van Biema Value Partners on How to Find the Best Managers

We recently visited the offices of van Biema Value Partners in New York, where we spoke with the firm’s members, including Michael van Biema, Chris Kehoe and Sam Klier. van Biema Value Partners specializes in investing in funds managed by value-oriented investors, many of whom are managers investing relatively small amounts of capital. van Biema’s firm manages portfolios of hedge funds in the U.S., Europe and Asia. Michael van Biema is co-author of Value Investing: From Graham to Buffett and Beyond.

Michael van Biema is the founder of van Biema Value Partners, LLC. Prior to establishing the firm, Michael was on the faculty of Columbia Business School from 1992 to 2004 where he taught value investing, general corporate finance, capital markets, securities analysis, and entrepreneurial finance in both the regular and executive MBA programs. He received his B.A. from Princeton University in Electrical Engineering and his Ph.D. from Columbia University in Computer Science.

MOI Global: Tell us about your investment approach and the genesis of your firm.

Chris Kehoe: Michael started the firm five plus years ago after teaching at Columbia for twelve years. It was there that he developed a value philosophy and a great network of up-and-coming and established money managers. Michael thought he could create an investment vehicle that took advantage of the best niche value managers. His thinking was to find managers of smaller size, but not necessarily managers that lacked experience. He realized that there are some managers that have been managing money for many years that purposely want to stay small. Michael gathered some of the current board members of van Biema Value Partners and brought them the idea. They liked it and decided to put their own capital to work as an experiment. That experiment was successful and they decided to launch the firm. The first fund launched in the U.S. in 2004 and concentrated on domestic fund managers. In 2008 an international fund was launched and, most recently, an Asia-focused fund.

So the basic investment thesis was to invest in smaller managers that can be flexible, can invest across different capital structures, are willing to short on an opportunistic basis, with the ability to provide diversified exposure to the value style of investing.

Michael van Biema: The funds have a relative simple concept. The concept came from reading Warren Buffett’s “The Superinvestors of Graham-and-Doddsville,” where he wrote that the great value investor of his generation had a couple of things in common. The first one was that they produced terrific long-term track records. The second was that they all had periods of big drawdowns (somewhat less attractive). Finally, and one of the key things for us, was that when he looked at the historical performance, their performance didn’t correlate strongly.

A thought occurred to me that there were a number of small value shops out there that I was aware of, and that it would be interesting to see if what Buffett had observed in his generation of value managers held true for the current small value managers of today. So we pooled some of our own money — my own and from our board — and ran the fund for awhile as, more or less, a social experiment to see if Buffett’s theory still held true.

One of our first big concerns was whether we could find enough high-quality small managers to populate a reasonably sized fund. That question was answered quickly as I went around to the members of the board to ask for names. I got over one hundred names of small value shops that had been around for awhile or in which our board members had already invested. We had a list of managers among whom many had already closed their funds. From my perspective this was a good sign because it meant that the board was picking out guys that were disciplined, controlled and closed their funds with relative modest sizes. Of the ones that were not closed, which was somewhere between 35 and 45 managers, we picked 20 managers to start the portfolio.

We discovered the exact same thing Buffett mentioned: the managers’ performance didn’t correlate strongly. We didn’t know if they were going to produce above-average long-term returns, but there was a decent amount of evidence that suggested they would. The other big hypothesis we had was that the portfolio would provide significant downside protection. We really had to wait until 2008 to see if our hypothesis was correct.

Basically, when I watched the fund from a quasi-theoretical point of view, it was my belief that the fund would be able to capture about 75% of strong upside markets and less than 25% of strong downside markets. To date the fund has captured 75% or more of strong upside markets and has captured less than 50% of strong downside markets. So it hasn’t done as well as I thought it would in down markets. However, the statistics may be slightly skewed by the events of 2008.

What’s extremely reassuring to me is that these funds — at least the ones that were in existence at the beginning of 2008 — showed the same pattern, which was a pattern I had predicted: They followed the market down at the beginning of the drawdown, but leveled out long before the market leveled out, which makes sense intuitively. If you’re buying stuff that’s already cheap, there is a certain point where it becomes absurdly cheap, and even guys who are panicked will quit selling, because they’re just going to say, “I might as well hold onto this.” And that’s exactly what happened. So in the beginning of 2008 we followed the market down and then we leveled off nicely.

MOI: The fact that value portfolios tend to be more concentrated and more volatile in the short term seems to fit well with what you are doing as opposed to other funds of hedge funds, which look through to vehicles that themselves are trying to have low volatility. It seems that what you’re essentially doing is grouping guys who are going to be volatile and, hopefully, not very correlated, and therefore there’s a value created in the process…

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