G&D Spring 2021 Issue: inteview with Bares Capital Management’s Brian Bares

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Interview with Brian Bares, the found of Bares Capital Management, from the Graham & Doddsville Spring 2021 Issue.

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Brian Bares founded Bares Capital Management in 2000. BCM manages $5.6 billion across two concentrated, qualitatively oriented strategies: Mid/Large-Cap and Small-Cap. Brian is the author of The Small-Cap Advantage, published in 2011 by John Wiley & Sons. He is also an external advisor for the M.B.A. Investment Fund at The University of Texas at Austin. He graduated from the University of Nebraska with a B.S. in Mathematics (1995) and has earned the CFA designation.

Editor’s Note: This interview took place on March 30th, 2021.

Graham & Doddsville G&D: Brian, thanks for being here with us. I was hoping we could start with you walking us through your background and what started you down the investing path?

Brian Bares: Sure, well, I grew up in Nebraska. My father was an eye surgeon, and I enjoyed watching him kind of expand the scope of his own business, engage in some entrepreneurial ventures and that dinner table talk sparked my interest in business, and he was very interested in stocks and would select his own portfolio positions from the 52-week low list in the weekend newspaper. And I started reading some newsletters and annual reports in high school and happened upon a publication called Outstanding Investor Digest, which chronicled a lot of what Buffett was doing and some of Buffett's contemporaries.

And then, of course, I read the Berkshire Annual Letters and was pretty much hooked at that point. I went to University of Nebraska, studied math and actuarial science, moved to Austin shortly after college and worked for an investment manager, who had some institutional clients and a high net worth practice. The firm was small and it was growing very quickly, and I got the privilege of having a lot of responsibility fairly early. And that gave me a great inside perspective on the various aspects of the firm. So I learned a lot both from an investment standpoint, and in dealing with the operations, trading, compliance, etc. And that gave me a lot of confidence when I made the leap at 27 years old to launch my own firm.

G&D: In terms of your early influences and mentors, either personally or folks that you looked up to from afar, who were the major influences on you? And with Buffett being from Nebraska and kind of the local investing hero, how much of a role did that play in your development?

Brian Bares: Yeah. Warren Buffett is clearly on the list, but he wasn't quite the superstar when I was growing up that he is today. He was actually fairly low profile, even in the city of Omaha in the 80s and the early 90s, and then he exploded into superstardom in the mid 90s. I clearly looked up to him, and reading the Berkshire Letters was a huge catalyst for me and my interest in investing generally. But thankfully, I think I got my hero worship out of my system at a fairly early age.

My earliest mentor was my father, who is the ultimate contrarian and very self confident and is completely comfortable operating alone when he feels like his reasoning and rationale are solid for making a particular decision, especially in business. And so I think I inherited a fair amount of that. And that has been a key in my success I think.

The founder of the firm I previously worked for is a guy named Mark Coffelt, who was also an early mentor. He taught me a fairly powerful lesson about hiring smart young people and empowering them to make decisions. And the autonomy and the agency that I felt as a young contributor on his team was a very powerful motivator for me, and it made me want to work harder and smarter for him. And that is a lesson that I've taken and applied at our firm.

I've never met David Swenson, who is the Yale CIO. But his book Pioneering Portfolio Management when it was published in 2000, was a huge catalyst for me starting the firm and growing the firm, and it was very critical in our early success, because it was essentially a guide book for where institutional allocation was headed, and where we could potentially fit into what is now known as the endowment model.

Ironically, some of my greatest mentors after starting my firm were actually institutional allocators. They helped me navigate some critical decision points along our path to success. So people like Ellen Shuman, who ran the Carnegie Corporation of New York for years and Anders Hall, who was at Duke, and now is the CIO at Vanderbilt University. They are two people that are probably unaware that they're mentors to me, but they have been extremely influential in my professional life.

G&D: That's great. You mentioned Swenson's book and launching the firm at a young age – was that the signal that kind of told you, hey, I'm ready to do this and strike out on my own here?

Brian Bares: Absolutely. It was critical. So my experience at the time was with a firm that was highly diversified in its portfolio implementation and almost purely quantitative, which are exactly the opposite of what we do today. And so, as I was working for this company, I noticed that institutional allocators were using a series of intermediaries, primarily investment consultants to choose 10 to 12 public equity managers each holding 100 stocks. And to me, it just didn't make any sense at all, because everybody's paying active fees and getting passive results. And at the time we would add a 50th, or a 60th name to the portfolio, and it was almost inconsequential in the grand scheme of things for the end client.

“I noticed that institutional allocators were using a series of intermediaries, primarily investment consultants to choose 10 to 12 public equity managers each holding 100 stocks. And to me, it just didn't make any sense at all, because everybody's paying active fees and getting passive results.”

And so I just gravitated from first principles towards this idea of concentrated portfolios. But given the state of the industry, I didn't know whether somebody who was 27, with very little experience, who didn't work on Wall Street and hadn't lived in New York could actually compete successfully for institutional allocations. And it was that book that gave me my “A-ha” moment where I said to myself, that the institutional allocator community will gradually adopt this endowment model, which internalized investment due diligence at the expense of relying on a lot of these third parties, institutional investment consultants and the like.

I thought that internalization of the due diligence process would allow for unconventional, younger, less tenured managers, like what I was contemplating at the time to successfully compete for large institutional allocations. And if there was any kind of a stroke of structural genius in founding the firm, it was a recognition that the endowment model would be widely adopted, and there would be a kind of categorical shift towards concentrated long-only public equity managers like Bares Capital.

And so we've rode the wave of adoption of concentrated managers as almost a new asset class like infrastructure, private equity, or venture. And so the 60-40 stocks bonds model gave way to the endowment model, which included a number of additional pie slices in the institutional asset allocation pie chart, and the public equity piece shrunk, but the constitution of managers within that piece reshuffled in favor of concentrated managers at the expense of the diversified 100 stock 1% managers from the mainline Wall Street firms. And so we were the beneficiary of that gradual shift over the last few decades.

G&D: It sounds like you had a very clear vision for the value proposition that you would have to these allocators. What were those early fundraising conversations like because of your age, and just given that you hadn't been a portfolio manager at a firm before? What did you point them to, to convince them that you were worth taking a shot on?

Brian Bares: Well, that's the trick, right? I am pretty fortunate in having had some institutional validation, some success and growth in assets under management. And so, I have a lot of emerging managers asking me this exact question. Because there are a lot of people out there that are pretty good compounders, good analysts, but they have a difficult time with the fundraising, and getting that first client and so that zero to one conversation is a very difficult one.

I think there's a couple things that are important, the first is that the personality characteristics of the actual manager are important. The first thing I learned is that I can't outsource the fundraising to somebody else if I'm a new manager. I have to go and give the impassioned pitch for the money myself, because I'm the one that believes in this process the most, and they're going to want to meet me and do the due diligence on me and make sure that they're comfortable with me as a manager to make that initial allocation.

“...the personality characteristics of the actual manager are important. The first thing I learned is that I can't outsource the fundraising to somebody else if I'm a new manager. I have to go and give the impassioned pitch for the money myself, because I'm the one that believes in this process the most, and they're going to want to meet me and do the due diligence on me...”

The second thing is I wanted to make sure that I could articulate a repeatable investment edge, and we can talk about the investment process itself in a moment, but I think we had a pretty good story around that. And then third, in a time and resource scarce early iteration of Bares Capital Management, I needed to focus on the smallest part of the US equity market, which is micro cap, and essentially sell the scarcity of a concentrated portfolio, implemented in micro cap.

And that was very appealing to the endowment managers. The capacity limitation meant that I was signaling that I wasn't an asset raiser, that I was going to close and I kept that promise of closing and occasionally giving money back to investors as we were successful. So just sort of fighting my own economic incentives to raise portfolio diversity beyond what was optimal for future compounding was something that allocators did and still do seek out in boutique managers.

I think another important point is that I was also doing this at a time that was pre-Madoff, and so there was a little less, frankly, operational due diligence than there is today. It was also coincident with the proliferation of hedge fund allocations. And so there was a lot of money going to brand new startup hedge funds. And that those same people, in many cases were due diligencing the public equity managers. I think that the early Bares Capital story sort of felt a little bit analogous to some of these startup hedge funds. At the time there was a little bit more of an appetite to take a bet on newer managers.

Read the full G&D Spring 2021 issue here.