BARRY COHEN, SPECIAL REPORTS EDITOR, HEDGEFUND INTELLIGENCE
Unlike some hedge fund managers, who prefer to be very cautious on markets, strategies and policy-makers, Jamie Rosenwald never shies away from expressing his views – whether positive or critical – on the broad range of issues that capture his attention.
Since launching Dalton Investments in 1998 with two partners, the firm has built an enviable reputation for delivering highly competitive returns. It runs the Dalton Greater China Fund, Dalton Asia Fund, Pacific & General Investments and the Dalton High Yield Mortgage Fund. At the 2012 AsiaHedge Awards, Dalton won the coveted Management Firm of the Year award.
Fuelled by a rapid growth in assets over recent years, Dalton currently manages around $2.1 billion in three strategies – global equities, Asian equities and distressed debt – and the Asian operations account for one half of overall assets. Based in Santa Monica, California, Dalton has established a global presence with additional offices in Tokyo, Shanghai and London.
Perhaps the 57-year-old Rosenwald’s greatest passion is his belief in the concept and application of value investing – which he imbibed from his grand-father who worked closely with Benjamin Graham, the pioneer of value investing. On a recent visit to London, where he met with HedgeFund Intelligence for a wide-ranging interview, Rosenwald took the opportunity to talk frankly about his investment philosophy and the triumphs and mistakes he has experienced in a long hedge fund career.
You named your firm after The Dalton School in Manhattan which you and your partner, Steve Persky, attended and where you originally met in 1970. You must therefore have fond memories of your school days to adopt that name for the firm.
JAMIE ROSENWALD It was Steve’s wife who picked the name. Steve and one of our other partners went to Harvard, but we clearly couldn’t pick ‘Harvard’. The fourth partner went to the University of Cambridge and we couldn’t name it after Cambridge. Steve’s wife correctly pointed out that ‘Persky Rosenwald’ sounds way too Jewish. So she suggested ‘Dalton’ – almost a WASP name – which is great. I didn’t think it would overlap with Dalton Strategic Partnership’s business in the UK.
|Jamie Rosenwald |
So Dalton was a good period in your life?
JR No. It was miserable. I went to Dalton for 13 years and met Steve in seventh grade. We’ve been close friends since then. He did my math homework and I figured it would be great to be partners with a guy who was so good at doing my math homework.
Tell us how Dalton got started.
JR In 1998, I was approached by a large New York Stock Exchange firm called Leucadia National Corporation. It was also involved in a joint venture with Berkshire Hathaway, called Berkadia, which is run by Leucadia and financed by Warren Buffett. It said it would like to allocate money to Asia. This was the period of the Asian crisis and Leucadia was a serious distressed investor. I told them I have the perfect person for you to meet: he is the world’s leading expert in Asian distressed debt. So I introduced them to Steve Persky, who said to me: “What are you talking about? I have no idea about distressed debt.” And I replied: “Neither does anyone else in the world.” There had been no Asian distressed debt because any debt that had been issued by a Japanese or non-Japanese company in Asia was oversubscribed five times by Japanese banks, since they had more liquidity in the 1990s than anybody else in the world. This was the end of the bubble period and they were chock-full of cash. As they had bought all this debt, they were eager to sell.
So I said: “Steve, you have worked in Japan where all your clients were basically Japanese banks and therefore you know where the paper is. You knew how to do credit at Citibank, I’ll be your analyst and you will be the world’s expert in Asian distressed debt.”
So Leucadia funded the first account that Dalton opened. At the same time, I personally seeded my other partner, Gifford Combs, who was Steve’s classmate at Harvard, to invest in equities anywhere in the world, but he thought Asia was the cheapest place at the time. That was how Dalton got started in 1998 when we took on our first clients, but we incorporated in 1999.
Dalton Investments has been built on the investment methodology of bottom-up value investing with a strong emphasis on an intensive research process and a disciplined valuation approach to minimise risk. Can you elaborate on your methodology?
JR There are some key aspects of value investing, as done by Dalton, and there is also a spectrum of the types of value investing that people hear about.
At one end of the spectrum, you have Benjamin Graham, who was the theoretical father of value investing, wrote Security Analysis and taught the subject. He had no interest in meeting management whatsoever; his was strictly a numbers approach based on investing 50 cents for a dollar’s worth of assets, and sitting with that investment forever.
At the other end of the spectrum, you have his pupil, Warren Buffett, who invests in operating and managing businesses and who may be willing to pay close to $1 for $1 worth of assets. He may even pay more than $1 for $1 worth of assets, because he either likes the management or he likes the sustainability of the business and the return on its capital.
So where we do we fall within that spectrum? We are probably closer to Buffett than we are to Graham, but we manage public equities and we don’t have permanent capital like Buffett does. So we have to think about various aspects of liquidity.
In terms of the long side of our portfolio, one aspect of our value investing approach is that we buy companies that are worth $1 for 50 cents, which creates a margin of safety. Hopefully, at the end of the year, they will be worth $1.10. Therefore, the valuation continues to grow over the term of the investment. And, over the past 15 to 20 years, our average term of investment has been five to seven years. Ideally, you would hold something indefinitely.
The second aspect is what we call an ‘alignment of interests’ between the investor and the management of the company you are invested in. So one of our critical measures is that we look for management that has more than five times their annual salary in stock ownership of the companies they run. And not just the CEO or CFO, but also the board of directors who have very large amounts of shares in relation to their compensation. For example, it might be an outside director who is paid $50,000 to $100,000 per year, but he has $10 million or $20 million worth of stock. So does he really care about the directors’ fees or is he much more interested in how the stock is going to do? That is important to us and that exactly illustrates the concept of alignment of interests.
The third key aspect is whether this is a sustainable business. Does the business have a moat, or is this, perhaps, a technology company where the technology is changing rapidly, which presents an additional risk? Like Buffett, who has historically bought businesses which are hard to replicate and therefore hard to compete with, we look for companies that have some kind of technological lead, some kind of moat, some sort of market share which provides them with the kind of leadership that enables them to sustain their position over long periods of time.
A good example is Allied Group, a Hong Kong-listed family conglomerate. The biggest driver of its growth will be its consumer finance business. For many years, it has been number one in consumer finance in Hong Kong, and is an early and the biggest independent mover in consumer finance in China. Its joint-venture partner is Orix of Japan, which has been very successful in that business in Japan. The growth rate of that underlying business is over 30% per year. There is an enormous, insatiable consumer demand in China right now, but there still isn’t a consumer credit culture in China. The banks offer very little in the way of credit cards or loans, while the loan sharks are going to charge exorbitant rates.
Now this consumer finance company does something very unique and interesting – namely, it buys the database for very little money from China Mobile and other mobile telephone companies so that it can run credit checks on the Chinese population and get customers through this means. It also enables it to differentiate customers between owners of smart phones and old-fashioned phones. So it is at the early stage when it is creating credit-scoring capability.
Allied Group also has a huge mainland Chinese and Hong-Kong-based property development company and a medium-sized stockbrokerage company in Hong Kong. It also has interests in a wide range of mining assets in Australia, Canada and Africa. So it’s quite diversified. There are all sorts of ways you can make money. And because it doesn’t have a lot of debt, and because it has all these different growth engines, you don’t need many things to go right to actually be a winner in that stock.
The Li family’s founding fathers of the company hold 40% to 50% of that company. That is a heavy alignment of interests. The son of the family is the CEO, and board members all own plenty of stock. Who buys a Hong Kong conglomerate? It’s not on any index and so institutional-index investors are not buying it. Dalton clients own 5% of the company. When we buy into a company, we’re not buying shares but rather buying a percentage of the company. We view our purchases in the same way that a private equity investor would view their purchases. In this case, we are buying a very talented, highly motivated, and incredibly well incentivised management.
It must feel good when you come across investment opportunities like that.
JR I only have to get two out of three right and yet I make plenty of mistakes every single day.
What major mistakes have you made in the investment world?
JR I’ve been lied to by CEOs for my entire career. That is why Ben Graham didn’t want to talk to them, and he was right. Many of them will lie. Hopefully, over time, I have become better at analysing the guys who are just blowing smoke and the guys who are telling it straight. And I can still get it wrong. Even a lie detector can be fooled.
So there I was in Indonesia in 1996 and I’m at lunch with the charming, erudite CEO of a family conglomerate, and I’m trying to get exposure to his group by purchasing some shares. So I said: “You run this wonderful business and I would really like to be a shareholder in this company but I’m having a difficult time buying enough stock.” And he replies: “How much would you like?” I told him I would really like to buy $1 million worth of his stock. He said: “Don’t worry. By the end of lunch, you will have your $1 million worth of shares.” So I paid for lunch and I bought $1 million from his personal account in which he can print more shares. That was a total mistake, and he ripped my face off!
When you do this for 35 years, you remember those kinds of families – they don’t go away. But you also remember the families who you made money with in the past. One of the few advantages of being older is that you have been around the block a few times and, occasionally, life will repeat itself.
Another mistake happened in Japan. The CEO and founder of the Shokoh Fund (later renamed SFCG) was on the Forbes 400 list and one of the wealthiest men in the world. He ran a phenomenal loan business for many years. Then the Japanese government decided that his type of lending should no longer be allowed. They moved the goal posts to the point where the interest rates, that he would charge, would be so low that he couldn’t make any money. So, in my opinion, he was forced to start fudging his numbers. He protested not only against the government’s actions, but also against anyone who criticised his accountant. I had invested with him and made lots of money over the years. So, when some of my analysts were telling me this guy is in trouble, I didn’t listen.
Now I listen more to them, because he eventually went bankrupt at the end of 2007. Lehman Brothers was his financier and when Lehman went bust, it called his bluff. And when it called his loan, he had to file. Although we sold out of most accounts before that happened, it was nevertheless a good example of a bad case where I really lost a lot of money.
We’ve covered your methodology on the long side. But how does it apply to the short side?
JR We are looking for positions which are almost identically the opposite of the long side. That means no alignment of interest with management; stocks that are incredibly expensive so they have 200% of what we value according to enterprise value, or the value of the business today compared to what it might be at some future time; and unusually large leverage. A classic example would be a Chinese state-owned enterprise where the management doesn’t own any stock; the management’s alignment of interest is totally with the political party that runs the country; the objective is to hire as many people as possible rather than making money for shareholders; and management is told to build factories by the central government.
In Japan, the equivalent of state-owned enterprises are what we call zombie companies such as Toshiba, NEC, Hitachi or Japan Railways. Elsewhere, for example, we’re looking to short state-owned banks in Thailand and Indonesia, or state-owned railways in Australia. There is certainly no shortage in Asia of state-owned, state-manipulated, state-managed and state-controlled companies that happen to trade on public markets. The same could be said of French state-owned companies like Crédit Agricole or BNP Paribas.
Compared to finding strongly aligned, high-quality companies on the long side, we tend to have a lot more ideas for opportunities on the short side.
Has your faith in value investing ever wavered – particularly during periods when the value approach was out of favour and overshadowed by cycles of growth-oriented investing?
JR As my grandfather asked my daughter: “Since your father is Jewish and your mother is Episcopalian, what are you?” And my daughter turned to my grandfather and said: “Grandpa, I’m a celebrationist.”
I may be a value investor but I also celebrate all religions. Value investing is a name and there is a spectrum of value investors. But I do believe in growth. People say that value investors don’t invest in growth and that value investing and growth investing are utterly separable. That’s complete garbage!
My view is that you have to believe in all these religions – whether it be growth, or value or growth at a reasonable price, and fit it into whatever makes you comfortable. The confluence of growth and value is the best of all worlds. If you have a fantastic growth company trading at a fantastically cheap valuation that is run by a benevolent dictator like Warren Buffett, that’s about as good as it can get in my world. It’s a long-winded way of saying that I, too, am a celebrationist.
Your grandfather, James Rosenwald I, who was Graham’s financial-services analyst, taught you to analyse company valuations from the age of 12. Would you say he has been a primary influence in steering you towards the philosophy of value investing?
JR He certainly showed me how making money translated into being able to buy an automobile and travelling to Europe. From a business-philosophy standpoint, he was a fundamental influence. The fact that he worked for Ben Graham meant he drank the Kool-Aid that Graham was serving and I drank the Kool-Aid one degree removed. But it was the same Kool-Aid – the concept of being able to buy a dollar for 50 cents, the concept of doing raw data research, the concept of understanding businesses. Where it has veered from my grandfather is more in the alignment of interests and on how much weight, at Dalton, we put on management’s capability. My grand-father believed there was absolutely no need to go and visit companies because management would simply lie to you and the exercise would only colour your review and analysis.
That’s why we have offices around the world, because you need to have boots on the ground if you are actually going to meet with management and learn about the businesses.
You are the senior portfolio manager for Dalton’s Asian equity strategies. So do you regard yourself primarily as a specialist on the Asian markets?
JR I’ve been a student of Asian equities since the early 1970s. Does that make me an expert? That depends on what your definition of an expert is. I am responsible at Dalton for managing the Asian equity strategies and that includes responsibilities for the teams on the ground in Tokyo and Shanghai. And, within that overall responsibility, it encompasses client and partner assets of more than $1 billion. So Asia represents around half of our business.
Dalton’s assets under management have grown rapidly in recent times. In October 2011, the firm’s AUM was $1.3 billion and it now stands at $2.1 billion. Can a lot of this gain in assets be attributed to very good performance in 2012, when a fund such as Dalton High Yield Mortgage returned 34.93% in 2012?
JR We probably took in between $200 million and $300 million in new assets last year. In Asian equities, we were up between 20% and 40%, depending on what type of mandates we are referring to. We were up so much that I even questioned the accounting. Had we valued all the assets correctly?
The mortgage business at Dalton, which started in June 2008, has been by far the best-performing sector and you would have made three times your money since June 2008. That’s a very, very good result. Having said that, the problem is that we are now in the bottom of the eighth inning. We might have a top of the ninth or we might have a bottom of the ninth. We could get a couple of more swings of the bat at the top of the ninth and then the game could be over. Therefore, in our mortgage strategy, we are now coming up with the next idea.
The fixed-income business has been Steve Persky’s baby. But, because the distressed fixed-income area is declining, his team have to think of some new and interesting ways of making fantastic returns. And you can’t expect them to generate 30%-plus returns for four or five years like they had done. So as the bonds roll off, I have a feeling that they will go into the bridge mortgage business. Some high-net-worth people may have had a problem with their credit during the last financial crisis, but they may want to buy a $5 million house. We will provide them with a value investment loan of $2.5 million. It’s sort of buying dollars for 50 cents – you have heard about this game before. And we will charge them maybe an 8% to 12% interest rate and some extra points for putting it on, which should generate a gross yield of around 12%.
It should deliver high-teen returns, which would be great in today’s environment. And it will also fill a big hole in America in regard to jumbo mortgages – especially if you have a ‘ding’ on your credit so that some box can’t be ticked. It’s very hard to buy expensive houses if you have difficult credit and it’s very hard to get jumbo loans.
In one of Dalton’s press releases, it mentions the aim of “protecting Dalton’s unique culture”. Can you elaborate on what that means?
JR What Dalton shares across all its platforms and all its products is the concept of value investing, and that resonates with our clients. They get it. We are not a much larger firm because it isn’t easy to find clients who understand this philosophy or believe in it. Many investors believe that you can make money by trading securities very rapidly, or that you have to trade securities in order to make money. They might think that sitting on your hands and doing nothing for five or six or seven years, which is our average holding period, cannot be really regarded as work. They might ask: “So what do you do?” I tell them I look for four or five new ideas a year. And they respond: “Is that really working? How can you charge all these fees if you are only coming up with four or five good ideas per year?” So I tell them: “You don’t really understand investing. Sorry. You should look for a fund manager who fits your description.”
As a result, the fact that we have highly sophisticated, interesting clients who are also great investors in their own right is not a surprise.
Over the course of your career, you have met a lot of outstanding managers in the hedge fund industry. Back in 1992, you founded Rosenwald, Roditi & Company with the legendary Nicholas Roditi.
JR Absolutely. The hermit of [London’s] Hampstead. He now splits his time between Hampstead, New York and Cape Town.
So is he still working above the Gap shop on Hampstead High Street, then?
JR No. He bought a building after that. But when we started, he was based above Gap. I was based on the pier in Redondo Beach [Los Angeles], and we each had a secretary.
What sort of strategies were you running together? JR
When we started out, our first fund was called Korea Non-Life Investment Company Ltd, which we launched in 1992 to invest in Korean non-life insurance companies. You couldn’t invest in these companies easily, so we had to create a Korean trust to get around the foreign-ownership rules. We raised between $15 million and $20 million from some of Nick’s former employers such as Jacob Rothschild of RIT. In May 1997, after Nick had had his phenomenal years and Rosenwald, Roditi had grown to over $700 million in AUM, I sold my shares back to the company and its name was changed to Rovida.
Nick is a brilliant macro and value investor. If you ask him, “How can you take so much risk?”, he will say, “It’s not my money.” And, if you ask him, “How much should I invest with you?”, he will say, “It’s too dangerous; I don’t think you should invest with me.” He understands the psychology of investing, and that also makes him a wonderful salesman. I place him in the Keynes category of investment, which really means sort of opportunistic, global and contrarian.
Between 1992 and 1998, you advised many of the Soros Group of funds. What sort of experience did you have working with the renowned Soros firm?
JR We created Rosenwald, Roditi because I was being hired by the Quantum Emerging Growth Fund at Soros to manage a $25 million equity portfolio. Nick was hired by Soros to manage substantial macro investments for the Quantum Quota Fund. When working for Soros, you either make a fortune for him or you get fired. We had a good chance of being fired. So we formed Rosenwald, Roditi in order to take advantage of a longer-term opportunity in the nascent Korean non-life insurance space. This was an opportunity that could provide satisfactory returns for investors for over five years – given the valuations in 1992.
You must have had direct dealings with Soros?
JR I had a few dealings with him. Soros is a fascinating, very thoughtful and extremely insightful character and one of the greats of our time. He was way ahead of his time in lots of areas and has been willing to bet big money on every one of the ideas he truly believes in.
Why have you chosen to take time out from your busy investment career to lecture at New York University’s Stern School of Business with a course called Global Value Investing: Theory and Practice?
JR It’s a way of giving back to society and I also donate to the school which is my alma mater. However, I’m not totally altruistic… because the course is a great recruiting tool.
For your own firm?
JR Yes. Every one of those students, who are aged between 26 to 35, holds a full-time job. It’s a six-week, three-hour-per-night course. Anyone willing to spend weekday nights after a 10 to 12-hour working day is probably taking the course because they very much want to learn something. We’re also running the same course simultaneously at the China Europe International Business School in Shanghai and the National Taiwan University’s business school in Taipei. We haven’t recruited anyone from the course as they haven’t graduated yet. At the moment, a Chinese-speaking individual that is a student of value investing is almost impossible to find. The final exam is a five- to seven-minute investment pitch by each student where they present their value investment idea in which we should invest money.
And the winning ideas are chosen for investment with funds drawn from the $1 million endowment that you and your wife have made to the school?
JR Yes. And those ideas have been performing fantastically well.
On the reading list for the course, you include works by Seth Klarman and Warren Buffett. Do you regard them as your mentors?
JR Not Buffett. Although I do revere his track record and style, and I think he is phenomenal, I’ve not had any personal dealings with him.
Besides my grandpa, who would be my number-one mentor, I would include Prem Watsa, Marty Whitman of the Third Avenue Value Fund and Seth Klarman of the Baupost Group – in that order.
Prem, who runs Canada’s largest insurance conglomerate, Fairfax Financial in Toronto, has been a client since 1996. He is a highly brilliant investor and many people describe him as Canada’s Warren Buffett. He believes that if you are working with him, you should have five times your annual income invested in the fund you are working on, since that will ensure that you will be definitely watching over the fund. That is more important than worrying about your frigging job, because a 20% increase in the fund represents a whole year’s salary.
As for Seth, I’ve been dealing with him for more than 20 years and he was an enormous help in the early days of my career. I view him as a friendly competitor and someone to model one’s business on. The concept of having all my employees putting half of their bonuses into the fund is something I attribute to Seth. However, he demands 100% of your personal net worth invested in the fund if you are going to work for his firm. Actually, I think that’s going a bit too far.
Looking back on your long career, what would you regard as your first outstanding value investment?
JR Going to Vassar College [a co-educational liberal arts college in Poughkeepsie, New York] was my first great value investment. For a heterosexual male, it was a phenomenal value investment. Think of the ratio of women to men. It’s not a dollar for 50 cents, but three dollars for 50 cents. It’s unbelievable! Many people say I wouldn’t want to do it over again. Bullshit! I want to do it over again at Vassar with this mind and that body. And I want to do it over and over, and I never want to leave.