[Asset allocation, diversification, value, growth — words that immediately connote investment concepts drilled into our brains by tradition and habit, established interpretations of financial research, and a form of “common” sense. But the evolution of the asset management industry and the investment process has demonstrated how many former money management concepts can be challenged by uncommon thinking, a variant perception, or can just slip into being applied in a vastly different way.
Questions can and do arise leading to new thinking and approaches. Does asset allocation and portfolio diversification, as applied by most, really reduce risk? Are growth and value stocks really that distinct? How important and effective is incorporating a top-down, macro level of research and analysis to your stock selection process? When the macro backdrop is extreme, how does a stock picker alter (or not alter) their investment approach in such a period?
To explore these topics in real world application, we were introduced to Larry Pitkowsky, co-founder, managing martner of registered investment advisor Goodhaven Capital Management and now sole-portfolio manager of a public no-load mutual fund Goodhaven Fund (ticker: GOODX) and managed accounts since December 2019 with the retirement of his co-manager Keith Trauner. Prior to forming Goodhaven, Larry was a portfolio manager of the Fairholme Fund.
While his investment style can be characterized as a value manager, there is a lot more going on here below the surface. We wanted to explore further with questions digging into his thinking and the changes made to his portfolios over the past few years that seems to be putting a new spin on old established investment concepts.]
Bill Hortz: What are your views on portfolio management and why have you said that it should not be conducted as an IQ test?
Larry Pitkowsky: IF some IQ threshold was the sole determinant to long-term portfolio outperformance, then everyone involved who met that threshold would achieve those results — which obviously is not the case. If it was about access to minute-by-minute financial information or the amount of money spent on research, then every subscriber to such information services would achieve great long-term results. But decision-making skills, judgment, and perhaps, most importantly, the right emotional temperament are the soft skills that, while harder to measure, are more important over time to outperformance.
We believe successful value investing is owning quality businesses run by exceptional leadership that can be purchased at a price significantly below intrinsic value. Our core belief is that markets can be inefficient and successful investing requires pattern recognition and understanding behavioral factors like greed and fear, as much as a strong analytical understanding of the fundamentals.
Our investment process is rigorous and highly selective. We approach each existing position or prospective investment with a business owners’ approach and a bias towards businesses with durable competitive advantages that can generate attractive normalized earnings and free cash flow. We invest with a multi-year mindset because it allows us to focus on the long-term, particularly in businesses that we feel are at or close to a positive inflection point that is material and underappreciated.
We only allocate capital to our highest conviction ideas because we believe that a rigorous underwriting process is the most important risk management tool if we define risk not as volatility, but permanent loss of capital.
Although the pace of change in our industry continues to accelerate and we strive to be nimble and agile, we remain focused on simplifying the complexity and constantly adjusting our biases and positioning, even if it can be psychologically discomforting. We love to learn and we are continuously learning as we invest.
Hortz: Why do you feel that the value and growth style of investing are more connected than distinct?
Pitkowsky: We are constantly looking for areas where we can have an edge over the market. There is a common misconception that value investing is about finding the cheapest statistical stocks where the absolute cheapest stocks on a screen are considered value and the most expensive is considered growth. The reality is that growth is a component of a company’s valuation and if we can pay an attractive price for a business that has a significant runway for growth, that is considered value. To us, a growth business with strong competitive advantages and high returns on invested capital could be more attractive as an investment than a statistically cheaper commodity business that faces increased competition. We aim to find opportunities that are good businesses led by great management and can be purchased at a good price. Having said that, our current portfolio is statistically cheaper than the S&P 500 on a Price/Earnings ((P/E)) basis and has in recent years had faster top line earnings per share growth than the S&P 500.