The underlying business model is all-important, says Chuck Akre, of the relatively few companies in which his firm invests
Compared to your peers, your investment portfolio is relatively concentrated in size and scope. Why is this?
Our investment philosophy is to invest in extraordinary businesses for as long as they remain extraordinary. We define an extraordinary business as one with very high returns on equity, a great management team that treats its shareholders as though they were partners, and extensive reinvestment opportunities and histories. This is what we call our “three-legged stool” approach. By definition, these extraordinary businesses are exceedingly rare. When we are fortunate enough to identify and invest in such a business, it makes for a wonderful compounding machine.
Can you expand on the idea of “compounding machines,” and how you effectively identify such companies?
Compounding machines are those businesses that produce returns on shareholder capital well in excess of the S&P 500 – somewhere in the neighborhood of 15-20% per annum – have superb management and can generate ample opportunity for the reinvestment of the company's free cash flow. The company's management is not only very good at managing day-to-day operations, but they are also exceptional stewards of capital and understand that their number one task is to compound the company's economic value per share, however measured, NOT to please Wall Street. When we find these qualities – and they are very rare indeed – we tend to hold the investment for many years. We call these businesses “compounding machines”.
You tend to maintain your holdings for extended periods – for example, you have been holding Markel Corp for over 20 years. What is it about Markel and Colfax, one of your largest investments, that makes them so good?
Markel is a business that we have owned for over 20 years in our private partnership. The business is run by a wonderfully gifted management team, has a history of conservative underwriting, possesses a very large pool – over $14 billion – in reserves, and every year it is investing those reserves in more and more profitable ways. In 2013, the real economic return on the business was over $70/share with a stock price that currently trades around $650/share, so less than 10x our notion of the economic value per share. Markel has compounded at over 14% for 20 years through good and bad underwriting environments. As for Colfax, this is a newer position but we are one of the largest shareholders already. Colfax was established by Mitchell and Steven Rales, who are best known for their track record at Danaher, which has been one of the great compounding machines of all time! Colfax, like Danaher, is based on the operational philosophy of Lean Manufacturing or Kaizen, which is Japanese for “continuous improvement.” Colfax's business model is to buy mission-critical businesses and through a focus on operational excellence turn them into the most efficient businesses in their industry. No industry or sector is immune to the virtues of improved operational performance so their runway is very long.
What defines exceptional management to you, and why do you think those qualities are essential to the growth of a company?
An exceptional management team is possessed of equal parts skill and integrity. They treat their shareholders like partners and their focus is steadfast on growing book value. To do this effectively, great managers tend to have a few common traits: they reinvest their company's free cash flow intelligently and prudently, provide shareholders full disclosure and accessibility, align their interests with all shareholders, develop talent internally, and they block out the noise and pressure of Wall Street and think for themselves. Nothing can destroy shareholder value quicker than poor allocation decisions by management so management is enormously important. There is a recent publication called The Outsiders by Will Thorndike that captures a lot of how we think in terms of great businesses. We highly recommend it.
For over 25 years you have been able to produce above average returns with below market risks. This has been true across all of your investment vehicles – the private partnership, the Akre Focus Fund and your separately managed accounts. How have you achieved this?
We remain very focused on our core philosophy of investing in extraordinary businesses with great management. If we do this, and if we remain disciplined in the price that we pay for the privilege of being shareholders in these businesses, the rest will take care of itself. Given that these businesses are above average, have strong balance sheets and exceptional managers running them, they should prove less risky over time as well.
An investment strategy that prefers long-term results is often less concerned about quarterly performance. How does this focus reflect your other core values?
Being based in Middleburg, Virginia – a town with one stop light – keeps things simple. We are removed from the clutter and noise of Wall Street and our partners are better off for it. We think for ourselves and avoid getting caught up with the latest fads or hot stocks that seemingly drive investment decisions for most market participants. We spend our time trying to understand the essence of each business in which we invest. We prefer spending our time focused on this and meeting with company management rather than visiting with whomever the sell-side asks us to.
These are very common traits and attitudes within family offices as well. Do you have many families as partners?
Most of our partners in the private partnership tend to be family offices or HNW individuals and they often note the similarities in outlook. For those who currently manage or formerly managed a business, our investment philosophy resonates deeply. They get what we do because they are (or were) owners of a business, or they are children of business owners, and so they understand how real wealth is created.
What kind of clients tend to invest with you, and what do you think attracts them to your fund?
I joke that there should be a third category beyond growth and value. We suggest naming it “compounders”. People who understand the value of compounding at above average rates tend to invest with us. We may not outperform every year but over time we have been able to compound significantly above the S&P 500 for over 25 years! This delta becomes very large in dollar terms over time because of the miracle of compounding.
Akre Capital Management LLC, 2 West Marshall Stree, Post Office Box 998, Middleburg, VA 20118-0998.