Idea Brunch with Ryan O'Connor of Crossroads Capital
Welcome to Sunday’s Idea Brunch, your interview series with great off-the-beaten-path investors. We are very excited to interview Ryan O'Connor!
Ryan is currently the chief investment officer of Crossroads Capital, a Kansas City-based long/short fund he founded in 2016. Before launching Crossroads, Ryan worked as an analyst at several value-centric investment partnerships and was an options trader on the Chicago Mercantile Exchange. Over the last five years, Crossroads has compounded at 14.7% annualized net of fees, outperforming both the S&P 500 and Russell Small Value and Microcap Indices.
Editor’s note: Sunday’s Idea Brunch is looking for new guests! If you know of a great, off-the-beaten-path investor we should interview, please email us at edwin@585research.com or hit reply.
Ryan, thanks for doing Sunday’s Idea Brunch! Can you please tell readers a little more about your background? I believe some of your relatives were early investors in the original Buffett Partnership back in the 1950s and 1960s. What’s the backstory there, and how has the Buffett Partnership influenced your investment approach?
Thank you for having me on Sunday's Idea Brunch! I'm happy to share more about my background and the origins of Crossroads Capital. The story starts at a personal level, and my journey into value investing began with my grandfather, Bill O'Connor. He was an IBM salesman in Omaha who happened to befriend a slightly younger Warren Buffett after selling him his first typewriter. But the lightbulb really went off after he decided to take some classes taught by Buffett at the University of Nebraska's Omaha campus, which sparked his passion for value investing writ large. Safe to say, he was captivated by concepts like margin of safety, compound interest, and contrarian thinking.
In any case, in the late 1950s my grandfather became an early investor in Buffett's original partnership. He actually had to sell his IBM stock (then considered the bluest of blue chips) to meet the $25,000 minimum investment, which was a bold and unconventional move at the time. At the time, as family lore goes, my grandmother wept when my grandfather basically put their entire life savings with a man she originally knew as “Bill’s Poker Buddy”. Hah. This decision to invest with the then-unknown Buffett ended up being transformational for my family in a way that’s simply never left me. All of which is to say that growing up, I was fortunate to learn investing lessons directly from my grandfather. He instilled in me the principles he had learned from Buffett, starting with simple concepts and progressing to more advanced topics over time. This early education laid the foundation for my passion for value investing, and the Buffett Partnerships have profoundly influenced Crossroads Capital's approach from the bottom up. In our ongoing quest to redefine value investing for the modern era, we've modeled many aspects of our fund after Buffett's early partnerships that are still advantages today, including:
A concentrated portfolio of best ideas rather than over-diversification
A flexible, go-anywhere mandate without arbitrary restrictions that leaves us free to pursue opportunities across market caps, sectors, and geographies. This adaptability has been crucial to the fund's success, enabling it to capitalize on mispriced securities wherever they may be found.
A focus on attracting and cultivating a group of long-term-oriented investors that don’t obsess over short-term results and who understand and support our approach, allowing for a truly long-term investment horizon.
Alignment of interests through performance-based fees and investing our own capital alongside limited partners
Emphasis on generating strong absolute returns while protecting capital during downturns
I could go on, but launching Crossroads Capital was a natural extension of this background. I saw an opportunity to apply the timeless principles of value investing in today's market, particularly in the small and mid-cap space where we can still find significant inefficiencies. And to be clear, we have developed our own flavor of “value investing” which I’m sure we’ll get into. But nevertheless, our goal is to generate superior long-term returns for our partners by focusing on deeply undervalued, high-quality businesses and catalyst-driven “special situations.” Moreover, by staying small and nimble, we aim to replicate some of the advantages Buffett had in his early partnership days. We believe this approach gives us the best chance to compound capital at high rates over the long run, just as the original Buffett Partnership did for early investors like my grandfather. Happy to elaborate on the strategy, as there’s more to say there than just the 50k view.
And to be clear, I’m no Warren Buffett, but Crossroads Capital does represent a modern adaptation of Buffett's early partnership model, combining value investing principles with tactical opportunism to provide families like my own with a compelling option for long-term outperformance in the small and mid-cap space. As the fund enters its next phase of growth, it remains committed to its founding principles and optimistic about future opportunities to compound capital for its partners. So far so good, but I can speak for all of us at Crossroads when I say that we firmly believe the best is yet to come.
From your investor letters, it seems like you prefer small-caps and special situations with catalysts. Can you tell us more about your strategy and approach to markets and portfolio construction?
So, while we say value investing, our strategy is really a fusion of what we might call value investing in growth companies coupled with opportunistic special situations, where there are market-agnostic value-unlocking changes occurring. We typically bucket our investments into two: “compounders” with long time horizons and special sits with short time horizons. The two categories typically offset each other over time in the portfolio, where short-term catalysts occur regardless of market conditions, and our concentrated long-term holdings do what they do but are more subject to market moves.
However, our best investments have been both at the same or different points in time. Essentially, we love to find a long-term growth company undergoing value-unlocking change. And because of that element of uncertainty inherent in the business transformation, once we understand it and underwrite it, we can invest in the company at a valuation that would appeal to a traditional value guy. As an aside, we really like an idea when a traditional value guy doesn’t “get” the business model and won’t touch it even when it’s “cheap.” How you define cheap is important to our strategy, which I’ll get to.
Our primary hunting grounds are small and mid-caps, and we focus on that area of the market for all the reasons every other small-cap manager says. We’d largely agree it’s an inefficient part of the market, but the key to our strategy is recognizing that the small-cap company they all think is a bargain will probably stay a bargain if it doesn’t bring something special to the table with a catalyst; recognition of inefficiency isn’t enough—we want to have a very good idea of not only what should make our investment “work,” but specifically when. If there’s nothing really going on at the company and the thesis really boils down to “it’s like XYZ but smaller and cheaper,” you’re just trading with other like-minded investors who found it later than you.
The catalysts we are looking for are ones that are transformative to the underlying business and are of greater economic potential than past financials would imply. The change in prospects (and earnings) forces a wider group of investors to investigate the name, some buying ahead of solid proof points to the thesis. And if the company comes through on its transformation, many more invest thereafter, and we’re happy holding our position for years, riding the fundamental and technical tailwinds we’ve identified in lockstep.
Now how do we define opportunity? That’s always a hard one to articulate, but I would say we see an opportunity when we can wrap our arms around a qualitative insight that has a high probability of occurring and flowing through a company’s financials in the next 6-12 months. We get bonus points when those financials come through that then validate our variant view, and the company can execute with substantive growth for years. With our way of doing things, we’ve found this framework does well across market caps, and we go where we see similar fact patterns line up.
We are also laser-focused on behavioral and qualitative insights. Nothing in a typical screen is helpful to our research process. Quants can have that game. Markets are forward-looking, and we should be too. There is no such thing as a future fact; once something is in the financials, it’s a fact (excluding fraud). We look for businesses where the past isn’t like the future. Our philosophy is marrying qualitative insights with a view towards the business’ economic future and a corresponding mis-weighting of the odds in its success/failure in the equity.
The goal is simply to acquire these investments at unsustainably cheap multiples to highly predictable normalized earnings a few years out. If our valuation and business quality work proves out, these setups tend to work out very well in the fullness of time. Anyhow, we get the muscle memory for these qualitative insights by being intensely curious about businesses in general, but we also have a research archive that’s been built upon since 2005 with materials and notes on hundreds of companies. I have notes from researching and meeting with Brookfield from 2005 that I refuse to get rid of even though they’re now photocopied and stored digitally. Also, we prefer being more like investigative reporters, or intelligence analysts, as my Director of Research, Daniel Prather, likes to say (speaking of familial roots influencing your investing style, Daniel’s grandparents were spies for the British during WW2 and he’s got some wild stories). But a key element to what we do is develop networks on the ground and dig intensely for information to build a mosaic that is outside expert networks. Expert networks are really table stakes these days, so you must do more. It’s a tried-and-true method that worked for Buffett back in the day too. Our concentrated portfolio of long-time horizon investments demands it.
Unlike a lot of emerging small-cap focused investors, you are also active on the short side. Why?
The way we see it is this: we want to spend almost all our time researching current and new investments; that’s what we’re best at, but even the best people in this business are wrong half the time. Anyone who tells you otherwise is selling you a fairytale. So, by extension, you’d think half our precious time going into research then goes to waste, but if you are rigorous in exiting losing positions and can invert the research process, you can take your mistakes and turn them into opportunities. It takes humility to recognize when you’re wrong, and rather than kicking ourselves thinking we’re smarter than everyone, we instead stick to our goal, which is to make money from mispriced bets. That ultimately cuts both ways, long and short.
We’ve had several instances where we just said, “ok this long thesis is wrong, but if this part of our thesis is broken that means x, y, and z are worth XX% below the market price. Instead of ditching the position, let's go the other way.”
At the portfolio level, being short anywhere from 5% to 25% of the fund is dependent on the opportunities in front of us, and flexibility is key to our strategy. Additionally, monetizing shorts at critical times allows us to have cash to deploy to longs when a downturn hits or some random event like DeepSeek spooks everyone.