Introduction

Patrick: [00:00:47] My guest today is Jeff Gramm, a portfolio manager at Bandera Partners and the author of one of my favorite investing books, Dear Chairman: Boardroom Battles and the Rise of Shareholder Activism. Jeff is also one of the nicest people I've come across in this business. It's been a pleasure getting to know him in recent months. In our conversation, we discussed the history and current state of shareholder activism and how Jeff invests himself taking large positions and often board sits in undervalued companies. Please, enjoy.

Activist Investing

Patrick: [00:00:47] Jeff, so I'm going to start with a couple of quotes from your book because I think they're good bookends for understanding this history of activism that you explore. The first one is from Ben Graham which kicks off the book. Really, I'm quoting these two passage less for their content and more for their tone because it's changed so much over the years. Graham was fighting against a company called Northern Pipeline which I'll let describe kind of what he was doing in a few minutes. But this is an excerpt from the letter you published in Dear Chairman where he says, "Because of its ownership of the largest interest therein and because of the prestige represented by its name, the Rockefeller Foundation must be considered to some extent in the ethical position of trustee for the smaller participants. We are hopeful, therefore, that it is high minded and generous solicitude evident in so many fields will be manifested to some degree in the foundation's attitude towards its fellow shareholders."

It's very nice professional tone. And then, we'll fast forward to a later letter in your book written by Daniel Loeb to Irik Sevin who was the CEO of Star Gas at the time. Loeb writes, "Sadly, your ineptitude is not limited to your failure to communicate with bond and unit holders. A review of your record reveals years of value destruction and strategic blunders which have led us to dub you one of the most dangerous and incompetent executives in America. I was amused to learn, in the course of our investigation, that at Cornell University there is an Irik Sevin Scholarship. One can only pity the poor students who suffer the indignity of attaching your name to his academic record."

So, pretty interesting change that we've seen in eight or nine decades in activism. What I'd love to start by doing is really highlighting the major stages that you lay out in your book.

Jeff: [00:02:56] Sure.

Patrick: [00:02:56] Maybe, starting with what Graham was fighting and what he was doing and how he was a pioneer of activism.

Jeff: [00:03:01] Sure. Well, with Ben Graham, he existed in a different era, right? When he was a shareholder in the Northern Pipeline company was the mid-1920s, and most of the smaller public companies had big concentrated owners. He had to appeal to the Rockefeller Foundation who was a 30% holder to win their vote. You don’t do it by calling him a crazy person and pulling a Dan Loeb on them but obviously, just the kind of times were very different. It was interesting to read the company's responses to Ben Graham. I don’t think I put them in the book, but they were very civilized. But with Ben Graham, the era was very different by the time that we got to the 1950s and the proxy tiers which was the next chapter. You had seen this big diffusion in stock ownership in the country and the proxy fight in the 1950s that I highlight which is the Robert Young against the New York Central. It was a political campaign because you're appealing to these individual's shareholders. That's kind of the key movement in the book. It really is a history of how passive share ownership evolved. A lot of the changes of activism and the changes in the dynamics of these campaigns has to do with the changes in the underlying shareholders.

Patrick: [00:04:41] Can you describe how that happened? You mentioned that early on, there were huge holders like, say, Rockefeller Foundation, and that became much more widely distributed. Can you describe what precipitated that change?

Jeff: [00:04:53] Sure. Historically, it's a lot about the history of American capitalism. In the early days, the capitalists would be big strategic investors or sometimes even bankers. A great example for this is General Motors. In the 1920s, GM had a big ownership from DuPont but also when they made all of their acquisitions, they did it with stock. And so, you had a lot of these owner capitalists's as Peter Drucker called them. What happened ultimately is between the 20s and the 50s, a lot of those older capitalists's died and passed away. These big concentrated stakes in public companies got essentially distributed and diffused out with the individual shareholders. And in the 1950s, there was even a movement by the markets by the New York Stock Exchange to advocate for this populist movement of, like, "This is the people's market. You need to own your shares." It was both the passing away of the old concentrated owners and a public interest in owning shares that drove that big diffusion. It really didn’t last long. You had the 1950s when you had this very diffuse ownership and beginning in the 1960s and late '50s even you saw these reconcentration into the mutual fund industry, the big pension plans, institutional investors as we know them now. It was a quick flash.

Patrick: [00:06:41] Let's back up for a minute. We'll come back to the proxy tier movement because I also felt that was the most interesting turning point both for the idea of shareholder value but also for the activist movement more broadly speaking. Going back to Ben Graham though, obviously, what activist want to do is earn a great return. Graham's story was so interesting because Northern Pipeline which I think you mentioned in the book was trading at $65 or whatever it is, had $90 of what he called gilt-edged securities sitting there.

Jeff: [00:07:08] Basically cash.

Patrick: [00:07:09] Right. Basically, earning nothing. Back then, companies were required to publish much less information. This wasn’t readily available knowledge and sort of the ultimate gold mine that Graham found, I think, through the ICC or some commission that Northern Pipeline was required to report to. He basically found a gold mine sitting underneath this company were the cash was worth a lot more than shares. His effort was ultimately to release that shareholder value, if you will, get that cash into the hands of the actual shareholders who could earn a much higher return than pipeline was earning in that cash.

Jeff: [00:07:42] Yeah. It's a great example because it is ultimately if you're trying to explain to your readers about the value of a company, it's a lot easier if just there's a huge pile of cash there to fight over. But, yeah. It's a fascinating story like basically the government collected a lot of information on the railroads. The public could go look up these reports, ICC reports on the financial state of all the railroads. A lot of financial analysts did that. Ben Graham was looking through the annual report of the ICC, and he sees kind of in a footnotes a table on the pipeline companies. There were eight public pipeline companies that had been formed when a standard oil was broken apart. He sees it. He's like, "Wait. I didn’t know that the pipeline companies reported to the ICC. If they do, then they might report more than just the basic statistics on this table." He takes a train down to DC and he asked him like, "Do you have any reports on the pipeline companies?" They bring out these full 20-page reports. I have the one for Northern Pipeline, and I got it from the National Archives. It's got a full balance sheet a list of shareholders, all the kind of things that at that time were very hard to get. He sees, well, not only the size of their balance of a valuable bonds but the names of the bonds. He's like, "Well, these are money good bonds." It was then that he knew that the company was essentially like if you liquidated just their financial holdings and kept the business whole, it would be a bonanza for shareholders.

Patrick: [00:09:28] Sort of like the perfect example against market efficiency back then, pretty amazing nobody else that information.

Jeff: [00:09:34] Yeah. It is like just the fact that you had to do hard work even after-

Patrick: [00:09:41] Probably still true today.

Jeff: [00:09:42] Yeah. Even after the formation of the SEC, you still had to go to the SEC reading room to get your reports. Even in the '50s and the '60s, a lot of public information about public companies was hard to come by which made the market less efficient.

Proxy Tier Movement

Patrick: [00:10:00] Sure. What is the transition from Graham to these proxy tiers because I think that that movement probably sets the stage for the rest of activist history.

Jeff: [00:10:09] Yeah. The proxy tier movement is a pretty fascinating movement because it really was the beginning of this pro-shareholder populism. People talk about that beginning in the '80s or the '90s and that the corporate radars and the shareholder activist and Boone Pickens were the first guys that talk about the shareholders' rights. But that's not true. You had this whole public movement that got a lot of press attention of these guys like Louis Wilson, Robert Young that were in Time Magazine and on TV talking about how public companies needed to protect their shareholders. They said, "Look, there's this whole campaign by the New York Stock Exchange like this own your share in American business," and that if you buy shares, then we're partners. If we're really partners, then we deserve our rights to vote in a new board if we want to.

They really began to flex that muscle that not... The Ben Graham thing with Northern Pipeline, that was very under the radar. That was not in the newspaper like when I did a search of the Wall Street Journal archive that was not even in there. These things in the 1950s were front page news. That was the real beginning of this kind of pro-shareholder populism.

Patrick: [00:11:33] How much of that was all talk for them trying to earn a buck for themselves or their investors? How much of it was real reform?

Jeff: [00:11:42] I'm always of the opinion that people are self-interested animals. As far as they were concerned. I think it was all kind of posturing to make profits for themselves. But I think a lot of what they said was right. I'm sure that they believed it. I guess a combination of both, but ultimately I think those guys were all out to make a buck.

Patrick: [00:12:08] Peter Drucker says that through this era we're the first truly socialist country because we're the first, where this ownership of American business is so widespread. You get from that. Then, what's the next stage? I think about it as the junk-bond era, the corporate raiding era especially of the 1980s. Would you say that's the next kind of major chapter in the history of activism?

Jeff: [00:12:29] No, because I think that you can't ignore. Well, there are two things that you can ignore. You can't ignore the conglomerators. That was this big M&A movement that did have some elements of hostile M&A. They had hostile tender offers. Those were smaller companies in general but it was... That sowed the seeds for the hostile takeovers that began in the '70s. Then, I couldn’t leave that in my book, like, you had to talk about emergence of Warren Buffett too which his career began in the mid'1950s. The '60s were a pretty grand time for him too, I think.

Patrick: [00:13:12] I want to get to the 1980s and some of the more famous activist that people now still were talking about today, Carl Icahn, et cetera. What changes because there seems to be a self-interest driving their actions above all else. Then, a lot of change in terms of how companies start to protect themselves from these raiders who don’t seem to be acting on behalf of broad shareholders but to make as quick and as big a buck as possible.

Jeff: [00:13:39] Yeah. It's an interesting question and I mean it's always fascinating within a historical exploration because there is your prejudices and how you think the world works, the lens through which you see the world has a huge influence on how you interpret these past events. This emergence in the 1980s of the corporate raiders like a lot of people are like, "Oh, this was the beginning of the birth of greed. These guys are greedy now where before that, business was more honorable." I don’t buy that at all. I think in the '50s and the '60s, you had a lot of greedy guys and you did in the '70s too. They just got all washed away. But I think in the '80s, to me, the defining thing was Michael Milken and this vast infusion of capital that he gave directly to the raiders. Guys who were small fry in the '50s and the '60s or the '70s, those kinds of outsider and investors would now have access to huge sums of capital. In my book, I profile Carl Icahn versus Phillips. Phillips was a top 20 company in the country who was, I forget, $10 billion or something, was a huge company. You have Carl Icahn going after it. He doesn’t have the money. He's not financed by the big banks or investment banks. He's financed by these cronies of Michael Milken and like the people that buy those junk bonds. He got to do this whole thing of going after a huge established company without any help from the kind of the financial establishment.

Patrick: [00:15:37] What was he trying to do with Phillips? What was his specific mission?

Jeff: [00:15:39] He was out to make a buck. With Phillips, they had been targeted by Boone Pickens. Boone Pickens is actually a great story which I put in the book too, is he actually... His father worked for Philips and he worked for Phillips, and he had a long history with the company. He goes after them as a hostile raider. They basically buy him out. Now, Boone Pickens was very sensitive to charges of greenmail. He was like, "Well, you can buy me out , but it has to be equal treatment to all shareholders." Instead of just paying Pickens a lot of money to go away, Phillips had to devise this scheme to pay out Pickens but to also do right by shareholders. They give the shareholders this complicated restructuring that the market ultimately values for less than the cash that is paid to Boone Pickens. Icahn sees that. He sees Icahn go after Phillips. Pickens is a smart guy. He knows the space. He clearly thinks it's undervalued. But what he's also going for is if he buys into the public shares, he thinks that they need to sweeten their offer. He's succeeded in doing that. He makes a big fuss. Phillips sweetens the recapitalization, so his shares go up.

Patrick: [00:17:07] So interesting example of making a quick buck I remember or I've heard this story where my mom wear shirt called People before Profits in the late '70s, early '80s which has been a ring to it than stakeholders before shareholders. But that's of what's going on here is you put in your book a couple of example that stands out to me was, I don’t know who it was, but somebody took over Pacific Lumber which had a sustainable growing plan for timber, basically fired everyone, canceled that sustainable plan, clear-cut a bunch of old growth redwoods to make the quickest of profits.

Jeff: [00:17:42] Yeah. Charlie Hurwitz. It was a gruesome case.

The Image of an Activist

Patrick: [00:17:45] I wonder was it through the '80s and obviously the junk-bond era came to an end ultimately? Was it public reaction to things like that to things like Icahn making a tremendous amount of money very quickly really to the benefit of nobody else but him? Did that change things? Was the attitude towards activism or even the strategy of activist changed after that era?

Jeff: [00:18:10] Yeah. That's a good question in a weird way our society both detested those people but also hold them up for our admiration. I was too young at the time to process it all obviously, but I don’t really know the answer in terms of public opinion. I do think that you did have a few specific policy initiatives and you had the end of Michael Milken which put an end to the raiding in the '80s as we know it. The '90s was a bigger deal decade than the '80s was. There were lots of huge mergers in the '90s like some big hustle deals, but this period where you could basically be a nobody. If you found an undervalued company, get quick funding to go after it in an aggressive manner. That's over, and it hasn't come back. It didn't even come back in the early 2000s when you had these ample supplies of capital out there. It's a funny thing I talk about in my book that was the only time in history where they just allowed people with no experience at all to go on a spending spree. Then, I had in my footnotes except for, well, maybe the Icelandic investment banks in the mid-2000s which was a little bit of a similar thing.

Patrick: [00:19:39] Icahn had this idea, this, I think you call it, anti-Darwinian idea of kind of corporate management that for the most part, it was dominated by really good institutional politicians, people who are good at rising the ladder, but not necessarily at either managing the company or allocating capital. You've got this sort of Peter Principle that people rise to the level of their incompetence. That creates the opportunity for a lot of these activists to go out and shape companies up. Obviously, I think that has persisted that the world is still full of especially maybe in what you call the wasteland of the small cap market, still full of companies that are badly or even horribly mismanaged, but given the end of the kind of Icahn, Milken junk-bond era, obviously, activists are still targeting companies like that. Maybe, close this history off for us through the 90s and then the 2000s to the present of what it's looked like since then.

Jeff: [00:20:33] Well, I mean I think that since then, you've seen this continued concentration of share ownership in the institutions. You did see this brief period that I talk about in the book of kind of the Dan Loeb public hedge fund letters like the shame-driven activism, but that didn't really last long because the way that it's evolved is that in any given public company if it's not controlled by insiders, there tend to be a handful of institutions that have a lot of the votes. The game of shareholder activism is a lot more a game of persuasion now. You as an activist are trying to convince the institutional shareholders that you have the right ideas and perhaps that the current management doesn't. In the '80s, you could go for the quick takeover. In the '90s, if you were a young activist with no access to capital, lots of them did this embarrass the company thing was all they could really think of. By now, a lot of it is behind the scene's persuasion. As a result, the big institutions are the arbiters in a lot of these disputes. You have these funds, people like ValueAct or Bill Ackman even, they're very politically astute in some ways and persuasive. They tell a very good story.

The game of shareholder activism is a lot more a game of persuasion now. You as an activist are trying to convince the institutional shareholders that you have the right ideas and perhaps that the current management doesn't.

Patrick: [00:22:07] There's this persuasion that's happening. I'm a quantitative investor, but I'm always very curious to see who are the major shareholders of some of the key businesses that we own. One of the things you have to do is scroll down a little bit on the page every time on the 13Fs because one, two and three is

Jeff: [00:22:24] Dimensional

Patrick: [00:22:25] Dimensional, a couple really concentrated massive asset players that are either purely passive or quant light. I'll call them a dimensional.

Jeff: [00:22:35] Yeah. But you'd be surprised. If you look at Vanguard, it's just an index. I don't know if you'd call that... Yeah. Well, whatever. Whatever Vanguard is, they're passive investors in the sense that they put together these, well, products to match an index, but they have a pretty robust team to study governance issues and to vote shares. Even a lot of these big institutions that they're not actively choosing to buy X or Y stock because of how they think it's going to do. They are active participants in its governance. Those are the kind of people that you need to persuade.

Patrick: [00:23:16] It's fascinating. It's almost like we're witnessing. I'm sure this will continue, Vanguard captures market share every day, an inversion of these ideas of passive and active where active for the longest time has been active selection meaning you're picking stocks trying to beat the market and probably less so than being involved in those stocks. It's active selection passive ownership, I'll call it. Now, it's the opposite. It's passive selection. It sounds with teams at Vanguard and probably this will happen in other places, active involvement in the management of the company.

Jeff: [00:23:46] Yeah. If you're a Vanguard, you are so established that your long-term interests are, A, that the S&P 500 is well managed, will be that the markets have integrity. You want for people to trust in the S&P 500. I can see the corporations have integrity. They do have a real vested interest in promoting good governance. Can they do it? Can you build an incentive system that makes sense? That's a weird dynamic when you have this entity with 22 paid professionals who have this huge impact. How much are those people getting paid? Probably not that much.

Patrick: [00:24:30] How's their performance measured?

Jeff: [00:24:31] Yeah. It's extremely hard to measure it. It is a weird dynamic. Yeah. If you think about it too hard, it's-

Patrick: [00:24:40] Talk yourself in circles.

Jeff: [00:24:41] ... it's a little bit uncomfortable to think about, wow. What's going to happen when Vanguard owns 10% of the market? How persuadable are the people who vote their proxies? They're going to be too bad ideas. Power intoxicates. That's a lesson from history, right?

Patrick: [00:25:03] Yeah.

Jeff: [00:25:04] It'll be fascinating to see. The whole growth and passive in ETF investing, I don't know about ETFs that could be a flash in the pan, but indexing is going to keep growing. That dynamic is only going to be stronger.

Shareholder Value & Governance

Patrick: [00:25:19] We've got kind of the complete history now where we start with Graham operating very much under the radar with information that nobody else has to unlock value in one very small specific company to almost activists as marketers. They're persuasion experts and trying to convince, I guess, we'll call them passive or big institutional owners to vote a certain way or to promote a certain kind of governance. For me, that raises the question which I think is fascinating of the very idea of shareholder value. You talk about this quite a bit in the book and unless you really dig into the history of this idea, you probably just take it for granted that US companies or companies in general should act in a way that is best for their shareholders. I guess what that means is the most cash going back to their shareholders, the greatest growth of share price, so on and so forth, but when you dig in, as you do in the book, you realize that is kind of a not only a fairly recent concept, but also potentially a fictional one. I'm going to read a quote from... You don't actually quote this in the book, but I went and read a book that you recommended or at least referenced by a woman named Lynn Stout talking... I think the book was called The Shareholder Value Myth.

She says, "Shareholder primacy had become a dogma, a belief system that was rarely questioned, seldom explicitly justified, and had become so pervasive that many of its followers could not even recall where or how they had first learned of it. Put bluntly, conventional shareholder value thinking is a mistake for most firms and a big mistake at that. Shareholder value thinking causes corporate managers to focus myopicly on short-term earnings reports at the expense of long-term performance, discourages investment in innovation, harms employees, customers, communities and causes companies to indulge in reckless socially irresponsible behaviors." Now, that's obviously probably an extreme opinion if there's some continuum of opinion on the idea of shareholder value. She's obviously very much against it. The question is, is this the right way to think about it of, let's say, stakeholders that includes employees and customers and society at large, the environment, what have you, versus just pure equity shareholders? Where do you fall on that continuum? What should companies be optimized to do?

Jeff: [00:27:39] Well, that's a key question. I really do think that's a good book by Lynn Stout. It's a really thought-provoking book. She has two arguments. There's the legal argument of like, "Look. There's no legal reason the corporations are required to prioritize the shareholders," which is true technically, but then, there's the practical thing of like, "Well, except, they're not forced to, but a board of directors is appointed by shareholders." That bias is always going to be there because you have to raise your capital from somewhere. But, then she also gets into the practical argument of, well companies that are run specifically for shareholder value can be a myopic that can be short-term oriented. We have to be careful there because it's easy to slip into kind of a semantic argument because I think when some people say shareholder value or people are focused on shareholder value, we're not all talking about the same thing.

I think for someone like me, I mean obviously, I guess not obviously, but if you have read my book, I think that you see that I'm pretty much pro-shareholder in terms of corporate governance. I think that a board of directors, I think their job is to protect the long-term interests of the shareholders. I think if a board is beholden to too many bosses, it's easy for them to be beholden to nobody. I do think it's important to run companies for the benefit of shareholders, but I think the way this devolves into semantics at times is, "Look. People in our shoes inherently understand that it's not in the long-term interest of shareholders to denude the environment and to exploit the labor to the point that we don't get good service to neglect our customers to the point that we lose them."

A lot of the debate in a weird way, it's about that happening. To me, that's bad long-term governance. I do think that the whole long-term short-term issue is a human nature issue. I think boards can be too short-term oriented. Shareholders can be short-term oriented, but so can managers and so can CEOs. That's a problem for all of us. I haven't seen lots of compelling evidence that, like, "Oh, well public company shareholders are just so myopic and they're so short-term focused that it's destructive to the economy." I think there's a lot of examples where if you look at a company like Amazon where they are investing all of their excess cash into long-term growth, they're doing everything for their long-term benefit possibly for the negative benefit of society, but for their long-term benefit and for their customer's benefit and for their shareholder's benefit. I'm not that compelled by the argument that, oh, we live in a world where shareholders are just completely short-sighted-

Patrick: [00:31:00] Rampaging.

Jeff: [00:31:01] ... and misinformed.

Patrick: [00:31:03] Alfred Rappaport who's written a number of books on this topic says that managers talk shareholder value, but then walk quarterly earnings. Obviously, Bezos is maybe the perfect example of the opposite of that, one of these kind of rare truly long-term thinkers that really does seem to walk that walk, but I guess the problem is balance that for every Bezos, there could be 50 or 100 much more myopic managers that are focused on hitting performance targets because let's face it, the average CEO tenure these days and the Fortune 500 is something like six years. I wonder coming back to the idea of stakeholder versus shareholder value, if the idea of shareholder value has become so popular and so commonly accepted because it's very measurable. Share price is share price. Earnings are earnings. You can really track those things and say whether or not a company is being effective for its shareholders. We live in this kind of age of measurables where we're obsessed with T stats and R squareds and statistics.

It's much softer and fuzzier once you start getting into stakeholders. I guess my question is there some set of measurables or at least some governing objective that companies could start to bake into the kind of the essence of their businesses because as you say if you go read companies' founding papers, none of them say our mission is to maximize shareholder value. They don't want to tie themselves to that. Can we get out of this bind? Can we move past the simple pure measurable of share price to something that better promotes stakeholder value or do we just need to let things play out as they have?

Jeff: [00:32:46] Yeah. I think, A, that we basically can't, but, B, I would even question your premise about the value of the measurable of the share price because I'm a firm believer that the markets are not efficient. They certainly are not efficient in the short term. Even of evaluating CEOs on the performance of their stock during their tenure is very problematic. To me, that's a big concern that I have with share-based compensation. I'm a value hedge fund manager. All of us for years have talked about the importance of incentivizing the management in the right way and making sure they have the skin in the game, all that stuff, but to me, stock options are highly problematic because, A, they're highly leveraged. Then, B, they're levered to an irrational market. You ultimately introduce this big hunk of compensation that's completely erratic. And you'll have a company's where everyone will get a huge pay year just because of the movement of the stock which will may or may not be warranted. In a year that they're doing all the right things, they make all the right decisions. They might not get rewarded. I think it's really problematic. I think, again, it's like among the many things in governance that boils down to the value of an effective board of directors because, ultimately, the board has to evaluate the CEO. They shouldn't just do it on the short-term share price movements. They need to understand that markets can get suckered into overvaluing companies.

Patrick: [00:34:39] Do you think that governance today, and I guess this is another way of asking whether or not the opportunity set for activists how that stacks up today versus the past? I guess one proxy for the opportunity set is how good is governance. The worst the governance, probably the better the opportunity set. Where do you think we stand today?

Jeff: [00:35:00] I would question the premise because I think there's a lot of bad governance, and there always has been and there always will be, but in terms of an opportunity set for activism, I think you really also need a deeply undervalued company because of the work involved, the possibility of failure. When you go active on a company, you lose your liquidity. I think the governance opportunities are there. Valuations are higher. We're in the middle of this or at the tail end or who knows? Who knows where we are in this historically long bull market? To me, the real gating factor on activist opportunity is undervalued companies. I'm not seeing them as much. I think if you're an activist and your only target is bad governance, then I think that's a dangerous situation to be in.

Jeff's Career

Patrick: [00:36:00] Very interesting. I'd love to move now into your history and your professional career outside of the book and outside of activism. I know you started in music. Maybe talk a little bit about that.

Jeff: [00:36:10] Sure. Yeah. Well, I played in a highly mediocre band, pretty much through college. We started at the beginning of my sophomore year of college. That was 1994 or '95. This band called Aden. We were on Teen-Beat Records which is a DC-based indie label. We had four records. We pretty much toured from '96 until 2001 when I went to business school. For those years, I lived in Chicago for one of those years, but then I moved back to DC. I lived some in DC and some in the near DC suburbs. I pretty much attempt and toured, but it was a really educational lifestyle, I think. I really think that going on tour is a pretty incredible life experience.

Patrick: [00:37:12] Sure.

Jeff: [00:37:12] But I think it was hard. It's funny. When I moved to New York, I came here for business school, I realized that all my friends in bands in New York had real jobs. They had jobs that would tolerate their artistic ventures. They all had careers going whereas everyone in DC and almost everywhere else in the country, if you played in a band, you were a bartender or temp or you did this hourly work. It was hard. I do feel Iike I had this great life experience which was incredibly valuable, but I didn't accomplish a lot professionally in that time.

Patrick: [00:37:56] I find that most people that have a story like yours ultimately a very successful one have some sort of threshold crossing moment. Going from that lifestyle to Columbia to business school seems like an odd transition. How did that come about?

Jeff: [00:38:12] I think, ultimately, I knew at some point that I would go back to school and do some kind of, I don't know, what you would call it career advancement. The band was really fun, but we never were, A, good enough, but we never... You really have to work hard and to make it work. They were seeing the bands that became successful in the time that we were doing it. The ones that succeeded, pretty much 100% of them were incredibly hard workers. And all of the band members were completely committed to it. We could never really do that. We were never all on the same page. We didn't tour nearly as much as we could have and should have. I think that deep down I knew that we weren't going to be a successful band. I don't really know what to do. I thought about like, "Do I want to learn to be a computer programmer or do I want to go to some kind of a professional school?" I had a family friend, Arthur Levitt, who was Clinton's SEC chairman, who basically helped me get into business school. I thought of business school at the time as a versatile degree that you could potentially do a lot with. I think I got real lucky it worked out very well for me.

Patrick: [00:39:43] You went to Columbia. I know you now teach there. That's sort of probably the school if you talk about what school has produced the most maybe famous investor's period, but certainly the most famous value investors. Obviously Graham and Buffett being the kind of founding fathers, but tons of huge names, Joel Greenblatt. I think Gabelli went there. I think Cooperman went there, some really big names. I'm curious when you got to Columbia, it sounds your idea was that a business degree can be broadly-

Jeff: [00:40:14] Yeah. I didn't know what I was going to do.

Patrick: [00:40:15] broadly strong

Jeff: [00:40:17] When I got there, I didn't know anything about investing. I had never heard of Warren Buffett. I didn't know that stuff. Columbia, it was pretty different. We didn't have that value investing program that we have now. I love that program, but I think one downside of that program is it restricts a lot of the best teachers to this selective program that is hard to get into. When I was there, I must have heard at some point like, "Oh, you should take security analysis. It's a popular class." There were three sections. The one that fit my schedule was the Joel Greenblatt one. Really, I was that lucky. I took it. It resonated with me, but I had no master plan to do investing. I didn't even really know what investing was about. I took that that class. It really clicked. At that time, I didn't know about Columbia's history with investing. I think the spring of my first year there, I had a person in my little what's called an IP group, but it was a four-person study group who was in to Warren Buffett. He gave me a book on Buffett. I think that he gave me the Lowenstein book which I didn't read, but then I read the Warren Buffett way. Then I read the Lowenstein book. Once I got into it, I got super focused on it.

Patrick: [00:41:51] How was the Greenblatt class structured? Was it investment case studies? Was it broad principles?

Jeff: [00:41:57] It was a lot about the secret... hiding places in his book, but, yeah. It was basically 12 classes in the first class, I remember he focused on debunking efficient markets. He brought the Wall Street Journal out, and we looked at the 52-week highs and the 52-week lows of these companies like American Express and Walmart. Then, usually, he would have in the first three or four weeks case studies, and he would have these very simple special situations. We looked at the Dun & Bradstreet spin-off. We looked at Munsingwear where it was like they had a particular line of business that was very profitable, but everything else will drain all the profits, but those could be cut away. Then by the end of the class, he began to have a lot of guest speakers. We just would do more stock pitching. We would get in our little groups and pitch stocks. To me, it was more the beginning of the class. I never heard of this special situation stuff, and it really clicked with me. I don't know to what extent this is was delusional, but at the time, I felt like I was getting it faster than everyone else in the class that he would go through an example, and I would get it, will raise my hand. I can get it first. Perhaps, everyone knew the answer, but didn't want to raise their hand or whatever. But I just felt like I had a knack for it.

Patrick: [00:43:32] Tell me how you got back into teaching there.

Jeff: [00:43:35] A friend of mine who I met in that class, Eddie Ramsden who's a fund manager, he runs a fund called Caburn Capital which I invest in actually, it's a great fund. He was a superstar student. He got seeded by Greenblatt after that class. Back of a bit, I think there were two classes there in investing that you had to apply for that were the new model at the investing school. There was this Paul Sonkin class and then a class taught by the Blue Ridge guys. I applied to both those classes and got rejected. Eddie took them both. He took the Sonkin class and did so well that he got asked to be the co-teacher the next year. Then, the next year, I think Sonkin had to back out of it. Eddie, one year, removed-

Patrick: [00:44:27] Amazing.

Jeff: [00:44:27] ... from being in the school was the teacher. He did a great job. He's a really good teacher. He moved back to England. He teaches at the London Business School now. When he moved, he put my name forward for doing it. I stutter. It's gotten a lot better, but I had a really bad stutter in college and after college. And even at Columbia, I had a pretty bad stutter. When I got asked to do it, this is not what I told Greenwald when we were talking about it, but I viewed it as if I'm not going to do this then, I'm never going to do something like this. It was my chance to try. I basically did it as a form of speech therapy.

Patrick: [00:45:13] Wow.

Jeff: [00:45:14] That was kind of the reason I did it. It was a little bit like I got this opportunity for my entire life, I would have said no to something like this. It was eight months away. It was just abstract enough that I was like, "Screw it. I'm going to try this." I did it. Yeah, I think this will be my fifth or sixth year teaching there.

Bandera Capital

Patrick: [00:45:36] Wow. What a neat story I didn't know that origin. Where we'll go next is your actual portfolio. There's no more, I guess, interesting way to really see what you believe than to look at what you own. One of the things I'm most fascinated with as an active manager myself is the institutionalization of asset management, the rise of we'll call it closet indexing where portfolios look more and more like the market or at least more and more sensitive to key risk exposures relative to the market because the fastest way to get fired and I can attest to this, running portfolios that look a bit different from the market is to underperform even if that underperformance is over a very short window of time, and nothing's changed about the strategy or the philosophy. There is, A, I think, shorter and shorter leash for doing badly versus very low-cost passive alternatives. I got a nice big smile on my face when I looked up kind of your top holdings because there's no mistaking. There's no mistaking you for a closet indexer and yet a good line which where you said value investors are journalists at heart who feel compelled to gather their own facts and do their own analysis which I think, obviously, needs to be the case for the kind of portfolio you have. What we'll do is maybe walk through a few examples kind of think about them like case studies and maybe use them as jump-off points for asking a few kind of broader questions about investing. The three we're going to go through are Star Gas, Popeyes and Tandy Leather. We'll start with Star Gas which was it's, I think if I'm not mistaken, at least in the last filing, it was about a quarter of your overall portfolio.

Jeff: [00:47:17] It's 21%.

Patrick: [00:47:18] Okay. It's still the number one holding.

Jeff: [00:47:20] With 13Fs, obviously, they don't include cash. They don't include unlisted stocks or foreign stocks. It's not the whole picture, but, yeah, Star Gas is our largest position.

Patrick: [00:47:33] I was interested to see that because obviously, that was one of the topics or chapters in your book with Dan Loeb versus Star Gas.

Jeff: [00:47:40] It's not a coincidence. When you're writing a book, you definitely hop at an opportunity to take a shortcut. It was easier for me. I knew that I wanted an angry Dan Loeb letter. I knew that was a good one. It was way easier for me to write about that company than ICPT or something where I didn't know the company at all.

Patrick: [00:48:02] Just to take one more opportunity before we dive into Star Gas to highlight because the Loeb letters are just awesome. Loeb writes in that same 13D to Sevin, to Irik Sevin, the CEO, how is it possible that you selected your elderly 78-year-old mom to serve on the company's board of directors and as a full-time employee providing employee and unitholder services? We further wonder under what theory of corporate governance does one's mom sit on a company board? Should you be found derelict in the performance of your executive duties as we believe is the case? We do not believe your mom is the right person to fire you from your job." I love how he keeps saying mom instead of mother. This is so condescending. Anyway, so obviously, you're not involved with Star Gas when Loeb is fighting.

Jeff: [00:48:50] Well, I was.

Patrick: [00:48:50] Where were you?

Jeff: [00:48:51] Well, so my first job in the industry, I was at a distress fund. I started during business school in 2002. Then, in 2000 either '04 or '05, my direct boss, Greg Schrock, he was the director of research at that fund. He and I launched a new fund called Arklow where I was the junior partner. we were receded by a protégé. That was also a distress fund. I think at both HPV and at Arklow, I had looked at the SG bonds. Then at Arklow that was when all of the Dan Loeb and the blow-up will happen. We looked, I think, that we owned both the bonds and stock a little bit. I will followed that whole thing. I remember we talked to Loeb. He had a lot more stories off the record-

Patrick: [00:49:44] I can only imagine

Jeff: [00:49:46] ... that we're even harsher about Irik Sevin. I had been following it. Then, when we launched Bandera, it was among our first positions. One thing that you see a lot with special situations is you do see kind of investor fatigue. With Star Gas, they did a restructuring. They equitized a lot of bonds. There were kind of two dynamics. A, the event had happened. Well, there were a bunch of dynamics. Another one was, the event had loudly and publicly happened.

Patrick: [00:50:19] Just describe that event kind of

Jeff: [00:50:20] Oh well, SGU in the old days was a basic... It was run by an investment banker and was a dividend-paying security. It was an MLP. It traded on yield. The stock was 20 to 25 bucks a share even though they were, ran these hard businesses including this heating oil business. They ran into trouble. They made some essentially directional bets on the price of oil. They blew up with this guy. Well, Irik Sevin in charge. They sold their propane business because it was an MPL. They passed on a $10 per share taxable gain to their shareholders at almost the same time as announcing that they might have to file for bankruptcy. Hey, here's your stock. You're about to lose everything, by the way. Yeah. Well, 10 bucks per share gain. Dan Loeb got involved, called for his ouster. They did this whole restructuring. It was all very ugly and public. When they did the restructuring that was a controversial thing too because the board took what on the surface looked like the less good deal. There was a Soros backed deal that looked like the better deal for shareholders in the short term, but they went with the more reputable management team.

They went with this Yorktown partner as a private equity firm who now controls SGU, had sold the old SGU, a heating oil company in 2000. It was their management team that came back in to recapitalize it. You had all of that happen. You had the new management team. You had a lot of the equity in the hands of these old bondholders which creates a dynamic. Then, you have that whole Dan Loeb noise where it got lots of attention. When all that died away, you're left with a stock where people are like, "Oh, yeah. SGU, I've heard of that." People, they tend to under follow these things that have been in the public eye.

Also, I think a part of it being in the public eye and of a lot of blow-ups in the heating oil space, so at the same time that SGU blew up, this other company blew up called Heating Oil Partners, that business got dismissed as a crappy business when in reality, it's a surprisingly good high return business. We saw this excellent management team buying into these assets. They're really good capital allocators. They're a good private equity firm. It all lined up. Then, '08 and '09 happened too. Then, in '07, the huge increase in oil prices which is bad for their business. It was a situation where lots of bad things were happening in a fatigued stock. Then, you had these real bad macro pressures, but yet underlying it all, you had a good change in management and good governance and good oversight. Setup great. Ultimately, it still isn't as respected as it should be which is the reason that we will still own tons of it. We've owned it for a very long time. I still feel it's extremely undervalued.

Patrick: [00:53:36] Value investing is I always say a nice way of saying very pessimistic outlook.

Jeff: [00:53:40] Look, this is the heating oil business is-

Patrick: [00:53:44] Secular decline.

Jeff: [00:53:45] ... declining. It has been for decades, but Yorktown, these guys that control Star Gas, they launched a heating oil business in 1981 that they sold to Star Gas in 2000. The same dynamic was happening over that period with a little bit of differences in the relative price of natural gas to oil, but it was a declining doom business. They return with something 65X in that period. They know what they're doing. The main thing there is they perpetually are valued at as this terrible commodity business when they're kind of not. It's not a great business, but you can earn an outsized return.

Patrick: [00:54:29] How long have you owned it? I guess how long has it been either your number one or top position?

Jeff: [00:54:35] Probably seven, eight years.

Patrick: [00:54:37] Is there a catalyst that would cause the market's perception to change, do you think?

Jeff: [00:54:42] I would have thought with the low interest rates, them paying a dividend, they pay the lowest dividend that they feel they can pay to keep the shareholders happy, but they prefer to retain the cash which I agree with for acquisitions and buybacks, but it yields 5%. I would have thought at some point that it would go back to trading on yield. Markets are optimistic. In history, there have been times that people have valued heating oil companies like propane companies with a lot of optimism. I would have thought at some point that would have happened. Then, we had two years in a row of these abnormally cold winters where they just made gobs and gobs of money. I would have thought that the valuation would have improved more than it did.

Capital Allocation & Buybacks

Patrick: [00:55:39] When you say they're good capital allocators, that perked my ears up. I think that is one of the more interesting ways of evaluating a business or certainly a management team. You mentioned both acquisitions and buybacks. When you say good allocators, what do you mean by that? Is that allocation piece or that allocation skill a key part of what you look for when screening for new investments or at least want to see continued good allocation from your existing investments?

Jeff: [00:56:07] Honestly, when I look at stocks, I'm more looking for bad allocation as a thing to avoid. Great capital allocation is so rare. It can be hard to predict in the future that it's not the driving thing that I'm trying to identify even though it's hugely important. I'm trying to avoid the disasters with bad allocation. With Star Gas, they're extremely disciplined and good on the acquisition front which is hard to be in a declining industry where you're the biggest player. Among the more annoying things that has happened to us with Star Gas is there were two or three great assets that popped up for sale in the industry that got gobbled up by these Canadian propane companies that we're playing the dividend game with their investors. They needed to grow. They grossly overpaid for those assets. The new Star Gas has been great. They've gotten up a bunch of good acquisitions done, but they don't overpay for the bad ones. Then, they are really opportunistic on debt and share repurchases. In the financial crisis, they bought back up a lot of their bonds at a huge discount. Since we've owned the stock, they've bought back about 25% of the shares at opportunistic times. They really are good on the capital front which is key for a declining cash-generating business.

Patrick: [00:57:37] Do you have a broader opinion on buybacks? It's one of the, we'll call it, quant factors that I find most interesting. The empirical evidence suggests that companies that buy back gob, as you say, gobs of their shares especially ones that do it at cheaper relative prices, low PEs, low prices sales, et cetera, have pretty significantly outperformed the market over the longer term. Now, we're in a period now of certainly 2015 and thus far in 2016 when these high buyback firms have lagged pretty considerably, but longer-term, it's been a pretty effective signal or factor to look for in companies. Do you think that, and I guess I'll frame the question also by saying that most coverage of buybacks is pejorative or negative. There seems to be this kind of narrative that it's manipulative, it's self-serving. It's a way of boosting EPS hitting targets and that instead that cash should be invested for growth. Where do you stand on kind of buybacks more broadly and knowing that it's been a good thing for Star Gas?

Jeff: [00:58:39] Yeah. Those are all great points. It really is the area of corporate governance that's probably the least understood. In every board I've been on and lots of dealings with management teams, they really don't understand buybacks. I vividly remember I was in a meeting with Popeyes, billion-dollar company, great company, discussing a buyback. I was pushing them. They had been essentially badgered into doing buybacks by their shareholders. I was pushing the CFO just trying to figure out how he thought about it. We're trying to evaluate would he be opportunistic. Would he turn it up or down depending on the market price? He was like, "Well, you really want to put these things, get them in the front the beginning of the year. It has the biggest effect on your diluted share count for your annual earnings." It's the worst thing that you want to hear as an investor. It doesn't have anything to do with long-term intrinsic value. They're so misunderstood. As you say, there are lots of companies that will have them on autopilot. To me, I really love to see it when you have these opportunistic-

Patrick: [00:59:58] Lumpier.

Jeff: [00:59:58] ... like aggressive buybacks. I don't know. To me, the main issue is that boards often don't know how to value companies. They don't know how to think about the value of their companies. When they seek a guidance on valuation, they'll get like a banker report that's means to an end. They don't really know. A, even if they knew well how buybacks worked which they predominantly don't, they don't understand valuation enough to do buybacks in the right way. It's another example of how with corporate governance, it's hard to have a best practice because with buybacks, you can see the best and the worst of performance. There's a good buyback creates a tremendous amount of value. A bad buyback directly destroys value.

Patrick: [01:00:53] Burns money.

Jeff: [01:00:55] The shareholder base is ultimately if you own the share then you're going to be biased in favor of thinking it's undervalued and that a buy-back is the right thing. It's a hard issue to think about from a governance perspective.

Patrick: [01:01:07] That seems to be a new major tool in the toolkit for activists is agitating for buybacks, Apple's one of the most famous example.

Jeff: [01:01:16] Yeah, but I think that you did have a little bit of a one-time period where companies are over-capitalized. Interest rates had dropped precipitously and the cost of borrowing was so low, and CFOs were not quite as sophisticated on their ability to borrow cheaply. I think a lot of that of the low-hanging fruit there is gone. That was a powerful tool that I think was good for shareholders when these overcapitalized companies were borrowed to buy back shares that cheaply. But now, it's less clear. I don't think it's just a tool that's always going to be there. With buybacks, if you look at the math on buybacks, if you're only buying back a small percentage of the float, it's really hard to move the needle. You have to buy back a lot. You have to buy it back at a pretty big discount to really drive value. I don't know. They're like our two approaches there, like are people think, "Well, there's a tax advantage if you buy back at fair value over time as if it's a dividend, then you add value there too." That is true, but to me, what gets me excited as an investor is a board that understands the value of their company. You see that will manifest through aggressive buybacks.

Patrick: [01:02:38] It's interesting that all the work I've done on buybacks and it's been a kind of key area of focus in my research has more or less empirically confirmed what you're saying which is the best way to, let's say, qualify a buy-back program is sort of this lumpiness, this relationship to big discounts and these kind of of high conviction bets that companies make. I once separated it into what I call lower conviction which was 5% or less of shares in a one-year period and high conviction or highest which is five or 10% plus of shares. Sometimes you see a 15 or 20% massive, massive bet. What you find is a couple interesting things where there's a correlation between the conviction level, the percentage of shares being repurchased and the relative valuation. So, higher conviction on average the share prices are trading at cheaper or bigger discounts.

Jeff: [01:03:31] Yeah. That's interesting.

Patrick: [01:03:32] Then the second thing may be more useful for active investors is that the forward returns of those stocks are considerably higher. You get large stocks at called 10% return since 1982 when share buybacks became really popular. The low conviction group outperforms by, say, 1% a year a little bit, but not hugely significant. It's varied. Then, that high conviction group outperforms by about 4% a year. It's a big gap. Of course, there's plenty of examples even within that high conviction group of value-destroying buybacks. But from an empirical standpoint, it does seem to be true that the-

Jeff: [01:04:14] It's interesting.

Patrick: [01:04:15] ... lumpier higher conviction bigger buybacks that aren't just a dividend proxy where it's one or 2% of shares every year or timed at the beginning of the year with diluted EPS in mind.

Jeff: [01:04:27] Yeah. It seems intuitively true to me. It'll be interesting to see if we get a sustained bear market what the data looks like because it's also you just have had a market that has gone up and when people were buying back shares. But to me, if I see buybacks with a brain behind them, usually, they're good. At times, they're bad if the board's just wrong and delusional which happens.

Patrick: [01:04:53] We talked a little bit about Popeyes I'd like to move to the last position we'll talk about before getting to some closing questions which is Tandy Leather.

Jeff: [01:05:01] Sure.

Tandy Leather & Small Cap

Patrick: [01:05:02] What I'm really most fascinated about Tandy Leather, first of all, I intentionally didn't really look into their business because I kind of wanted to hear it from you.

Jeff: [01:05:08] It's a weird business.

Patrick: [01:05:09] But the number that jumped off the page is not the weight of Tandy Leather in your portfolio, but the percent of shares outstanding that you own of the business. Are you the largest shareholder?

Jeff: [01:05:20] Yeah.

Patrick: [01:05:21] You are.

Jeff: [01:05:21] Yeah. We own about 30% which this is also that's a real hornet's nest with affiliation rules, all that kind of stuff. I'm on the board. I have to be careful about what I can say about it. But the main thing with Tandy is it's a really good niche business. They're a retail company that sells leather and tools to leather crafters, so for people who make things with the leather. They have a fanatical customer base. They can have their stores and will vary the low rent areas, and the customers will come to them. I bought it. It's kind of a classic microcap a story these little tiny companies, like, their valuations get heavily influenced by the activities of the large shareholders and liquidity. In 2008 and 2009, there was a 16% shareholder like the Wellington Group. I don't know why a company like that would own 16% like of Tandy Leather, but-

Patrick: [01:06:29] They're a big micro-cap player, I think.

Jeff: [01:06:30] Oh really?

Patrick: [01:06:31] Yeah.

Jeff: [01:06:33] They're big funds.

Patrick: [01:06:34] Oh yeah, sure.

Jeff: [01:06:34] They have big funds. We basically bought a big hunk of our position at probably a 30 or 40 million valuation for a company with no debt and excess cash that at the time was probably doing 8 million of operating income and did 12 million last year or the year before. Then, we bought another huge chunk from a retiring CEO to bring us up to basically the 30% where we are now. I was just a real fan of the quality of their business. Usually, with our positions again as we talked about with Star Gas, with Popeyes, it's a lot like the Star Gas story. It was a special situation. They were a conglomerate. They basically liquidated. They went a year with no CEO. They got an excellent CEO. People were tired of the name. Then the financial crisis hit. You had a year of great performance, but during the financial crisis with a new CEO, it had a special situation narrative. Tandy was just a really good business where you had for some reason a shareholder that wanted to sell at all costs at any price. We stepped up with the bid.

Patrick: [01:07:54] It strikes me that when you think about, obviously, hyper-liquid large-cap markets that dominate stated equity returns, everyone talks about the S&P 500 that maybe the future of, we'll call it active management, I want to get your opinion on the active passive debate in a minute, but maybe the future of active is more in situations like this where you're sacrificing liquidity obviously for a longer-term view on a good operating business that obviously Tandy Leather means nothing to almost every single stockholder out there but is a meaningful part of your fund. Do you think that that's true? Do you think that the real opportunity is going to be in smaller cap, less liquid, longer horizon-type investments like this?

Jeff: [01:08:42] No. I'm agnostic on that front. I mean I'm agnostic about a lot of things, but, yeah. Look, I think there's a dynamic to micro-caps and the liquidity problems and the issue ultimately a lot of times, you're at an information disadvantage from the seller. It's a lot like distressed investing with you're buying a block of distressed bonds from someone that knows a lot. There are all these aspects of a micro-cap investment that would make it hard to have a quantitative or an indexing strategy. I think there will always be room for active managers in tiny, tiny companies. To your question of, so there's a second question like implicit in yours which is with this fund and indexing and the mega-caps, will we hit a point where the quality of it like an individual fund managers judgment, in general, they're not going to be good enough to compete. I think it's just a completely different question. It's a question about I mean essentially judgment or what kind of access to information, but I don't know. I just assume the market is prone to bad misjudgments. I do think there's a place for concentrated big cap investors too. I think there will continue to be. Look, I think it's hard to outperform. I think over time, there will probably be compression on fees, but I think there's a place for active managers across the board.

I wonder as quantitative investing grows, will that help a small pocket of active investors? To me, the more problematic issue with the growth of algorithmic hedge fund investing in the mega caps is I think that we're seeing this real imbalance and access to information there too where you have the really big funds now have the resources and the world has evolved in this way where they have access to more real-time information than even the companies do. They're buying all of this real-time data on consumer habits which I assume skirts the gray areas of securities law, but is pretty fascinating. I thought it, like a lot about that and the impact that that'll happen in the long term.

Patrick: [01:11:25] I've seen satellite imagery for mall parking lots-

Jeff: [01:11:29] That kind of stuff.

Patrick: [01:11:31] Crazy unstructured data.

Jeff: [01:11:32] I get an email I mean every day from like, "Oh, we have a few big cap positions. We own Google or Chipotle." I think that what puts us up on the radar of these little firms that are like, ''Hey, we have all this value-added research on how Chipotle's doing this week or whatever." There's this whole industry of that stuff.

Patrick: [01:11:55] It's like Graham looking through the ICC-

Jeff: [01:11:57] Yeah, totally.

Patrick: [01:11:58] ... at special information. I think the question now is the problem we face now as active investors is how in the world to separate signal from the noise because, surely, most of that information is completely useless.

Jeff: [01:12:14] I think that's a good thing for long-term investors ultimately. That's not going to hurt them if there are people out there that know what the next quarter is going to look like.

Patrick: [01:12:25] Two quick questions on your business. I'm curious. One, if you benchmark yourself and if so, against what. Two, maybe talk a little bit about your investors because I can tell having talked to you before this conversation, but also through this conversation and based on your portfolio that you've got a high conviction long-term investing strategy here. That's not all your money. You've got investors. The quality of those investors, I'm sure matters. Maybe, you could touch on that.

Jeff: [01:12:53] Sure. Yeah. We've been really, really extraordinarily lucky in that a large percentage of our current investor base. They were only a fraction of our beginning investor base, but they have come to dominate it in terms of assets our collection of high frequency traders. They're all high net worth individuals. They tend to be young and sophisticated and interested in markets. We're fortunate that over the life of our fund which coincided with '07, '08, '09 which were banner years in that industry that they grew at a period where it really helped us to have access to capital. We've been really, really lucky on that front. I knew lots of the fund managers in '08, and '09 who had to close shop who were doing just as well. My old boss at Arklow, Greg Schrock who works here now, he's the one at the end of the office. He was a big subprime short. He was up 80% in '07, up over 10% in '08. Then, he was up in '09, but just a little bit. He basically lost his seed investor and had to fold up shop. We've been really fortunate to have a great investor base that understands what we do and that allows us to invest in the way that we know how to invest.

When you think about benchmarking, we're not out there marketing to new funds. We're not out there both trying to get big institutions like when our clients invest in us, I think of them as choosing us over the S&P 500 index fund. That's our competition. I feel not only is that hard to outperform in terms of its return. It's a lot more tax efficient. It's way easier from an administrative standpoint. I think that we have a high bar to live up to we sometimes have these investments where we're investing in some kind of a liquidating trust where it's a tax disaster and we'll get our K1 in September. We really are an administrative burden on our investors. They're choosing us. I feel to make it a worthwhile investment, it's the S&P 500. It's not just that it performs well. It's easy for these guys right to not have to deal with the K1s and the liquidity and all that stuff. We never really compare ourselves to the value indices or the Russell, or I don't know. I guess that we have. There are times when we obviously are going to be more correlated to the Russell. In periods where we really suck, we might say, "Well, the Russell sucked."

Patrick: [01:15:53] Yeah. We're value-based.

Jeff: [01:15:55] That could partially explain it. But they know that we have 10 to 15 positions and that in any given year, that it will be driven by these idiosyncratic things.

Patrick: [01:16:09] How often do you have or maybe the most recent time that you've made a major portfolio change which is I'm assuming your turnover is very low?

Jeff: [01:16:17] Yeah. Our biggest portfolio, we used to own General Motors. We sold it. Yeah. In the last three years, all of our big changes have been sales. We really haven't bought a new core position in a long time.

Patrick: [01:16:32] Is that value driven? Is it a lack of cheap opportunities?

Jeff: [01:16:36] I think so. I mean I hope so. Yes. I view it as its lack of a productivity on our part, but hopefully, the reason that is the case is because there's not compelling ideas out there.

Patrick: [01:16:49] I'm going to close with a few kind of fun quick questions.

Jeff: [01:16:53] Sure.

Patrick: [01:16:53] The first of which is what is the kindest thing that anyone's ever done for you professionally.

Jeff: [01:16:58] Definitely, Arthur Levitt got me into Columbia Business School. I applied there. I did the interview. After I got in, I think it was the first week of school, I think it was the dean of admissions called me into her office and basically explained we wouldn't have let you in for Arthur which in hindsight, I think her telling me was... I'm glad that she told me. I'm glad I knew. It did motivate me as opposed to make me resent them. I'm incredibly grateful that they did it because going to that school has been extraordinarily good to me, but then at the same time, there's a part of me that's like, "They should be taking more people like me." I had the aptitude to go there by a wide margin. I just didn't have-

Patrick: [01:17:52] The resume.

Jeff: [01:17:53] ... the business background. A part of me is like, "Well, they should take more people like me." But, yeah, without him, I wouldn't have gotten in there. At the same time that I applied to Columbia, I got rejected by NYU. Those were the two schools I applied to. It was real proof that Arthur did get me in.

Patrick: [01:18:18] You mentioned that at Columbia in Greenblatt's class, you felt like you just got some of the stuff faster than other people. Maybe, this is the answer to the question, but I'm curious that if you could isolate one skill or skill set that you feel you're just better, if you have more aptitude that drives a lot of your advantage, what would it be?

Jeff: [01:18:37] I don't know. If I have a skill set that is above average, it's above average for the general population, probably not above average for-

Patrick: [01:18:48] Right, the paradox of skill that Mouboussin

Jeff: [01:18:49] For hedge fund managers.

Patrick: [01:18:51] talks about

Jeff: [01:18:52] I think I'm good at big picture thinking. I think I'm a good writer. I think I'm a good written communicator. I think those are things that have helped me professionally, but I'm not sure that they make. If we're talking about above average in the peer group, I think I'm pretty average in the peer group.

Patrick: [01:19:12] Given that we first met each other because of your book and we're both, I think, pretty voracious readers or at least some love books throughout our lives and both writers as well. Every one of these kind of podcasts has the interviewer asked people for a book recommendation. I'm going to try to do it a little bit differently just to keep it more interesting not so much just a one book recommendation, but if you somehow had the power to force everybody in the world to read one book, what would it be?

Jeff: [01:19:42] Interesting. I have thought about this some. I think the big issue is I'm 41 years old. When you're 41, every book is a baby step. There's no one book that you can read when you're 40 years old that is going to have a profound influence, I think. I just think it all feeds the way that you see the world in a positive way, but I mean I read Ayn Rand in the 10th grade. It had a profound impact on me even though within three years I had completely rejected everything that she said. It was like you are just at that age that books have a profound impact. I think the way that I read now is very different from in high school. You're like the-

Patrick: [01:20:36] Sponge.

Jeff: [01:20:37] Yeah. Well, sponge. And, you know so little, that everything affects you in a huge way. All of those books, all of the books have a huge impact on the way that you see the world. You like to read at that age. I don't know. I love a lot of books now, but they don't... Every book is just a small change on you now. It depends on who you are. I don't really have an answer. In terms of business books, I guess when people ask me investing wise is that I do always push the Snowball. I feel like, A, it's-

Patrick: [01:21:22] Great book.

Jeff: [01:21:23] Yeah. That's weirdly under the radar even among the Buffett devotees. I think that book is more valuable than I think like a young investor coming up now will get more from the Snowball then from the intelligent investor or security analysis or-

Patrick: [01:21:45] Kind of like a lot of aspects of your story that we've heard today. I think there's huge value in the Snowball in just understanding the stages and hardships and hard work and strokes of good luck and all the things that go into looking back seems an inevitably great career. It's very hard to be successful as a fund manager, and a lot has to go right. I think Snowball is probably the best example of understanding that journey.

Jeff: [01:22:16] Yeah. I think it's a significant achievement. I think it does exactly what Buffett wanted the book to do. I think it's a real shame that he's divorced himself from it because I go to the Berkshire meeting every year, but this year was the first year that I did the book circuit. I went to all these book events, and the Snowball was invisible from them. When I talked to young people, a lot of them have read the Lowenstein and not the Snowball. The Lowenstein book is good, but to me, it's completely unnecessary especially if you read the Snowball. The Snowball just has incredible access. It gives you such a better feel for how much of an anomaly Buffett is, but also for how he thinks and what drives him. It's a shame that it's not the profile book at the meeting every year. It should be.

Patrick: [01:23:13] Last question, if you could hear anybody else interviewed like this, who would it be?

Jeff: [01:23:19] That's a good question. I'm always fascinated by people who are productive but have diverse interests. I really like this guy, Tyler Cohen. He blurbed my book, but he's interested in lots of different-

Patrick: [01:23:34] Is that marginal revolution guy like George Mason?

Jeff: [01:23:35] Yeah. I don't know how he does it. How does he have time? How does he organize his day to cover that much ground? Ultimately, I think a lot of fund managers are interesting people. I think Carmen, Cliff Asness, well, guys that, they're well-rounded and sophisticated thinkers. I think ultimately when you get writers or people who might have a little bit of a more narrow interest, you might learn less from guys like that than from people that really cover lots of ground.

Patrick: [01:24:16] Broader interests. Interesting. Great. Well, thanks so much, Jeff, for doing this.

Jeff: [01:24:20] Cool. Thanks for

Patrick: [01:24:21] My first recording, it's been a blast. I appreciate it.

Jeff: [01:24:27] Okay. Thank you.

Created by Tim Roe