Cook & Bynum Fund: An Overlooked Gem

If you just gave Cook & Bynum Fund (symbol COBYX) a quick once-over, you probably wouldn’t even consider investing in it. Since its inception in mid 2009 through July 8, the fund returned an annualized 14.6%. Standard & Poor’s 500-stock index returned an annualized 17.9% over the same period.

Morningstar says the fund charges an annual expense ratio of 1.88%. At first blush, it’s easy to see why the fund has attracted only $116.5 million.End of story? Not if you love to dig into funds. First, that expense ratio. It’s out of date. Expenses are still high at 1.49%, but that’s par for the course in such a small fund.Now look at the three-year Sharpe ratio, a measure of risk-adjusted return. It’s 2.0, which is extremely high for a stock fund. A big reason for that high Sharpe ratio is that the fund has been only about half as volatile as the S&P 500 over the past three years.

Shall we dig a little deeper? Turns out that managers Richard Cook and J. Dowe Bynum, who are based in Birmingham, Ala., have invested money for private clients since 2001. Since then through March 31, their annualized return (after fees) was 9.4% — more than double the S&P’s 4.3%. Not only that, but the returns were achieved with average cash levels of about 25% of assets. The mutual fund currently has 40% of its assets in cash.

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All this sounded so intriguing that I decided I needed to learn more. So I called up Cook. He and Bynum, both 35, have been close friends since they were children and have been fascinated with the stock market since Cook’s father gave his son five shares each of five stocks at age 8. Their fifth-grade teacher enrolled the boys in the high school Stock Market Game, which teaches students about economics and finance in part by giving them hypothetical cash to invest. The precocious Cook and Bynum won the game’s annual national investing contest.

The pair have been investing for a living since college. They manage a total of $275 million, including what’s in the fund. “Picking stocks is what we’re passionate about,” Cook says. The firm has no analysts. A third partner handles everything but the stock picking.This is not your ordinary stock fund. The fund owns just seven stocks — one of the most concentrated portfolios I’ve ever seen. And two-thirds of the stock money is in consumer stocks.

Again, that’s off-putting at first glance. But when you look at the holdings, they’re just what you’d want in a focused fund. The managers have 15% of assets in Microsoft (MSFT), 13% in Wal-Mart Stores (WMT), 11% in Coca-Cola (KO), 7% in Arca Continental and 5% in Berkshire Hathaway’s Class B shares (BRK.B). (Arca is the second-largest Coke bottler in Mexico.) British food retailer Tesco (TSCO) and Procter & Gamble (PG) round out the list of stock holdings, with 5% and 4% of assets, respectively.

/p>All these companies seem solid enough to survive virtually any economic catastrophe and, in my view, sell at relatively modest valuations. They have great brands, boast pristine balance sheets and seem to have sustainable competitive advantages over their rivals.

Cook says he and Bynum prefer high-quality businesses. Before they buy a stock, they project how they think the company will perform over the next 12 to 15 years. “We know our accuracy won’t be very good,” Cook says. “But when you pay 15 times earnings for a stock, you’re implicitly saying you know where a company will be in 15 years.” On average, they own a stock for about four years.

Cook and Bynum haven’t always focused on quality stocks. When they launched their business, they liked small U.S. companies. Until two years ago, when valuations got too rich for them, they owned a lot of emerging-markets stocks, mainly in Mexico.The pair loves to kick the tires. “With Microsoft, that means reading bleeding-edge tech blogs and trying out beta products. With Coke, that means driving across Argentina, looking at how Coke products — and competitors — are displayed in gas stations,” Cook says. Nothing wrong with that.

Cook knows that stock picking can be a humbling business. “It’s important to rub your noses in your mistakes,” he says. “That’s how you learn.”

The 40% cash level, he says, isn’t a product of big-picture forecasting. When he and Bynum look at a company, they buy only if they think they can make 10% annually on it. If a stock doesn’t exceed that hurdle, they don’t buy. They’re not finding much to buy in today’s market.

This fund, in my view, shouldn’t be the main course for anyone’s investments. Sturdy as the holdings are, there are still only seven of them. And there’s only so much cash that I want to pay 1.49% a year to own. Cash was a great asset during many of the firm’s early years, but it has been a huge drag on returns since the stock market bottomed in March 2009. As a low-risk side dish, however, Cook & Bynum Fund has real appeal.

Steven T. Goldberg is an investment adviser in the Washington, D.C. area.