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Opportunistic Value Investing
Money Manager Interview - published 02/06/2006
M. THOMAS HERZIG has been managing money for clients of P.R. Herzig &
Co. since 1980. He holds a BA in Economics from Bowdoin College and an
MBA from the University of Cape Town. He earned the Chartered Financial
Analyst designation in 1982 and is a member of the New York Society of
TWST: Would you start with an overview of P.R. Herzig & Co.,
Mr. Herzig: P.R. Herzig & Co. manages money for wealthy individuals,
pension funds and charitable foundations. The firm was founded 50 years
ago by my late father, Philip Herzig, who for decades owned a seat on
the New York Stock Exchange. For many years we were located in downtown
Manhattan, but we moved out to Long Island after 9/11. We have kept our
original structure as a broker-dealer and NASD member firm, but operate
essentially as a money management firm and family office with a core of
loyal clients who have been with us for many years. We have about $250
million in client assets, of which we manage about $140 million on a
fully discretionary basis. I am President of the firm and have been a
primary portfolio manager since 1980. I make most of the investment
decisions. In terms of philosophy, I'd say we are opportunistic, cost-
conscious and big believers in common sense and keeping things simple.
We've been in the market too long to think that any one approach works
forever. We tend to avoid artificial distinctions between value, growth
and momentum investing. We've got holdings that belong in all of these
categories. But if forced to choose, I'd have to put us in the value
camp. We tend to like stocks that are depressed by short-term
difficulties. We always try to have a margin of safety in price, as we
have found that long-term success in investing comes as much from
avoiding large losses as finding big winners. So we tend to be
conservative. We're always watching the downside. We don't use leverage
in our client accounts or take short positions. I'm happy to say this
approach has paid off so far. We underperformed in the bubble years of
the late 1990s, but have done well long term. In the last 12 years, we
have only had three down years. In 2002 we were down 6% versus a drop of
22% for the S&P 500, including dividends. We were down less than 1% in
two other years, both in the 1990s. After all costs, our managed client
accounts have outperformed the S&P 500 in the past one, five-, and 10-
year periods. This past performance, of course, does not mean we will
continue to outperform in the future.
TWST: Are your portfolios mostly all-equity or are they balanced?
Mr. Herzig: In addition to common stocks, many of our portfolios have a
significant proportion of income-oriented investments, including bonds
and preferred stocks. As one might expect, we tend to have a higher
proportion of income-oriented investments in our pension fund,
foundation and retirement account portfolios than in other portfolios.
TWST: What is the investment decision-making process? Do
you have an
approach that differentiates you from other firms?
Mr. Herzig: We are probably less rigid than a lot of firms. We are
opportunistic and flexible. We are always very price conscious, but we
don't believe black boxes with set formulas and screens can substitute
for common sense tempered by decades of experience in the market. There
are almost no truly original ideas on Wall Street. Having said that, we
are usually looking at stocks that are down rather than up. We tend to
look at the new low list more than the new high list. Companies that
have had a short-term business interruption or disruption that has
knocked the stock price down usually interest us more than good
companies whose stocks seem to be already reasonably priced by the
TWST: How many stocks would you have in a portfolio? Are
or do you like to concentrate?
Mr. Herzig: We tend to be quite diversified. Over the last few years,
we've become more diversified as the bull market ages and we see fewer
obvious sector plays. We currently hold between 30 and 40 different
issues in a portfolio. This sounds more diversified than it really is,
because we'll often have several holdings in the same industry.
Typically, when we initiate a new position, we'll start with a 2% or 3%
weighting. A few years ago we might have taken a larger position.
TWST: What in your view is the investment climate like as we start
in 2006, particularly for the type of stocks you would look for?
Mr. Herzig: We are positive on the US market going into 2006. Corporate
earnings are reasonably sound. The US economy is expected to have
reasonable growth, and the emergence of more affluent consumers in
overseas economies ' among them China, India, and Indonesia ' is
starting to create more demand for US goods and services than perhaps is
reflected in stock prices here. Having said that, the market is
maturing. We've been in a three-year bull market. The market's pretty
well picked over. At this stage in the market, we are tending to look
for stocks that have some sort of near-term interruption, have been
knocked down. We don't see too much in the way of stocks to buy and hold
for a long time. So were looking for stocks we think could bounce 40% to
60% in a year or so. This is a shift in strategy for us. In recent
years, we typically were looking for stocks that we thought could double
or triple over a five- to seven-year period.
TWST: Do you do sector weightings?
Mr. Herzig: We, of course, track our sector weightings, but we don't
have any specific targets. We do not believe in closet indexing. When we
can, we try to let our winners run. For example, we've had a number of
energy holdings for the last seven years. They've done much better than
we ever expected and, as a result, energy has become outsized in our
portfolios. We are monitoring the situation very closely and are looking
for opportunities to slowly ease out of that sector. Similarly, we have
a pretty good weighting in Japan. We first bought Japan in 1998, much
too early. We added positions in 2002 and they've done very well. We are
looking to lighten our exposure there as well.
TWST: Do you have any other overweight areas in your
portfolios at this
Mr. Herzig: We have a big sector weighting in financials. But again,
these are positions that we've held for a long time. Our biggest
position in this sector is probably in Fidelity National Financial
(FNF), which we've had since it acquired Chicago Title and Trust, our
original position, back in the late 1990s. They are the largest title
insurer in the country, with about 30% market share. Fidelity National
has done a certain amount of financial engineering in spinoffs and
dividends, and so forth, so our cost is essentially zero on a $38 stock.
We've seen other opportunities in the financial sector. Recently, we've
been active buyers of Montpelier Re (MRH), a reinsurer that was hurt
very badly by the three hurricanes in the Gulf this past winter. They
lost about half their capital, did a secondary to replace $600 million
they lost, and then found out that they had actually lost close to $1
billion. Their stock had been in the high $40s but has fallen sharply.
We started to buy the stock around $18, $19, which is where it is at the
moment. The company now has been recapitalized. We think reinsurers will
benefit as premium rates rise to compensate for recent losses, yet the
group is very much out of favor. People talk about the hurricanes, and
everybody is afraid of another big hit. We think that the market is
over-discounting. Reinsurers are bound to adjust their underwriting
strategies to reduce their exposure, even if the hurricanes do come
again. There are good people behind Montpelier Re. White Mountains Group
(WTM), perhaps the leadng insurance investor in the world, is a
TWST: What would you say are some of your core holdings
in other areas?
Mr. Herzig: We don't usually think in terms of core holdings. Last
summer, we felt there was an opportunity to invest in so-called deep
cyclicals ' the steels and the chemicals. The stocks had sold off, in
some cases 50% or more, from their highs, and we felt that the market
was selling the economic recovery short and that the cycle was going to
extend longer than the market seemed to be acknowledging. So we bought
Steel Dynamics (STLD), Oregon Steel (OS), Lyondell Chemical (LYO), and
Georgia Gulf (GGC) at 6 to 8 times forward earnings. With the exception
of Lyondell, these stocks have recovered very nicely. We will probably
be looking to sell these highly cyclical stocks after the positions go
TWST: What is the sell discipline that you use?
Mr. Herzig: As with our buy decisions, we don't have any set formula for
selling. When we buy stocks, we tend to form a general opinion of what
we think they're worth. We usually do not engage in elaborate
projections. We think about what their p/e might rebound to, and what
their earnings might look like in the future. That gives us a price
target to keep in mind. Since events seldom turn out the way one
imagines, we constantly monitor and adjust our thinking. We are
constantly looking at our positions and developments for each company to
make sure things are on track and that we are moving in the right
direction. When we get to what we think is an appropriate target, we
begin to ease out of a position over time. We don't try to sell at the
top. We are looking to sell at a fair price that gives us an adequate
TWST: What is the average turnover in a portfolio?
Mr. Herzig: Our turnover varies from year to year. It tends to be higher
during market extremes. It typically is well under 100%. We have some
holdings we've held for 10 years or more. We also have a large number of
one-to two-year positions. Our only compensation is in the form of
commissions on purchases and sales. We do not charge a management fee.
With our low turnover, lower than on most mutual funds, total investment
expenses for our clients are very reasonable. They vary from year to
year, but tend to run between 1% and 1.5% of assets under management.
TWST: In what ways do you attempt to control investment risk?
Mr. Herzig: The obvious way is through diversification, and by making
sure we don't pay too much for a stock. As we've discussed, we usually
hold between 30 and 40 positions in an account across a number of
sectors. And by buying stocks that are down we try to have a margin of
safety that protects us when the fundamentals don't work out as we
anticipated. We are constantly monitoring our stocks and questioning our
assumptions. We're always looking at the downside for a stock if things
go wrong and comparing that to the upside. We don't hesitate to sell if
the fundamentals or market sentiment no longer support the price.
TWST: Your firm is noted for its strong ethics culture. Do
anything to say about that?
Mr. Herzig: Ethics are very important to us. We encourage all of our
investment professionals to earn the Chartered Financial Analyst
designation. We have adopted the CFA Institute Code of Ethics for both
individuals and for the firm, which requires us to place our clients'
interests before our own. We also participate in the CFA Institute's
continuing education program. Holding ourselves to the highest standard
is integral to the culture in the firm. If we do right by our clients,
they will do well for us.
TWST: In what other ways do you think your firm's investment
differentiates you from other firms?
Mr. Herzig: We have always placed a lot of emphasis on performing well,
and on keeping things simple and costs low. We are investment
professionals, not marketers and asset gatherers. We manage our own
money alongside our clients' money. We believe if we are successful in
our investments, the firm will continue to thrive and grow.
TWST: You have been in this business a long time. What do you
see as the
most rewarding part of your investment discipline?
Mr. Herzig: As I said, we are very investment driven and if I can do
well for my clients, that gives me tremendous satisfaction. Being a
portfolio manager is usually a thankless task. When things go wrong, you
hear from the clients; when they go right, the phone never rings.
Nonetheless, I do get tremendous satisfaction from having performed
well. I cannot guarantee we will continue to perform so well, but I can
guarantee that striving to do so will continue to be my greatest source
TWST: What advice would you give to investors who are looking
in the market at this time?
Mr. Herzig: I think that common sense is a key component to investing in
the stock market. Successful investors think independently, keep costs
low and remember there is no such thing as a magic formula that works
all the time.
TWST: Is there anything that I overlooked that you wanted to
about your work or your views?
Mr. Herzig: First, I would like to remind your readers that we currently
own all the stocks I've mentioned, but we may sell them at any time.
They all have risks and are not suitable for everyone. I encourage a
visit to our website to read our disclaimer. Second, we do things
differently from many money management firms. Even for the accounts we
manage, our compensation is entirely in the form of commissions on
purchases and sales. We do not charge a management fee on the value of
assets in an account. Some people argue that this arrangement is not
good for the client because it encourages churning, which means higher
taxes and other costs for the client. Of course, any type of
compensation method can be a problem in the hands of an unscrupulous
manager. But in the hands of an ethical firm, our system offers
significant benefits. It is simple for us to administer and keeps our
costs low. It encourages us to focus on coming up with good investment
ideas rather than spending most of our time going out and gathering
assets from new clients so we can earn more management fees. And
finally, it means our charges are totally transparent to our clients.
Our clients receive confirmations showing what we charge down to the
penny. There are no hidden fees or extra costs to decipher, as one often
finds with mutual funds and even fee-based investment managers, whose
clients pay not only the management fee but also trading costs and other
charges. There is a real benefit to keeping things simple and we pass
those advantages on to our clients.
TWST: Thank you.
Note: Opinions and recommendations are as of 1/30/06.
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