“First shalt thou take out the Holy Pin. Then shalt thou count to ten, no more, no less. Ten shall be the number thou shalt count, and the number of the counting shall be Ten. Eleven shalt thou not count, neither count thou nine, excepting that thou then proceed to ten. Twelve is right out. Once the number ten, being the tenth number, be reached, then lobbest thou thy Holy Hand Grenade of Antioch towards thy foe, who, being naughty in My sight, shall snuff it.”

A little Monty Python should erase any sense of maudlin thoughts regarding the tenth anniversary of the founding of Cove Street Capital—with the term maudlin being defined as “self-pityingly or tearfully sentimental, often through drunkenness.” The following cannot be but somewhat personal, though I will attempt to share some lessons on how to create a sustainable culture and investment process and offer some conceptually relevant thoughts on how the world in which we work has evolved. And, of course, what in God’s name comes next for us.

If you read our blog and Strategy Letters, you get plenty of our take on the world at large. For those who have criticized the style and length of how we communicate, go away to your Twitter feed (or check out Ben’s: @BenClaremon). Despite the unbridled and random joys derived from being hugely right over a short-term period while managing a lot of assets—and no one should knock it—successful long-term investing requires a rolling cognitive dissonance that usually requires lengthy internal and external exposition. This process, over years, enables one to be in a position to see the large opportunity and to have the mental fortitude to commit in an appropriately large fashion. “Work, work, work, wait, and then be there in size,” is the Munger paraphrase. And this piece of course ignores the advice I gave Ben Claremon for his own 10-year review.

Cove Street was born out of a 40-year-old firm in a remarkably successful transaction for both the legacy firm and Cove Street, which is a highly unusual statement. One approach to this transaction would have been to build on the old foundation with a series of compromises; but, Cove Street started as a brand new, ocean-front lot. So, all faults and misses can only be attributed to the founder, or in his weak moments, his team. And in a story I rarely tire of telling, we were in the throes of the final deal and we lacked a name. The acquirers of our predecessor became insistent. Tequila did not help the naming process, nor did teenage family advocates shooting down every idea as “stupid.” At last, the acquirers of our predecessor offered a name they had in storage: Cove Street Capital. What’s that? It stood for 97 Cove Street, New Bedford, MA, the original home of Berkshire Hathaway. Done! And the title was purchased, in the words of Duke and Duke…for “one dollar.”

We had a year to prepare for the moment and our operations were seamlessly converted. I offer a humble shout-out to co-founding partner Daniele Beasley who retired in 2017 for facilitating that transition. She did the heavy legwork to enable Cove Street’s investment team to be 100% focused on investing and making money versus wandering aimlessly in search of the perfect coffee machine. Admittedly, however, an appropriate amount of time was allocated to that endeavor at the highest level of the firm.

We started a new firm. There are many ways of going through life without taking that risk, and plenty of them are just as lucrative or more so. On this issue, I have no advice. “You either have it or you don’t,” is a statement that is not a criticism toward anyone. Having backing helps. Having great partners helps. Having worked at the Goldman Prop desk or Tiger really seems to help. We decided to have none of that. This firm was created with internal capital, sweat, and what may just be a standing record of unsuccessful interviews at Goldman. We turned down a number of offers to “back us,” which essentially translated to us giving up a substantial amount of incredibly expensive equity on day one. But, we didn’t need the startup capital, and if I could take away one lesson from 38 years in the investment business it would be that there is no greater false God than the aspiring prophet who appears at your deal with a promise of bringing in huge sums of money in the future in exchange for equity today. Like marriage, it’s a great idea if the partner is right—a smaller piece of huge can be better than a larger piece of small. (I was luckier in marriage.) We will admit to being systematically “long investment capability and short distribution reach,” and we are very keen to fix it. Announcement: we remain open to suggestions and opportunities, but you had better bring your A+ game. I have seen an awful amount of BS.

So, for Bruce Lederman, a client, friend, and schemer extraordinaire who figuratively slapped my face and told me to stop whining and do something about my prior professional unhappiness—that pesky maudlin thing—I offer the following quote, not from Goethe to whom this quotation is frequently misattributed but from William H. Murray, its true author:

“Until one is committed, there is hesitancy, the chance to draw back, always ineffectiveness. Concerning all acts of initiative (and creation), there is one elementary truth, the ignorance of which kills countless ideas and splendid plans: that the moment one definitely commits oneself, then Providence moves too. All sorts of things occur to help one that would never otherwise have occurred. A whole stream of events issues from the decision, raising in one’s favour all manner of unforeseen incidents and meetings and material assistance, which no man could have dreamed would have come his way. Whatever you can do, or dream you can, begin it. Boldness has genius, power, and magic in it. Begin.”

And we did. Besides technology, compliance, and back-office strengths that were (and are) ridiculous overkill relative to our starting assets of around $200 million, we were a little unusual in that I started with a new team supporting me. (Our processes and procedures were inherited from a bank partner who seemed to delight in subjecting our predecessor to both FED and SEC rules.) Ben Claremon and Eugene Robin were young, hungry, and had requisite and completely different backgrounds and skills. I had started interviewing long before Cove Street opened its doors, I just wasn’t telling people what firm they were interviewing for. I had fought for, and lost the ability to take, a handful of old research associates with me and I thought that would be hurtful at the start of Cove Street. In the words of Rod Stewart, “Look how wrong you can be.” Starting fresh without emotional baggage and old war stories and “how it was once done” was an unforeseen gift. We started with a carryover portfolio and the process of putting each name through a new grind covered by new eyes resulted in some true mental comeuppance. In a number of cases, I simply didn’t have a good defense against a withering onslaught of fresh thoughtfulness. It was a gift and we had a marvelous six-year run of performance, which I believe was a direct result of the fresh start. Ben and Eugene are critical partners of the firm, and flash to today, you should get me out of the office and talk to them. Your “key man” questions will melt.

Two other things were “new and improved” at Cove Street. The meaning of “value-oriented” hasn’t changed terribly for me for a long time. Besides the usual obsessive reading about anything ever written about value (Graham/Dodd, Fisher, The Buffett Partnership Letters, Templeton, etc.) as my career was beginning, quite frankly my personal seminal moment as an investor surrounded Ametek (ticker: AME) and Stern Stewart back in the early ’90s. We had a new account and we had an archaic method of “sell one-third we don’t like, keep the third you do like, and look opportunistically to sell or learn about the other third in a timely and tactical fashion.” What you learn of course is that the portfolio is 100 percent YOURS at the close of the first trading day. AME naturally chose day 2 to report a terrible quarter, announce a massive restructuring plan, cut their dividend, and announce a stock repurchase plan—and the stock dropped 20%. What I subsequently learned in the following weeks was that they had hired management consultants Stern Stewart and began to employ an EVA, or Economic Value Added, model, which called for jettisoning and/or starving businesses that weren’t earning their cost of capital; feeding and growing businesses in which they earned well in excess of their cost of capital; lowering their cost of capital by adding a reasonable amount of leverage to their capital structure; and tying the whole ball of yarn into a management compensation plan. (Go look at that stock chart since 1992.) VOILA! Stern Stewart in no way created this, but they did a damn good job marketing it and I have been onboard since. Thirty-eight years in, the philosophy is fiendishly simple: invest in businesses that have high sustainable spreads between return and cost of capital and that have the ability to drive lots of capital through the hole (AKA Buffetts) or those companies that have or are about to embark on a program of on-the-margin change to “fix” problematic returns on capital by starving or selling them (the Grahams).

The new and improved parts of the process that came about with the formation of Cove Street were procedural. The first was team tackle with a devil’s advocate or “short.” If a smart group of people come in every day and do the same thing, huge errors can ensue. Groupthink is endemic in human organizations. Every idea has a “short” whose job it is to create a narrative that begins with, “you people are morons.” The second improvement was to record our decision process. Nothing is more annoying than the selective memory capability of the human psyche—just go ask your significant other. It is just as bad at the office. We created a checklist of previous stupid mistakes that we are intent on not repeating…and the list grows regularly. We run through a defined list of questions, we define critical variables (what is important is usually much less complicated than you think), and then the keyboard is passed around the room until everyone expresses a written opinion. And we keep dated records of this. It’s not a perfect process, but it continually improves and adapts. We try to get smarter every day about how we do what we do.

Now comes a brief detour to discuss equity, motivation, people, culture, and money. The agonizing over a name was because “Bronchick and Associates, Capital, etc.” not only sounds as ugly as a bad Beatles cover band, but It Ain’t Me Babe. Cove Street has a position plank: the founder admits to taking perverse personal pleasure in hiring young, non-traditional people, beating them to within an inch of their lives (which is simply known as mentoring on Wall Street), and then challenging them to run the place without my dirty hands mucking up their process. While the founder is unmedicated, obsessive, and has in-depth experience and opinions in all possible aspects of investment, operations, trading, compliance, management, and HR (okay, not so much HR), which many might find implausible, the previous statement is the operating goal. I am 59, own 78% of the firm, and give up equity every two years. Nine of our ten firm members are equity partners and the 10th has only been with us for three months, but I would consider it my personal failure if we do not reach 100%. And if you are asking, anything I have said above or will say below applies until the day I drop below 50.1%, although I am 98% certain that threshold won’t matter given our firm culture.

The relevant point is ownership mentality. The best results come from the decisions of a small group of people with skin in the game. I know there are many successful firms who are 95% owned at the top and then cycle through smart people who come and go in support. Of course, there are days where that seems like a great idea, but that is not us.

But I think our original mission statement still represents our firm and culture to a tee, and you have no idea the sneaky things I continue to try to employ to keep this fresh:

We are a highly motivated, entrepreneurial, and open ecosystem. Every member of the firm understands DHM and the importance of its ordering—Delight Clients, Have Fun, Make Money. The atmosphere is highly collaborative and ideas flow across rank and job description, enabling “failure-free” expression. The best thing a human being can do is help another human being know more—personal growth is encouraged and compensated. Resonating themes include: unwavering ethics and devotion to the client first; independent work with full accountability; ownership mentality; a focus on what is the “best way,” not “this is how it has been done before;” and submission of rank and seniority to best idea and best practice.

I have spent a lot of time on “development,” but I have found over time that you are not a family but rather a team and sometimes being the head coach sucks. I have had to make some difficult people decisions from time to time and it’s the worst part of my life. I can recall a meeting with a CFO and I stared at his “pig” cufflinks for 40 minutes until I interrupted the meeting and asked about their meaning. He told me he was a management consultant in a prior life and a team exercise revolved around the idea of breakfast: chickens contribute to the meal, but what a successful organization really needs are pigs—because they are all in. That is what I try to ask of everyone. If you work at Cove Street, you get a lot of autonomy, you are tasked with getting better at what you do, and we ALL try to be part of something bigger than ourselves and own it.

One of my biggest challenges in this area is, “what the heck do I do with the formerly young investment people?” I concluded ten years ago that I am simply not well-suited to a committee decision-making concept. (Well, I actually knew this 25 years ago, but I decided to bang my head against the wall for years before giving up.) It’s a great book to write about the investment business. The idea is to interview “known entities” and ask them how they went about the process of sharing decision-making. (If Seth Klarman agrees to go first, I will write it.) All that aside, here is what we are doing. We have developed a Venn Diagram process wherein we overlap in work but someone else is making the final call. In response to aggressive and ultimately unrequited interest from a certain large firm in and around Boston, we created and internally funded Small Cap PLUS, which everyone else in the world calls SMID. We started with a shared PM structure, but that has run its course—Ben makes the call. PLUS is more Buffett-y than our core Small Cap, which reflects the personality of its PM. And, because it often owns larger and more liquid companies, it can and is more concentrated. The Strategy had a great start and faltered in the last 2 years from some “more cautious than others” thinking and a shared disdain for “silly” versus real businesses with steady growth prospects with legitimately visible futures at a reasonable value. There has never been a better time to give the strategy money.

The other bookend is Partner Eugene Robin, who arguably shares a more eclectic, alternative, and active view of the world with the firm’s founder. We are in the final “start-up” stages of another overlapping diagram strategy under our leadership excitingly entitled CSC Partners Fund. This will be a Limited Partnership structure that will be zero management fee and all incentive fee over a hurdle. The evolutionary premise is that there is an insane amount of money chasing “Private” companies while many Small and Micro public companies languish. The Fund seeks a handful of material-to-control-sized positions where we can have Board representation and pursue a “private equity in public companies” approach. There will be some holdings overlap with our Small Cap work, but this will really be a home for opportunities where there is simply not enough liquidity to be a core holding. As an added bonus, an LP structure is easier for SEC oversight and governance purposes to lock positions, particularly when you are over 10%. This wraps up dozens of years of collective experience in business evaluation, governance expertise, M&A evaluation, and investor relations know-how, skills in which many smaller companies lack one or all…and thus languish. We have a wide network of highly experienced people in all relevant areas who are excited to partner with us as Board members and as investors. We have had material inbound interest from of all things CEOs of current and former holdings who came to see us as thoughtful partners with material skin in the game. (Okay, we will be honest that it wasn’t always love at first sight.) We have done dozens of “things” behind the scenes over decades that don’t involve waving 100-page presentations and hoisting executives on poles. Eugene has been our point person on many of these ventures, and while our initial fundraising will be limited, the opportunity to do material larger side pockets should also be highly interesting. Keep your eyes and inboxes open for an official September launch—capacity is severely limited.

As far as investment partner four—Andrew Leaf—we will all likely end up working for him. News to follow in the years to come.

A brief shout out to the “rest of team CSC” who sadly but mostly labors under the “who cares if they aren’t picking stocks” veneer. Merihan Tynan on Compliance and Ops, Matt Weber, Trading and everything else, Andy Harnett, Trading and Ops, Fabiola Barrios, All Things Money, and Paul Hinkle, All Things Outward-Looking, are the Partners and bandmates who enable the investment team to mostly do nothing but the necessary navel examination required for successful investing.

This ends this part of the “firm review.” We remain open to opportunities, but these will require new bodies. If you have an idea but lack the back-office, compliance, and overall infrastructure to seem credible enough to larger sums of money, contact us. Our screen is three-fold: (1) is this an intellectually good idea that the founder can stand in front of the smartest pools of money and be 120% behind it, (2) can we be “excellent” in it (you wouldn’t believe the 20-year track record in fixed income we had for a former client, but that is an example of “could” yet unlikely to be top tier), and (3) does anyone else in the world care? Being accurate in the first two but completely missing the third part is a lot easier than you think.

There are an awful lot of messy things out there. Former consultant deity Charley Ellis once noted that much of our daily activity “diverts our attention from the profoundly important long-term investment policy decisions on which all investors should concentrate their time, energy, and thought.” How do you/we spend our time? Certainly not on yesterday’s performance which remains an excellent piece of paper in which to wrap today’s fish in. We are about to go through yet ANOTHER period whereby we look stupid on September 23rd but incredible on October 4th simply as a result of one quarter dropping and a good quarter being added to the math series. We rhyme with the past but have the benefit of a multi-decade track record. Find a decent business/manager, analyze the conditions and probabilities that something has changed in the narrative, and if not…give us money when the tears are in our eyes. It’s worked for a long time.

What we learned in the last two years is how to better spend time. JP Morgan once noted that he can do the work of a year in 9 months, but not in 12. In other words, recharge, refresh, read something different, talk to multiple and different people and get away from your screen time. It is amazing what happens sometimes with a blank piece of paper, a pen, and alone time. (It also helps if you add a bourbon here and there too.) 2020 should also force you to focus on how you spend your time and with whom you spend it. Employ “zero-based personal management” and focus on the things and people that bring you the greatest relative pleasure, or profitable ideas, within the confines of necessity. And necessity involves being at the office most of the time. Count us among those who think Zoom calls are a crutch for our time and place, not a process by which one clings to attempts at culture.

And the old NY Times test: if what you are doing today were in tomorrow’s paper, you would…? That is what is so absolutely insulting and infuriating about how the nearly completely BS du jour of “ESG Investing” is being practically implemented as we speak. The basic implication is that the day before we adopt someone’s consultant program we were apparently aiding and abetting larceny, mass destruction, and the crushing of the human body and soul. It is personally insulting as a business owner and it is insulting to many with whom we work. In practice, it is a phony game of “hide thy hypocrisy” in attempts to capture money from headlines and it has become a playground for the PR righteous to arbitrage their advantage as self-perceived current pillars of the community. Do you need the people who brought you Enron, SPACs, and leveraged mortgage tranches to now be your arbiters of the global consciousness? I have managed socially conscious money in some form for almost 30 years—and bringing together those half dozen accounts and putting them in a room to agree on common principles and how to put them into action is easily duplicated by watching 5 minutes of Rugby. What we bring is a meritocratic organization of ethical doers who practice full transparency, admit mistakes and weaknesses, and treat your money as if it were our own. It is a lot easier to make the world a better place than to prove that you have made the world a better place. We are busy at it.

We will close before the maudlin kicks in. This firm remains firmly in adolescence, which some may argue is a character flaw of its founder. We have the assets and capabilities necessary to do almost anything we may choose to pursue, but there remains a culture of continuous improvement, dogged curiosity, and unlimited opportunity for everyone who enters our doors.

And as Bart Starr noted about Vince Lombardi, “Our first meeting with him was at the old Packers offices in downtown Green Bay. We were sitting at these different tables when he walked into the room, greeted us, and began by thanking the Packers for this opportunity. Then he quickly turned to us and said—and I’ll remember this as long as I live—“Gentlemen, we are going to relentlessly chase perfection, knowing full well we will not catch it because nothing is perfect. But we are going to relentlessly chase it because in the process we will catch excellence.” He paused for a moment, got up even closer to those of us sitting up front, looked us in the eye, and added, “I am not remotely interested in being just good.”

To our next ten years together.

Jeffrey Bronchick, CFA
Principal, Portfolio Manager
Cove Street Capital, LLC