We are pleased to present an interview with Austin, Texas-based value investor Brian Bares. Bares Capital Management was founded in 2000, initially focusing on investments in micro-cap public companies. The firm launched a small-cap strategy in 2001. Brian has adhered to a disciplined business strategy, limiting the growth of assets under management over time. Brian is the author of the newly published book The Small-Cap Advantage: How Top Endowments and Foundations Turn Small Stocks into Big Returns.
Our first interview with Brian Bares was published in the August 2009 issue of The Manual of Ideas and focused on Brian’s investment philosophy. This month’s interview focuses on some of the topics covered in Brian’s new book.
Brian T. Bares, CFA, is a Research Analyst with Bares Capital Management, Inc. He founded the firm in 2000 with the belief that concentrated portfolios of inefficiently priced small companies could lead to high relative compounding. His firm manages institutional portfolios of small-cap and micro-cap common stocks in long-only, replicated separate accounts. Bares began his career by working his way up from the bottom. From compliance and operations, to trading and portfolio management, he garnered experience in nearly all aspects of running a boutique small-cap manager before starting his own company. He graduated from the University of Nebraska with a degree in Mathematics. His investment philosophy and strategy have been profiled in Value Investor Insight and The Manual of Ideas. Mr. Bares holds the Chartered Financial Analyst designation and is a member of the CFA Society of Austin.
MOI Global: Much has happened in the markets since we last interviewed in August 2009. How have rapidly rebounding equity prices affected your ability to find bargains? What are you worried about most today?
Brian Bares: Our investment process is different from that of other managers. We do not screen for low prices in comparison to earnings, cash flow or book value as a starting point for our research. We seek out competitive businesses run by exceptional managers. In this respect, our search for value is qualitative instead of quantitative. Our contention is that the market chronically undervalues exceptional businesses and management teams. Today we are finding more of these than ever before. Prices have risen since we last touched base, but we are finding opportunities where the recognition of exceptional qualitative factors has yet to manifest itself in market prices. In many cases, underlying business value and earnings power has recovered more quickly than market pricing. Our worries today are no different than our worries were in 2009. We are concerned with the economic exposures of our businesses. Because we run concentrated strategies, we attempt to minimize correlation between the drivers of value within our portfolio.
Our contention is that the market chronically undervalues exceptional businesses and management teams. Today we are finding more of these than ever before.
MOI: We recently had the pleasure of reading your newly published book on the small cap value process. You generously provide a blueprint for institutional investment in this part of the equities universe. What differentiates your book, and what is the key message you are hoping to get across?
Bares: There are a few differentiators. First, the book focuses on the opportunities available to small stock investors who cap their asset base. Capping assets is critical for managers who wish to maintain flexibility in the space. Most professional small-cap investors who experience success attract significant asset inflows. This handicaps their potential for sustained outperformance. An increased asset base leaves a manager with two choices — increased diversification within the portfolio, or increased market cap of potential ideas. The first choice crimps potential returns, and the second choice increases competition for investment ideas.
The second differentiator is that the book offers a window into the challenges of growing an institutionally-focused small-cap firm. Institutions and their consultants should be able to come away with a greater understanding of how they can increase performance by investing with small entrepreneurial managers and what extra due diligence may be required before committing capital to these managers.
MOI: The historical outperformance of small caps and their relative illiquidity are well documented. What are some of the less well-known advantages and disadvantages of investing in small caps?
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