So We Get Questions
Q. Should we be concerned that you have a small investment team? How can you cover hundreds of stocks? Won’t you miss things?
A. No, we don’t need to, and of course. We run a concentrated portfolio that strives for low turnover. Classic behavioral finance and my personal practical experience suggest that the amount of intensely motivated and bright people in a room is highly correlated to the amount of turnover in a portfolio. If we ran a 150 stock portfolio that was equal weighted to a benchmark and our world was about beating a sector by 100 basis points, having 20 people spread widely would be a natural structure. That’s not us and the history of performance measurement suggests an inverse relationship between size and bodies, and performance. Just as nearly every New Yorker suffers from apartment envy from time to time and nearly every Los Angeleno has at one time looked wistfully at the Ferrari stuck in traffic next to him, every investor compiles a growing list of woulda coulda shoulda’s as the years go by. Good results are much more about consciously missing potential mistakes and being mostly right about decisions you do make, rather than swiveling your neck into a frenzy at what may or may not be happening next door.
Notes from the Front Line: UCLA
The opinions expressed herein are not those of Cove Street Capital. The post was written by Ben Claremon, an employee of CSC, and includes his summaries of speeches given at a recent UCLA Anderson Investment Association Conference. You should not consider this information a recommendation to buy or sell any particular security. You should not assume that any of the securities discussed in this report are or will be profitable, or that recommendations we make in the future will be profitable or equal the performance of the securities listed in this report. Cove Street Capital is an investment advisor registered with the Securities and Exchange Commission. Consider the investment objectives, risks and expenses before investing. Past performance of CSC is not a guarantee or indicator of future results.
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This past Friday, Cove Street Capital was in attendance at the inaugural UCLA Anderson Investment Association Conference. For those of you were unable to attend, I put away the 10-Ks, dusted off my laptop and took my note-taking skills out of cold storage so that I could provide my customary summary of the discussion. What follows is an Investor’s Overview of the conference and then a link to my full-bore set of notes.
by Ben Claremon, Research Analyst
Investor’s Overview:
Greg Farber Joins CSC Marketing
I am of the belief that there is a lot of misconception between a goal and a strategy. Our goal is to have a superb performance record and be surrounded by delighted clients and colleagues. Our strategy is to deliver performance through diligent research and introduce our firm to prospective partners and their intermediaries with a well-reasoned and transparent approach.
On that note, I am incredibly pleased to welcome Greg Farber to Cove Street Capital as a Director of Institutional Marketing. I have known Greg for almost 15 years as both a consultant and client, and I am confident that he can assist in our efforts to match our skills and service with the right clients.
CLICK HERE to download the hiring announcement.
In Support the of Home Team
by Ben Claremon
It was less than two years ago that I was sitting with some of my UCLA Anderson classmates, desperately trying to figure out what to do for our Applied Management Research or AMR project. Most students fulfill this requirement by completing a consulting project for a local company and writing a paper detailing their recommendations. However, we had our sights set on a different kind of project, one that would have a much greater impact on Anderson. As a result of our efforts and after almost a year of discussions and planning, Anderson’s inaugural Investment Management Conference will take place on February 10th 2012. Here is a list of the fantastic speakers and conversation moderators the talented current MBAs have lined up to participate:
- Howard Marks: Chairman of Oaktree Capital Management
- Steve Romick: Managing Partner of FPA Funds
- James Ware: Founder of Focus Consulting Group
- Drew Zager: Managing Director of Morgan Stanley
- Dave Carpenter: Portfolio Manager at Capital Group and an Anderson graduate
- Chris Brightman: Director and Head of Investment Management at Research Affiliates
- George Letteney: President and CIO of the UCLA Investment Company
- Jonathan Sokoloff: Managing Partner at Leonard Green & Partners
- Dan Ewell: Chairman of the Western Investment Banking Division at Morgan Stanley
For anyone who is going to be in the LA area next week and would like to attend, I believe there read more…
What We Are Thinking: Approach Resources
by Eugene Robin
Approach Resources, Incorporated (AREX: NASDAQ) is an independent oil and gas exploration company located in west Texas. As a spinout from energy private equity firm Yorktown Partners, Approach situated itself on land that was, at the time, a natural gas play on what was known as the Ozona Uplift formation. The average purchase price for each of their acres from 2004 through 2009 was roughly $300 per acre. In parallel to the company’s acreage acquisition, several other larger E&P independents moved into acres north of their foothold to explore a new shale discovery named the Wolfberry/Spraberry field situated on the Permian shale reservoir. Eventually it was realized that the entire Permian was a strategically important “oily” shale play with an average of 60 percent oil content in addition to the 20 to 30 percent natural gas liquid (NGL) production expected from a typical well.
Even though it was located on the marginal edge of the Midland Basin on the Permian, Approach was successful in initially proving out their acreage via a vertical well drilling program into the “Canyon/Ellenberger” formation. These vertical Canyon wells show after-tax internal rate of return (IRR) of 12 to 14 percent based on $3-gas and $80-oil assumptions. Interestingly, the wells on their own were enough to create over $300 million in net asset value (NAV) for the company, which in early 2010 was only around $220 million in market cap. In response to the new “fracking” sensation Approach began to prove out their acreage for both vertical and horizontal fracked wells in early 2010, naming the horizontal program the “Wolfcamp” and the vertical “Wolffork.” The released type-curve for the Wolfcamp horizontal indicated poor initial production (IP) rates and estimated ultimate recovery (EUR) relative to those of their peers in the area, EOG Resources, Incorporated (EOG:NYSE) and El Paso Corporation (EP: NYSE). Initial results supported the expected curves and as a result, the stock floundered and declined as people wrote off the horizontal play as a flawed attempt on flawed acreage.
A Plea for Higher Interest Rates
What’s great about Jim writing for the unwashed minority (those who toil in official positions in Washington) is that you can re-link and comment without running into the Wrath of Grant’s for violating his confidence as a paid-up subscriber. Our point here is that he is echoing our current belief that the current level of government mandated interest rates is a disaster for the economy in many ways, one of which is the depressive nature on the spending habits of the saving class.
On a similar note, one of the other two paid subscriptions we have to outside research comes from the desk of Jim Bianco. “Simply, the actions of people like Ben Bernanke or Mario Draghi matter far more than any specific fundamental of a company. It’s as if every S&P 500 company has the same Chairman of the Board that only knows one strategy, resulting in a high degree of correlation between seemingly unrelated companies. Massive central bank/government involvement in markets risks returning us to a de facto centrally planned economy. Every time the Federal Reserve opens a swap line or the ECB hints at another program to stem the crisis the central banks/governments are trading a short-term fix that raises all boats, even the bad ones, for an even more inefficient capital allocation process.
Co-written by Jeffrey Bronchick & Ben Claremon
A recent article in the Wall Street Journal—from which we lifted the chart below—once again highlights the never-ending debate about the merits of growth versus value, a discussion that inevitably forces an investment manager to self-reflect. What kind of stocks am I investing in? What kind of manager am I? Will I be judged unmercifully if I am perceived to be picking outside of my “box?”
![[VALUE]](http://si.wsj.net/public/resources/images/BF-AC072A_VALUE_NS_20120106163003.jpg)
Yes, there remains hundreds of billions of dollars managed via a mental process in which these issues are incredibly real and potentially career threatening, despite a lot of evidence to the contrary. There have been “rumors” that the “long equity” investing world is breaking down these boxes. This is the result of some unsatisfying results in 2008, not to mention the inherent complexity and costs of assembling a 24 manager roster in order to cover all bases; however our own experience suggests that these efforts remain at the margin.
We would note several issues:
Trying This at Home
We reprint with permission a recent email from a sell-side colleague who we hold in high regard, despite his familiarity with the institutional investment consulting industry (laugh here). Like any number of experienced investment people, he has seen a lot of what passes for money management and thus he has always harbored a sneaking suspicion that he could do it at least as well as any number of individuals he has witnesses.
But as a universal truth of managing money, sometimes things just don’t go our way, despite however many hours or bodies are thrown at the issue. ANYONE who has tried to take investing seriously has felt what is expressed below.
And jumping ahead, while we are looking gingerly at RIMM and Nokia, (Who doesn’t have the rubbernecking gene?) we have nothing intelligent to contribute to the conclusion at the current time.
—begin reprint—
Dear Oracle of all things squat and curious (unfortunately he means me):
I could use some help. I’m struggling with my faith. Can you help me with perspective on what I’m not doing in my analysis, or not looking at in my analysis? I don’t mean technically on the math, but conceptually on the approach.
Click HERE to download Cove Street Capital’s December Strategy Letter, Volume 1-Issue 4, “Tis the Season I Doubt You Will Remember.”
