Baron Funds' First Quarter 2014 Commentary
Former Treasury Secretary Larry Summers was recently invited to a dinner at one of my friend's homes. The intent was to have Secretary Summers speak to and answer questions posed by twenty investors…and by two brothers who are astronauts! I was among the investors at that dinner. Astronaut Mark Kelly, the husband of former Congresswoman Gabby Giffords, after scanning the room filled with men from many cultures and backgrounds, whispered to me, "Aren't there any women on Wall Street?" I told him at my firm, there are. 50% of our employees are women, including Linda Martinson, Chairman of Baron Funds. Many of our senior executives, in addition to Linda, are also females. Although only a few of our analysts are women, we're working on that, too. But, I digress.
I found the former Treasury Secretary and advisor to Presidents among the most interesting and impressive speakers to whom I have ever listened. That should not have been surprising. Secretary Summers has served as the President of Harvard, the chief economist for the World Bank and as an advisor to Presidents Obama and Clinton. Summers' family members' accomplishments are not too shabby, either. His parents were renowned Yale economics professors. Two of his uncles have been awarded the Nobel Prize in economics, one of whom, MIT professor Paul Samuelson, authored the textbook I used as a college freshman in Economics 101. All of which sure makes you believe in genetics.
One of the first questions posed to the former Treasury Secretary was a request to explain why interest rates were so low and credit so widely available. Summers paused for a moment before answering. One likely cause, he explained, was that in the 1950s, when our country was growing rapidly, General Motors, Ford, Chrysler, industrial companies, and businesses that benefitted from the construction of our nation's interstate highway system, like hotels, restaurants and resorts, had to borrow large amounts. This was because they were in the midst of substantial capital spending programs. In the face of significant demand for credit, providers of that credit had an opportunity to charge more for it and demand better terms. That is no longer the case. Summers then turned to face Carl Icahn (Trades, Portfolio), another dinner guest and a "genial" participant in basketball games at my summer home on Long Island. "Carl, you
think Apple, Google and eBay are earning so much money they don't know what to do with it? They're certainly not capital intensive businesses required to spend a lot to grow."
Summers then addressed questions about whether the dollar would likely survive as the world's "reserve currency" with all the benefits that affords America? His answer was straightforward. "There is no risk that the dollar will be replaced as the world's reserve currency. There is nothing to replace it."
The room then pivoted to a discussion of world events and the crisis in Crimea. The Secretary first noted that our nation's standing army was now 400,000 men and women, the smallest at any time since 1950. He reminded us that it had taken a 500,000 person force to beat Saddam Hussein. He then quoted from the research that President Kennedy had done to author "Why England Slept" prior to his election as President in 1960. The future President had then made the case that the English really had no choice but to allow Hitler to advance through Europe before the start of World War II. They were unprepared to stop him. This answer was intended to provide us with context for the rationale why western nations did not quickly and decisively respond to Putin's annexation of Crimea.
Finally, the discussion turned to the near- term impact of world events on stock markets. The Secretary thought that following the unforeseen events that we had all witnessed in recent years you "need to be skeptical of predictions about the future." We agree with that assessment. Baron Funds has long believed it is not possible to successfully "trade the news" to make better than market returns over the long term. We think our assessment has been confirmed by observing few individuals over the course of my career who have invested in "macro" developments and have consistently earned returns in excess of the market. As a result, our investment process is to invest in businesses with significant opportunities to become much larger; that have sustainable competitive advantages; that are run by exceptional people; for the long term. We base our investments on independent fundamental research by our research analysts...not upon the work and opinions of others.
Warren Buffett (Trades, Portfolio) recently remarked that "I read 500 pages per day" when he was asked to explain the "secret sauce" for his investment success. "Knowledge is cumulative and compounds," was Buffett's explanation. We could not agree more. Buffett also recently remarked during a CNBC interview that "if I had known in 1973 what would happen in 1974, I never would have bought stocks in 1973." He did invest in 1973. The Dow Jones Industrial Average fell below 1000 in 1973. It is now over 16,000.
"If I were a young man, I'd like to work here." Mort Mandel. Age 92. Co-Founder. Premier Industrial Corporation. Author It's All About Who...You Hire, How they Lead. Fall 2013.
The Parkwood Corporation is a large, family owned, Cleveland trust company. It was founded in 1995 by three brothers, Jack, Joseph and Mort Mandel. The trust company manages money for the Mandel families and a large charitable foundation also started by the brothers nearly twenty years ago. Two years ago, Mort Mandel, then aged 90, the youngest of the three brothers, had read about our business and asked one of his firm's executives if he could arrange a meeting. Last November, Mort had breakfast with me in our offices. Mort's parents and siblings were immigrants who had come to America from Galicia, Poland, to escape the violent, anti-semitic pogroms that were then commonplace throughout Poland and the Ukraine. Mort's dad came to America in 1913; his mom, two brothers and a sister joined him in 1920. One of my grandfathers also lived in Galicia before coming to America in 1905 for the same reason. Mort's parents and siblings were penniless when they arrived in our country. Mort was born in America. In 1940, Mort became the first in his family to attend college. One of his brothers was selling milk shake machines to restaurants; and the other was working for an uncle who owned a small auto parts business. When the three brothers learned their uncle was going to sell his business, they decided to buy it. The brothers then tried to borrow from everyone they knew to make the "acquisition." A week later, when they had exhausted their ability to raise any more money, they offered to purchase the business for $900 and their uncle accepted the offer! Mort told me last fall, "I'm convinced that if we had only been able to raise $450, he would have sold us the business anyway."
Once the brothers began to operate Premier Industrial Corporation, the distribution company they now owned, they called on auto repair shops trying to sell them spark plugs. Most already had enough. The Mandels would then ask how much they had paid? When their customers answered $.72 per plug, the brothers offered to sell them more for $.69 apiece. Since spark plugs cost the Mandels $.67 each, their profits at year-end predictably weren't much. After the first year, the brothers decided to ask their customers what products they would like Premier to distribute? The number one answer was fasteners that were used to attach decorative chrome strips to the sides of car doors. Surprisingly to the Mandels, no one asked how much fasteners cost. Premier initially sold fasteners which cost $.08 for $.12...and soon increased their price to $.16, then to $.20, and finally to $.26. When customers began to complain, they reduced their price to $.20. At year-end, Premier's modest profits became much larger profits. In 1960, Premier Industrial Corporation became a publicly-traded global distributor of industrial and electronic parts; was listed on the New York Stock Exchange from 1964 to 1995; and was sold in 1996 for $3 billion!
Following a really fun breakfast with Mort last fall when we discussed business, charitable interests and how to recognize, hire and retain exceptional people, we walked through our office. I then introduced him to a number of our portfolio managers, analysts, including my sons, and senior executives. I had previously read his book about business and community leadership, It's All about Who...You Hire, How They Lead.
Among the broad topics Mort addressed in his book, from which I think most entrepreneurial business executives could learn a lot are "what it takes to build an enduring business from the ground up" and "what it takes to live a life that really matters?" I found myself in complete agreement with Mort's ideas that "nothing matters more than surrounding yourself with exceptional people;" "there is great power in very deliberately building a great place to work;" and, "a culture of family-first, respect, kindness and consideration is how you are able to attract and retain A plus employees." One of my good friends recommended this book to his sons; I recommended it to my sons as well. I took it as a great compliment that, after the walk through our office and a number of brief conversations with our employees, Mort told me that "if I were a young man, I'd like to work here."
23rd Annual Baron Investment Conference. Metropolitan Opera House. New York City. November 7, 2014.
Baron Investment Conferences give Baron Funds' shareholders; intermediaries and consultants who advise them; and our Firm's private clients an opportunity to meet the managements of several businesses in which their hard-earned savings have been invested. We ask managements to outline the prospects for their businesses and to "tell their stories," to tell how they became Ralph Lauren, Chuck Schwab, Steve Wynn, Tom Pritzker, Kevin Plank, David Rubenstein, Mitch Rales, Leo Melamed and so many other individuals we believe are unusually talented, hardworking, ethical and inspiring, but perhaps not as well known...yet.
We also give you an opportunity to listen to several Baron Funds' executives and portfolio managers, including me, and question us in the same way...unscripted...no holds barred.
Baron Investment Conferences allow you to judge for yourselves the talent and directness of individual executives of our portfolio companies and of Baron analysts, portfolio managers and executives. We hope this will help you judge whether we remain true to our objective of "investing in people."
We again expect more than 5,000 conference attendees this year, including doctors, lawyers, engineers, teachers, firemen, police and doormen as well as financial advisors, consultants, family offices, plan sponsors and other institutional investors.
We long ago replaced Beatlemania at breaks and lunch with surprise lunchtime entertainment like Harry Connick Jr., James Taylor, Hugh Jackman, Diana Ross, John Mellencamp, Sheryl Crow, Faith Hill, Lionel Richie, Kelli O'Hara, Belushi and Aykroyd's Blues Brothers, Jessica Simpson, Bernadette Peters, The Jersey Boys and The Counting Crows.
We've also added surprise entertainment at the end of the day that last year featured Barbra Streisand. Celine Dion, Sting, Jon Bon Jovi, Jerry Seinfeld, Rod Stewart, Bette Midler, Sir Elton John, Billy Crystal, Stevie Wonder, Cher, Paul Simon, Neil Diamond and Billy Joel performed in prior years.
What hasn't changed? The annual Baron Investment Conference continues to be at our expense not yours. All costs are incurred by BAMCO, Inc., our privately owned management company, not by Baron Funds. We've also continued to do our best to find executives to speak with you whom we think provide case studies of so many who run the companies in which Baron Funds has invested. We hope you'll be able to attend our annual meeting this fall. We're looking forward to seeing you November 7.
Thank you for investing in Baron Funds. Thank you for joining us as fellow shareholders in Baron Funds. We believe the growth prospects for the well-managed, competitively advantaged and appropriately financed businesses in which Baron Funds has invested ar e favor able. Volatile markets in recent months have created uncertainty among investors causing many to be fearful about investing. These developments have made stocks, in our judgment, attractive, which should offer investment opportunity and limit investment risk.
We are continuing to work hard to justify your confidence and trust in our stewardship of your family's hard-earned savings. Thank you, again, for your long- term support. We are especially thankful for the confidence you have expressed in us.
CEO and Portfolio Manager
April 11, 2014