Common Cents Investment Group

1. Common Cents Investment Group March 2, 2009

2. Hedge Funds • Flexible investment funds generally with lower regulation. • Now refers to a wide variety of funds following a number of different investment strategies. • Originally, hedge funds sought to actually build hedge portfolios and use hedging as a means of reducing risk. • Often limited to “accredited” investors, defined by the SEC as a minimum net worth of $1 million or $200,000 in income ($300,000 if married) for the previous two years.

3. Mutual Fund Restrictions • Regulated by the Investment Company Act of 1940. • Allowed to borrow to a specified degree (although few do). • Must file financial reports with the SEC and shareholders at least once semi-annually. • 75% must be invested in securities, with no more than 5% of fund assets in any particular security, and with the fund owning no more than 10% of the outstanding stock of any particular company. • Priced daily and daily liquidity.

4. A Few More Notes on Mutual Funds • Targeted to retail investors. • When one experiences good performance, even if the manager is capable, increasing assets make it harder for managers to generate excess returns. • Many mutual fund managers are compensated based on a percent of net assets. Thus, they would rather have more assets under management than better performance. • Tend to follow convention because they don’t have much to gain by being unconventional, but they have a lot to lose. Examples of this include mutual funds owning the same stocks as other competing funds and mutual funds refusing to own stocks that do not pay dividends or that are priced below $5.

5. Comparison of Hedge Funds to Mutual Funds • Managers have a great degree of flexibility. • More restrictions on putting money in and taking money out can lead to enhanced returns. • Fees on both net assets (usually around 2%) and performance (often 20% of profits). • May have hurdle rates (performance fee applies for returns above those of the S&P 500) • May have high water marks, meaning that the performance fee only applies as the fund hits new highs. • Use leverage more often. Less transparency. • Can take on more risk in an attempt to increase returns.

6. Some Examples of Hedge Fund Investments and Styles • Long/Short • Paired Trades • Merger Arbitrage • Statistical Arbitrage • Quants • Momentum • Computer-Based • Derivatives • Commodities • Relative Value

7. Famous Hedge Funds • Long Term Capital Management – Collapsed in 1998 and shook the financial world. Profiled in Roger Lowenstein’s When Genius Failed. • D.E. Shaw & Co. – New-York based quantitative hedge fund, previously known to account for 5% of the NYSE volume. More recently it has become involved in bankruptcy and private equity investment. Jeff Bezos worked at D.E. Shaw before founding Amazon. • Citadel – Another of the largest hedge funds, based in Chicago. According to the WSJ, it had a pretty tough 2008…

8. Famous Hedge Funds • Soros Fund Management – Founded by George Soros, operates the Quantum Group of funds. Soros is famous for betting against the pound in 1992 and “breaking the bank of England.”

9. Value Hedge Funds • Baupost Group – Managed by Seth Klarman, author of Margin of Safety. • Pabrai Funds – Managed by MohnishPabrai, author of The Dhandho Investor. • Abrams Capital – Managed by David Abrams (who got his start under Klarman above). • Greenlight Capital – Managed by David Einhorn. Also see Greenlight Capital Re.

10. Value Hedge Funds • Gotham Capital – Managed by Joel Greenblatt. • Private Capital Management – Managed by Bruce Sherman, now owned by Legg Mason. Poor performance last year by buying financials. • Okumus Capital – Deep value, but holding period relatively short.

11. Researching Hedge Fund Holdings • Go to sec.gov and search for a particular fund or management company name. • When you get to the list of filings, look for form 13F-HR. • This lists the fund’s holdings at the end of the previous quarter. Filing the form is delayed until about 45 days after the end of the prior quarter.

12. Example: Abrams Capital

13. Value Funds • This can be a good way of getting ideas and also of trying to figure out what kind of value these funds see in particular companies or segments of the market. • It is also interesting to note that many of these funds overlap, that is, they have similar holdings. • Note Abrams Capital position in Mueller Water.

14. An Idea from Baupost (text from VIC) • “SPACsare companies that issue shares to the public with the intention of using the cash raised during the initial public offering combinedwith the equity (stock) currency and debt to execute an acquisition. • The cash raised at the IPO is largely (usually ~97% or more) is held in a trust. • The trust is typically mandated to invest only in short-term government backed securities. • The SPAC has a defined time period to find and execute an acquisition (typically approximately 24 months). • If the SPAC is unable to complete an acquisition in the allotted time, the cash in trust is returned to the common.”

15. SPAC Thesis Continued (text still from VIC) • “The common shares of many SPACs are trading at a discount to the cash in trust. • This discount is implying annualized yields of approximately 8%+ if held to the final liquidation date. • The yields have increased from approximately 5% at the end of August, but are off the 10-12% yields of the October - December period. • Most liquidations are within 6-18 months. • The downside is protected by the cash in trust, usually mandated to be invested in 180-day US gov't notes.”

16. Berkshire Hathaway Holdings(Over $500m Excluding Moody’s and Burlington)

17. Warren Buffett’s Letter to Shareholders • Book value of $70,530, probably declined from the end of last year, but this isn’t too far from the recent share price. • Treasury market bubble. • The economy will likely stay bad for a while, but that does not mean that the stock market will go up or down. • Interesting insurance and derivative conversations. • And more details on Berkshire’s equity put contracts. • Mark to market.

18. Recently on the Forum: Link to Berkshire’s 13-F SEC Filing Reverse Split Going Private Deals (including one that we haven’t talked about and an update on another that we mentioned briefly this fall) New Thread for Oil Discussion Follow-Ups

19. Discussion Follow-Up on Last Week’s Oil Conversation What do you make of the current markets? Are you buying? If so, what?