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    Guest Interview:

   Bernzott Capital Advisors

    888 West Ventura Blvd., Suite B
    Camarillo,CA 93010-8383

    Telephone: 805-389-9445
    Fax: 805-389-9456


    Interview Quarter: 2Q2002

 Kevin Bernzott

 Chairman - CEO

Q: Kevin, how did you go from receiving a law degree, to commercial real estate, to establishing an investment management firm?

A: I earned the law degree at night while working in commercial real estate. I never intended to practice, but valued the Socratic process of a law school education because it teaches you to think critically about all sides of an issue. In 1993, I developed a large shopping center. It took ten months to build the project, but three years to obtain all the requisite governmental permits and entitlements.

That was my last real estate development project; life is too short for that kind of aggravation. Money can be very effectively managed absent the frustration wrought by interaction with bureaucrats and suffering through interminable public hearings.

Q: What prompted you to get into the business of managing people’s money?

A: I educated myself and began actively managing my own money after realizing that stockbrokers were simply commissioned salespeople with varying degrees of investment skill and Wall Street research was so conflict-ridden as to be virtually useless. After some success on my own, I began managing small accounts for friends and found it very rewarding.

Money management is so much more fulfilling than wrangling entitlements to develop real estate. I began running money as a sideline and the business just grew by word of mouth. It’s been a very gratifying experience.

Q: MMR tracks your mid to small cap value product. What advantages does an investor have in that sector of the market?

A: Over statistically significant periods of time, history has shown that the small to mid cap arena offers the greatest opportunities for capital appreciation. We also like that market segment because of the lower visibility and somewhat more constrained liquidity, which we perceive as advantages for small shops like ours.

Small and mid cap companies don’t attract as much attention from the talking heads, which we like. When we’re talking with a client about a new addition to their portfolio, a not uncommon response is, “Never heard of them.”

Q: What kind of research do you use to identify potential investment candidates?

A: First of all, we do our own homework. We like to see either increasing earnings per share or an increasing dividend for a number of consecutive years; if both are increasing, so much the better. Then we look at the usual ratios and some other metrics. Insider ownership is a plus. Finally, we meet or talk with management and make a number of subjective decisions, not the least of which is whether or not management is trustworthy.

That said, we’re not mechanical about screening but are nimble enough to act opportunistically if warranted. For example, last year, the stock price of Tommy Hilfiger just got hammered on a litany of hapless miscues and bad news. The company didn’t
even begin to meet our criteria, but was trading for less than the value of the cash and equivalents on its balance sheet. We took a position and closed it out three weeks later with a nice profit. But it’s rare that we do something like that.

Q: For you, what is the single most important characteristic that defines value in the market?

A: Our first screen is for either increasing earnings per share or an increasing dividend for a number of consecutive years; if both have been increasing, so much the better. But that’s only a starting point from which the real work starts, because all we know about a company at that point is that someone there did something right for a significant period of time.

Q: Are you a bottom-up stock picker or do you do a general survey of the market and invest in the companies you have not eliminated?

A: We’re bottom up stock pickers. In the eighteen months ending June 30, 2002, The Nasdaq is down 46%, the Standard & Poor’s 500 is down 27% and the Dow Jones Industrial Average is down 15%. The days when someone could throw darts with their eyes closed and make money are gone for now – these are times for hired guns.

We believe that there are companies with a demonstrated ability to perform well regardless of industry problems, cyclical trends, or gyrations in the economy or market. Our job is to find them, buy them right, and watch them carefully to make sure management doesn’t do something stupid.

Q: Why do you normally hold so few positions in a typical account?

A: We think that concentrated equity positions produce superior returns over time. If a portfolio holds fifteen stocks and a few of them double, the impact is huge. But if a portfolio holds scores of stocks and a few of them double, so what? Besides, we’re not smart enough to have fifty or sixty “best ideas” to stuff in someone’s portfolio. If an investor needs to own that many issues to feel comfortable, they should buy an index fund instead of hiring a money manager.

Q: Is there a cap size range upon which you focus your research?

A: No, we look across the board at all capitalization ranges as long as there is sufficient float and liquidity for us to block trade. The micro caps are problematic, but we do own one because the opportunity is so compelling.

Q: How well do you know the companies you are buying? Do you visit them or know the management teams?

A: We know them as well as we can without actually running them or taking a board seat, although I am on an advisory board of one of our two banks. In virtually every case, we either visit the company or meet or talk with management. When I say management, I mean management – the CEO, CFO, or other senior officer. We’re really not interested in spending time with the IR folks other than perhaps to gather statistical data or something.

In the last month, I’ve personally met with five CEO’s and four CFO’s. That’s a bit atypical because several were in New York at the same time for an institutional investor forum, but we are in frequent contact. I can call the CFO of one of our REITs on his cell phone or at home if I need to, so we’re appreciative of the access and mindful of the constraints imposed by Regulation FD.

I think our managers like us because we are patient investors with a long term view and we understand them and their business, as opposed to the “What have you done for me lately?” mindset found elsewhere. Half the people on the Street can’t seem to see beyond the current quarter and sound like they suffer from ADD on conference calls.

Interestingly, one of the few companies we don’t talk to, because the company doesn’t talk to anyone, is one of our better performers. We bought the “B” shares of Berkshire Hathaway at around $1500 solely on the strength of the company’s transparent financial accounting and the integrity of the men running it.

The integrity is a key issue. We try to own companies run by managers who have character, not managers who are characters.

Q: Do you set price targets for either buying or selling your stock positions?

A: Some investment managers seem to focus on identifying good companies and paying the current market price for the stock; that’s not us. Our discipline includes not overpaying when we find a good company with quality management, so we establish a fairly firm “not to exceed” buy price considering projected cash flow and other valuation metrics. It’s hard to lose money if you don’t overpay in the first place.

The sell discipline is a little different and we don’t use a firm target number. We would love the opportunity to own most of what we buy for a long, long time, indefinitely really. But if the price gets ahead of the business, which is to say ascends to an unrealistic or unsustainable level, we’ll look at it, particularly if the appreciation has resulted in a skewed asset allocation.

Basically, if we bought something at $30 and it’s at $60, we’re probably having intense discussions about whether it’s more likely to go to $90, or back to $30.

Q: I see your turnover rate is extremely low. What compels you to sell a stock?

A: We have a strong buy discipline coupled with a reluctance to take our winners out and shoot them. Firm-wide, we’ll generally sell only if the fundamentals deteriorate or we conclude we were wrong about a company. Account specific, we’ll sell to raise cash for a more compelling opportunity, and may sell or trim if a position becomes significantly overweighted or overvalued. We’ll also sell for considerations unrelated to the security, usually having to do with a particular tax consideration or whatnot.

Q: How do you manage risk and do you ever hold any portion of your portfolio in cash?

A: We manage risk by not paying too much for businesses with great track records run by smart, honest people. We frequently hold cash in a portfolio while waiting for prices to come in line with what we are willing to pay for a given company, but prefer not to hold cash and equivalents as an asset class or pursuant to an asset allocation decision unless client-specific reasons obtain.

That said, right now we’re more than a third in cash and short term equivalents. Why? Things are too expensive.

In 2001, the Dow Jones Industrial Average dropped 7%, the S&P 500 fell more than 13% and the Nasdaq Composite skidded 21%. In just the first six months of this year, the declines have accelerated with the Dow dropping almost another 8%, the S&P off almost another 14%, and the Nasdaq plunging another 25%.

Let me emphasize that: in the just the first half of this year, all three widely cited benchmarks have dropped more than they did for all of last year. And we’re still having trouble putting money to work without overpaying for good companies.

That should give people pause, although it’s way too late for many people who paid ridiculous prices for companies with no earnings. For example, who paid $168.75 per share for Ariba in September, 2000, and watched it drop to $1.42? Not us – weren’t there, didn’t do it. Never owned it, and since it still doesn’t have any earnings, probably never will.

Q: What or who has been the greatest influence on your investment philosophy?

A: Warren Buffett, hands down. Using a baseball metaphor, he pointed out that an investor can stand at the plate day in and day out taking investment pitches and not ever get called out on strikes. We swing at pitches, and at times, of our own choosing.

Q: Please tell us what your Investment Policy Statement covers and why it is important?

A: Institutional clients tend to draft their own mandates, so our Investment Policy Statement (IPS) chiefly provides private clients with the guidelines we use and explanation of a general framework within which we discharge the duties set forth in our Discretionary Investment Management Agreement. But perhaps more importantly, it is a tool to help us educate folks and manage their expectations.

The IPS explains and documents a variety of basic concepts. It also sets forth a long list of things we never do when investing: buy commodities, futures, foreign issues of any kind or ADRs, warrants, options, or physical real estate; or purchase on margin, purchase IPO’s or penny stocks, or engage in short selling. And it specifies services we do not provide: financial planning or estate planning, or legal, accounting or tax advice; and advice concerning contributions to or distributions from IRA or qualified plan accounts.

Then, we turn to client specific concerns and discuss time horizon, any needs for current income from the portfolio and any special circumstances germane to the investment situation. Clients are free to instruct us to retain or purchase specific securities not on our Buy List, which we carry as unsupervised positions not subject to a fee. They may also instruct us to refrain from purchasing or holding specific securities in their account.

Q: How do you change your investment style to accommodate clients with varying investment objectives?

A: We don’t change our style; we just do different things for different people.

That’s the beauty of separate account management. We’ve got the ability to consider the time horizon, risk tolerance, goals and objectives, tax consequences and unique circumstances of each relationship before investing.

Q: Tell us about the other principals in your firm, their backgrounds and functions within the firm.

A: Peter F. Banks is our Vice President and CFO; he concentrates on research and portfolio management. Previously CFO of Ojai Ranch & Investment Co. Inc., a private investment firm, Peter was responsible for investment analysis, treasury functions and accounting and MIS systems and controls. He prepared asset allocation strategies combining elements of investment selection and tax and estate planning.

While serving as CFO of Ventura County National Bancorp, Peter managed a $100 million bond portfolio, evaluated and executed investment strategies, formulated and executed strategic and capital management plans and analyzed product and business line profitability. He was also responsible for compliance, accounting and tax issues and interfaced with both banking industry regulators and the U.S. Securities and Exchange Commission.

Prior to joining the bank, Peter was a manager with KPMG Peat Marwick where he supervised the analysis of internal controls and accounting systems and the application of audit techniques for clients including banks, savings and loans, and non-profits.

Peter holds a BBA in Finance from Texas A&M University and has done graduate work in accounting at California State University - Northridge. He speaks fluent Spanish, is a CPA and member of the American Institute of Certified Public Accountants and the California Society of Certified Public Accountants.

Dale A. Eucker is our Operations Manager; she concentrates on trading and client service matters. Previously employed at Next Step Productions Inc., Dale was responsible for the day to day operation of three separate entrepreneurial businesses. She played a key role in the start up, implementation and ongoing operation of an Internet based e-commerce business and was responsible for web site maintenance, MIS and IT related functions.

Dale began her business career at Industrial Tools, Inc, a leading designer and fabricator of high quality ultra-precision cutting tool systems used throughout the world. She advanced through positions in accounting, sales and marketing and operations before becoming the Executive Assistant to the Chairman of the Board.

Dale holds a BA in Linguistics from the University of California – Irvine, where she graduated cum laude. She is a Level I candidate in the CFA Program of the Association for Investment Management and Research.

We recently hired a sales professional from the sell side, Bruce A. Blais, who joined the firm as Vice President. Bruce holds a BA in Industrial/Organizational Psychology from San Diego State University.

Finally, being a relatively small shop, we utilize the services of a consulting economist, Dr. Michael Bazdarich of MB Economics. His clients include other money managers, banks, insurance companies and financial services companies.

Q: With the attack on the World Trade Centers on September 11th, 2001, most portfolios were down for the third quarter. How did you fare so well?

A: On September 12th, we realized three things: first, our elected government was still in place; second, our military capability was undamaged; and third, our economy and the ability of the companies we own to produce earnings were basically unchanged.

People were glued to CNN in shock for a while, but the American consumer likes to spend. And the consumer drives about two thirds of GDP. Cap ex by business was a no-show before September 11th as well as after, so what was new?

We also judged that the market would eventually recover from even a horrific exogenous event. Investment decisions should be driven by intellect, not emotion, so when the market reopened, we refused to participate in the panicked selling that ensued and instead put some cash to work.

Q: When comparing you to other managers, MMR’s analysis shows that you have outstanding returns as well as very low volatility. How do you manage doing so well in both?

A: With one exception, the beta of every equity security we own is zero-point-something. We don’t set out to do that on purpose, but that’s where our research leads us. Our conservative, fundamental bent coupled with price discipline on the buy side, results in low volatility.

It’s not very exciting. But we get paid to preserve and grow capital, not provide entertainment.

Q: What makes you different than other investment managers?

A: Our fundamental investment philosophy has allowed us to do well in good economic times and bad, regardless of whether this or that style is in or out of favor. On the equity side, we generally buy quality companies run by trustworthy managements and have the discipline not to overpay for them. On the fixed income side, we never stray from investment grade issues. It’s not flashy or exciting, but we don’t lose money either.

We also put our own money where our mouths are. Our compliance manual requires that our corporate pension plan and the securities accounts of our employees and their immediate family members be invested the same way we invest for similarly situated clients. I’m happy to share and explain my personal portfolio information with clients.

Q: What plans do you have for the firm’s future?

A: The big thing is that we’re a 100% employee owned firm and would like to keep it that way. We talked with consultants for CalPERS some time ago, a marquee client we’d have been unlikely to win a mandate from, about a program for emerging or developing managers. But in exchange for letting us run some money for them, CalPERS wanted equity in the firm and that was a non-starter here.

Now that we’ve got an AIMR-compliant Level I verified seven year track record coupled with an increasing base of assets under management, we’re considering actually marketing to institutions for the first time. We’ve always said that we don’t wear ties or work with people we don’t like, so it looks like the tie rule may go by the wayside.

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