quantitative about it. The result is quantitative obviously. And so you need to understand how value is created within a business and common size financial statements and how that drives intrinsic value over time. But the primary point of analysis we're all qualitative and so I just came to that rationally and just sort of accepted that conclusion. And so you know over time just sort of had to ditch a lot of that tool kit that I had built up over the years. If somebody gave me an integral calculus right now I would have to open up a textbook to figure out how to do it because I know I've forgotten it all. Yeah. So we try and fish in the ponds where there's you know we think there's a lot of fish. And so airlines banks you know steel companies commodity companies basic chemicals. These businesses tend to be price takers not price makers. There's not a lot of points of competitive differentiation in that space. So we tend not to spend a lot of time in those areas. Information services software precision instruments there's just a ton of differentiation. Razor razor blade sort of dynamics business is where there are more price makers and therefore returns on capital are more likely to be high. So we just sort of spend more time in those buckets. But the cool thing about our firm is if you have a you know if you're intellectually curious about a certain area we just let you go check it out.

And so you know I don't say Hey go look a company ABC you know if you've got an interest in whatever it is you know 3D printing or whatever is you know go rip the space apart and come up with something. And if that doesn't work that's great. I mean that's part of the process. And so we have for each strategy we have a research head that is sort of coordinating the analyst activities in those areas. And so you can't just be sitting at your desk twiddling your thumbs. I mean it's a small firm. Everybody's work is pretty magnified and upstream. On Friday to the research heads which is distilled further and upstream to me. And so I see the activity on a look through basis of what everybody's doing and so you've got to have a pretty pretty heavy research clip going in your workflow but you can pretty much look at what you want. Now every now and then we're going to say hey there's a particular company that we're following like why don't you update the model on it or whatever but. But for the most part if you know if you like you know align technologies or intuitive surgical or you know just like go knock yourself out and like you know check it out. So that's a good question. Are after after employees in rent. That's probably our biggest budget item. So I'd say on our research analyst budget ex employee costs just like on the travel and hotels and conferences stuff like that probably a couple hundred thousand dollars a year. So what is the meaning what does it look like when something like it.

I heard I was going to go you know yeah. We don't want to we don't want to waste people's time. And so we have a reputation that we have earned that we do good work on companies and that we don't waste their time on things like you know we're going to waste a CEO's time on talking about tax rates or something like that you know it's like we want to understand competitive strategy what they're working on why they're working on it. We'll have a list of questions that we'll know that couldn't have been answered by reading the public documents and the proxy the 10k and all that sort of stuff. Not wasting anybody's time. And to the extent that there is something to see we want to see it right. So if there's a secret sauce in manufacturing or a cultural competitive advantage that people are claiming we want to see that in action. And so so each company visit looks a little bit different. It depends on what stage of the research process it is and it depends on how complex and so we own National Instruments which is a company that's based actually in Austin. That's a very technical company we were following for eight years before I made the purchase and we all went to and I we can talk to customers and talk to industry consultants and all these sorts of things and an attempt to better understand the company. And then that's one example and on the other end we've had companies that we've familiarized ourselves with for a month and within the portfolio.

And so it just depends on sort of how complex how much there is to see if it's an insurance company or something like that. You know there's not much to see. People computers and cubicles and so you know maybe a two hour meeting with the executive team is enough to kind of get us comfortable with what's happening there. If it's you know a specialized manufacturing process where you've got to sign NDA has to like look at it and stuff like that know it's absolutely critical that you go you know walk the factory floor with them will sit in user conferences will train on software will go to industry trade shows and you know talk to vendors and whoever we need to to just sort of get the complete picture of a business and again this isn't about predicting next quarters earnings or whatever. It's about understanding the competitive strategy the business and whether that strategy can lead to sustainable compounding in excess of what sort of perfect competitive theory would would dictate. Yeah. Yeah. All these answers are unfortunately it depends right. You know if it's something new if it's something complex and high touch will mean a lot. You know there's we own one company where the CEOs on the Forbes 400 and he's very difficult to get a meeting with. And every time we can get a meeting with them we'll meet with them. And so you know if that's twice in a year five times and here we'll do whatever we can. So I think early in my career I got to I got into my head about like everyone else knows more about all of the names that we own than I do.

And so it is just like this intense focus on learning every possible thing about every business. But the pendulum has swung too far one time when one of our analysts got invited to the CFO of a companies house for Thanksgiving and it was like OK we're you know. Yeah. More information. And so the pendulum sort of swung back and then it sort of settled into this like what's critical of the investment thesis. Identify those key points and let's learn as much as we possibly can about those points and then ignore the shoe size of the CEO and all that other stuff. Absolutely yes. Absolutely. Any new filing we're cataloguing we're talking you know talking to other people in the office about you know how critical is this stuff that we update the model that sort of thing. Obviously earnings calls every every management meeting that we do. You know if something happens competitively you know we'll interestingly you know one big behavioral finance piece of all this is that a lot of people anchor on purchase price. So we work really hard to be dispassionate about that. And you know let's say we buy something at 50. And the competitive thesis starts to deteriorate and we'll sell regardless of what the stock price 35 or 85. You know we're not trying to anchor on that stock price to sort of you know that purchase price to try and come out even before we exit or whatever it's like optics be damned or going to try and do what's dispassionate and rational for the investment portfolio. So that's where all the gray hair came. Yeah that was tough. It was really tough.

We had one of our university endowment investors was a pretty significant portion of our assets in 08 09. And this is a little bit more industry like in-depth knowledge and you guys probably are you know care about but in 0 8 0 9 the university endowments which were our core client base were suffering a very unique problem and that was the public markets were declining which was providing them more opportunity and any rational investor would start allocating more money as the market's dropping. But they had what's called the denominator effect where essentially the private book was overcommitted and was also seeing opportunities and therefore they needed to fund their private equity poured capital calls. And so there are situations where major universities were borderline insolvent because they had these unfunded liabilities to private equity that they had made. And the only place that they could fund those was pulling from the public markets so it added fuel to the fire. So in March of 09 as things were just you know troughing I got a call from our largest investor their public equity team and he said Brian we're consolidating around a handful of public equity managers which means we're firing some people. You're safe. And I was just like as I went home and sat with the Fosters. Who knows. So it was a big moment because like I had employees that were paying and mortgages people that were required stuff so very very difficult time period. That being said you know my peers were getting washed out. You know there's friends of mine in Austin that ran hedge funds that got all their money from Lehman Brothers or whatever.

So we had a great group of long term nontaxable perpetual time horizon money. So one of our structural advantages is actually our client base. I mean they're long term. There are not a lot of intermediaries between us and the decision makers and so these large cascading movements of money in and out of our firm aren't as big of a deal for us as they are for others which is a huge structural advantage that showed itself in 0 8 0 9 although that was a 100 year flood for our client base. So very difficult. Also a tangential question I get a lot is well if stuff was cheap in your portfolio and March of 09 it was screaming cheap so why not go from 10 stocks to 20 stocks in micro-cap at that point. And the answer is like we don't want to just over diversify for the sake of accepting more money. We made promises to our investors we get to keep his promises so we stayed in stocks and people then say well okay what is really cheap in March of I want to take more money and just Jamma in those 10 stocks is like. When you own 17 percent of the shares outstanding. This is a microcap stock. You can't putting more money into it. And so we were just sort of locked up. And you know it might as frankly saved us a little bit too because you know a allocator university endowment office is probably looking at us going micro-cap like how are you going to unwind all those positions. We can't pull money from him.

You know let's pull money from the largecap guys so we probably got a little bit lucky in that time period too. But you know this business has always been you know two parts really hard work and one part luck. Yes ma'am keep going. Here now you're like yeah well we're going to talk a little bit about that. We have somebody here that worked for us. We have a collegial office that we have one compliance meeting a month. Other than that there's just no B.S. It's here's a company credit card. Get on the road do your job. There's no nobody tracking time sheets. There's it's a very casual office. You know people come in jeans and Birkenstocks or whatever whatever you want to wear. It's Austin so it's kind of you know feels comfortable. And you know I would say that everybody at the firm like I would trust them to watch my kids over the weekend like they're nice people on top of that I would want to just go grab a beer with anybody and the firm too. They're just fun people. Everybody has each other's backs. Very collegial. And we get that from a rotating stable of interns because that feedback it's like you guys have unique culture in that you know everybody's on the same page. They know what they do but everybody is treated like an adult. So there's not you know like at the end of the year there's not you know 16 categories that I'm rating people on or whatever you know it's like there's intellectual honesty is pretty pretty prevalent in that in the firm and people aren't incented on weird things that make that induce weird behavior. CompE is pretty subjective.

I mean there's a base comp That's not subjective but the the bonuses are reasonably subjective except at the top where it's tied to performance of the actual portfolio which is very objective. And so you know beyond that people are just incented to do their job in part because they're you know trying to pitch in for the team. They want things to work out. And the beauty of what we're doing is that if you source an idea from the lowliest intern all the way to the top and it's a good idea it's going to impact the portfolio and it's going to impact the performance of these big university endowments in a big way. I mean you know a 30 percent position by weight in the portfolio. You know it's you know once you are a research analyst at our firm and we end up with a 30 percent weight in your idea you'll learn what pressure is like you know but it's fun. It's why we're doing it. You know I can't imagine what it would be like to be at Fidelity or something and to do a bunch of work on a name and have it be point 0 3 percent of a portfolio and just meaningless in the context of not only just that portfolio but then the ultimate investor's portfolio where that fund is only a 1 percent position. I mean it's just you know to me this is bonkers. So we just like the way we do it. The other thing is our hiring process a little bit unique in that we don't. So we have a we have a junior analyst track where it's three years and then you're out.

And that's because we are structured with a cap on assets and so we can't give the sort of upward path for everybody in the firm. So we have this pool of rotating junior analysts that come and they work hard for three years. Then they go to business school or they go to another firm or they start their own firm or whatever they want to do. But you come and you work really hard for three years and you get to see all these companies and travel all over the country and you apply your craft. We get great work out of out of the analysts they love working for us. But there's you know sort of an adult conversation. Three years just like if there is a tenure track spot will pull from the you know the junior analyst pool. But generally speaking the people on the upper tier of the organization are going anywhere. So they're there they move on. So it helps us keep fresh eyes on ideas too. So new you know youthful enthusiasm is helpful for a firm like ours. Every now and then so. See I'm trying to think of any other cultural. We have corporate values or anything like I don't really believe in mission statements and things like that. So well how about this. Here's the here's how I make sure intellectual honesty happens in our organization.

So if we have a presentation on an idea let's say IBM is an idea and it goes through the process and it's presented formally to the research team I start with the youngest person in the room the least tenured person at our firm and I get their feedback and then it works its way up to me because I know that the youngest person will not be intellectually honest with me once they know my opinion right because everyone wants to please the boss and the bureaucratic pressures are to not give your unvarnished opinion when you're young and have a unique or contrary and take on something it is a very you know diluting environment and so we start with the least tenured person because I want people's sort of unvarnished and contrary opinions on things and so that's one way that we try and keep things honest. Yes I mean yeah yeah. So we look for things that are very similar to what a lot of other managers in the value crowd look for in terms of like high insider ownership you know aligned incentives and the proxy I want to make sure that you know a founder owner operator sort of dynamic exists. And so we we like it when there's a huge you know outside passive minority interest sort of alignment with a Founders stake in a company that that's an obvious one that a lot of people look for that we also look for. We also look for something we call encore performances. So if somebody has been successful in building a business somewhere typically they're pretty good when they do it again. And so you'll see in all of our portfolios the sort of common theme where you know the CEO or top team has been successful somewhere else and they're doing it again this time in smallcap or whatever you know. And so we'll look for sort of call it encore performance internally.

And so that's it that's one sort of pattern thing that's popped up over the years that that we glom onto. We also go beyond this sort of great capital allocator Manotoc a label that everyone in the value crowd seems to have. You know it's like everyone's looking for this Henry Singleton or Warren Buffett analog where they're sitting isolated in an office and pulling the strings on capital allocation. That's OK. But we actually look for great strategic operators as well. And so you know walking factory floor with a manager and having them talk about competitive products and you know why they're driving to continue to lean on their competitive advantage and this is what we're doing differently and we're going to go into this market you know tangentially next bubble a lot you know that's really important too. So I think management is just bigger than just buybacks versus dividends or being good at Amadei it's it's this whole suite of things. And increasingly I like this sort of talent stack analogy where it's like you know it's not a checklist but people have got to have a lot of you know personal characteristics that allow them to be successful that would be visionary. They have to be persuasive they have to be smart. They have to be dispassionate. They have to have all these sorts of characteristics so you know it becomes obvious when you do it over and over again who really who is really exceptional. And so that's just part of getting your reps in. I think for us it's like you know the first company visit you go on as an analyst with us you'll think oh yeah that's a really interesting company.

And then you do 10 of them back in the first meeting you're like it's probably average and then you do 100 of them and you look back and the first one you're like I can tell you now that that was a good bad average or whatever. Just based on this library of information and building up the reps and the pattern recognition starting to kind of harden in your brain. Yeah. So no we've never short a stock and we don't own and have never owned any derivatives. We are plain and simple common stock pickers just long only common stock pickers. So there's two parts to that. One is the investment reason for selling and then two is the actual mechanics of selling investment reasons for selling as we'll sell something if it's sort of wildly overvalued. If the thesis is sort of handicapped in some way you know we've made made a mistake or if there's just a better relative value trade out there let's say something is 150 cents on the dollar and it's a good business. But there's a better business available at 80 cents in the dollar will sell this one and buy this one you know. So that's a pretty standard sort of sell discipline's slide that probably most managers have. So I don't think we're materially different from other managers with one exception that is will tend to hang on to stocks after they've reached our estimate of intrinsic value for all those reasons I talked about earlier. Price being like our least reliable indicator of whether to invest and how much.

And so if something exceeds our intrinsic value estimate we'll typically hang on if we really like the name the actual mechanics are selling mid large cap is pretty straightforward. I mean there's a lot of daily liquidity and most of those names. If we take a few weeks to get into and out of a name that's not a big deal for us the problems are you buy a microcap stock. You're wrong. The stock goes from 7 to 1 and you own 15 percent of the company. And in those instances we've taken nine months to get out of the positions. You know they call him roach motels. You can get in which you can't get out you know. And we've we've suffered our share of black eyes in that area. But you know it's the price of being an micro-cap and the rewards are much greater. So it's worth going through those hiccups every now and then yeah. So there's good bad the bad is you know everyone goes to New York and so if you want to be in the sort of deal flow of management teams coming in and doing you know in office visits with you. I mean it's much easier to be in New York. Travel is much easier to be in a major hub like Houston or Dallas and be much better. So there's a couple of knocks against it. The goods are overwhelming. I think you know the quality of life in Austin I love Austin. I fell in love with the city when I moved there in 96.

You know love the food music all that sort of stuff flakes and so we so we have a huge applicant pool for any opening which is awesome and you know it's just I think most people just want to live in a popular millennial city like Austin and so people you know people throw us resumes all the time especially those that are fleeing like the higher tax jurisdictions like California New York. You know it helps us not being in the midtown Manhattan sort of rat race to you know I'm not comparing our firm numbers or profitability with anybody care about that stuff. We can think and kind of do our own thing. Like I didn't have a new york stint in my background and so like I built the business sort of from first principles like that made sense to me. And so I didn't inherit that like Midtown Manhattan hedge find DNA from anybody else too. And so we're just kind of this quirky island in Austin and we've gotten used that over 18 years. We kind of like it now is probably a badge of honor so. But yeah it's kind of a pain to have to connect through Dallas and Houston when you travel. I was telling Dave earlier we have 18 years and we last year we got or two years ago maybe last year. Two years ago we got our first Texas client. Yeah. Almost 3 billion in assets and it took 16 and a half years to get a Texas client. So so yeah we have to travel to see people have to travel to see us. Yeah good question. I mean part of it when I look back is I was probably like a therapy catch question or something but probably it was like an early insecurity about money.

So when I was growing up my dad was in medical school we didn't have any money and it wasn't like oh my god we were poor and it was like I think I just remember my dad being very influential my life and taking us from bank to bank to get a better interest rate like an all Asef and so I think I just became intellectually curious about it and I always thought you know for me this business has never been about it's never been about applause. A lot of my peers in this business it's about applause. Like I want to be like the next Warren Buffett. I want to be like the guy in the Forbes magazine and on CNBC and stuff like that that has zero appeal to me. The money is nice but for me it was about independence. I just didn't want somebody coming up at any point in my career putting a gun to my head and saying you have to do something that's uncomfortable because your paycheck depends on it. And so for me that was like an entrepreneurial motivation that was incredibly strong in my life. And if I'm honest with myself I don't really know where it came from. It's probably just you know a combination of environmental factors and maybe a little hereditary stuff because it seems to run in my family but you don't have a real good answer for that. But you know I was the weird kid in college at the bar that was counting the patrons and trying to calculate how much the bar bar was making rather than just enjoying the beer. So you know I don't know. It is partly wiring and partly just you know intense interest.

So I'll get to you in a minute. That's a great question. So interesting little tidbit is probably a half a million to a million bucks a year to be public. OK. And that's if you're trying to be thrifty about it. I mean it's just really expensive to be public. And so when you think about it you know 10 times earnings on 10 million and an earnings gets you 100 million our market cap. That's like kind of in the middle of the microcap space. I mean a million bucks a year. And public company costs 10 percent of your profits. This is a why do it. And the answer is most people are not anymore. And so when I started the business there was like 70 800 companies in the Wilshire 5000 which is the broadest measure of market capitalization from top to bottom. Despite being called the Wilshire 5000 there are 78 100 companies today there's less than 5000 companies like 45 or 4600 companies now. And all of that shrinkage is coming from the smallest market caps. Dodd Frank Sarbanes all that sort of stuff has come in and it's just making regulatory complexity so great that people are just you know it's not worth it to be an 80 million dollar public company anymore unless you have a really good plan for growth and you really need the capital and there was probably some quirk in your history that made you go public. And then remember that you know micro-cap is a graveyard for public companies as well. So it could be that they're gone out and they're on their way to disappearing.

So you know that's a huge drag on the space as well. So so yeah. Every company's got a different reason for being there. You know most it's pretty straightforward hey we Republic because you know a bunch of employees own shares they want to public markets. We maybe you need to raise capital beat out some combination of those things. And yet if a company is permanently destined to be 60 million dollar microcap company probably now worth being public and there's probably you know 100 firms out there that are private equity firms that are licking their chops to take it public and remove that million dollar line item and put that in their own pocket you've got nothing. You want war stories. OK. Bed Bath Beyond. Yeah we had. I don't know if anybody ever went on the site. We owned bids dotcom. Don't be easy. Remember that. There's like this sort of third rate like Pawn Shop jewelry that was sold like in a kind of eBay sort of format. And so we bought it at 7 and I went to one and didn't work out like we wanted. And you know it's too long of a story to give you the full you know top to bottom on. But yeah it took it took like nine months to get out of that name. Actually owned the company. Kind of the flip side it wasn't a success but it was a similar roach motel but it just didn't do anything. We bought a company called Hawkin's chemical which is a regional chemical distribution company that was an upper Midwest.

We owned it for a couple of years and it just kind of went sideways and the thesis didn't really play out like we wanted to a great company but but we owned all this. I mean we own hundreds of thousands of shares and it traded like 2000 shares a day just like we're never going to get out of this saying you know it's going to be months and months of just 100 shares 200 shares with shares. And out of nowhere we found the other side of the trade and we were out of it and like two weeks. And so sometimes that happens it's just kind of weird like you never know and you know Fidelity or Vanguard is rebalancing or you know wants to be on the other side of your transaction and we're happy to obviously accommodate in those instances. Yeah. Yeah. You know we we prefer the fanaticism for our particular style of investing. I think first and foremost is we want people that are onboard with us the people that have worked out the best for us are like I want to work for you because I've independently come to the conclusions that you've come to make sense. Like you know I was into Buffett whatever but I'm just like huge on moats and competitive advantage and all that sort of stuff and they have like the theoretical basis for why they've gotten to that point you know whether you've got to three point eight or you know 3.0 GPA or whether you know we have people from Princeton we have two guys from Princeton in our office and we have people from Nebraska or you know some random college in the Midwest or whatever you know like we have.

It doesn't matter where you went to school you need to be smart and passionate hungry all that stuff but it's really really important that you understand like the theoretical basis for why we're doing what we're doing. And then you get turned turned loose pretty quickly and you can be pretty productive you know in pretty short order. Yeah. Yeah. Yeah. Great question. So obviously high class problem. And yes it's happened multiple times which I'm very happy to say. Yeah. And so we don't have an upper bound per se that where there's a statutory exit from the portfolio like the contract says well we have sort of an agreement among our investors and micro-cap that if something gets to about a billion and a half we'll have some sort of orderly exit from the name. But you know we'll have conversations around that if there's extraordinary circumstances we feel like we've got really competitive research if there's another 30 percent or 50 percent we see for some reason or some catalyst or something we made just go to everybody and say here's what we own. It's 20 percent of the portfolio and it's a billion and a half. We want to own it for another six months. And when you compound it you know 17 percent for 18 years like you tend to have the clout at that point to go to your investors and say hey we can you know we'd like to do this and I'll be like No problem. You know. Not so in a brand new strategy with you know a short track record.

No confidence for investors but in general we get to we get to have those conversations and kind of do what we'd like to do in small cap that number is 10 billion. So in small cap we're bounded by the the market caps of the Russell 2000 which is I think about three and a half billion on the upper end as of the latest reconstitution. So we'll hold past three and a half billion. Let's say by buy a billion dollar company and smallcap and graduates past three and a half four or five six billion dollars fixed to 10 billion. It's like it's not a small cap anymore. Let's let's move on. Typically we're exiting before that. We'll wait for some disparity between price and intrinsic value and we'll sort of take that opportunity to trim it out and move on. We'll still follow it because it may be on limits for mid large mid slash large is named as such because we actually don't like that upper bound issue. And so rather than having a mid-cap strategy and then a large cap strategy we just said All right we're just going to have essentially a mid-cap strategy with no upper bound. So in mid large we have 10 sort of mid-cap ish names with essentially no upper bound. So hopefully we find the next you know Google or Facebook or whatever and we can ride it to tens of billions or 100 billion dollars or whatever. So that's a good question. It's hard. I mean it's as much a qualitative as a quantitative exercise. And so it's about understanding you know sort of the TAM that tangential opportunities from their core products and increasingly what the appetite is for the management teams to engage in mergers and acquisitions.

So you know you look at some companies and it's like we explicitly want to grow through acquisition. Well you say you know I've read the research 80 percent of acquisitions fail to meet their intended synergy targets. That's not a good batting average and so let's just avoid acquisitions. Well you would've missed Berkshire Hathaway like probably archetype one of the best Amadei story of all time. So you know in my career I was sort of avoidant of acquisitions generally and kind of came around to it after sort of thinking this through that if you can identify the 20 percent that do it really well that can be a huge point of qualitative differentiation and can lead to some of the best long term compound stories. There's a great book out there called 100 baggers and it's like the contents of the book aren't you. I mean say there's not huge insights in the book in my opinion but it's just sort of a chronicling of all the companies that have 100 times themselves. And if you look at it there's a bunch of in that list there's a bunch of emanate driven stories like Danaher and Berkshire Hathaway and others and so would be stupid for us to just sort of totally remove that category as I ignorantly did in the first couple of years of Bear's capital increasingly sort of came around to this let's let's focus on Monet as a category and see if we can understand the people well enough to know whether there is a abnormally skewed distribution of outcomes that's in our favor based upon just the people.

And I'd say we have a don't have a 100 percent track record in assessing that but we're doing pretty good yeah. Terms of formative stuff. You know I think I was informed by you know growing up with sort of Graciella Christmases and stuff like that you know it was pretty. As a result pretty thrifty in my my sort of early entrepreneur days like I didn't have cable TV you know like I said you had almost no expenses in the world including no food in the fridge or anything like that it was a sort of single minded about about making it happen. The Froogle this is something that I used to kind of wears a badge of honor but may have gotten me into some trouble too. So this is a rare story about my firm as the first nine years of Kappel I didn't have a lawyer. So I just like did all the contracts myself. Are they like that. I don't recommend that as a horrible horrible path to take but I was just so cost conscious that I was like I don't know if this thing is going to work and so I need to bring the breakeven cost like you know so low. Like there you know I needed to bring expenses so low that like you know I just need sustainability because I have no plan B. You know I just threw everything into this and prepared to burn through my savings and so anywhere I could shave a few pennies I would do it you know. And so I think that's that was a helpful attitude and getting to breakeven and sustainability.

But it was a little bit reckless in a couple areas too that I was you know got frankly a little bit lucky and you know finally now have good attorneys and good contracts and things like that. But I wouldn't necessarily recommend that. It also may have extended the runway a little bit. What I mean by that is had I spent a little bit more money and just sort of getting stuff up to speed quicker. I might have seen the hockey stick of assets under management growth a little bit earlier. So I don't know. I mean it's worked out great some you know hindsight at this point is 20 20 but yeah I don't know. I mean you know frugality drive is super important. Just sort of the grit and fanaticism for the business. It really really helps to have time and work in your favor too. I mean like you know I started in June of 2000 which sounds like the worst time ever to start investment management business because it was the dot bomb era but it just so happened that value stocks you know were kind of doing this well all the you know the bubble stocks were kind of declining. And I was on this side. And so you know we had good performance in excess of market averages. Obviously that helped early too. You know there's it's just two parts hard work one part luck of a good friend in Austin that started a firm in 2007. You know it's like it was great great great and then. And he was so far below highwater and there was so much dislocation a market that he just folded up shop.

And so you know there's stories like that where any good person great entrepreneurial spirit spirit lots of drive worked hard and just timing was just poor. And so you have to be a little bit lucky. Somebody said I think as a Twitter account that I follow somebody said Oh yeah business is easy. If to work really hard to have your career coincide with a 30 year decline in the end like benchmark interest rates or something like that. And it's just like so much of this is luck. I mean it could be for the next 30 years we see you know depressed economic activity and this is a morose business to be in for another three decades. Who knows. Or it could be bumper crop you know for 30 years you just don't know. Dave what would you say to that. Do you have any personal characteristic sort of data points that would cause similarities. When the last few last year I laughed in my head. Were you there or had it with your mind. OK. Why is that the market ate away the assets in the fire. So I better my life. It operates by way and playing for about three years I save money and I make sure that I was on the phone. Now Ryan is over like my wife doesn't mind telling this story. Buy it. When I first started my firm one day my wife's affair as a very strong willed woman here. And why. Well you're always gone. You're always happy all the time. A very logical thing but the obvious I was there 20 hours a day. Dr. White answered those questions. Yeah.

So that brings up another point which is I think a personal it's not characteristic but it's a situation. This was so much easier for me at 27 not being married with kids. I think if I did that now I have a 10 year old the 7 year old a 5 year old and I just don't think I would have the energy to pour. What I did into the business and have enough leftover to you know to pour into what are the most important things in my life. And so I think that piece of it just not being there yet was super helpful so I'm very happy that I went through my neuroses right in my mid mid to late 20s. And a much more balanced person now. And one of the reasons I'm I'm able to be more balanced is because I have a really awesome team. You know I mean you've met most of the team and so you know it was you know for years like kind of everything you know was like if we had to pick a health plan I was like wait we don't have a human resources department. Me if we need to hire somebody if we need to know whatever it's just everything falls in your lap and then you have to also get clients and invest and balance statements and send outs and it just everything falls in your lap. And so it takes it's an all consuming effort for a long time.

And you know it might have been a better plan to go out raising outside money give somebody 30 percent of the business or something for enough money to hire a couple of people to do all that stuff and have me just focus on the two value drivers of the firm which is to you know recruit the right clients. And to compound the money I mean those are the two value added parts of our business getting the money and company money. And those two parts of the profession pay very well as a result operations you know trading all the stuff is incredibly important as well and can be very value add and you need the right people in those those parts of the organization but without the clients and without the compounding you know those other functions are you know are moot because you don't have a firm sense of your clients to you because they know you and you speak to your number well we never sell our numbers which is a good thing. The numbers are good but we don't sell the numbers we sell people philosophy process and we do that because the numbers aren't always going to be there especially in a concentrated portfolio we have these disconnects where we're down the market's up. And so if people are focused on the numbers as sort of the lead hook that's what they're going to focus on all the time and that's what the conversations are going to be about every month or quarter that you know the numbers are working out for them. And so our best results with long term relationships and clients have been those that have bought into the people philosophy and process. And I sort of like.

I'm a college football fan because I'm from Nebraska but you know I sort of liken it to just pay attention to the blocking and tackling and the formations and you know the reps at practice and you know the score should take care of itself. And so rather than just assessing the football program that just puts up the most touchdowns it's like let's let's actually tear the program apart and see who's the most disciplined about practice who does the best recruiting who does that. I think analysis of an investment manager should be similar in the same way that we actually look at companies. It's not just rank ordering on return on capital or whatever the primary determinant of compounding is it's who is running this business. What's its competitive advantage what's the structure it's tearing it apart piece by piece and investing in the people and the philosophy strategy process etc.. So direct answer to a question is I'm sure there are some clients especially the early ones that are like hey I invested with Brian. He's got my money and whatever but what they perhaps failed to realize is there's a big team and it's the process that's producing the results and you know they're guys at my firm and women in my firm that are much much smarter than me and that are executing this process all day long. You know I've helped to create the ecosystem for this to survive thrive and evolve. But you know in general like the hard work is being done at various levels of the organization within a process that's producing the results chirp yeah you worry maybe I follow like a bunch of those into it guys and Twitter it's more for comedy than for yeah it's more for comedy than for information. But it's you know exactly. I like the Patrick dishonesties podcast. The investors feel God.

Yeah I'm a huge fan. Anything that he's done so far is stuff that I listen to. I listen to. I try. I try not to get so deep into the sort of value investing Kolt where it becomes an echo chamber. So try to get out of that a little bit. And I like the you know Sam Harris novel Ravikant like some of these people that are that are kind of either Silicon Valley based or they're just kind of outside of investing generally but just talk about life philosophy and you know you know pass to success in other areas of life that I can hopefully pull a few pieces from and either improve my non-professional life or sort of glommed onto to my professional life please don't apologize. Good questions all good questions. Yes so the question we get a lot. Some investors are what they call Sri conscious where they'll have no tobacco no firearms or something like that embedded in their contract because we're such a concentrated portfolio. We can customize accordingly that's not a problem for us to accommodate those sorts of requests unless they're really onerous. The other thing we're cognizant of as most of our early clients were university endowments and charitable foundations and so we're not going to run out and buy Smith and Wesson and you know companies like that. And so those sort of sin stock areas are just generally not places that we go sort of shopping around. So we're just sort of cognizant of that and who our clients are and trying to match. We aren't advocates in any one regard.

I sat on the investment committee for the Missionary Society of St. Columban which is a Catholic charity in my hometown and the Sri question as they are rewriting their policy was very complicated and it's just not obvious to me after going through this how to address this like I thought a lot about this and very deeply about this and is the right answer to not own the companies that you disagree with. Or is the right answer to own the companies you disagree with and trying to effect change. And then what's the best way to do that. So there are some people that just say well we're having SRI fund and we're not going to own the tobacco manufacturers or we're not going to own retailers that have child labour in Pakistan or whatever. Or you know is the right answer. Some of the advocacy programs where they take a position in a retailer and they advocate and lobby for improvements in their supply chain or working conditions or whatever. And I just don't know the answer to that. I just don't know what the best way that kapitalist tools can be used to affect social change especially within a firm like ours that's tasked so narrowly to do a specific thing for an already eleemosynary or charitable endowment. So most of our money. You know one of our clients you know supported Sesame Street which I grew up on. You know it's like women's rights in Africa. They do all these great things. Should I be concerned in the investment function with trying to improve you know child labor in third world countries.

Or should I try to compound the capital as much as possible so they can do that with more resources in the social programs that they're doing know not obvious to me and I don't think there's a lot of clear answers. You know the Kumbaya answer is for everybody to work and row in the same direction and try and stamp out all of these problems which I'm a total advocate for. But I don't know if any actions I would take would be you know working towards that are against it and in any sort of obvious way is probably a more in-depth question than you wanted to know. But but I think it's a very difficult question and we're not just washing our hands of this and it was all. And I say what somebody else's problem. We think about it we don't invest in companies that we deem are too controversial. And so you know we have a hard and fast screen but we'll present something and we'll say is this is it something that would be you know an alarming thing for our clients to see in their portfolio. And if the answer is even close to yes we'll we just won't own it. We've had instances we actually there's a microcap company we used to own that made female contraception guys. Not overly controversial purchased by the AIDS organizations around the world the WHL distributed you know on behalf of women's reproductive rights in Africa could be controversial. You know Catholic focused charities and hospitals and things like that. And so we had to have conversation with our clients. This is something we're contemplating just palatable to you.

And somewhere I guess this is real like perfectly in line with our mission and others are like you know this is you know maybe not so palatable and so everybody's got a different take on how to change the world. And so we're just trying to live in the cozy middle one last question most traditionally you go back to your 20 year old self when these men don't take myself so seriously. I don't know. I mean college is a fun age. I mean it's a fun time it's one of the few times in your life where you know although you probably don't feel right now you truly are free once you once you get in the groove of a career and family and stuff like that you know free time and a lot of those things that it seems like you don't have a lot of because you're you know obsessed with school work and getting ahead and getting the first job. You know it seems like you don't have a lot of free time now but compared to where you are when you're in your 40s it's it's night and day so don't forget to stop and enjoy your life a little bit. I would say in terms of preparing yourself for the real world and getting out and I'd say don't try and be something that you're not. Don't look at Warren Buffet's life and say you know one of the richest guys on the planet. And you know what he says really resonates with me. But then say you know I'm going to go try and do that without understanding what it cost him to get to where he is and ask yourself whether you're going to you know prepared to pay that price. I think T Boone Pickens is credited with this quote oddly.

Life is really easy. Just figure out what price you'd have to pay to get what you want and then go out and pay that price. You know I mean it's pretty simple actually. And I paid a pretty high price just personally like in the early years to get Kapell off the ground and be realistic with yourself and ask yourself what price you want to pay. You want to have work life balance do you want to have all these things that seem like a luxury that are very necessary for you to you know take stock and enjoy the journey. If you do. Entrepreneurship is probably not the right path for you because it's an all consuming thing and it's not you know it's not a smooth line up into the right it's really squiggly and circuitous to get to where you want to go. And that's even the hard work is no guarantee of success. And so you have to ask yourself if you've got that sort of grit to get there and if you don't it's fine to just find something that fits your personality and make sure you it's in concert with your core values. So best I can do for more information please visit you dot edu.