Brian Skally is portfolio manager of the Absolute Returns model, a special situations portfolio that holds stocks Brian believes have become mispriced due to extraordinary corporate events, including spin offs, mergers, restructuring, bankruptcy and liquidation. His model seeks to achieve positive returns regardless of overall market conditions, with low correlation to the broad indexes over a prolonged period.
Brian works in the private shipping sector, and previously worked as private consultant in the maritime industry and at a hedge fund.
We had a chance to ask Brian a few questions about his model, which as of 12/11/12 is up 34.7% since its 2/13/12 inception, versus the S&P 500’s 5.6% gain in that period.
How does your portfolio reflect your approach to investing?
The model essentially reflects my view that the best investment performance will be found by concentrating on your best ideas that are within your circle of competence. In an investing environment saturated with information, the areas in which an investing edge can be found are relatively rare, but they do still exist.
In areas of special situations investing, there are certain inherent information shortfalls which can be exploited by diligent investors. I don’t believe that this style of investing requires any specific background or knowledge, but rather the time and willingness to explore opportunities in areas that others can’t or won’t, and the patience to wait for the right pitch.
Who are your investing mentors?
There are many but the most significant would probably be Mario Gabelli and Joel Greenblatt, who are the foremost practitioners of special situations investing in the United States. There are also some exceptional investors in both Europe and elsewhere who are seldom mentioned. Keeping an eye on the likes of Francisco García Paramés and Álvaro Guzmán de Lázaro has provided me a number of ideas in the past.
Why do you prefer a concentrated portfolio?
In general I look to position size in relation to the potential for permanent loss of capital in a given position. Most of the time, my actual portfolio composition is a function of the availability of attractive opportunities, which tend to be more plentiful at market lows and less so when the market is buoyant. With regard to concentration, I believe that the majority of capital should be employed in your best ideas and within your circle of competence. Blindly diversifying outside of these parameters is likely to increase, rather than decrease, risk when measured in terms of the potential for investment error and permanent loss.
What has been your biggest investing mistake and what have you learned from it?
There have been many, but I would say that the biggest mistakes have been in underestimating the potential for a company’s balance sheet impairments and the rapid pace at which they can occur.
Companies are often statistically cheap for a reason, and not every cheap looking company represents an investment opportunity. My lesson has been to understand that genuine opportunities occur much less frequently than you may think – having the patience to wait for them is key.
What are your top conviction holdings right now?
Of late, the model’s position in Home Loan Servicing Solutions (HLSS) is one I am watching closely, and has been one of its top performers. This was a recent spinoff from Ocwen (OCN), which purchases mortgage servicing rights.
As can often be the case with spin offs, the security was under followed and poorly understood. The security is now becoming better known with greater analyst coverage and this has coincided with an appreciation in its share price.
In my opinion, the business, while not without risks, compares favorably to other income paying securities and should trade comparatively higher given the quality of its assets.
Marchex (MCHX) is another interesting business, which is aiming to spin off its portfolio of internet domain names in 2013. The separation of these and other non-core assets should materially improve the company’s financial position and could result in increased shareholder value.
Under what circumstances do you cut loose holdings?
The portfolio generally holds securities undergoing some kind of extraordinary corporate event and often surrounded by some type of uncertainty. In many cases the investment thesis can change dramatically in relatively short periods.
The decision to sell is based simply upon potential for future gains versus the available alternatives. The investment case often hinges on a certain corporate event, be that a restructuring, spin off or legal event, the conclusion of which should provide a logical exit point for the investment.
What are the big risk factors going forward into 2013? What could surprise investors?
While there would appear to be numerous risk factors going forward, I generally try to avoid making predictions or in making investment decisions based upon them. It is a simpler proposition to consider the risks inherent in an investment at the company level.
Thank you, Brian.
My pleasure.
Disclosures: The investments discussed are held in client accounts as of November 30, 2012. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable.
Certain information contained in this presentation is based upon forward-looking statements, information and opinions, including descriptions of anticipated market changes and expectations of future activity. The manager believes that such statements, information and opinions are based upon reasonable estimates and assumptions. However, forward-looking statements, information and opinions are inherently uncertain and actual events or results may differ materially from those reflected in the forward-looking statements. Therefore, undue reliance should not be placed on such forward-looking statements, information and opinions.
Performance discussed is net of advisory fees, and includes reinvestment of dividends or other earnings. Any index comparisons provided in the blog are for informational purposes only and should not be used as the basis for making an investment decision. There are significant differences between client accounts and the indices referenced including, but not limited to, risk profile, liquidity, volatility and asset composition. The S&P 500 is an index of 500 stocks chosen for market size, liquidity and industry, among other factors.
