Czech Investment Conference (details available HERE) is behind the door (11.11.2019) and I had an opportunity to ask founder and portfolio manager of Curreen Capital Christian Ryther few questions. Christian is a value investor with primary focus on global small-cap companies and special situations. I asked him about his investment philosophy, portfolio concentration, spin-offs, current investment opportunities and much more.
Mr. Ryther, thank you for the interview.
- Could you give us a brief summary of your investment philosophy?
It is a mix of Warren Buffett, Charlie Munger and Joel Greenblatt. The short version is that we want a good business, with a good management, selling at a good price. That tends to mean different things to different people, so the slightly longer version is: we invest in businesses that can sustain after-tax returns on tangible capital above 20%, with management teams that operate the business well and allocate capital intelligently, where we can buy with an upside-to-downside ratio of more than 5-to-1.
I think that it is difficult to find businesses with all three of those characteristics, so we focus on areas where our odds of finding a good investment are better – spinoffs, unusual transactions, and turnarounds. Even with this focus, we only find a few investments that meet our criteria, which means that we end up with a very concentrated portfolio.
- Your focus is primarily on global small-cap companies and you have quite concentrated portfolio. If I am not misunderstood, you have only 7 stocks (according to 3Q/2019 investor letter HERE) and your four biggest positions are responsible for more than 50 % of your portfolio. This is quite unique for a small-cap value fund. Why such a huge concentration?
This is the result of our investment criteria – I have trouble finding dozens of businesses that meet each of our three key criteria. Great businesses with intelligent management are seldom attractively priced, and the cheap things that I find seldom meet my management and business quality requirements.
I could buy more stocks if I relaxed my requirements (especially on price), but I would rather have a volatile portfolio with great investments than a less volatile portfolio with ok investments.
- It must be very volatile portfolio. Your clients must have a lot of discipline, patience and strong stomach to withstand such volatility. Do you choose your clients personally to be sure they perfectly understand your investment strategy and so they provide some sort of “permanent capital”?
The partners in the fund all found me in various ways, rather than having salespeople bring them in. So they bought into the fund, rather than being sold on the fund. I think that their having chosen to join makes them less likely to panic when we inevitably face reversals. I have written or spoken with each of them, and I like them all and think that they have good self-control. So far this has been my experience. We have had painful months and quarters, and while I do not hear “congratulations” when that happens, I have not heard anger or frustration either.
I think that I have excellent partners, who understand our investment strategy and trust me to execute it. But I cannot call it “permanent capital”. Everyone thinks that they are a long term investor, but bear markets demonstrate that many, many people panic and sell.
- I assume that part of your job is also to take your clients through difficult times, to explain them regularly your investment strategy and positions in your portfolio, so they are comfortable with it. Is it difficult for you and how much time does it take?
The main ways that I communicate with our partners is in writing our quarterly letters, and periodically reaching out with email and phone calls. I also had a partners meeting a few months ago – where everyone could speak with me in person.
I would not say that it is easy for me. I tend to think about the conversations a lot before I have them, which sort of doubles the time spent. But I enjoy communicating with my partners – after all, they are lovely people who trust me.
Time-wise, it is probably a week or two of work per quarter, if I added it up.
- Crucial factor in concentrated portfolios is to avoid serious mistakes, which can have devastating effect on the performance. How do you avoid these mistakes?
I think that I use three elements in trying to avoid mistakes: following our investment strategy, following my process and reviewing my actions to look for patterns.
By sticking with our investment strategy, I stay in situations that I have demonstrated that I can succeed in, and that should succeed over time (after all, a good businesses with good management that is selling at a cheap price should do well over time). I see a lot of potentially interesting investments, and eliminate them because they do not fit one of our three key criteria. For example, there are a lot of mediocre businesses that are super cheap – and I do not work on them. And there are bad management teams running great businesses – and I do not work on them either. So by following our investment strategy, I can keep myself away from areas that I consider more dangerous, and more likely to produce mistakes.
My investment process has a few elements that are designed to reduce my risk of making mistakes. The upside-to-downside ratio requires that I have a downside valuation. I think that it is helpful to think through what a reasonable downside scenario would look like, and look at what the business would be worth if that happens. This has killed ideas for me – ideas that I liked a lot, but where the business could be devastated if bad things happened. I also write a premortem before making trades – I write out what could make my proposed purchase (or sale) a disaster. This is like brainstorming, in that it give my mind free reign to think of bad things that I might otherwise have ignored. I use the ideas that I come up with to adjust my downside valuation and ask myself whether I truly want to bear those risks at the current price.
I also review my actions and look for patterns – usually after I am frustrated or have made a mistake. This led me to realize that I have had very poor results from buying illiquid microcap companies (<$50m market cap). There is nothing in our investment strategy or process that makes microcaps a less attractive area for investment, but I have a terrible track record with them. So I now avoid microcaps, just as I avoid mediocre businesses, bad management teams, and unattractively priced stocks.
- Do you confront your analysis with the opposite opinion of short sellers?
I do not go out of my way to find short sellers (or fellow owners) in the stocks that we buy. I follow Buffett on this – when I get up in the morning and look in the mirror, everyone has had their say.
I think that the most shorted stock that we owned was Credit Acceptance, and that rose and rose while we owned it. And where I have made mistakes, I do know of anyone who was short those stocks.
- It seems (from your 3Q/2019 letter to investors) that you are lately mostly focusing on spin-offs. Could you tell us how you evaluate these special situations?
I evaluate spinoffs the same way that I evaluate other businesses – working to determine the quality of the business, the ability of management, and what I think that combination is worth. Where spinoffs are more difficult is in getting data – sometimes I have trouble finding historical financials for more a few years in the past, and management seldom has a long public track record of allocating capital. I can usually assume that they have been successful in operating the business – otherwise they would not get to run it.
I think that I have an advantage in spinoffs where I can piece together historical financials from the parent company or prior owners. This is not rocket science, but it is not as easy as just using the spinoff filings. I develop my views on the business and then compare them to what the spinoff company’s management is saying about the business. Where the management of the spinoff intelligently addresses the issues that I think matter, I become more confident about them.
I think that evaluating a spinoff business is reasonably straightforward, though I may have to put together older financials myself. Evaluating the management team is more difficult – I have an initial opinion of them, and have to keep updating that opinion as time passes and new information comes out. I usually base my initial opinion on what they have done in the past, and what the parent company has done in the past (for example, did the parent company direct free cash flow to share repurchases, dividends, or M&A?). This allows me to have an opinion even when management has been noncommunicative or vague.
- The evaluation must be very difficult, because you don´t have any reliable audited history. What models do you mostly use and what are the crucial factors when you are evaluating spin-offs?
I addressed some of this above.
My overriding model of the world is that people and businesses will continue to do what they did in the past. So I home in on what the business did in good and bad times in the past, and failing that, how competitors did. I also look at how management has allocated capital in the past (perhaps at other companies), and if that is not available, I assume that they will do what the parent company has done – because that is the environment that they ‘grew up in’.
- How long does it take (on average) to analyze a spin-off?
I will stop looking at any idea as soon as I realize that it does not meet one of my three key criteria, so sometimes it is a very short look. If everything continues to meet my standards, I can usually have an opinion on the business, its management, and what I think the 5-to-1 upside-to-downside price is in a week.
That is my initial view, and I update it as I get new information.
- In US it is an obligation to announce any spin-off to SEC, therefore a list of these special situations is easily accessible via EDGAR. Where do you find spin-off opportunities in Europe and Asia and all reliable documents, which are necessary for your analysis?
The two main ways that I find non-US spinoffs are through Bloomberg searches and using google alerts.
It is certainly more difficult for me to find the relevant information with non-US spinoffs. As with US spinoffs, I often have to piece together financial history using parent company historical financials, supplemented by looking at the financials of competitors. I sometimes stumble onto useful information in specific countries – Companies House in the UK, for example, has been useful in looking at private competitor financials, or historical information for meaningful divisions of the company that I am researching.
Evaluating management’s capital allocation skills is always difficult, and I tend to rely on the assumption that management will allocate capital in the “normal” way for their home country or industry, unless I have good information that they will do something else.
- Do you think that special situations are an area for individual “weekend” investors?
I think that they can be – if you focus and know what you are doing. You want to focus your efforts on areas where the base rates are positive, and spinoffs have historically produced good returns.
The key is that you know what you are doing (valuing businesses) and know yourself enough not to get too greedy or fearful. If you can do those things, you are probably already a successful investor, and spinoffs and other special situations can be a great place for you to apply your talents.
But if you don’t know what you are doing… then I would encourage you to outsource your investing to someone who you can trust, who knows what they are doing.
- Where do you find currently most opportunities? Is it in the area of spin-offs or excellent businesses with exceptional management? And which regions are most attractive?
For businesses that meet my criteria, it seems that the areas that are most attractive are companies that are likely to have weaker earnings in 2020. Either a cyclical company where investors seem worried about a recession, or businesses facing a more company-specific headwind. I have seen businesses with these issues offer better upside-to-downside ratios that many others in the stock market. If I had to pick a geography for the companies facing these factors, it would be Europe.
I have seen only one spinoff in the 2019 that excited me, but there are several spinoffs from the past few years that are interesting.
- What is your search process for identification of excellent businesses with exceptional management?
I look at every spinoff, tender offer, and other ‘strange’ transaction that I can find – evaluating the businesses against our three key criteria. I also read the newspaper, scan the new lows, and talk with other investors – and evaluate the businesses that come out of those sources the same way. Since potential investment ideas come in bunches, I write them down on a pad of paper, and then flip through it looking for interesting businesses when I am ready to analyze a new business.
- Could you tell us about your biggest investment mistakes?
I think that my biggest mistakes have been microcap investments and Socket Mobile in particular. My issues with Socket are similar to my problems with microcaps in general.
I became interested in Socket in early 2018 when they announced a tender offer for 17.8% of the company. I looked at the business and thought that I saw a good business emerging from years of weak performance. I saw that they had had a weak quarter, and reasoned that only idiots would push through a tender offer when business results were continuing to weaken. I thought that management was repurchasing shares before it became obvious that business had improved.
I completely misread the situation, and then held on to my view that this was going to be a great business and that management was good – for far too long. I continued to buy shares through several quarters of weakening business performance, when it should have been clear to me that I had made a mistake, that the business and management were not of the quality that I had believed.
While I could make this mistake—of misreading a situation and holding on to my erroneous belief in the face of mounting evidence—with any company, I believe that this is more of a problem for me with microcaps. I have a desire to root for the little guy, and so am more likely to misperceive small businesses and their management teams as better than they are. And selling an illiquid position is much more time consuming and frustrating when I realize that I am wrong. I can sell a position in a $1B market cap company in a day or two, with Socket, it took us months to get out – and our selling still moved the price.
- And what was the best investment of your life?
Going to Columbia Business School is probably the best investment of my life. I had been extremely interested in investing, but did not really know what I was doing before business school. At Columbia I learned the basics and was exposed to the full gamut of value investing. That was a great start for me to direct my own learning and develop my own investing strategy. Beyond that, Columbia got me to New York City, which had intimidated me, and in meeting top notch people – gave me the confidence to put my ideas against anyone else’s.
The best part was that I met my wife while I was at Columbia.
All in: a great investing foundation, self-confidence, and my wonderful family – Columbia was a great investment!
- And last question. Could you give us any clue about your investment opportunity which you are going to present on Czech Investment Conference?
As much as I have disparaged microcaps, I will present on a company with “Micro” in the name.
Thank you very much and I hope you will enjoy Prague and Czech Investment Conference.
Christian Ryther has been passionate about investing since he read Peter Lynch’s “Beating the Street” in his early teens. He loves hunting for unexpectedly beautiful businesses, and seizing opportunities in an endlessly shifting environment.
Like many investors, Christian earned his MBA at the Columbia Business School and went through its value investing program. Unlike many investors, Christian was a Peace Corps Volunteer in Morocco.
Christian also runs, a lot. He ran the Boston Marathon in under three hours before embracing ultramarathons. It took more than 25 hours through 90 degree heat, but he earned second place in the Black Hills 100 mile race.
Christian’s passion, determination, and heart drive results for Curreen Capital’s partners.