From Buffett with love: Meet the activists shaking up small cap stocks
The Oracle of Omaha famously detached his investment strategy from his civic pursuits.
Lauren Taylor Wolfe says her biggest disappointment so far with her fledgling hedge fund is that one of its investment wins came so quickly. Taylor Wolfe and Christian Alejandro Asmar, the founders of Impactive Capital, expect every investment they make to be the beginning of a yearslong, hands-on partnership that includes a long-term ESG (environmental, social and governance) initiative to add to a company’s bottom line. In an environment in which simply buying an S&P 500 index fund produces impressive returns, the duo are a rarity: deep value investors, outperforming by owning only eight to 12 unglamorous companies at a time.
“These investments, they’re like your children,” Asmar says when asked to pick a favorite. “You love them all.” In March, the activists saw an opportunity in Hilliard, Ohio’s Advanced Drainage Systems after its stock was slashed in half in the span of a month. Advanced Drainage is a $1.7 billion (revenue) stormwater-management company that manufactures underground chambers and drainage pipes used beneath roads, homes, parking lots and golf courses. The little-known Midwestern company doesn’t stand out as a haven for environmentalist investors.
But Taylor Wolfe delves into an explanation of the carbon footprint of recycled plastic pipes compared to concrete pipes and how promoting the company’s new “Mega Green” polyethylene pipe, made with 60% recycled plastic, is an opportunity to take market share from competitors such as JM Eagle and Diamond Plastics. It’s the pitch Impactive made to management as it bought a million ADS shares. But just as the company was preparing its sustainability report and ESG-focused website—to promote its recycling record and philanthropy, among other things—Covid-19 ignited a homebuilding boom that caused demand for its products to surge. In a matter of months, ADS shares more than doubled. headtopics.com
“We were forced to sell it,” Taylor Wolfe laments, referring to the firm’s strict intrinsic value discipline. “Those returns were no longer there.” Value investors can’t get too attached to their children at the right price. That’s an analytical framework borrowed from Warren Buffett, the first name both Taylor Wolfe and Asmar invoke as an investing inspiration.
Impactive underwrites all its investments for an expected holding period of three to five years, and it has time to be patient thanks to a $250 million investment and six-year commitment from the California State Teachers’ Retirement System, which kickstarted the firm in 2019. Early returns have been strong—that investment is now worth $320 million for Calstrs, a 28% increase over 20 months, representing about half of Impactive’s $630 million in assets. Over the same period, the Russell 2000 small-cap index has gained only 10%.
Taylor Wolfe and Asmar are using their growing pool of capital to try to revamp the activist playbook by replacing confrontation with collaboration and putting sustainability at the forefront. As ESG compliance is rapidly becoming an institutional-investor must, chief financial officers should take note. However, unlike other “rattle the cages” activist hedge funds, Impactive eschews public proxy battles and threats, preferring an occasional board seat and gentle behind-the-scenes persuasion. Their message: ESG will improve profitability, and they pledge not to jump ship if the next earnings report isn’t up to par.
“ESG factors relate to attracting and retaining the stickiest customers, shareholders and employees, the three most important constituents, and companies that do that better than their peers are going to create a competitive advantage,” Taylor Wolfe says. “They’re going to outperform from a profitability perspective.” headtopics.com
Long Island–raised Taylor Wolfe’s first taste of activism came when she worked for a family office while pursuing her MBA at the University of Pennsylvania’s Wharton School. There, a 2003 investment in retailer TurboChef rose tenfold after her group forced a management overhaul and ultimately a sale to Middleby Corp. In 2007, the activist bug led her to Clifton Robbins’ hedge fund, Blue Harbour Group. Asmar, who spent his childhood in Puerto Rico and graduated from Princeton with a degree in operations research and financial engineering, arrived at Blue Harbour from a six-year stint at Morgan Stanley a couple years after Taylor Wolfe.
The two worked together as managing directors, and much of Impactive’s DNA is inherited from Blue Harbour: a focus on undervalued businesses, a self-described private equity approach to public markets and an aversion to conflict. But as Taylor Wolfe and Asmar heard stories from CEOs about feeling ESG pressure from shareholders, and spoke with disillusioned former employees who wanted their workplaces to better reflect their values, the two both began to feel that ESG levers in activism were being underutilized.
They had plenty of time to talk to each other about it. Asmar doesn’t drive, and he and Taylor Wolfe both lived in New York, so he often hitched a ride home with her from Blue Harbour’s Greenwich, Connecticut, headquarters. They became fast friends, comparing notes in bumper-to-bumper traffic about their shared investment philosophies and entrepreneurial ambitions. Both wanted to prove that successful hedge funds could be run by people other than white men.
“I think we both would have left to start our own thing anyway,” Asmar says. “Then it was just, should we do this together?” Little Big Picture VIRTUE VS. VICE You don’t always do well when doing good. The oldest socially responsible fund, PAXWX (Pax Sustainable Allocation), founded in 1971, is up about 17% over the past decade. The more sinful VICEX (USA Mutuals Vitium Global Investor), which invests in casinos, gun makers, booze companies and Big Tobacco, has done four times better over that period. But both have underperformed the broader market. Maybe those “all things in moderation” killjoys were right after all. headtopics.com
After eight years working together at Blue Harbour, they both quit in 2018 to take a sabbatical year and hatch their new venture, which launched in March 2019. Taylor Wolfe and Asmar are equal partners in Impactive. Taylor Wolfe, 42, is an extrovert, happy to engage with executives and investors to promote the firm, while Asmar, 38, is more comfortable crunching numbers behind the scenes.
“I like to say that when you think about investing, I’m sort of the [Charlie] Munger to his Buffett,” Taylor Wolfe says, “but when you think about the marketing, I’m the Buffett to his Munger.” They’ve formulated a four-pronged investment strategy. Their first screen is qualitative, considering only existing high-quality businesses with smart management teams and pricing power in their industries. Then, like all card-carrying Graham & Dodd practitioners, they analyze whether it’s trading at a discount to its intrinsic value using gauges like free cash flow, return on invested capital and return on equity. Their third criterion is how well the business is set up for the long haul, and whether its barriers to entry are growing or shrinking. The final piece is whether pulling activist levers can accelerate returns.
They do all the research up front before welcoming a company into their exclusive portfolio, and Asmar says there are about a dozen companies “in the bullpen” while they wait for a buying opportunity or need to fill a spot after selling a stake.One of the first companies they invested in was Duluth, Georgia–based Asbury Automotive, a $7.2 billion (revenue) car dealership with locations scattered across nine states. Given the low margins in new car sales, its parts-and-services segment drives two-thirds of its Ebitda, but when Impactive began examining its business model, its utilization rate was only 50%. It had the capacity to double the number of repairs it offered, but it couldn’t hire enough mechanics to do so.
To address the labor shortage, Taylor Wolfe identified a large group of potential employees most dealerships and repair shops weren’t even thinking about: women. Only 2% of car mechanics are female, even though they spend more than $200 billion a year in the industry as customers. Impactive pressured the company to offer paid maternity leave for mechanics, move to a four-day workweek and provide flexibility with shifts, all changes that would help recruit women. It wasn’t a hard sell to management when Impactive showed that if the utilization rate increased by just five percentage points, to 55%, it would boost the company’s enterprise value by 15%.
Asbury’s progress in attracting female mechanics has been gradual, so Impactive’s investment didn’t pay off immediately. Shares sank 60% from the beginning of 2020 to their low point on March 18. Impactive’s portfolio was particularly exposed to the coronavirus selloff—time-share company Wyndham, which is implementing a rewards program under Impactive’s guidance that gives customers points when they elect not to wash their linens every day, fell 68% in a matter of months as the travel industry collapsed.
Impactive responded by doubling down, buying more shares of every company it owned. So far it has paid off, and Asbury recouped its pandemic losses to reach an all-time high in October. “Some other large investors take big core positions in companies and smaller toehold positions in companies,” Taylor Wolfe says. “Those toehold positions are just emblematic of a lack of conviction.”
While they work to diversify the ranks of auto mechanics to make money for themselves and their investors, Taylor Wolfe and Asmar are on a personal mission to diversify Wall Street. Five of Impactive’s nine employees are women or people of color, and the firm tries to practice what Taylor Wolfe calls customer activism, asking their outside research vendors, accountants, investment banks and lawyers to support them with a diverse team. She calls for other asset managers to demand the same.
“Talent in this world, in our view, is relatively evenly distributed, and the number of women and minority hedge funds is not,” Asmar says. “We are acutely aware of the fact that if we are successful, it could be a positive contribution toward when the next asset allocator is looking at the next generation.”Read more: Forbes »
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