In his quest for value, manager Karim Mawji of Dickenson Bay Capital is often attracted to the messy stock stories that send other investors running. The securities he’s drawn to typically involve companies undergoing major changes – in the midst of a restructuring, divestiture, merger or management shifts.
Such so-called “Special Situations” often have many moving parts. They can be difficult even for professional investors to fully understand. As a result, stocks in the group rarely get the benefit of the doubt from Wall Street; they can trade at deep discounts to their historical prices.
Because of those potentially steep price discounts, however, an ideal Special Situations investment can offer a combination of stock price appreciation and less potential downside, as their prices already are often depressed due to the uncertainty.
Karim has spent most of his career evaluating Special Situations as an investor, banker and executive. He draws upon his past experience as a Restructuring Banker at Deloitte & Touche and as the number two executive for an $800 million internal Morgan Stanley hedge fund.
At Covestor, Karim’s Macro Yield portfolio leverages his Special Situations research methods to find yield-focused investments that are designed to generate income and can help to meet clients’ capital preservation objectives.
Covestor’s Mike Tarsala recently sat down with Karim to gain more insights into his strategy:
Q: Karim, what would you say is your investing edge versus other macro yield managers?
I’ve been in this business nearly 20 years. I began doing M&A and restructurings as an investment banker. I did traditional deals and I also ran turnaround companies
So I am not just a guy sitting in a vacuum reading SEC documents and sell side research reports. I have operated businesses and had to resuscitate or liquidate companies. There were situations where if I didn’t get them financing and stabilize the operations, 1,500 people would be out of work. I like to think that I understand the mentality of management teams and I have a sense for what a management team is capable of achieving in a certain period of time.
Moreover, I was on the buy side as a portfolio manager with firms that had between $100 million and $3 billion under management. I have personally run $300 million dollar portfolios. I believe I have a very good framework for idea generation, corroborating work and testing ideas.
I also ran a short book for a hedge fund in 2007 and 2008. That experience has reinforced the need to first try to understand the underlying investing risks. By doing so, I attempt to make higher quality long investments.
From my perspective, It doesn’t matter if I own a stock or I am short a stock. I believe opportunities to make money exist either way. So I try to take an objective view.
Q: You state that your target total return is mid-single digits net of fees, yet you have beaten that target significantly in 2012 and so far in 2013. How have you managed to outperform your benchmark in each of the past three years?
The way that I invest changed with the investment environment. As tail risk was reduced, I became more comfortable owning securities with a little more risk, but they are all a similar profile: Higher dividend, higher margin of relative safety, with an opportunity to unlock value.
Q: What are the investor profiles you have in mind for your Macro Yield model (without, of course, making specific recommendations for any particular individual)?
There are three profiles I have in mind:
1) A post-retirement, high net worth individual who owns a mix of assets. I’ve found that in many cases such an investor earns a low yield, but on a large asset base. The investor typically wants to increase their yield, but without taking on a lot of risk. They also may want quick access to their capital if necessary, so they want liquidity and they don’t want it locked up.
2) A younger investor with some money to invest conservatively that they don’t need in the near future. This investor often shares the goals of the post-retirement profile I mentioned above.
3) A family in their 40s or early 50s who typically has some younger kids, perhaps junior high/high school age. This client profile looks to use the income from a relatively conservative strategy to help fund monthly expenses.
Q: In what market conditions does your strategy tend to perform the best, and in which markets does it underperform?
I view this as a lower volatility strategy that tends to lag the market in a strong uptrend. But it is designed to protect capital and outperform the market in a downtrend.
Of the three strategies managed at Dickenson Bay, the Macro Yield model offered on the Covestor platform has the lowest volatility and the most consistent returns. The reason it’s acted like that is that it’s had a third to a half of the assets invested in ETFs that are either fixed income securities related, or dividend related in some way. So that seems to have added some stability to the way the portfolio acted as the market declined in various selloffs.
The focus on Special Situation securities is also an important factor: I often invest in companies going through restructurings, spinoffs, IPOs, or transformative M&A. These are typically value-oriented companies that have hard assets underlying the value. In my view, that provides valuation support.
Also, there are events occurring that may unlock value – for example, improving operations or selling a division.
Plus, the long holdings either pay dividends or are expected to start paying a dividend soon. The key point there is that these are not the first stocks someone is likely to sell when the market turns south. I feel like those are the key attributes of the investment portfolio that have protected investments on the downside and helped us to create alpha.
Q: How do you manage risk given current (possibly overbought) market conditions?
First of all, I am not afraid to go to cash. If I am that worried about how things look, I will go to cash. And I have done that in the past.
Today’s market scares me a little bit. Do I want to put fresh money into the stock market today? If I were a client looking at that, I honestly don’t know. Lately (in Q1 2013), I have been taking profits.
But I think it’s important to be careful about changing exposures too rapidly. Because the reality is that nobody – myself included – has a crystal ball. My decisions come from my bottom-up stockpicking and my top-down macro analysis.
Q: What processes do you have in place to try to help avoid doing worse than the market in a downturn?
First of all, my willingness to go to cash, as mentioned. Also, I generally do not own any positions that I can’t be out of entirely within 5 days – without my trading significantly affecting the security price due to trading volume. The diversification is also important in this regard – I have much less concentration risk in this strategy.
Being balanced between fixed income and equities has held up reasonably well in downturns the past four years. Most of the individual securities owned pay a dividend between 2% and 7-8%. People aren’t as likely to just dump those because they are earning significant income every quarter.
All of this together has resulted in a more stable return profile so far. I have in mind a client who is more afraid of losing 20% in a market downturn than making only 8% when the market is up 16%.