‘Long-term compounding is an investor’s best friend, so why get in its way?’
These words were written by Gordon Gekko wannabe turned Warren Buffett disciple Guy Spier, but they could easily be the mantra for New York-based growth specialists Needham Asset Management.
Spier wrote them in his 2014 book The Education of a Value Investor, long after Needham portfolio manager John Barr and his colleagues had begun putting this philosophy into practice.
‘The strategy is to create wealth for long-term investors. We invest in growth companies at a reasonable price and the predominant strategy is to find compounders,’ Barr said.
‘Companies you can own for a very long time that have reinvestment opportunities will lead to significant cash generation.
‘We hold these companies through thick and thin as long as the fundamental thesis is still in shape. We tend to buy them when they are small and mid cap and then they grow through the market cap ranges.’
The firm does this through three mutual funds and three hedge funds, which between them account for around $650 million of assets under management.
Barr is the sole manager of the Aggressive Growth fund and co-manages the Growth fund with his colleague Chris Retzler.
The asset management arm of Needham Group, which also includes boutique investment bank Needham & Company, was set up 1985.
The asset management division emerged in 1992 when the firm’s first hedge fund was launched.
The first mutual fund, the Growth fund, was launched in 1996, with the Aggressive Growth fund following in 2001 and the Small Cap fund in 2002.
An example of a long-term compounder in the aggressive fund is satellite and communications firm ViaSat, which it has held almost since inception.
The stock not only demonstrates Barr’s preference for compounders but also his willingness to run his holdings.
‘It was a small-cap stock at the time, but 15 years later it has a $4 billion market cap, right in the sweet spot of mid cap, and it has transformed from an electronic systems maker to a communications services provider,’ he said.
The firm moved from providing technology to satellite companies to launching its own satellites and breaking into communications.
It is typical of Barr’s holdings in another way too. It was initially a technology stock and has morphed into a different beast.
Big on tech
While this evolution is a cause for celebration for the fund manager, the fact firms are often not re-categorized can leave the portfolio looking a little lopsided. It is currently 72.7% in technology, versus the Russell 2000 Growth’s 23.3%.
‘Companies change faster than their category names,’ he said, citing laser-maker IPG Photonics and real estate lease intelligence provider Reis as two further examples.
This does not entirely explain the huge tech overweight, which in reality has more to do with the group’s background and is a reflection of the market cap and qualities the manager looks for.
‘Needham & Company is a specilaized investment bank focused on growth equities. It lives and breathes growth equities in institutional sales and investment banking,’ Barr said. ‘On the asset management side, we also live and breathe those companies and there tends to be a lot of technology companies.’
His own background is a factor too.
‘Wall Street is my second career,’ he said. ‘I started on Wall Street after 15 years of chip design and software sales so I know these companies and find that the technology market is fruitful for finding compounders.’
This background led him to the fund’s current top holding and last year’s big winner PDF Solutions, up 108% in 2016, which supplies services and software to semi-conductor manufacturers.
That firm also encapsulates the last of Barr’s key tenets for investment: high quality but low paid management.
‘As I looked at our compounders, I came around to the fact that they were run by founders, family or long-tenured management,’ he said. ‘These are CEOs that have a vision that goes beyond their current pay package.
‘I found many of these CEOs had pay packages of around $1 million. In the PDF case it’s stunning. He is paid $380,000 and has never taken a bonus, has never been granted stock options, he owns it as founder, but has never sold it.
‘My conclusion is great management has a vision, which is to fulfil something well beyond compensation.’