Why would someone with Du Bain's resources and experience go such a young advisor who had little in the way of a track record? "I know enough about investments so that I'm able to evaluate when someone knows more than I do," Du Bain comments. "I can't evaluate stocks as well as he does. It's mainly evaluating the projections, the future of the company. Anyone can look at what's happening today."
Du Bain adds it was obvious to him how bright Schaff was. "He just had a feel for this business. He's very analytical. He can take a company's financial statements and tear them apart and know exactly where they stand," he says. Today, Du Bain still is a Bay Isle client and serves on the board of several nonprofit organizations. Like a wily baseball scout who spotted a superstar when he was a teenager, Du Bain takes pride in the fact that Schaff, whom he calls "a top-flight man," started with just his account and now has a very substantial business. These days, he keeps an office at Bay Isle and buys secretarial services from the firm.
Despite Du Bain's account, it took a couple of years for the firm to grow significantly. Other early clients were friends and colleagues who had worked at Chevron. The corporation offered a good early retirement package in late 1989 and again in 1992, when Bay Isle got 15 to 20 clients from Chevron that year alone, Pollock says. "We specialized in lump-sum rollovers, IRA distributions and retirement packages, that whole area of retirement-oriented investment and planning," he says. "It helped that I had gone through the same paperwork as all of these people."
Early on, Schaff and Pollock concluded that equity management with a style bias toward large-cap value would be an investment area on which they would concentrate. "That doesn't mean we can't buy a growth or small stock, but what we're saying is that large-cap value is what we're best suited at," explains Schaff, who has done models on every company in the Russell 1000.
Feeling confident with his abilities in the large-cap value arena, Schaff started building a strong record of returns in that segment. "We're doing the analysis, and everything is fundamentally done. We use no Street research," notes Schaff.
Bay Isle's large-cap value product has been a key in attracting institutional clients. The firm first got smaller-tax exempt accounts, and in 1995, it landed its first large institutional customer, Daimler Chrysler Corp. The company, for which Schaff manages pension-fund money, still is his largest account.
Over the last few years, the number of Bay Isle's institutional clients have increased dramatically. Institutional clients (including funds) represented 64% of the firm's total assets under management at March 31. Among Bay Isle's institutional clients are Mazda Motor of America, Hitachi Data Systems, Sunkist Growers, Shell Pension Trust, Museum of Contemporary Art in San Diego, Scripps Health, University of San Diego and Ronald McDonald House.
During a decade that favored growth over value, Bay Isle's Large Cap Value composite had achieved a 10-year return at Dec. 31, 2000, of 19.69%, compared with 17.47% for the S&P 500 Index and 17.37% for the Russell 1000 Value Index. Last year, the composite posted an 8.09% gain, versus -9.09% for the S&P and 7.01% for the Russell 1000 Value. At March 31, Schaff was managing $666.1 million in the large-cap value portfolio, and its top five holdings were First Data Corp., 6.6%; McGraw-Hill Cos., 5.2%; Lockheed Martin, 5.2%; Bank of New York Co. Inc., 5%; and Safeway, 4.9%.
When evaluating investments, Schaff considers all of the stocks in the Russell 1000 Value Index, which comprises the 1,000 largest value companies and uses a four-step selection process to reach a fully invested portfolio of 25 to 35 stocks. The process begins with Schaff eliminating any that have a market cap of less than $3 billion, as well as any highly cyclical stocks-such as those of auto, airline, commodity and basic materials, and oil exploration and drilling companies. He then applies his own proprietary modeling for discounted cash flow, asset valuation, sum of the parts and relative multiples.
He also looks at the quality of the company's cash flow and analyzes its balance sheet, as well as considering management's track record and the company's position in its industry. The third step involves screening based on discounts to fair value, catalysts that could drive appreciation and the strength or improvement of the company's sector. In the fourth step, the final selection process, he takes another look at discounts to fair value, financial position, catalysts for appreciation and management's ability to execute its plans. Rules are applied to selling, too-he unloads a holding whenever the current price exceeds a predetermined valuation, management loses focus or significantly deviates from its strategy, the stock exhibits a 15% price depreciation relative to its market segment or it is overweighted within the portfolio.