Q: What is the history of the fund?
The Tarkio Fund was launched on June 28, 2011, and is managed by Front Street Capital Management, Inc. This small, non-diversified fund is a no-load fund that invests in companies based on their management culture.
Tarkio Fund is a frequent occupant of the Wall Street Journal’s monthly “Category Kings” mutual fund rankings, included 10 times since its inception. For four of those periods, Tarkio Fund was the #1 ranked mid-cap core fund for both 1-year and 5-year performance, including most recently in August of 2017.
Q: How is the fund different from its peers?
We are different in several ways. Our long-term perspective enables us to evaluate companies through a different prism. We are qualitative value investors and look for companies with specific characteristics that give them long-term advantages in the market.
We first identify companies that we want to own, then we wait around as long as it takes to purchase the company at a fair price. Sometimes, that can be years. The entry price is important, but the quality of the company is paramount.
We are not influenced by disruptive geopolitical or macroeconomic fluctuations. However, when such events happen and there is havoc in the markets, that generally gives us the fair valuation and buying opportunity we wait for.
As qualitative value investors, we don’t run into value traps, but do experience timing mistakes. We try to buy securities when they are cheap; but once invested, we don’t sell something just because it goes up. So, we don’t have well-defined target prices.
Q: What are the core beliefs that guide your investment philosophy?
We believe in a strict adherence to specific criteria for determining the quality of the businesses we buy. Our criteria are based on the assumption that great managers can create a corporate culture of empowerment for their employees that results in strong customer loyalty and company performance over time. The core of this philosophy comes from the work of W. Edwards Deming, the management consultant.
We think that the businesses we identify will outcompete their peers over extended periods of time by better weathering the downturns and capitalizing on the upturns.
Q: How do you define quality?
Deming’s idea is that everybody at every stage of the production process is their own quality inspector. Nothing will be passed along to the next stage unless it is 100%. Every person in the production process is empowered to do whatever it takes to make sure their process works as well as possible.
Toyota’s management system was designed around Deming’s idea. To achieve quality and eliminate the need for a final inspection, you just have to build quality into a product at every stage of production. As with the Toyota model, as quality goes up over time, cost comes down.
Q: What is your investment process?
We start by identifying companies the meet the following criteria: they are run by people we believe to be trustworthy; they have an ultra-long-term focus; they have a stated purpose and passion; and they were started with a clear vision. We seek companies that believe in teamwork, strive to drive out internal competition, and empower their employees to make decisions. Finally, we make sure these companies have a disciplined approach to the allocation of their capital.
Generally speaking, we believe companies that are managed with these principles become learning organizations with a culture that gives them the ability to outperform their peers. If they run into challenging times, their culture will enable them to find solutions necessary to overcome the challenge.
Traditional value investors have not focused on these quantitative value characteristics and that has tended to dilute their selection process. The criteria that we use cannot be computer screened, which means we should continue to have a competitive edge in our portfolio selection process.
Q: Can you describe your investment process with a few examples?
The largest position in the Tarkio Fund at this point is Cognex Corp., the manufacturer of machine vision systems for industrial applications. We identified them early on as a company with a different culture that sticks out like a sore thumb. They have found unique ways to break down barriers in the organization or driving out internal competition.
We were convinced by their management style and focus on robotics that their stock would be a winner. Because of its current valuation, we are not buying more Cognex today. But if the stock returns to a reasonable level, we will start buying aggressively.
Another example would be Herman Miller, Inc., the manufacturer of office furniture. The brothers Hugh De Pree and Max De Pree assumed leadership of the company in the early 1960s. They had been working on corporate culture, breaking down barriers and empowering employees, since the 1940s.
Eager to boost their efficiency, they sought help from Toyota and hired a Toyota consultant to refine their manufacturing processes. The objective was to empower individual managers and production teams to continually tinker with and improve their own work flow. The result was a 99% error-free supply chain.
This again is the Deming model and it is a perfect example of the type of company we seek. There’s no company in the United States or the world that’s as deeply embedded into these principles as Herman Miller.
Just to cite one other case, we started buying Whole Foods Market in 2000. It was a classic situation where we identified the target, but the price was nowhere as low as what we wanted to pay. Finally, in early 2008, the stock fell from the mid-eighty-dollar range and we started buying it in the high-thirties. By 2009, we bought the stock all the way down to $8.00 and then, within a year-and-a-half, it soared to $125.00.
Q: What attracted you to The Container Store?
The Container Store is another company that has embraced the idea of conscious capitalism. John Mackey, the current CEO of Whole Foods, and Kip Tindell, the founder of The Container Store, are on each other’s boards. They both share a commitment to an employee oriented management style.
The retail environment has been undergoing a dramatic shift during the last few years and that will certainly have an impact on companies like The Container Store. It will be a great test case for their management style to see if they can effectively navigate their business through a really challenging period.
We bought the majority of that stock when it was priced in the $3.00 range, and it is now at $6.00. The company has a higher debt load than we like, but if they didn’t have that debt we might have taken a larger position. Our position in the name is just over 1% of the portfolio, and we are not planning to add to our position at this point.
Q: What is your sell discipline?
From the beginning, our plan was to find stocks that we would buy and hold forever. A security would only be considered for sale only if the company’s culture were to break down or the management significantly changed to render our analysis invalid. We rarely reduce our position in a stock just because it’s gotten overpriced. Periodically, we might do a little buying and selling if the company is in a cyclical industry, but quite rarely.
Q: Where does the portfolio fall in the market capitalization range?
We don’t label ourselves as a mid-cap fund, and we have the flexibility to invest across the capitalization range. Everything else being equal, we would rather own a small company than a large company because small companies usually have greater potential for faster growth.
But there are some advantages to larger companies because they have had time to develop their cultures. A perfect situation for us would be to find a small cap that has embraced a qualitative culture and then grows a large cap company.
Q: What drives your portfolio construction process?
We undertake our search process every day looking for great companies that meet our criteria. Only when we have identified the perfect company and the entry conditions are right, do we make a move. When we decide to buy, we try to add as much as possible. Ideally, we would like to maintain the portfolio with between 20 and 40 stocks.
In valuing a company, we conduct a discounted cash flow analysis. Then make a judgment as to the rate at which the company is likely to compound their earnings over time. That provides us with a benchmark in making a decision as to the proper entry point.
We are currently experiencing a fair amount of inflows - particularly given the size of the fund. Our biggest challenge right now is making sure that we allocate those inflows properly. When the price of our great companies falls within a reasonable price, we want to make sure that we get all we can afford to buy at that price. It is really a matter of being very opportunistic and looking for reasonable entry points. We don’t chase a stock after it gets out of our price range.
Q: Is there any limit to position sizes?
In general, we will not add to a position once it has reached 8% to 9% of the portfolio. If a position were to appreciate beyond that point, we might let it increase to 15%, but the decision is really situation dependent.
Q: What types of risk do you focus on?
Every company faces challenging situations from time to time. We believe that the companies we have identified have the ability to overcome those challenges. Herman Miller is a good example. When they recently released quarterly earnings, they announced their success at bringing their products into the home and office market with a different distribution model. They had been trying to do this for 30 years and finally found the right solution.
We think these companies that have the right cultures will eventually find the right solution to any challenges they face. So, our strategy is to stick with them as long as they maintain the right culture.
When they face a challenge and the price of the stock pulls back, it gives us an entry point. The companies that really are risky are the ones that don’t have the management culture. When they run into a challenge, it could be the end. Those are the companies we want to avoid.
