We had the pleasure of interviewing Lisa Rapuano of Lane Five Capital Management.
Lisa Rapuano founded Lane Five in January, 2007. She managed a long/short equity hedge fund for Matador Capital Management for over two years prior to founding Lane Five, and spent over ten years at Legg Mason Capital Management. At Legg Mason, she was the Director of Research and portfolio manager of the Legg Mason Special Investment Trust. She co-managed this fund with Bill Miller from 1997-2000. As sole manager of the fund from 2001-2003 she achieved top-decile returns as tracked by Lipper. Lisa graduated from Yale in 1988 and received her CFA designation in 1994.
MOI Global: Tell us about the genesis of Lane Five. What goals did you have at the outset, and what principles have guided you since then?
Lisa Rapuano: At the end of 2006, I sat down with a blank sheet of paper to design a firm and product I thought would do three things: (i) optimize the skills I had learned in my fifteen years (at the time) of managing money; (ii) create a vibrant workplace of smart, energetic people with shared values; and (iii) attract clients with a long-term focus and a deep understanding of our values and process.
To have a large short book and manage risk, you must have many more positions and you have to be very sensitive to timing. This type of thinking is not the mirror image of the long investment process; it is actually counter to it. I found one could spend an inordinate amount of time on hedge shorts, add very little value and create a massive diversion of resources.
To optimize my own skills, I looked at my experiences, my temperament, what I had loved to do and what I had not. I love and am good at picking apart companies, finding and evaluating contrarian ideas, gaining deep conviction from thorough research, looking at businesses with a long-term view, ignoring short-term noise, getting to know managements and companies exceedingly well, and working collaboratively with a small team. I’m very patient in my investments. So, Lane Five was designed to invest in a relatively small number of names with a three-to-five-year time horizon with no constraints on market cap or stylistic definitions of value.
We adopted a long-biased approach, where we run 60-100% long. We can hold tons of cash and/or short if we think the opportunities merit that approach, but we’re not running a hedged, volatility constrained portfolio. I think that shorting is appropriate in certain circumstances and the ability to short makes you a better analyst. When I co-managed a traditional long/short low exposure fund at Matador Capital Management, I learned a lot about shorting. I am very good at identifying bad businesses and high valuations, and if you are patient with those two characteristics in place, shorting can be a low-risk, value-added activity. However, if you are running a very long-term value portfolio on the long side, a traditional hedge portfolio is often largely mismatched with your long book and mismatched with your analytical resources. To have a large short book and manage risk, you must have many more positions and you have to be very sensitive to timing. This type of thinking is not the mirror image of the long investment process; it is actually counter to it. I found one could spend an inordinate amount of time on hedge shorts, add very little value and create a massive diversion of resources. So, when I decided to create something new, I decided shorting would be a limited part of the strategy and exposure would run predominately long.
…the value of a company is the present value of its future free cash flow. This is a concept that goes all the way back to the first dividend discount model developed by John Burr Williams in 1938.
Once I settled on the investment vehicle, I decided to have an innovative fee structure as well. Given the long bias, I did not think it appropriate to charge full hedge fund fees. However, given the specialty, boutique nature of the firm and the desire to have a small, cohesive team with a go anywhere approach, I decided the long-only market structure and fees also weren’t appropriate. I settled on a hybrid approach with a 1.5% management fee and a performance fee of 20%, charged only on positive returns above the S&P 1500 [includes all stocks in S&P 500, S&P 400 and S&P 600]. Initially, I deferred the performance fees for three years in exchange for a three-year lock-up. After the first three-year period expired, I elected to move to a one-year fee, still with the hurdle rates of both zero and the market, and a traditional high-water mark as well. This is a specialty fund with an appeal to a certain type of client. Since it is a hybrid, it doesn’t fit into a lot of institutions’ pre-defined “buckets”. I decided I didn’t need to compound the problem further by asking for a three-year lock-up in the market we’re in today. We’ve been very fortunate to find clients who understand and appreciate the approach.
After nearly five years, we remain as we set out to be. There are three of us on the investing team, and we have an operating person to handle all the non-investment related issues and a part-time marketing person to handle all the outreach and communications, though I also am very involved in that. We have about $125 million in AUM and will limit that based on keeping our team small, collaborative and cohesive. I’m not sure what that limited AUM number is, but it’s probably somewhere between where we are now and $1 billion. We have lots of room to grow and compound without changing what we do.
We set out a list of Core Values when launched, which I have found very helpful in guiding my decisions about the firm over the years.
Lane Five Core Values:
• Invest with integrity
• Strive for excellence in all areas
• Work with brilliant people
• Adapt and evolve actively
• Learn and read widely
• Collaborate with each other and with clients
• Be authentic, trustworthy and open
MOI: How would you describe the investment philosophy you adopted while working with Bill Miller at Legg Mason? How has your approach evolved since then?
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