In the pantheon of investing greats, Sean Riskowitz may barely get a mention. But investors in his fund are a satiated lot.
Last year, Riskowitz Value Fund, or RVP, returned 50.5% net to investors after expenses. The Johannesburg All Share Index returned -4.5% (in U.S. dollars) and the S&P 500 returned 33.4% (including dividends) over the same period.
This was no flash in the pan. The fund delivered 34% in 2012. And in 2011, when tumbling stock markets around the world battered the wealth of shareholders, his investors were sitting pretty with a return of 68%. That was the year the South African index fell by 16% and the S&P 500 barely managed to forge a gain, closing the year at 0.9%.
(The above mentioned returns for 2011 are from the inception of the fund till the end of the year - January 11, 2011 to December 31, 2011).
Its stellar returns notwithstanding, RVF stands out being a New York-based hedge fund that invests only in stocks listed on the Johannesburg Stock Exchange. And fund manager Sean Riskowitz is a die-hard value investor.
Value, with a difference
When Riskowitz is on the hunt for value, he refuses to be constrained by formulae or shackled by traditional value investing rules. Instead, he attempts to profit from the mispricing of a stock, where that company has a significant opportunity to cement its position and grow its intrinsic value at a high rate over the long term. What he calls “compounders”.
Finbond, a financial services institution, is one such stock that elucidates this point. According to RVF’s report for the quarter ended June 30, 2014, it was the fund’s largest investment by market value. Incidentally, it was also the best performing stock in S.A. in 2013.
At the time of the report, the stock did not appear to be a value investment in the traditional sense of the concept since it was trading at a rich valuation. While it is generally understood that a low PE and low PB stock would generate returns ahead of the market over time, Finbond was trading at a high multiple of book value and a high PE ratio. But that did not mean it was time to sell either.
According to Riskowitz, a good company has high returns on invested capital. But the best companies to own are those that have high returns on incremental capital. In other words, companies that can continue to invest at a high rate of return in the future.
“This high rate of return is usually a function of something unique about the business model, usually called the competitive advantage. So we look for companies with durable competitive advantages. These companies tend to produce high returns on invested capital,” he explains.
In Finbond’s case, Riskowitz understood the company’s tremendous competitive advantage and found it cheap relative to its prospects. The short-term nature of Finbond’s products give it a significant advantage. The company’s loan portfolio turns approximately 4 times per year and hence is cash flow generative and a good source of internally generated liquidity.
He explained the numbers in his report:
If a longer term lender’s average tenure is 36 months with a book size of $60 million, that lender will collect $20 million in cash per year and $60 million over three years. If Finbond’s book is $60 million, Finbond will collect about $240 million in cash per year and more than $720 million in cash over three years.
Riskowitz looks for compounders and then sits tight for a long and beneficial ride.
The key ingredients of his value philosophy
Riskowitz’s success can primarily be attributed to his innate ability to latch on to the acumen of other successful value investors. Intelligent and renowned investors like Benjamin Graham, Seth Klarman and Warren Buffett have often discussed their strategy and thoughts in the media, in books and in letters to their investors or shareholders. Riskowitz chose to devour their views passionately, internalise it and build upon it.
When he started off, he was a “cigar butt” investor. Buffett, in his 1989 letter to shareholders explains this concept.
If you buy a stock at a sufficiently low price, there will usually be some hiccup in the fortunes of the business that gives you a chance to unload at a decent profit, even though the long-term performance of the business may be terrible. I call this the ‘cigar butt’ approach to investing. A cigar butt found on the street that has only one puff left in it may not offer much of a smoke, but the ‘bargain purchase’ will make that puff all profit.
Riskowitz’s style gradually evolved into looking for companies with low PE ratios, low PB ratios or for situations where there was a clear short-term catalyst, what we would refer to as special situations. He eventually began to focus on “compounders”.
His basic premise is simple. Buy a great company at a good price and hang in for the long term.
So a company trading at a very significant discount to its present day value will grab his attention. If this parameter is not met, he would bypass the stock. “There are plenty of companies available in the world that turned out to be not-so-great investments because the price paid was too high. In investing, you make money when you buy, not when you sell,” he says.
But that does not imply he is looking for a ride up to fair value only to sell and then recycle it again later. He latches onto companies where the present day value is not static. In other words, the companies must be cheap but provide him with a margin of safety and over the long term compound their intrinsic business value at high rates. As a result, given his purchase price, he can compound his equity at the same or even higher rates.
Taste Holdings, another one of his stock picks, brings this out. The company is a vertically integrated, category specialist fast food and jewellery franchisor. The company has franchise offerings in the fast growing low-to-middle income consumer markets. Here purchases are driven by price and Taste’s vertical integration capability is a durable competitive advantage. At the higher end of the market, the company licenses the strongest brands (those with the potential for the largest market share) rather than own the challenger brands (second or third by market share).
While Riskowitz understood the business model, he underestimated the power of the model once it reached scale. When a results release explained what was being done to support growth in the future, he realised that the company was ideally positioned and operating in a segment where people are getting richer. The more stores they opened, the more franchises, the bigger the economies of scale and the bigger the advantage. Given his low entry price, the growth trajectory is impressive. His thesis probably played out better than he anticipated.
This may give the impression that value investing is a fairly straightforward and simple. Maybe, but far from easy. Riskowitz is a skilled asset manager who has added significant value because he is extremely diligent and rigorous in his understanding of his stocks.
Before investing in Finbond, he studied the company’s nationwide infrastructure, its reputation amongst borrowers, its growth of deposits and increase in loan volumes, how the lead management views capital, and the quality of the loan book. He and his team personally visited numerous branches and spoke to the branch managers, customers and tellers. He also studied the projections of the credit market in S.A. and looked at the history of a similar company that evolved in the same way a decade ago. When he found tremendous value of safety and huge scope for intrinsic value to grow significantly, he decided to bite the bullet.
In other words, he attempts to know the most about the company and acquire an exceptional understanding of the business model and business economics.
A look at his portfolio reveals his deep conviction based on superior reasoning. His portfolio had just 7 stocks and he rarely goes above 10.
So convinced is he about the success of his strategy that he chooses not to levy a management fee. The fund has a 6% hurdle rate. Up to that level, the return is completely allocated to the investor. The fund’s performance fee is 25% of return above the hurdle.
The logic behind the positioning
When Riskowitz set up his maiden hedge fund, it was no cheap tactic to being different for the sake of being different.
For one, he decided to stay within his circle of competence. He personally is of the view that as an investor it helps to have an astute understanding of the culture, the government, the economy, and consumer behaviour. Being born and raised in South Africa, that is familiar territory.
Another advantage being the size of the universe of investible stocks. There are just a little above 400 listed companies on the Johannesburg Stock Exchange, enabling him to build a database of each company, establish which of those are good business models and then come up with an idea of the kind of price he would want to pay for a business of that nature.
His decision to roll-out an offering to give U.S. investors exposure to South African equities is also based on the premise that he sees immense potential in these stocks. He believes that the South African economy is very similar in characteristics to the BRIC countries but is generally overlooked by U.S. investors. Moreover, there are solid companies in S.A. with great management who are expanding and doing business in other countries in Africa. The opportunities are humungous and will result in huge revenues for these S.A. firms.
Interestingly, around the time he launched his fund, The Economist noted that over the 10 years to 2010, six of the world's fastest-growing economies were in Africa – Angola, Nigeria, Ethiopia, Chad, Mozambique, and Rwanda. Ironically, over the past few years, Africa’s biggest economy, South Africa, (now replaced by Nigeria) has been one of its laggards. Finance Minister Nhlanhla Nene told parliament in October that economic growth would only be 1.4% this year though GDP growth was earlier forecast at 2.7% back in February.
But as Riskowitz stated when he set up the fund, “People who engage in value strategies have done extremely well in the South African market.”
He has more than adequately proved that point.
