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Interview With Steve kiel: Portfolio manager of The Hayek Fund And The Freedom Fund

September 21, 2010 | About:
Can you tell us a little bit about your background and how you got into the investment industry?

Sure. I’d say that I have a pretty eclectic background. I’m sure it’s much different than most money managers, and I think it causes me to look at companies and the risk associated with them in a different way than others. My first job out of college was as a fundraiser for The Heritage Foundation, which is probably the world’s leading think tank. I met a lot of business owners and wealthy individuals, and heard a lot of great stories about success. In a way, it was like an MBA program where each donor I met was a case study in entrepreneurialism and leadership. I was there for about five and a half years, with a year interrupted because of a deployment to Iraq with the Army. I’ve been an Army Reservist since 2000. During my time at Heritage, I was also going to law school at night and once I finished that and passed the bar, I became a Judge Advocate in the Army Reserves.

I’ve managed my own money since college, and in 2005 started managing a few accounts for family members and friends. It was really around that time that I seriously thought about making it a career. I enjoyed the research, finding hidden stocks and arbitrage opportunities, assessing risk, and making allocation decisions. I launched Arquitos Capital Management in 2009.

What made you decide to start your own firm instead of working for an existing firm?

The primary reason was that I wanted to manage portfolios and be the decision-maker. I wanted to do things my way. I have very specific ideas on what I think is the best way to allocate a portfolio, and I wouldn’t have been happy in a research or support role for someone else’s decisions. This certainly isn’t the best approach for everyone, but I had already, basically, had two careers, as a fundraiser and a soldier, and I wouldn’t have given those up unless I was calling the shots. It certainly would have been different if I got into finance immediately after college without experience. I’m sure I would have taken a different route, but at the same time, I wouldn’t have gotten the valuable experience that I got in those other careers.

With so much information that is so easy to find, investing is more of an emotional exercise than ever before. You can certainly do original research on smaller companies and arbitrage opportunities, and that’s very valuable, but for a stock like Bank of America (BAC), everything you need to know is easily found. We’re invested in Bank of America because my life experiences give me faith in America and our economy. This quarter’s tangible common equity level means very little, for example, and if I would have worked as an analyst first, I would have overestimated the importance of the trees, and underestimated the forest.

Can you tell us a little about the way your funds are organized?

I manage two portfolios: The Freedom Fund, which is an actively managed fund, and The Hayek Fund, which we recently launched, and is what I call semi-actively managed. These are set up as spoke funds. The spoke fund concept is fairly unique, but I think a concept that has the potential to really catch on. The spoke fund term was started by Cale Smith of Islamorada Investment Management, and there are a few of us who run portfolios based on it, including Kevin O’Reilly of Foothills Financial Planning. We’re all licensed as Registered Investment Advisors. There are a few requirements: Portfolio managers must have a substantial personal investment in the fund they manage, the portfolios are more focused than traditional mutual funds, fees and expenses are transparent and low, and investors have online access, 24/7, to view their holdings.

Investors actually own the underlying shares of the companies we invest in. This is a real advantage to our investors for tax purposes.

For The Freedom Fund, what type of investments do you make?

At any given time I like to have three types of investments in The Freedom Fund. The majority of it is made up of value stocks. I don’t limit myself to small or large cap companies. If I find a stock that I feel is significantly undervalued by whatever metric I feel is most appropriate to that industry, then I’ll consider owning it for this portion of the fund. I mentioned Bank of America before, and another stock we recently purchased in this category is Intel (INTC). I’d certainly prefer to own smaller companies, and we do own a few, but the current investing environment is so beneficial to gains in larger cap names that I’ve been focusing there most recently.

We also allocate a portion of the fund to arbitrage and special situations. These are stocks that I feel are not correlated to the overall market. Here, we’re trying to get a gain no matter how the rest of the portfolio does. This helps to dampen some of the volatility, and provides support in down markets. An example is our investment in Gyrodyne (GYRO). The stock price depends on whether a court of appeals overturns a judgment in its favor. The odds of an overturned judgment are very low, in my opinion. We’ve also played WebMD’s (WBMD) tender offers a few times now. It’s an easy way to pick up a few percentage points in a conservative way.

Finally, we also put a portion of the fund in what I call our superior leadership category. These are companies I’d love to own forever. I have a tremendous amount of faith in management’s ability to create value for shareholders. Two that we own here are Greenlight Re (GLRE) and Compass Diversified (CODI).

Do you keep any of your money in cash, or are you using arbitrage stocks to mitigate market risk?

One thing that we’ve learned over the last few years is how many markets have become much more correlated than in the past. This is a real danger for people who don’t recognize the change. Stocks, bonds, real estate, even gold, react similarly to the decrease in the amount of credit available. That makes perfect sense, in hindsight, but people weren’t thinking that way before 2008. Modern Portfolio Theory is extremely over-rated, in my opinion. I mention all these things in response to your question, because I think Seth Klarman has it right here. You do have to keep some of your money in cash. I know that sounds very Yogi Berra-like, but it’s true. At any given time a panic can crush every part of the market. If you have some cash set aside here, you have the ability to be the buyer when everyone else is selling. So, we do keep some in cash, and we also treat some of our arbitrage stocks as cash-like as well. If Israel attacks Iran’s nuclear sites tomorrow, causing the stock market to fall significantly, I would sell Gyrodyne and look at starting to buy some of those lower risk stocks that have fallen the most.

Which value investor has had the greatest influence on you?

Like most value investors I learned a great deal, and continue to learn a great deal, from Ben Graham and Warren Buffett. But, what really put it all together for me was reading Seth Klarman’s “Margin of Safety.” I’m not sure what it was specifically, but everything I had learned to that point just made a lot more sense. I owe much of my success to Klarman. I had always marveled at Warren Buffett’s comment about how he watched Coca-Cola for decades before actually investing in it. Then, he chose a perfect time to get in. How could he have that kind of patience? Klarman helped answer that question for me (although I still marvel at it). David Einhorn has been a big influence as well. I pay attention a lot more to the research of short sellers because of him. For the special situation investing, watching and reading Joel Greenblatt has been very important.

You also run a fund called the Hayek fund can you tell us more about it?

I do. This is a portfolio we just recently launched, and I’m excited about its prospects. As I mentioned, I use to work in the conservative movement and I’m familiar with a lot of the corporations who are friendly to it. While doing research earlier this year, I came across a few of these companies and realized how well their stocks had performed over a long time period. Really, more out of curiosity than anything else, I decided to make a list with every corporation who had given to the top few free-market organizations in the most recent year and see how that portfolio would have performed. I thought it would do well, but I was blown away by how well it actually did, going back to 2000. I can’t get into performance details here, but if you’re interested, you can see the results at www.hayekfund.com. I encourage you to read the disclaimer.

From that research, The Hayek Fund was born. It has 22 stocks, all of which give to at least one of the top few free market organizations in the country.

I guess Friedrich Hayek is one of your heroes?

I am a fan of Hayek. His faith in individuals and the chaos of the markets is important. Most importantly, though, he recognized that without economic liberty, there could be no personal or social liberty. That’s something that his counterpart, Keynes, missed. Fundamentally, Keynes failed to understand human nature. When the government gets involved in something, it is extremely difficult and nearly impossible for the government to then step back from that involvement. This goes to the ego and hubris of politicians. It’s a control issue. The constitution was designed to check that, but the Keynesian approach walks all over the constitution. And, unfortunately, it seems as if nearly all government leaders right now believe in Keynesian economics. We’ve got a lot of work to do in this country, and my hope is that raising the profile of Hayek, in my own small way, will help.

Have you really found that these companies have outperformed over time and why do you think that is?

I have, and I have two theories as to why. I believe that when a company’s management has a culture of entrepreneurialism and believes in things like creative destruction, they’ll more properly allocate resources. Secondly, for a company to be able to make regular donations, they also probably are profitable year in and year out, and generate a lot of free cash. As you know, companies that consistently generate a lot of free cash tend to outperform the market.

Does this approach pick up all of the free market-oriented corporations out there? Certainly not. It probably only picks up a small percentage of them, but it’s a start. It’s possible that a few of these companies give to the other side as well. But, the vast majority of the companies in this portfolio believe in free market principles and the best way to prove it, in my opinion, is to ask if they put their money where their mouth is. That is, do they financially support free market organizations?

I should also note that the performance results listed on the website are not from cherry-picked companies. The data is purely quantative. The portfolio that I launched in September 7, 2010 is made up of the same stocks and same allocations as I used to do the performance backtest. Additionally, this portfolio contains every corporation that gave to the free market organizations that I chose to follow.

Thanks Steve. Where can the readers find more information on your firm and the portfolios you manage?

Thank you, Jacob. My firm’s website is at www.arquitos.com, and The Hayek Fund’s website is at www.hayekfund.com.

About the author:

Jacob Wolinsky
My investment ideas have been inspired by many of value investors including Benjamin Graham, Charles Royce, John Neff, Joel Greenblatt, Peter Lynch, Seth Klarman,Martin Whitman and Bruce Greenwald. .I live with my wife and daughter in Monsey, NY. I can be contacted jacobwolinsky(AT)gmail.com and my blog is www.valuewalk.com

Visit Jacob Wolinsky's Website


Rating: 3.7/5 (16 votes)

Comments

brianbook
Brianbook premium member - 3 years ago
"Keynes failed to understand human nature"? Read "Keynes, The Return of the Master" by Robert Skidelsky & maybe you will agree with Jeremy Grantham, Charlie Munger & Robert Shiller that Kiel "may not know what he thinks he knows about Keynesian economics". As for Hayek, in the interest of full disclosure, read his 1960 essay "Why I am not a Conservative". Hayek observed that "Conservatism may often be a useful practical maxim, but it does not give us any guiding principles which can influence long-range developments".
slkiel
Slkiel - 3 years ago
Well, first off, I don't believe the Keynesian approach of today was even what Keynes himself would have promoted, but that's just my opinion. The Skideslky book is very much biased in favor of Keynes, so I'm not sure that's the best way to prove an anti-Keynes point. It's a bit like quoting Krugman to say that I'm stupid because I believe something opposite of what he does.

As for Hayek and conservatism, I don't think I said that he was a conservative, and if I did say that, it's not something I believe. He described himself as a classical liberal, which many fiscal conservatives would describe themselves if they weren't forced to make a long explanation out of it. Also, would you not agree that conservatives of today are very, very different than conservatives of 1960?

At any rate, I'm not an economist or historian. I'm simply a portfolio manager trying to make good returns for my clients. If in some way naming a portfolio after Hayek helps people to at least take a look at Hayek's ideas, then so much the better. If not, then so be it.

brianbook
Brianbook premium member - 3 years ago
As a portfolio manager, you can't be agnostic about macroeconomics, according to David Einhorn. You should not summarily dismiss the ideas of one of the greatest economists of the 20th century (often quoted by Grantham, Munger, etc.) by stating that "he failed to understand human nature".Such hubris demonstrates a lack of critical thinking, & does not inspire confidence for potential investors.

slkiel
Slkiel - 3 years ago
Again, you're attributing something to me that I haven't said. I am certainly not agnostic about macroeconomics approaches, and I've clearly stated that I do not agree with the Keynesian approach.

In my opinion, you cannot believe that both Keynes and Hayek fundamentally understand human nature. Their positions are opposed, so to say that I've summarily dismissed a position you believe in is a very simple way to approach the discussion. If I were to believe in Keynesian economics, then I would have to believe that Hayek fails to understand human nature, and vice-versa. To say that I'm the one with hubris is rich, considering my position advocates for less control and more individual liberty.

Now, this is twice that you've unnecessarily attacked me in a rather personal and unflattering way. Hayek and Keynes were great debating partners, and held each other in high regard. I very much doubt they would have made the debate personal in a way in which you have. If you'd like, feel free to send me an email and we can discuss further.

brianbook
Brianbook premium member - 3 years ago
I am not attacking you personally, I do not even know you, I am just trying to show "that you do not know, what you think you know about the ideas of Lord Keynes". How can his ideas be summarily dismissed when they have influenced the thinking of Jeremy Grantham, Charlie Munger, Krugman, Stiglitz, & Reich. You state "the Keynesian approach walks all over the Constitution". Yet the wise Martin Whitman notes in Third Avenue's semi-annual report (4/30/10), the government & private sector are in partnership whether they like it or not. In light of this economic reality, what evidence do you have that the Keynesian approach is unconstitutional? Please be more humble when criticizing such a brilliant economist, an academic field in which you have minimal training. Shouldn't you be more open to the ideas of the specialists, especially when economics is considered a "soft science"?

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