Boyles Asset Management On Moat Investing, Continuous Learning, And Daily Rituals… by Lukas Neely, EndlessRise Investor
Joseph Koster and Matthew Miller founded Boyles Asset Management in May 2013 based on the inspiration and principles of the Buffett Partnerships during the 1950s and 1960s. Which means they believe in pay for performance; and structured the fund in such a way that ensures incentive fees are entirely dependent on strong performance for their investors.
Their value investing philosophy is complemented by their patience, long-term mindset and investment process. And although they have a broad mandate for investment, they pay particular attention to the small and micro-cap space (U.S. and select International territories)
Currently, they are finding value in businesses in the small/micro cap marketplace. They are finding value in such industries as insurance, equipment manufacturing, and automobiles.
Gates Capital Management's ECF Value Funds have a fantastic track record. The funds (full-name Excess Cash Flow Value Funds), which invest in an event-driven equity and credit strategy, have produced a 12.6% annualised return over the past 26 years. The funds added 7.7% overall in the second half of 2022, outperforming the 3.4% return for Read More
How did you get started in value investing?
Boyles Asset Management – Joe Koster: Matt and I first really learned about value investing at Coastal Carolina University from a professor we both had, Dr. Gerald Boyles. As you might be able to tell from the name of our firm, he had a huge impact on the course of our lives and careers. He taught both an investments class and a stock market challenge class where he introduced value investing and Warren Buffett to students, and even used the book The Essential Buffett as the textbook for one of the classes.
While in college, Dr. Boyles also was also the reason that Matt got in touch with Mike Pruitt. Mike was looking for his next project and ended up hiring Matt and me right out of school to serve as analysts for the new company he was forming called Chanticleer Holdings. We were lucky once when we crossed paths with Dr. Boyles, and got lucky again working for Mike, who made sure to give us all the resources he could for us to continue our education.
After a year-and-a-half on the job, we launched a tiny fund with money from friends and family to start managing public investments more formally. And then in 2013, with the help of a sophisticated firm in Charlotte that we had gotten to know well, we formed Boyles Asset Management in order to focus our full attention on the fund management business.
Has your view of investing evolved over the years?
Boyles Asset Management – Joe Koster: As far as how my view of investing has evolved, I’m reminded of an answer Peter Bernstein gave to Jason Zweig in a 2004 interview: “I make no excuses or apologies for changing my mind. The world around me changes, for one thing, but also I am continuously learning. I have never finished my education and probably never will.” My view of the world continues to evolve and I’m constantly changing how I look at things, and I think that will always be so.
But when I first started, I probably focused too much on only looking for low P/E stocks or stocks with good returns on capital. Now, I’m probably a little more skeptical overall, and realize that low P/E stocks might be that way for a reason, and returns on capital often mean revert. And stocks with higher P/Es and lower returns on capital on the surface can sometimes be the best investments if they are that way because management teams are making the right investment to increase long-term value at the expense of short-term earnings.
In light of all of that, I’ve realized the importance of really focusing on one’s downside protection, either in the form of a moat, balance sheet values, or some unique insight into the sustainability of earnings, because things aren’t always what they seem, and the future is sure to surprise me at some point, no matter how deeply I think I’ve read and researched something.
What does your typical day look like from beginning to end?
Boyles Asset Management – Joe Koster: On this topic, I’ve recently begun to read the book Daily Rituals: How Artists Work, and have really seen how people who have accomplished great things don’t really have a whole lot in common in their daily routines, at least not anything that can be seen as a universal type of rule. Their schedules and daily habits are personalized to their individual preferences and circumstances.
As for me, I’m usually more of a morning person, and the routine isn’t the same every day. But on a typical day, I get up, grab a cup of coffee and start the day going through my memory palace for about 15-30 minutes (which I described in a blog posted titled “Memortation, or One Way to Put What You Learn to Practical Use”). I then read through a few things—books and/or some reminders and quotes I’ve compiled—that I consider the fundamentals of my investing philosophy.
This usually takes anywhere from 15 minutes to an hour. I do this to make sure I stay on a disciplined path, as it’s all too easy for psychology and a good narrative to lead me, and probably most investors, astray at times. I then go through all my daily news and site feeds. As I’m going through them, I’ll email the things I find especially interesting to myself and link to them on my blog when I’m finished going through that process.
I then go through my daily, automated stock screens that get sent to me (more on that below) to try and see if any ideas pop up that look especially interesting. The goal here is really not just to try and find new ideas, but to compare what shows up with the stock ideas I’m currently working on to see if there’s something worth working on instead. In effect, it’s part of the constant process of trying to increase the opportunity cost of how I spend my time.
The time for news-related things and screens can be a bit unpredictable depending on how many interesting articles and companies show up in those processes, but after I’m finished with those, I turn my attention to whatever portfolio idea task is at hand, whether it’s researching what I think are the most attractive new ideas or keeping up with current portfolio holdings.
I usually leave the office in time to have dinner with my wife about every night, and then usually have an hour or two before bed for something additional, which usually involves catching up on the Charlie Rose show, “60 Minutes”, or something else I’ve recorded, and then either reading, watching a video or lecture, or catching up on some podcasts.
You mentioned that your heroes include Charlie Munger, Warren Buffett, and Benjamin Franklin. What did you learn from them?
Boyles Asset Management – Joe Koster: Besides the quality they all share of a lifelong commitment to continuous learning and improvement, they were—and continue to be in the cases of Buffett and Munger—all committed to giving back to society and leaving the world in a better place than when they entered it. They were all also quite skilled at figuring out what to avoid in life, or to put it as Munger often says it, “All I want to know is where I’m going to die so that I’ll never go there.”
What are the top 3 books people don’t talk about, but that you would recommend to an investor?
Boyles Asset Management – Joe Koster: I think Charlie Munger’s concept of developing worldly wisdom is hugely important, and besides the compilation of his thoughts and talks in Poor Charlie’s Almanack, I believe Peter Bevelin’s Seeking Wisdom: From Darwin to Munger is about the best place one can go to get an overview of the big ideas from the big disciplines. Two other books that I’ve made it a plan to re-read every year are Nassim Taleb’s Fooled by Randomness and Howard Marks’ The Most Important Thing, which I also think are brilliant.
What is your philosophy and process to investing?
Boyles Asset Management – Joe Koster: I guess the best way to describe our philosophy is “global value investors.” We define value investing the way Munger has in the past, which is simply acquiring more than you are paying for. We will look anywhere, but our main focus is on the developed, English-speaking countries of the world, primarily the U.S., Canada, Australia, and the U.K. We can invest in companies of any size, but we’ve primarily focused on small and micro-cap companies given the greater number of chances to find mispricings for a fund of our size.
We do utilize a large number of screens using Capital I.Q. as our research platform. We both have dozens of screens set up that run each week automatically, and in which we receive notifications when companies are either added to or removed from results. The screens are also pretty wide ranging. We have some for valuation or return on capital metrics, some for keyword searches in company filings, some for insider purchases, and so on.
Other than screening, we basically try and get ideas by reading widely and building our network of people that we are close with and who share similar investment philosophies. Before investing in an idea, we usually spend at least a several weeks digging into it.
Are there aspects to your research process that you would consider unique?
Boyles Asset Management – Joe Koster: I’m not sure our process is all that unique compared to others like us, but I think in-depth research in general is unique compared to the way most of the population invests. The one possibly unique thing we do is that normally one of us talks to management, while the other does not. This fits our own personalities better, but it also acts to balance the added understanding you can get from talking to management with the potential risk of having an enthusiastic CEO sell his company’s story well. It can become easy to get detached from the current numbers and potential risks that one should dispassionately consider before investing when in the presence of a charismatic executive, and that is a risk we take seriously.
How important is it for you to have investors in the fund that share your focus on the long-term?
JK: Having a long-term client base is certainly one of the most important advantages a fund like ours can have. There aren’t too many advantages one can gain over most in the market, but the ones we think are achievable and that we aim to have in place are:
- Process – An almost obsessive focus on process over outcome, or in the lingo of Scott Adams, on systems over goals. It’s okay to set big picture goals and you need to observe outcomes in order to assess and/or improve your process, but that is a small part of the day-to-day activity of focusing on your process and the things that within your control.
- Ego Elimination – Keeping your ego out of the investing process. If you don’t keep your ego out of the process, you are much more likely to fall for the psychological biases that are likely the biggest cause of investment mistakes. You can’t worry about looking good. You need to worry about finding out what is true and what is not.
- Long-Term Thinking – Keep a long-term outlook when it comes investing and analyzing businesses. There is a lot of noise out there, and being able to clearly focus on making long-term decisions isn’t always easy. After psychological mistakes, the inability to be patient and look past the short-term is likely the next major cause of investment mistakes, maybe even the biggest cause.
- Structural – This is where having the right client base comes in. Having investors that understand our long-term focus and that understand our philosophy is a big advantage to achieving success over time. Investing is the type of business where one can and will underperform for significant stretches of time, so having an investor base that will stick with us through the ups and downs is very important.
Do you have interest or expertise in a particular industry that you would call your “circle of competence”? Or are you more of a generalist in search of value or market inefficiencies?
Boyles Asset Management – Joe Koster: For the most part, we are generalist. We will look at anything that is simple enough that we feel we can gain an advantage over most people looking at it if we put in enough effort. To paraphrase Warren Buffett, we want to be able to narrow down what is important and what is knowable in each investment. We have to have some idea about what we need to know, and what we don’t need to know, while realizing that what we need to know can change as the price of an asset changes. And while we’d consider ourselves generalists, we have had some decent success in the past investing in insurance companies, largely thanks to the expertise that Matt has developed in that space over the years.
Describe your value discipline once you have arrived at an understanding of the Intrinsic Value of the business?
Boyles Asset Management – Joe Koster: We tend to focus on the downside first. We want to invest in things where we think we have good downside protection, and where fairly conservative assumptions lead us to believe the stock will be worth at least double what we are paying for it in 3-5 years (or sooner), based on the earnings or book value we expect for the business over that time and the range of multiples we think are reasonable for the quality of the business, based on our own assessment as well as current private market multiples, if there are good comparables. Because the future is full of surprises, we try hard to understand the downside as well as the reasons the opportunity is presenting itself, instead of just focusing on the potential upside.
Selling is usually more difficult. In general, we have a range of intrinsic value, but that range can be quite large. So we’ll usually tend to start selling some as it approaches the lower-end of our value estimate, and then sell out fully as it gets into the mid and upper end of our range. We’ll also sell earlier if we either have a better use for the cash, or if we realize we’ve made a mistake.
How do you think about managing risk (for each investment and portfolio as a whole)?
Boyles Asset Management – Joe Koster: We describe risk as both the probability and amount of potential loss on an investment. Trying to figure out the amount of potential loss is essentially what I was describing earlier when discussing our focus on downside risk. Trying to handicap probabilities is harder, because you can’t get the precise odds of being right when it comes to investing.
But there are traits to an investment that we try to focus on to improve our odds of success, even if we can’t quantify exactly how much those traits tilt the odds in our favor. These traits include things such as competitive advantages (moats), management teams with “skin in the game”, conservative balance sheets, downside protection in the form of tangible assets in the absence of moats, or buying from distressed or uninformed sellers, to name a few.
If you did know the precise odds and payouts of a given investment, then you could use the Kelly Formula to determine optimal position sizes. And while that kind of precision isn’t possible investing in a focused portfolio of equities, we do believe using the Kelly framework is a good way to philosophically think about position sizing even in the absence of precision.
For example, if you can consistently find ideas where you make 50% more when you are right than you lose when you are wrong, then even if you are right only 50% of the time, the Kelly Formula would say that the optimal position size on those investments should be 16.67%, or a total, fully-invested portfolio of 6 positions. We are looking for traits that hopefully give us better than 50/50 odds, and are usually looking for about a 3-to-1 upside-to-downside ratio, which should hopefully provide us a little extra protection from being wrong.
But even being conservative beyond that and assuming a ½ Kelly position size instead of a full Kelly position size would still yield a fully-invested portfolio of only 12 positions. So we think that range of 6-12 core positions is about correct for investors who are willing to put in significant amounts of work and only invest in their highest conviction ideas. We normally lean towards the higher end of having 10-12 core positions if fully invested to account for some correlation among securities, and could consider having more than one stock make up a given position if the attractiveness of those stocks is about the same and the correlations between them are high.
Of course, the odds and payouts change as prices change, and certain things may be being bought or sold over time, which can lead us to having a few additional positions. But in general, if we were fully invested, we’d expect to have 10-12 core positions, possibly less under the right circumstances. And if we can’t find things that meet our standards of being high conviction ideas, then we hold cash and just keep on searching. The discipline to hold cash in the absence of the right opportunities is also a key aspect in how we manage risk.
How do you handle currency risk, if at all?
Boyles Asset Management – Joe Koster: We’ve thought about this quite a bit given that we do invest internationally. As of now, rightly or wrongly, we don’t hedge our currency risk. The studies we’ve seen show that it tends to move closer to evening out over the long run—more than five years—though there certainly can be some significant effects in the short run, as we experienced in our fund during 2014. Hedging adds another layer of complexity and layer of decisions to make and as of now, we are really focused on trying to find things where the undervaluation is so great that over time, even if the currency moves against us somewhat, we’ll still earn a good return if we are right in our analysis on the opportunity.
But given that we also want to make sure that our ability to identify undervalued stocks shows up in our results, we are looking hard at implementing a hedging program if the cost to do so isn’t too great. As of now, we do think about how much exposure we have to a given currency and would consider pulling back from a country should we get closer to having an exposure of about 25% of our portfolio in a given foreign currency, and that percentage would likely be quite a bit lower if we were investing in lesser-developed countries.
Are there potential areas of opportunity that investors should be aware of over the next 6-12 month and beyond?
Boyles Asset Management – Joe Koster: Our time frame is usually based by looking out 3 to 5 years at the businesses we are looking at, and we claim to know very little about anything that will happen in the next 6-12 months. But in general, we are still finding a lot more opportunity in international markets. Our work is based more on working from the bottom-up, but I think if you look at the cyclically adjusted price-to-earnings ratios from around the world, it confirms the general view that the U.S. is one of the more expensive markets out there right now.
When it comes to oil, and anything macro-related, I’m reminded of the Howard Marks quote: “It’s one thing to have an opinion of the macro but something very different to act as if it’s correct.” The big drop in the price of oil has certainly increased the number of energy-related ideas that are popping up on our screens. And while we tend to think there is a decent probability that the long-term price of oil will be much higher than the $50 or so it is at today, we don’t want any investment we make to have its downside protection depend on that, and so we’ve a pretty careful and measured approach to looking at companies in that space so far.
We’d love to take advantage of the volatility, but we want to make sure we have downside protection before putting capital to work, just in case energy prices stay subdued for an extended period of time.
What is the #1 mistake that investors make as it relates to investing in general?
Boyles Asset Management – Joe Koster: While I hinted at this a bit earlier, I think the biggest mistakes investors make fall largely into the categories of: 1) Psychological; 2) Lack of Patience; 3) Underestimating Competitive Forces; and 4) Extrapolating the Recent Past into the Future.
At the top of that list for me are the psychological mistakes. There are so many biases that can work against investors that I think everyone is bound to make a psychological mistake at some point. Being aware of those biases is something that I think is essential to being successful over a long period of time, because it is very easy to fool yourself into doing something you shouldn’t do. As Richard Feynman said: “The first principle is that you must not fool yourself, and you are the easiest person to fool.”
What are The 3 Things an investor should focus on the most to produce out-sized investment returns over the long-term?
- Develop a process that you stick to and continually improve over time.
- Remember that no matter how much work you do and how much you think you know, the future will always be full of things that you never see coming.
- Remember that you just need to find a few intelligent things to do, or as Charlie Munger put it: “Our job is to find a few intelligent things to do, not to keep up with every damn thing in the world.”