Shai Dardashti recently had the pleasure of conducting an exclusive interview with Michael Weinberg, CFA, Senior Managing Director and Chief Investment Strategist of Protégé Partners.
Based in New York City, Protégé is a specialized asset management firm founded in 2002 to focus on investing in established smaller hedge funds and select emerging managers. Differentiated from hedge fund investors that focus on large, widely-held funds, Protégé is an expert in the less efficient, and under-allocated universe of smaller hedge funds. Protégé employs a model that blends seeding and arms-length investments.
The following transcript has been edited for space and clarity.
MOI Global: What differentiates great investment managers from those who are merely good?
Michael Weinberg: Good investment managers can readily access and evaluate basic publicly available data, for example 10Qs, 10Ks and valuation metrics such as price to earnings, price to book value, return on equity, etc. Good investment managers also meet with company management.
As an adjunct Professor of Finance and Economics at Columbia Business School, where I teach an investment course, I will use a scholastic analog. These endeavors are merely akin to the 101s of investing. To quote Wikipedia, “In American university course numbering systems, the number 101 is often used for an introductory course at a beginner’s level in a department’s subject area.”
The great investment managers have moved beyond the 101s and engage in investment research and analysis that is akin to advanced coursework in academia. To simplify what they do differently from the good ones, they have a true research and/or analytical edge.
They also understand why investments may be mis-priced by the market. This is still not enough. The great managers then want to understand if there is a catalyst, or a reason to believe the market will close the discount over time. This helps them avoid ‘Value Traps.’ They also try to determine if they themselves can be or create the catalyst. Then they are looking for asymmetric upside to downside. To add to the laundry list, a margin-of-safety is also desirable.
Let’s go back to the research edge. This is where managers go way beyond the low-hanging fruit such as 10Qs and 10Ks and do what great security analysts are supposed to do; create a strong mosaic theory. Perhaps the best way to illustrate this is with real world examples where I have seen great managers do this and achieve out-sized returns. A great manager may hire a petrochemical engineer to analyze an exploration and production company’s publicly filed reserve data.
Some time ago, I remember a legendary fund manager who had people in the Middle East counting oil tankers to provide a true information advantage. While that can still be done, it is much more easily accomplished by requisitioning satellite photographs from oil ports and maritime passages. That is exactly what some of the great managers are doing today.
Again, some time ago colleagues and I would do store checks, physically going into retail stores to get a pulse on how they were doing. Today that can and is accomplished by great managers with satellite access to parking lot density and credit card data or other web scraping techniques that provide insights into sales.
A last area of information edge worth highlighting relates to public filings. This is where a great hedge fund manager uses the Freedom of Information Act to secure documents from the government. Similarly, in regulated areas, such as airports and alternative energy, there are often quite interesting filings to be had that shed valuable insight into those companies or derivative companies.
Moving back to the analytical edge, great investors employ, methods beyond simple earnings, return and cash flow metrics. They try to determine whether a company has been mis-valued by the street because the investment community hasn’t correctly analyzed it or may not understand the business dynamics or the combination of its businesses.
Multiple examples come to mind. Using an exploration and production company for illustrative purposes, the sell-side often values such companies on an earnings basis. There are multiple reasons why they may do this ranging from laziness to ease of comparison to companies in other industries. However, if one thinks about a business as having reserves and a depletion rate, it typically makes no sense to value it on a current earnings basis. If many investors are valuing them this way, it may explain why some businesses are unwarrantedly overvalued and others similarly undervalued. This is the WHY the inefficiency exists.
A company might drill through its reserves and increase the depletion rate to have high current earnings, at the expense of future earnings. The other extreme is that the company will have low current earnings, but massive reserves. The great investors account for these nuances and value these companies on a combination of cash flow, reserves and depletion rates. This is more complicated and not something easily captured by a simple Price-Earnings metric or screen.
Another example of an analytical edge is based upon companies having more than one business. One business line may be losing money and masking the immense profitability of another one, resulting in a depressed valuation of the company. The manager would then have to understand that there is a catalyst, or be the catalyst for management to disaggregate them or liquidate the undesirable one. A simple earnings metric on the aggregate of them would be highly misleading.
MOI: Would you describe your skill set as mastery of pattern recognition, mastery of spotting situation specific opportunity, or a particular blend of both?
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