Shannon Zimmerman: For Morningstar, I am Shannon Zimmerman here today with Tim Hartch, comanager at BBH Core Select, a Silver-rated fund with about, what, $5.5 billion in assets?
Tim Hartch: Correct.
Zimmerman: And then also the comanager at BBH Global Core Select, which recently launched I believe in March.
Zimmerman: All right. So let’s begin with Core Select, the older fund. You’ve been a manager there since 2005, and it’s a large-cap fund, as I mentioned. And it closed with about $3.5 billion in assets back in November; not a huge sum for a large-cap fund. What was the thinking behind the decision to close it?
Hartch: We had visibility in our Core Select in terms of certain of our largest investors who had intention to invest in each case several hundred million dollars more. It actually ended up that those existing investors continued to invest more than we had expected. But we had awareness that that was going to happen, and so we wanted to close the fund at a level that was appropriate for the strategy. We also have a significant amount of separate accounts that are very similar in approach and strategy.
So in total, we were managing about $19 billion in the large-cap space. So it's in looking in that whole context that we felt it was the right time to close the fund back in the fourth quarter. And then both a combination of significant appreciation as well as those anticipated flows have actually been somewhat more than expected from existing investors is how were at the $5.5 billion today.
Zimmerman: So a lot of good questions coming out of that. So the flows have come in pretty fast and furious since the close. We show you with about $5.4 billion as of the most recent reporting period since November, so it’s up about $2 billion since November into the mutual fund alone. How much have you seen in the other channels? You mentioned that there are a number of separately managed accounts that you run that are similar in strategy. Has all that money coming in so quickly been a problem for you?
Hartch: Well, in terms of the cash position in the fund…
Zimmerman: About 12%.
Hartch: 12%, that’s not the primary driver. It's definitely [the fact that] valuations are up, and so it’s harder to deploy the cash into companies that are trading at the discounts that we like. We always like to buy high-quality businesses, and then have a double margin of safety: the quality of the business and the intrinsic value. But that's what’s driving it more than the inflows in terms of the cash position. Then for our institutional separate accounts, we've made a hard close. We’re simply not accepting additional institutional assets both from our existing or new investors.
Zimmerman: That’s what they get for sending in more money that they said, right?
Zimmerman: Just one more question about assets, and then we’ll move into the process at the fund. What do you think the overall capacity is for the strategy? It’s a large-cap fund, but it’s a rather concentrated large-cap fund, and as we’ll discuss in just a minute, your valuation requirements are rather stringent, as well.
Hartch: Well, I think this is the right time to close the fund and close the strategy.
Zimmerman: About $20 billion in assets?
Hartch: In total. We’ve always thought the overall, if you look at the separate accounts in the fund, we’d want to close somewhere between $15 billion and $20 billion, and here we are at $19 billion. We thought it really was appropriate to take that action, and a lot of that’s been through appreciation. Going forward, it's much easier to manage a fund or a strategy when you're growing organically through appreciation as opposed through inflows. So I think we'll be able to invest the amount we have in the way we have since 2005.
Zimmerman: Is there anybody who is looking at the fund's cash position right now and sees 12% as maybe a red flag? It’s not a red flag because you are saying it’s not driven primarily by flows, but because the universe of stocks that you would consider, the valuations look little stretched.
Hartch: That's the primary reason for the increase in the cash position. It's just that the opportunities to invest in businesses trading at 75% or less of our intrinsic value estimate, there are far fewer opportunities than there were. If you look at our portfolio and look at the last 12 months and at what stocks have been up, companies like Comcast, Novartis, Diageo, or Berkshire Hathaway, they are trading at 30% plus more than they were a year ago. These are good, solid-growing businesses, but their free cash flow is not growing at 30% per year. It's a much more modest, typically single-digit rate.
So we were no longer able to invest in those businesses at a substantial discount. There still is a discount, or else we would have sold those positions in the names that we own in the portfolio, but it's small. I suggest not trying to predict what’s going to happen to the market, but predict over the long term that from this starting point returns for our businesses will be less than they have been in certainly last three years.