By Allen Kenney
Phocas Financial is a simple, straight-to-the-point business. For example, if you want to get in touch with the company's founder and chief executive officer, Bill Schaff, it isn't too hard. Just call the company's sole office in Alameda, Calif., and you'll be connected to him directly. No personal assistants. No gatekeepers.
Things like advertising and promotions aren't high priorities. No, Schaff and his six-person staff keep their focus pretty narrow. “We have no marketing team. You won't find a brochure in our office,” Schaff says. “All we have are our numbers. You won't find much else going on in our office other than research and portfolio management.”
Mind over Matter
Schaff has more than 20 years of experience managing an assortment of different kinds of equity portfolios and mutual funds for companies, including Janus Equity Group and Bay Isle Financial LLC. Today, Schaff and Phocas co-portfolio manager James Murray run the Phocas Real Estate Fund (PHREX).
A new addition to the mutual fund market, the Phocas fund began trading in September 2006. Since its inception, the fund has lost 4.6 percent during its first 15 months, besting two-and-a-half percentage points. For the 2007 calendar year, the fund had lost 13.5 percent, while the NAREIT Equity Index had fallen by 15.7 percent during the same period.
In total, the fund holds nearly $4 million in assets, 80 percent of which are spread across REITs and other commercial real estate securities. While the fund is designed to hold up to 40 stocks, Murray and Schaff aim to keep that number closer to 25. They invest strictly in domestic companies.
Murray and Schaff contend that keeping their office small actually improves their performance and is a boon for their shareholders. For instance, Murray notes that Phocas fund managers are able to make quick decisions and efficiently alter their positions in the market if needed.
“Unlike the big firms, we don't have to have a weekly investment committee meeting. Committee meetings happen minute-by-minute on a daily basis,” he says.
“The number of bodies doesn't improve your performance. As a small group, we're the ones doing the analysis, making the decisions and implementing them in the portfolio,” Schaff says. “James is literally one office down, and if a decision needs to be made or implemented, it's done quickly.”
Because their priority is investment performance for incumbent clients, Schaff and Murray are adamant that the capacity of their fund remain small. By strictly limiting the maximum amount they will accept in their REIT strategy—including mutual funds and separately managed accounts—to $750 million, they insist that they will preserve their nimbleness and ability to invest in smaller REITs.
Walk It Like You Talk It
The meat-and-potatoes culture at Phocas is clearly evident in the investment style employed by the real estate fund's managers. The financial models that they use have remained basically the same since Schaff started evaluating the REIT market in the early 1980s. When asked about the key part of their approach to picking REIT stocks, Murray and Schaff's answer is immediate: management.
“The fact is, this is not a short-term business,” Schaff says. “You want your core portfolio to be in companies with solid management teams that have long track records, add value over time and have shown sustainable business models.”
Managing a REIT involves a lot more than just constructing buildings, Murray notes. That's why the Phocas Real Estate Fund doesn't invest in initial public offerings, he says.
“When you look at a proven management team, we sincerely mean real estate as well as equity markets. That includes managing expectations,” says Murray, explaining why he and Schaff prefer to hold off on buying new companies. “The management team could be great, and they may know the real estate better than anyone else. But they've never managed a public company and have never dealt with sell-side and buy-side analysts asking, ‘What is your AFFO run rate?'”
So what counts as “good management” in the eyes of Schaff and Murray? The answer, they say, can be found in their fund's portfolio. The fund's largest holdings include major names, such as AvalonBay Communities Inc. (NSYE: AVB),
Boston Properties Inc.
(NYSE: BXP), ProLogis (NYSE: PLD) and Simon Property Group (NYSE: SPG).
“We'll always own REITs such as Simon Property Group or Boston Properties because of these companies' management teams and their history of adding value to shareholders,” Murray says. “We will always own the best of the best.”
“Those who follow through in action and behavior in being shareholder proactive have generally shown the best and most consistent returns over time,” Schaff adds. “Their history shows that they deliver on their commitments.”
Similarly, with the growing changes being foisted upon the marketplace by globalization, Murray and Schaff urge REIT shareholders to trust the judgment of their management teams. For instance, if an acquisition model is what a REIT knows best, the company should probably resist the urge to stray away from a winning strategy.
“As the market is saturated with analysts and followers, the management teams and their companies need to stick to their guns and do what they do best,” Murray says.
“We have patience, and I think that is sorely lacking these days,” Schaff says.
Gardening?
There is one thing that doesn't seem to fit in with Phocas' keep-it-simple approach: the company's unusual name. It's more than just a play on words. Phocas was a Christian martyr during the Roman Empire who is now considered to be the patron saint of gardeners—not quite as venerated as Francis and Jude and Peter. Even after Murray finishes explaining why gardening is actually an apt metaphor for real estate development, it's clear that the obscurity of the reference isn't lost on the pair.
“As cute as we think we are, most people just complain, ‘Why can't you spell it correctly?',” Schaff says with a laugh. “And, no, we didn't hire a marketing person for that.”