Christopher Browne never thought he'd live to see the day. But thanks to the steep market sell-off, Tweedy, Browne Co., a longtime value manager, is doing the unthinkable.
By Alexandra Alger
May 2001
Institutional Investor Magazine
Christopher Browne never thought he'd live to see the day. But thanks to the steep market sell-off, Tweedy, Browne Co., a longtime value manager, is doing the unthinkable. "It's funny, we're actually starting to look at technology stocks," says the 54-year-old partner at the New York-based firm.
In March, for example, running a screen for stocks trading at low multiples, Tweedy found Netro Corp., a San Jose, California-based supplier of wireless networking equipment to telecommunications service providers. It was selling at $5.50, down from its 52-week high of $86. What caught Browne's eye was Netro's cache of $14 a share in cash. Because he doesn't have a good handle on Netro's business lines, Browne has not yet bought the stock - but he's keeping an eye on it. "What we've uncovered makes us want to keep looking," he says.
Tweedy Browne began life as a market maker in 1920 and is now 70 percent owned by Affiliated Managers Group. Tweedy's assets total $7.6 billion; $1.4 billion is institutional, and $6.2 billion is retail. The overall amount is up from $1.3 billion in 1993.
For the past five years, its U.S. equity portfolios have returned an average annual 19.5 percent, comfortably ahead of the 18.4 percent of the Standard & Poor's 500 index. Over the past ten years, the portfolios have averaged 18.9 percent annually, versus the S&P's 17.5 percent gain. Tweedy boasts an average annual return of 20.3 percent since 1975, compared with 16.1 percent for the S&P. Though overseas investing was not an initial focus of the firm, Tweedy's international fund has become an important contributor to performance and asset growth.
Browne and his colleagues are sticklers when it comes to a classic Benjamin Graham dictum: They only buy companies that trade at 40 to 60 percent of intrinsic value, or the value of the assets at liquidation.
Of course, virtually all value purists suffered during the peak years of the bull market, but Tweedy was hurt more than most. In 1999 Tweedy's average return was down 0.7 percent before fees, versus a 9 percent gain for midcap value funds and a 21.1 percent gain for the S&P, the firm's worst performance against the S&P in its history.
Last year, though, Tweedy rallied as the tech sector faded; its portfolios returned 16.1 percent, versus a 9.1 percent loss for the S&P. Still, Tweedy trailed its midcap value peers, which returned an average 17.4 percent.
So far this year, Tweedy's domestic fund, the $956 million American Value, was down 2.9 percent in mid-April, while the S&P was down 10 percent and the Nasdaq composite index fell 20 percent. On the other hand, its midcap value peer group is down just 1.94 percent, with some big names, such as Dreyfus Corp.'s Midcap Value Fund and Franklin Templeton Investments' Mutual Shares Fund, eking out gains for the year.
But in its international stock funds, Tweedy really shines. Its Global Value Fund (despite the name, the fund meets the definition of an international fund, with less than 20 percent of its assets in U.S. stocks) is down just 1.9 percent so far this year. That's far superior to the 11 percent loss for the Europe, Australasia and Far East index and the -11.8 percent return for Morningstar's group of international funds.
In 1993 Tweedy launched its Global Value Fund as a vehicle for its existing clients to diversify, but the partners never thought it would amount to more than a sideshow. Today international and global assets account for nearly 60 percent of Tweedy's total. The global fund alone stands at $3.6 billion. In an unexpected turn of events, international investing has become Tweedy's specialty.
The international portfolios have returned an average of 20 percent annually since the end of 1992, compared with 13.4 percent for the hedged EAFE index. Since inception the Global Value Fund is up an average annual 16.1 percent, while international equity funds have averaged 7.25 percent. Last year the fund posted a 12 percent return, the best among overseas value funds. Morningstar analysts last year named Tweedy international manager of the year in recognition of the firm's solid long-term performance.
"It's been a pleasant surprise, how well the international side has done," says John Spears, 52, who runs Tweedy's portfolios along with Chris's brother, William, 56, and Thomas Shrager, 43.
Shrager points out that Tweedy benefits from its willingness to take time to understand foreign accounting and tax quirks, such as the myriad ways that companies can depreciate fixed assets. For example, Tweedy owns stock in Telegraaf Holdings, a Dutch newspaper company that revalues its fixed assets before writing them off, allowing it to reduce its reported earnings and taxes.
Tweedy managers use the same criteria for international stocks as they do for U.S. stocks. They look for cheap multiples and prefer a sliding share price. They also like to see a history of recent buying by top executives. Taking a page from Warren Buffett, Tweedy managers also look for evidence of a sustainable business with a competitive advantage.
In Pharmacia Corp., which Tweedy bought in 1994 when it was an obscure Swedish drug company selling for $16 a share, or roughly ten times earnings, Tweedy found some very healthy returns. The company merged with Upjohn Co. in 1995, and the stock recently traded at 51. Says Shrager, "Pharmacia was cheap, and pharmaceuticals assets don't stay cheap for long."
Another Tweedy favorite is Takefuji Corp., a Japanese consumer finance company that Tweedy bought a few years ago at seven times earnings and is now trading at nine times. All told, the international assets are spread among 200 stocks in about 20 different European countries and Japan. Tweedy stays out of emerging markets. Says Kunal Kapoor, a senior analyst at Morningstar: "They invest in companies outside the mainstream of Wall Street. And it has served them very well."
Tweedy's performance doesn't come cheap. For individuals and institutions, fees for domestic accounts start at 150 basis points for the first $25 million (nonprofits get a 10 percent break). At other firms, individuals might pay 125 basis points, and institutions as little as 35 to 50 basis points, estimates Brian Bedell, an analyst at Salomon Smith Barney. The mutual funds' expense ratios - 1.37 percent for the domestic fund, 1.38 percent for the international counterpart - are lower than average, but higher than many of their main competitors'.
"Sometimes people ask us why we aren't four times as big, and I say, 'Have you seen our fees?'" Browne says. "It sort of puts a brake on business."
Tweedy's fixed costs, on the other hand, appear to be pretty low. The firm has 44 employees and comfortable but unremarkable offices on Park Avenue. Its marketing efforts are negligible, its sales force nonexistent. To distribute its funds, Tweedy uses the Charles Schwab & Co. and Fidelity Investments supermarkets, as well as Pershing and TD Waterhouse Group.
The combination of high fees and modest costs naturally bolsters Tweedy's bottom line. Browne says pretax margins are 80 percent, but that's before the significant component of partner compensation (the firm is set up as a limited liability company). Although it's difficult to compare a partnership to a publicly traded company, Salomon's Bedell says that, at 80 percent, Tweedy's margins are substantially higher than the industry average of about 40 percent that prevailed during the late '90s, but are in line with those of other successful small asset managers.
After buying Tweedy for $300 million in cash in 1997, AMG, which owns stakes in 15 asset managers, has remained mostly hands-off. Tweedy partners do have a strong incentive to perform well: When they sold out to AMG, the three original partners put $100 million of their proceeds into Tweedy's portfolios. The partners already had $250 million, most of their families' net worth, invested in the business.
As part of a revenue sharing agreement between AMG and Tweedy, AMG lays claim to about half of gross revenue (Tweedy's total gross revenue last year was roughly $80 million). About 30 percent pays for Tweedy's operating expenses, and the Tweedy equity partners are entitled to the rest. If they can cut back on costs or grow the business while keeping costs down, they get to pocket the savings.
Higher cash flow, in turn, means a higher equity value. Starting next year, the partners will be able to begin selling to AMG some of the remaining 30 percent of the firm that it does not already own.
For this second part of the deal, AMG will pay Tweedy an undisclosed, but agreed-upon multiple of cash flow. Chris Browne says it's less than ten times cash flow, which is what AMG paid for its 70 percent share. "It's a good strategy for motivating managers," says William Katz, an analyst at Merrill Lynch & Co.
AMG will likely take more than a passing interest in identifying the next generation of Tweedy leaders. In 1997 the three partners were joined by two more: Robert Wyckoff Jr., 48, who has been in charge of client services for a decade, and Shrager, a veteran of 12 years. In time, a third of the original partners' 30 percent stake will be divvied up among future partners and key employees.
Who will replace top partners Chris and Will Browne and John Spears? That's the big question, and for the moment the answer is unknown. "We haven't solved the succession problem for AMG because none of us feels the need to move to Hilton Head," Chris Browne says.
