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Notes From the Front Line: UCLA

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This past Friday, Cove Street Capital was in attendance at the inaugural “UCLA Anderson Investment Association Conference.” For those of you were unable to attend, I put away the 10-Ks, dusted off my laptop and took my note-taking skills out of cold storage so that I could provide my customary summary of the discussion. What follows is an Investor’s Overview of the conference, and then a link to my full-bore set of notes.

— Ben Claremon | Research Analyst

INVESTOR’S OVERVIEW

James Ware | Focus Consulting Group, Founder

  • Author of Higher Performing Investment Teams: How to Achieve Best Practices of Top Firms
  • Recommended that we read Drive by Thomas Pink and Multipliers By Liz Wiseman
  • The 5 things that separate the best investment management firms from the rest of the pack are:
    • Compensation practices
    • Teamwork
    • Trust
    • Debate
    • Appreciation
  • Suggested that to prevent what he calls “sludge” from building up in an organization, people need to move from the circle of entitlement to the circle of appreciation
  • Many investment management firms have what James calls “Red X’s,” or high performers who do not fit in with culture
    • These people need to be managed carefully because they can impact the satisfaction of others
  • Suggested that the best way to avoid compensation issues is for managers to get everyone at the firm to make a recommendation of how the bonus pool should be split up
    • Then the management team should take that into consideration when allocating bonuses
    • Good compensation schemes are simple, transparent and fair

Chris Brightman | Research Affiliates, Director + Head of Investment Management

  • Explained the difference between cap-weighted indexes and fundamental indexes and suggested that fundamental indexes have the potential to outperform cap-weighted indexes by 2-3% per year just through formula-based security selection
  • Explained the benefits of selling winners and buying losers when re-balancing funds
    • Told us to buy banks and sell Apple (Ticker: AAPL)
    • Also told us to sell Japanese bonds yielding 1% and buy Australian bonds yielding 4%
  • Suggested that with the current dividend yield on the S&P 500, we should not expect that index to return better than 4.5% per year
    • Said that pension funds and endowments with 8.5% return targets will not reach them

Dave Carpenter | Capital Group, Investment Analyst

  • Believes that markets are inefficient and that volatility is the friend of active investors
  • Warned people to be careful not to sell their winners too fast
    • Try not to cut your flowers (your winning stocks) and water your weeds (your laggards)
  • Believes that global austerity is deflationary and that we will be in a five year muddle through period in developed market economies
  • Believes that we are in the decade of the dividend but that the dividend offered by utilities are not attractive
    • He would rather have exposure to more cyclical companies such as Dow Chemical (Ticker: DOW) and General Electric (Ticker: GE) that also pay dividends

George Letteney | UCLA Investment Company, Interim President + Chief Investment Officer

  • Said that UCLA’s endowment has moved from active investing to almost all passive investing
  • Mentioned that the endowment is now overweight in stocks: a 30% allocation versus the 20% target
    • Likes US large cap and emerging market stocks
    • Correspondingly the endowment has a low allocation to bonds
  • Suggested that the return target for the fund is 8-8.5%
    • Given the low rate environment, it has pushed the endowment much more into alternative asset classes such as hedge funds and private equity funds
  • The endowment’s single largest position is the PIMCO Fundamental Index Plus Total Return fund
    • Has delivered 1500 basis points of outperformance over the last 3 years

Steven Romick | FPA Funds, Managing Partner

  • Said he wakes up every day looking for bad news
    • He is looking for forced sellers in the market as opposed to natural sellers
  • Suggested that returns are driven by what you own and what you don’t own
    • Not owning financials over the last few years has really helped FPA’s performance
  • FPA is currently buying farmland and subprime loans
    • He is also finding attractive opportunities such as providing loans to commercial real estate developers at 11% yields
    • The Crescent Fund still holds a lot of cash due to the lack of opportunities out there right now
  • Thinks that right now you need to buy assets at a price that reflects a significant margin of safety
  • He does not own gold because he does not know how to value it
    • Said that he believes the US dollar will go down over time but warned us not to think it will happen in a straight line
      • This is why FPA likes producing assets such as farmland
  • He is hoping for more opportunities to deploy cash in the years to come

Jonathan Sokoloff | Leonard Green & Partners, Managing Partner

  • Presented data indicating that Leonard Green’s compounded return over the last 20 years was 37%
    • Promised us that this would not be replicated in the future
  • Suggested that the difference between the private equity and public equity models is that his firm never has to worry about redemptions or quarterly earnings
    • His investors also have a much longer investment time horizon
  • His firm looks to identify the market leader in certain retail spaces and attempt to take it private
    • If that is not an option, the firm is willing to take minority stakes
  • Leonard Green is a hands-off partner that does not spend time second guessing the management teams of the companies
    • Have more of a Buffett-like model when it comes to establishing a partnership
  • Said that the weekly data he receives from the portfolio companies suggests that the US consumer is strained that people are still spending
  • Suggested that internet retailers are putting pressure on some of Leonard Green’s brick and mortar retailers
    • Accordingly, it is very important for all of the companies to have a digital presence

Howard Marks | Oaktree Capital Management, Chairman

  • Presentation was called The Human Side of Investing
  • Said that you need three legs under your stool to be a good investor:
    • Financial analysis
    • Finance theory
    • The human side
  • Categorized asset markets as a pendulum that constantly swings between greed and fear
    • However, the pendulum rarely spends any time directly in the middle and investors must take the temperature of the market when making decisions
    • Howard believes that today the pendulum is not at either extreme and thus Oaktree is moving forward, cautiously
  • Discussed the three stages of both bull and bear markets and suggested that you buy when others think the world will never get better and sell when others think the world can only get better
  • Suggested that we all read Nassim Taleb’s books The Black Swan and Fooled by Randomness
  • Talked about the “I Know” and the “I Don’t Know” schools
    • The people in the “I Don’t Know” school who can admit that they can’t predict the future are less prone to overconfidence and are more likely to be successful investors

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