The managing partners at Tweedy Browne stick with their conservative style even in a time of bigger payoffs for risk.
Woe betide he who tries to fight a style box. As much as some money managers might want to resist Chinese menu style descriptions of the way they invest, people have to organize their lives somehow, and where does that leave an old-school value investor like Tweedy, Browne & Co.?
Trailing. Perhaps unfairly. "Whether you go from the slug to the human being, your whole life is boxes, and unfortunately sometimes they move us into certain boxes," says William Browne, a managing director at the storied brokerage, money manager and intellectual salon that helped shape that value movement, the one launched by Benjamin Graham and made famous by Warren Buffett.
The managers at Tweedy still trumpet with the piousness of Quakers a kind of investing that you can set your watch by: One that eschews risk by looking for companies whose intrinsic value is trading at a deep discount to their stock prices, buying those companies, and holding as many of them as possible for a dog's age. Thus, there's not a lot of turnover in the holdings of its two traditional funds. The most important thing is that its holdings are earning them what Graham described as satisfactory return and they are not overpriced. When the prices do get too hot, it's time for them to hit the circular file.
This style is finicky in judgment, quantitatively screened, empirically sniff-tested, rigorously implemented-and seemingly too dull for many. After all, lots of investors don't invest the way Warren Buffett does, even though, says one Tweedy Browne partner, Buffett is the five-sigma anomaly that frustrates the predictions of Modern Portfolio Theory.
For Tweedy, knowing the history is important, because if you only looked at the firm for the last seven years, you might not think they were all that exciting. Value investing in general has had a renaissance since 2000-near the end of the dot-com era. Morningstar says the average large-cap value fund from January 1, 2000, scored a total return of 66.44% through Sept. 30 2007. The total return for mid-cap value in that time was 129.76%. Tweedy's funds, though they are up, have fallen behind a bit. Its now-$8.4 billion flagship Tweedy, Browne Global Value Fund had a glowing five-star Morningstar rating during the 2002 bear market, but it has now dropped down to a lackluster two. Much of the time, when they have had money to put to use, they wouldn't tread where some value managers started to-picking up fallen tech stocks such as Intel or Microsoft-because these companies still didn't fit Tweedy's more parsimonious definition of value. Taking risks has paid off, they say. But this is not a risky crew.
"Every once in a while, I'll get a call from a guy who says that for the last three or four years you guys have been trailing our international funds," says Robert Wyckoff Jr., another one of the firm's five active partners, along with Thomas Shrager, John D. Spears and brothers Will and Christopher Browne. "I'd look at it in the last three to four years and it would be 18% compounded, which was a phenomenal total return number. ... Invariably I'm asked, 'How are you going to catch up?' I say it's kind of hard to apologize about 18% compounded, and furthermore, we're probably not going to catch up. They're probably going to come back to us."
According to Bridget Hughes, a senior fund analyst at Morningstar in Chicago, Tweedy's two traditional funds have trailed peer averages, mainly because they are both misfits for their categories. The search for value, as Graham would define it, means the firm is agnostic about cap size, and as they drift away from their peers' holdings, the comparisons become a bit fuzzy.
"For the last few years they've been buying large companies [in the smaller Tweedy, Browne Value Fund] because that's where they are finding their best opportunities," says Hughes. "But smaller companies are the ones that have been leading the performance over the past four years-they suffer because they've got this cap bias." In the much larger Global Value Fund, she says, the firm tends to drift again, which also makes it a square peg. "It's been in the small- and mid-cap category and it's really an all-cap fund," she says. Furthermore, the global fund has always used cash hedges against foreign currency drops-at a time when the euro keeps rising against the dollar-and thus hedges have put salt on their wings and clipped performance when the competition is unhedged.
A Rubber Name
It's often in down markets that the firm proves its mettle. What's important to the managing directors is that they don't shrink from the style of investing that the firm made its bones on-knowing the difference between the price that changes hands every day in the market and the price that would exchange hands in an entire transaction between a knowledgeable buyer and seller.
Thus they seek companies selling at discounts to what the managers find the intrinsic value to be, usually at two-thirds of net current asset value or tangible book value or perhaps 8 times or 9 times earnings (maybe as low as 4 times if they're lucky, but never as high as 18 times). And where one company might look cheap to some value investors, Tweedy will draw a frown on it by normalizing earnings to make them seem less robust, or haircutting valuations to be more conservative, or pooh-poohing profit margins if they don't think these are sustainable.
And yet, value investing, especially in its most recent resurgence, has been stretched in its definition, so that now, former high-flying technology companies such as Microsoft and Cisco pop up in value funds, as have many commodity and energy stocks. You won't find lots of names like these in the Tweedy Brown universe, and for good reason.
"I think there was probably more discussion at the time that we might perhaps invest in Microsoft rather than Intel," says Browne. "And we ended up not choosing either. It really comes down to ... do you feel reasonably comfortable that you understand the dynamic of the business. If you want an extreme example of the stock we've held forever, it's Nestle. We feel reasonably comfortable about the dynamics. Here's a company with 125 products in 150 countries that are consumed every day ... that do have this nice middle-class upper income whiff about them that people desire."
Predictability is not a factor with a company like Microsoft on the other hand, which must constantly come out with new products like Vista to stay in the game. With technology, the Tweedy managers say, by the time you know something that might become a franchise or have some repeatable, predictable revenue, the price of entry into the security is very high.
"And yet overhanging this high rate of growth," says Wyckoff, "is this black swan kind of risk that can come out and take away technology's advantage, and that can happen relatively quickly. If you're in at a high price-[and] often you are not able to get in at a low price - it can be damaging to wealth creation."
A lot of energy companies have also been non-starters at Tweedy. "I would mention that one of the reasons for the performance of the fund is the fact that we didn't diversify in oil stocks and all kinds of energy-related stocks and raw materials," says Shrager. "And one of the reasons that it's been difficult for us is that it's impossible to find an intrinsic value for oil. Oil can be at $30 and it could be at $130."
Graham's screening process was severe, and critics of the style have said that opportunities to find companies that meet the criteria get more and more difficult. It's also been harder since private equity companies have started to feed on the cash-rich value sector and drive up prices further. Thus it's probably not surprising to critics of the style that Tweedy has found it harder to find companies that fit its criteria, especially in the U.S.
The big plays for the company have more and more been overseas in both of its funds, including its smaller Tweedy, Browne Value Fund, which shed the name "American" last year. Its most recent instincts have led it to scoop up a brace of companies in South Korea, which Browne says is unfairly characterized as an emerging market. They have also tried to cash in on consumer finance in Japan, which has a big market for hungry borrowers, but anti-industry legislation made that bet a bad one, concedes Shrager.
"We're hampered by the fact that we've been around a long long time, and we haven't seen stocks at 8 times or 9 times earnings in a long long time," says Wyckoff. Thus, much of the money is often stored up in cash reserves (sometimes 10% and higher), and the funds are often closed for long periods as they wait for new ways to deploy the money in their own way. The global value fund is now closed to investors except those whose financial advisors had clients in before. The much smaller Tweedy, Browne Value Fund, at $509 million in assets as of July 31, 2007, reopened in May after its name change, which the partners said had to do with advertising restrictions that kept the managers largely hemmed into American companies for as long as the moniker "American Value Fund" hobbled them. (Before it reopened, it had been closed since 2005, as was the global value fund, which remains shut.)
"We closed our funds, particularly the global value fund, perhaps at the height of our popularity," says Wyckoff. "And it all related to the fact that it was getting tougher and tougher to put money to work and cash reserves were building in the portfolios, and we thought it just made no sense to dilute the returns from our existing shareholders by trying to bring in a bunch of new cash."
Tweedy is still more likely to prefer cyclical companies such as Nexans SA, Forbo Holdings, or Volkswagen, or non-cyclical companies with perennially used products that provide predictable income, such as Swiss food company Nestle SA, British beer and spirits maker Diageo plc, and the Mexican Coke bottler Coca-Cola Femsa SA de CV. "People don't change much in their consumption of chocolate or beer," says Shrager.
Another longtime holding, and still their largest, is ABN Amro. "ABN Amro has been a collection of good businesses that have been very badly managed for a long time," says Shrager. "If a bank trades forever at 10 times earnings, and then they have operations in the U.S. that you know in the past traded at 18 times because it's a regional bank; [if] you have a bank in Brazil where you have high book value multiples for the acquisition of banks; and if you have a bank in Italy and the multiples of these banks have been acquired at 18 to 20 times-and then here sits this bank in front of you trading at 10 times-the probability is that if that continues without deterioration in the fundamentals of the company, that at some point a takeover or merger of the companies will take place."
Indeed, the bank is now caught in a bidding war between Barclays and a group of banks led by The Royal Bank of Scotland. Tweedy hopes RBS will emerge victorious, even if it means ABN Amro might be dismembered. "We don't care as long as we have our money," says Browne. "We want RBS to win because they're offering more, and then we own Barclays and it might become a takeover target."
On occasion, the firm gets into the news as activists, and was especially demonstrative when it came to its holdings Hollinger International and Volkswagen. The former, it said, had had monies diverted by its former chief executive, and the latter was falling prey to a possible conflict of interest as its chairman was also a major shareholder of carmaker Porsche, which was buying a big stake in VW and would probably have drawn on its resources for itself. However, the company says that its desire is not to control and shape companies.
"To use the vernacular, we'll get involved if we think we're being screwed," says Will Browne. "But we don't get involved with the idea of trying to screw them."
A New Fund
Given the conservative bent of the company, change is rare. (They boast that the firm has had only 11 partners since 1920, a small group that can take all the credit in good years-as well as the erstwhile blame.) But the firm in September opened a third fund with a bit of a different bent-finding high-dividend paying stocks for income. Though the value discipline will still come into play, and there could be as much as a 50% overlap among the names of this fund and the other two, the new fund is more interested in finding dividend payouts that contribute a higher percentage to a company's overall total return, and valuations in this fund might be a little higher than normal if the juice from the yield is good.
The firm has been running separate account portfolios with a dividend slant since the '70s when clients started to request it. The good performance, as well as the Bush administration's tax cut on dividends in 2003, made the partners think it might be time to take the strategy into primetime. They were further convinced by a phalanx of new studies coming out that show that high-dividend paying stocks have been long-term outperformers in earnings growth.
According to Wyckoff, "We looked at our returns, [and they] were quite comparable if not better than the returns we'd produced in our traditional approach and we thought, 'Why not. It makes sense.'"
Shrager says that the new fund is a little different in methodology, but still jibes with the very strict way that the firms look at the companies they invest in. "It's very important to state that we're a very empirical group," he says. "We look at evidence. We look at what has worked, and in this case we have seen that the discipline has worked for 28 years. So that's a relatively long incubation period. So when we see that something works, we trade off on it, if it doesn't affect our existing business."