A Mutual Fund For Special Occasions: A Conversation With Value Fund Manager Tobias Carlisle, Part 2

This is the second half of a two-part interview. Click here to read part one.

Tobias Carlisle is the founder and managing partner of Carbon Beach Asset Managemnet and the author of "Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations." Marketfy Maven Tim Melvin recently spoke with Carlisle about some independent bank stocks, Carbon Beach's new fund, and managing value investments in a bull market.

Below is part two of their interview edited for length and clarity.

Tim Melvin: When you and I talked earlier this year, of course you were starting to see a lot of the small community regional banks show up on your screens. Of course, they’re always on mine. Are you still seeing that?

Tobias Carlisle: Yes. The Aquirer’s Multiple screen doesn’t include banks and financials just because that metric isn’t so good. I use a different screen that is just a broader number of metrics, and it includes things like tangible value, price to earnings, price to cashflow, nothing particularly exotic in there.

If it’s not quite shareholder yield, you look at the cashflow, you look at the invested cashflows and you have a negative invested in cashflows. That indicates one of three things: shares being bought back, dividends being paid, or debt being paid down. So I use all of those together to include insurers and banks. It’s being, like I’m sure you’ve seen, it’s been filled with little banks. I think they’ve been performing really well. 

Melvin: It’s shrunk a little bit. Our buy list has gone from 35 stocks before the election to I think we had 17 last week. But you’ve got to remember, my buy list is really strict. It’s got 100 percent or 92 percent of tangible book with nonperforming assets less than 3 percent and equity assets of at least 10 percent. I’m still pretty excited about the space in spite of the tremendous rally we saw in December.

Carlisle: So just looking through my screen now, I have not done any work on these names. I’m literally just pulling the tickers off the screen. The first one I’ve got is First Bancorp FBP of Puerto Rico which I can understand why they’ve got a problem there. What do you think about FBP? 

Melvin: Yeah. They own a lot of Puerto Rican bonds. But I think they have enough capital and more importantly enough committed shareholders that they probably survive. Just don’t expect a short payoff. I think looking out long term, it’s probably a double. I would look at that and I’d wait for the next piece of bad news to be a buyer because, I promise you, that there will be more. I mean, Puerto Rico is a huge mess, and it doesn’t get solved without a lot of really bad headlines.

Carlisle: You know one thing we did this year was Bank of America Corp BAC. I don’t think that there’s anything particularly interesting about Bank of America in and of itself, but the top warrants were really interesting. When it was sort of risky in 2009 or earlier, whenever it was, they issued these warrants which were interesting because they had this adjustable strike, so as Bank of America pays dividends the strike reduces, not dollar for dollar, but there is a formula for calculating how it reduces. The strike had traded down to $13, or maybe it was high $12, with the stock trading at close to that level earlier this year and I think top warrants were $3.50 or $3.75 so the breakeven on that was $16. That was still a discount to Bank of America’s book. That was still a substantial discount. That was like 60 percent or 70 percent of book. So we took a really big position in those warrants.

Melvin: Those warrants, and they’re on most of the major banks. They’ve been kind of fun to trade around over the last 10 years or I guess 6 years actually, 6 years since TARP was done.

Carlisle: I think that it is much more interesting now because the discounts to Bank of America, it’s not totally gone, but it’s getting much closer to value and now you have to have some view on how Bank of America runs its business. I’m just not smart enough to figure it out so we’ve trimmed that position a lot. We’re almost out of it. But it’s interesting to think about that with the Glass Steagall, if that gets resurrected, which I’m imaging that it will at some stage, which was the prevention of the investment bank and the money center bank being glued together. So when that happens I think that is going to be another interesting watershed for banking in America where those things split apart between Bank of America and Merrill Lynch will split apart. Again, I am not smart enough to figure what is going to happen there, but I do not think it is a bad thing for Bank of America shareholders at least.

Melvin: If it happens, I think there is a pretty good probability to it, it is going to be really tough pre-spin to figure out what the parts are worth. But once they split up it will be very easy to spot where the value went, whether it went with the bank or the broker.

Carlisle: They are way too complicated to value. I agree with that. Investment banking and money centered banking are two totally different businesses. There is so much more risk in the investment banking part of it and I think that has infected the money center part as well because you have to assume that the money center part is the risk from the investment bank. So I think it is probably net positive, but you are right, it is hard to see how the value is distributed between the two.

Melvin: So you have got the [DEEPX] fund. It is available to trade now I understand.

Carlisle: Yes. We are literally two days into trading at the moment. It is all new to me, the actual marketing of the fund. It is slowly being propagated out all the brokerages, but the easiest way to do it I think is just to go straight to US Bank or USA Mutuals.

Melvin: Looking at 2017, we’re a solid 7 and ½ years into a bull market. How do you feel about overall investing condition right now?

Carlisle: I think it is most difficult when it looks most easy. I think 2016 was an easy year for all investors and it was particularly easy for value guys because it was 45 degree run the entire year. So I think that things are looking expensive at the moment, although I would have said that three years ago too. I am not much of a market prognosticator, but I do think that there is sort of nosebleed expense at the moment, particularly in the kinds of things that I like which is the EBIT that acquires multiples stocks. They are as expensive as they’ve been in previous market peaks. I do not know what happens from here. In order for the market to keep on going in multiples it has to expand the underlying performances of the businesses.

Melvin: It’s not like multiples are cheap at the moment.

Carlisle: Multiples are stretched. One of the things we do in the mutual fund, which is a little bit unusual, is we hedge the portfolio in the event that it goes into a downdraft. We have done some research looking at market valuation and trends.  When the market is trending up, if it is expensive or it is cheap, it does not really matter, those are pretty good conditions to be invested. When the market turns around that can be a treacherous time, but particularly so when the market is very, very expensive as it is now.

So at the moment it is still in an uptrend so it is not something that anybody needs to be concerned about. That could all change fairly quickly if it is down 5 or 10 percent. It would then qualify to be in a downtrend and then we would hedge the portfolio. In the ordinary course putting a hedge on like that tends to cost the portfolio a little bit of money because in the ordinary course any time between March 2009 and now, anytime the market has fallen 5 percent or 10 percent it has immediately into hedge has cost you money in that scenario.  But the times when it does help, 2000 to 2002 type cataclysm or 2007 to 2009 style blowup, in those instances you want little protection. We can hedge the portfolio and it reduces our drawdown. It reduces the decline by a little bit.

Melvin: Do you anticipate a very concentrated portfolio or are you going to be more diverse, a wider range of holdings?

Carlisle: We run pretty concentrated portfolios, but it is one of those funny things. If you talk to some investors they think 10 positions is an index and you talk to other guys and they think that 40 positions is conviction investing. We are more toward the 40 positions. We’ve got a farm team of little positions all the time that might only have 1 percent or 2percent in them and they are the undervalued stocks and we are waiting for an activist or private equity firm to show some interest even just management to start buying back stock in wholesale quantities, and when that happens we take those positions up. We call those little positions acorns, and we call our big positions oaks. We typically only have four or five oaks at any one stage and then have between 5 percent and 10 percent of the capital.

Melvin: Those would fall more into the category most of the time?

Carlisle: Yes. There is one, it is not really a special situation at the moment but it’s a short guarantee. It has a little bit of exposure to Puerto Rico. It’s a monoline, so it ensures government debt issues basically. It underwrites the debt issue and it has been impacted by the issues in Puerto Rico, but we think that they have appropriately protected themselves and they have got the cash to survive it. They have been pretty good about buying back and if they resolve the situation in Puerto Rico then they will initiate a bigger buyback.

It is a stock that has been hated because they were associated with the mortgage crisis and they are in another crisis now. It looks like they are stumbling from crisis to crisis. The underlying business is really strong. It is pretty successfully just compounding at the book value. It trades at a big discount to adjusted book so we have held it for most of the year. It is one of those things that we are watching really closely. We are always prepared to sell it if there is any deterioration in the business, while it trades at a discount and keeps on performing the way it has hold it in size.

Melvin: It sounds like you have got a lot going on. I take it you are still going to keep AquirersMultiple.com, the website up and running.

Carlisle:  AquirersMultiple.com is going to keep running. In addition to that this really interesting series of books, these were special situation books from the 1940s and 1950s that are going to be issued and I have written the foreword for that. So I am excited those when they are issued. They are entirely about special situations. The exact examples done aren’t so particularly useful, but the philosophy of it is very useful these days. [Maurece] Schiller wrote these 5 tomes covering everything from A to Z. The books have been lost to antiquity so this Tom Jacobs, who is an investor, he tracked down the grandchildren or the children who are now in their 80s and they had no idea that their father or grandfather had been this towering genius in this arena. He is like a Graham or Fisher or Greenblatt, you know that kind of academic and practitioner melded together, so the books are going to be reissued so that is something exciting that’s going to happen this year.

Melvin:  Alright, Toby, I want to thank you for spending this time with us today. It’s always an interesting conversation when we have you on.  I wish you the best of luck with the new fund, the books, and the websites and everything else you seem to have going on over there.

Carlisle: Tim, thanks for the great question. I always enjoy talking to you.

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