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Undiscovered Managers: Swift, Smooth, and Silent

Beck, Mack & Oliver's low-key, team-based approach carries the firm's success.

Kate Stalter, 10/24/2011

For its 80th birthday, asset-management firm Beck, Mack & Oliver is throwing its coming-out party--metaphorically, anyway. BM&O, which has quietly served its institutional and high-net-worth individual clients since 1931, has achieved quick success with its mutual fund, formally launched just two years ago.

But you haven't seen the partners on cable-TV finance channels giving their stock picks or touting their approach. The firm has never marketed itself and doesn't even include photos of the partners on its website. 

Partner Robert Beck, whose grandfather was one of the firm's founders, says the low-profile mentality is ingrained into its culture. "A guy asked me for my business card yesterday," he says, "but I don't even have one. This fund has really been a homegrown effort, but we think we have a story worth telling."

As of July 31, the Beck Mack & Oliver Partners Fund BMPEX, managed by Zachary Wydra, boasted a year-to-date return of 9.71% versus the S&P 500's return of 3.87%, placing it in the top 1% of its Morningstar category. For the trailing year, the fund's return was 30.45%. The fund currently has $27.1 million in total assets. The firm's assets under management total around $4.2 billion.

Though the fund was reorganized into its current publicly traded structure in December 2009, its origins lie in a limited partnership that dates back to 1991.

Morningstar fund analyst Ryan Leggio has begun tracking the Partners fund. He hasn't finished his analysis yet, but he finds it compelling enough to research further and likes what he's seen so far.

The firm and its fund overcame some of Leggio's early doubts. The fund falls into the large-blend section of the Morningstar Style Box. It faces stiff competition in that crowded space, but Leggio says that the fund's performance has been eye-catching. He was also impressed that its character differs significantly from that of a typical index fund.

"One metric we look at, which is called Active Share, measures the percentage of the portfolio overlap with the S&P 500," Leggio says. "This fund's active share is over 90%, which  means less than 10% of the fund's assets are the same as the S&P 500's. For perspective, that places the fund easily within the most independent, or most distinctive, in the large-blend category."

Manager and Team Member
Fund manager Wydra, who joined the firm in 2005 and became a partner two years later, is quick to credit his colleagues for their role in the portfolio's success.

"If I come up with an idea that I want to buy in the Partners fund, it doesn't get bought until I've convinced my partners, who are all seasoned investment professionals, that it's a position that should be proliferated throughout the firm," Wydra says.

He emphasizes that BM&O's culture influences investment decisions and sets it apart from other asset managers. "We come together as a group of senior investment professionals, and we make the decisions ourselves. We are the ones actually doing the research," Wydra says. "So, we aren't relying on teams of analysts, with the portfolio manager becoming removed from the data collection and due-diligence process."

He notes that partners are involved even with ground-level research details. "The people actually building the discounted cash flow models are seasoned portfolio managers, not fresh-out-of-business-school associates. I think that's a very important distinction. My partner Walter Giles has been known to sit in his office for a week and complete 40 due-diligence calls with a company's management team, its customers, and its competitors."

Before joining the firm, Wydra was an analyst at Jacksonville, Fla.-based long-short equity hedge fund Water Street Capital. There, he worked under the tutelage of renowned asset manager Gilchrist Berg, whom Wydra calls "an exceptionally talented investor. I had the great pleasure of working for him and learning from him for several years, post- business school." His resume also includes a stint at private-equity firm Graham Partners, which he credits for teaching him to think like a business owner. "We take a private equity approach/mentality and apply it to the public markets, investing in businesses, not just buying and selling stocks," Wydra says.

Wydra has an MBA from the University of Pennsylvania's Wharton School of Business, a master's from Columbia, and a bachelor's from Brown. As a baseball and basketball fan, Wydra is comfortable using sports analogies when describing his reasons for joining BM&O.

He draws a parallel between the firm's approach to investing and the philosophy of the Dallas Mavericks, who bested the Miami Heat in the most recent NBA championship series. "The Miami Heat is a team of three superstars and then a bunch of bit players around them. The Dallas Mavericks are a team of players from all over the world with a great deal of experience, who have come together as teammates to do something special. They're certainly willing to give up the opportunity to shine like a superstar for the opportunity to win as a team," he says.

When deciding whether to join the firm, Wydra says that part of the appeal was BM&O's philosophy of investing in companies, rather than simply picking stocks. "This is a group of like-minded, creative investors who think about the world over longer time horizons and believe that a patient and thoughtful approach to allocating capital supported by thorough due diligence can add value for clients over time," he says.

The BM&O approach to making investing decisions, he says, has evolved from a culture that centers on a high-functioning team rather than a handful of "superstar" fund managers.

Wydra and Beck report that only two partners have resigned from the firm in 80 years (other than retirements). "And after a short stint away, one of them came back," Wydra says.

Putting Theories to Work
The Partners fund has a three- to five-year time horizon for its investments, meaning that Wydra can be patient even if a stock has a temporary price downturn. He'll even add to the fund's position to get more shares at a lower price, as long as the partners remain confident that the stock offers solid long-term appreciation prospects.

Beck says that the firm prefers to avoid investments in companies and industries that require extremely specialized expertise to fully understand. However, health care is one of BM&O's areas of expertise. Beck himself began his career as a health-care industry analyst, and he takes an active role in ferreting out potential opportunities.

At the end of the second quarter, health care was the second-largest sector allocation of the fund, behind financials. In this category, the fund comprises some well-known names, such as Merck MRK, Johnson & Johnson JNJ, Abbott Laboratories ABT, and Baxter International BAX.

But that doesn't mean BM&O just snaps up S&P 500 health-care sector names and calls it a day. Wydra, Beck, and the other partners do extensive analysis on company fundamentals. They go beyond basic metrics, such as earnings per share growth and price/earnings multiples, and examine factors such as share buybacks.

When a company allocates a sizable percentage of its discretionary free cash flow to a share-repurchase program, it catches the fund managers' attention. Says Wydra, "That creates a situation where net income does not have to grow in a robust sense for earnings per share to grow at a very attractive rate."

He cites Merck, the fund's largest health-care holding, as an example of a company that's added shareholder value through buybacks.

Though some of the largest health-care holdings are widely traded large caps, other names in the fund are less well known.

Wydra calls the investment approach "market-cap agnostic," and a look at the top holdings bears that out.

The fund's largest position is Enstar Holdings ESGR, a Bermuda-based specialty insurer. Its market cap is just $1.3 billion. 

On the other end of the spectrum, and in addition to the large-cap health-care names, the fund also has big holdings in IBM, whose market cap is around $200 billion.

Mid-caps that constitute a large portion of the fund's net assets include electronic connector maker Molex MOLXA and water-treatment specialist Nalco Holdings NLC.

Nalco, which was taken public by its private-equity owners in 2005, was a name that Wydra recommended to the other partners. It provides a good illustration of how BM&O's culture and investing philosophy play out in the real world.

Because Nalco had gone through a leveraged buyout, the company had a relatively high debt/equity ratio. But Wydra and the other partners were convinced that Nalco's competitive advantage boded well for future cash flow and price appreciation.

"We started buying it at $17," Wydra recalls. "But in the midst of the credit crisis the stock trades down to $7." The partners discussed whether or not Nalco remained a viable investment, and Wydra maintained that it was worth continuing to support.

"We knew what the debt maturities were, and we'd spent a lot of time studying the balance sheet," he says. "We understood the durability of the cash flows. I felt very good about this position, and we continued adding through the bottom."

The stock rallied from its bear-market bottom, rewarding investors who stuck with it. In July, Nalco bolted 27% on news that it would be acquired by Ecolab ECL for $38.80 per share, a 34% premium over the stock's closing price before the announcement. Wydra points out that as of mid-August, Nalco's share price had nearly doubled since May 2005, while the S&P 500 was essentially flat.

"This shows you the power of actually doing the work ourselves," he says. "We absolutely do not rely on Wall Street research to make our investment decisions for us. During the period we've owned Nalco, it's probably been upgraded and downgraded by a variety of Wall Street analysts 15 to 20 times. They want you to buy it, sell it, hold it, buy it, sell it. We understand and appreciate that their incentives are very different from ours. They don't make money as a result of buying the stock and waiting five years for it to go up, and then selling it. They are transaction-driven and make money as a result of generating activity or commissions. We view that as inconsistent with the objectives of our clients and the fund--which  is to compound capital over long periods of time."

Another significant holding is Brookfield Asset Management BAM, a Toronto-based specialty asset-management firm. It's a company that is difficult to categorize, in that it owns both significant commercial real estate assets and North America's second-largest portfolio of hydroelectric power-generation assets.

Despite a market cap of $19 billion, Brookfield moves a relatively small number of shares, about 1 million per day. Its dividend yield is 1.8%. It's yet another example of BM&O's efforts to uncover companies that Wydra says don't fit neatly into S&P's sector categories.

"There are aspects of Brookfield's business which you can say are appropriately categorized as a financial, but it is a business that we would say is much, much more interesting and nuanced than your run-of-the-mill  large-cap bank, and it has an exceptionally talented management team, led by Bruce Flatt" he says.

The Right Kind of Attention
Morningstar analyst Leggio was impressed not only with the portfolio mix, but also the partners' decision to launch with a competitive expense ratio of just 1%.

"That's relatively rare for newer funds," he says. "Clearly, they could afford to lose money for the first few years of the fund, since they are doing well in the private client business. But we've seen a lot of funds launch in the same category that started at 1.3%, and it was only after asset growth that they were able to reduce the fees to a reasonable level of 1%."

Morningstar's analysts are not the only ones who have taken note of BM&O's successful, unusual approach. Todd J. Peters, CEO of Lyndhurst Enterprises Inc. in Richmond, Va., specializes in finding undiscovered or emerging managers. He's not interested in those who fit neatly into a style category.

"I'm looking for managers who bring a unique perspective to the table. One of the things that's most intriguing to me about Beck, Mack & Oliver is that you're getting a chance to leverage a firm with an 80-year history, but with what I would consider an emerging or undiscovered fund," he says.

Peters has followed the Partners fund for about a year and a half. He likes the portfolio's mix of well-known big caps, along with the opportunity presented by small- and mid-cap firms that aren't on the radar of as many institutions. Peters says he generally tends to recommend funds that own fewer than 30 stocks for his institutional clients. The Partners fund held shares in 31 companies at the end of the second quarter, but 80% of the fund's allocations go to the top 20 holdings.

"There's a limited number of ideas that a firm can cover and know them well,"  he says. "And I feel like I'm getting the best ideas from this unique portfolio. "

‘Don't Lose Money'
Wydra quotes Warren Buffett as he sums up the firm's philosophy of investing through various market cycles.

"Rule number one in investing is ‘Don't lose money.' Rule number two is ‘Don't forget rule number one.' If you look at our pattern of returns over time, that's very much been the case," Wydra says. "If you can consistently and meaningfully outperform during down markets, even if you give a little bit up in the strong markets, you will create an enormous amount of outperformance, net of fees, over time.

Kate Stalter is a columnist for RealMoney at TheStreet.com. She also writes a daily column for MoneyShow.com.

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