Heirs to A.W. Jones
Last week, in The Daily Reckoning column entitled, Hedge Yourself!, I shared a few highlights from the investment philosophy of Alfred Winslow Jones, the “father of hedged funds.” Today, I’ll share some insights about some very smart guys who manage money in the style of A.W. Jones.
In 1994, Daniel Och and the Ziff brothers started Och-Ziff Capital Management (NYSE:OZM). They wanted to earn consistent returns with low risk. In a sense, they were heirs to the ideas and techniques of A.W. Jones. And they have done him proud. The success of the OZ Master Fund, the main fund of the company, is one of the best in the business.
Since inception in ’94, the OZ Master Fund returned 14.2%, versus 8.4% for the S&P 500. That’s huge outperformance. Even more impressive is how it did so with a lot less risk. This is the idea of being “hedged.” You can see it in the performance of the fund during down months.
In all but four of the years, the OZ Master Fund actually made money during down months! And even when the fund fell, it fell far less than the market. With performance like that, it is no wonder Och-Ziff today manages $30 billion in assets, mostly institutional money such as endowments, pension funds and the like.
In the world of money, Och-Ziff is known as an alternative asset manager, an option becoming increasingly popular post-crisis. Based on various surveys, institutions are likely to boost their allocations to alternative managers more than threefold from 2009. This is a good tail wind for Och-Ziff. So one catalyst for the stock is growing that $30 billion number.
But what I really like about Och-Ziff is the people and the structure of the company. Successful money manager Martin Sosnoff was once asked how he invested in management teams. What did he look for? He answered: “I am always looking to buy owner-managers who want their stock to go up for solid reasons.”
Och-Ziff has exactly that. Dan Och is CEO and head of the investment committee. Och and his partners own nearly an 80% economic interest in the same assets at OZM shareholders. The firm went public in 2007, and these insiders have a five-year lockup. That means they can’t sell until late 2012. I would expect the partners to cash out some of their stake at that time. They have every incentive to the get the stock price up before then.
Moreover, they eat their own cooking. Of the $30 billion in assets under management, about 9% is money the partners and employees invested themselves. They have every incentive to do well in their funds because a good chunk of it is their own money. Plus, the partners take no salary or bonus. They get paid the way shareholders get paid – through distributions.
Those distributions are fat. Och-Ziff pays out 80-90% of its earnings. In the past three years, distributions per share were $1.42, $0.19 and $0.88. The distributions reflect the performance of the year prior. They took a hit in the financial crisis in 2008, as you can see with the low distribution in 2009. But they have since recovered. For the last 12 months – which includes the first quarter of 2011 – the stock’s paid $1.01 per share, for a near-10% yield!
In 2011, Och-Ziff should earn around $1.50 per share. Take 85% of that and you get $1.28. On $11.25 per share, that’s an 11.3% yield this year. The big dividend is always the last dividend, declared at the end of the year and paid in February. In 2012, the stock could earn $1.80, which would pencil out to yield of 13.6%, based on the current share price.
Key risks? There are always at least a few. One is there is some discussion of raising taxes on publicly traded partnerships. If subject to full corporate taxes, Och-Ziff would suffer a 20-25% drop in net profits. However, this has been bandied about for a while, has gotten lots of press and is at least partially discounted already. Plus, such a rule would likely be phased in over a number of years, softening the blow. The other key risk is what we called “key man” risk in my banking days. If Dan Och got hit by a bus, that would have a big impact on the firm that bears his name.
Let’s see if Och-Ziff meets my CODE criteria:
Cheap? The stock market is a market of secondhand goods and it can help to think about why the shares are for sale at all. The insiders sold a piece of the business to the public at over $30 per share in an IPO in late 2007 (and invested 100% of the proceeds in Och-Ziff funds). Today, OZM is half that. Asset managers typically get valuations of 19 times management fees and 9 times incentive fees. The former fees are valued highly because they are very stable, and the latter less so because they are more volatile. Using the blended 14 times for Och-Ziff gives us a value of about $21 per share on $1.50 in earnings, which seems fair, if conservative. When you consider Och-Ziff has grown assets under management at a 19% clip since 2001, it looks cheaper still. Looked at another way, the stock trades for about 10 times 2011 earnings. A growth stock, yet you are not paying for growth. The high yield offered also protects the downside here.
Owners? Och-Ziff aces this test, which forms a key part of our thesis, as I discuss above.
Disclosures? One of the most transparent companies in the business. It’s also a simple business. Gather assets, get paid. Invest well, get paid. There is little mystery here.
Excellent financial condition? Och-Ziff has few assets of its own, mainly cash, tax assets and some investments. What it has is $30 billion under management, a great brand name in the business and a team of talented and vested insiders. There is little debt, especially compared to its huge cash flows. Och-Ziff is in excellent financial condition.
Asset management is one of the best businesses in the world. It generates a lot of cash and has little need to reinvest that cash in the business. (Hence those fat distributions.)
I like Och-Ziff.