graham and doddsville - issue 7 - fall 2009

8/2/2019 Graham and Doddsville - Issue 7 - Fall 2009

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I had a summer job in theinvestment research depart-ment at First National CityBank (now Citibank) in 1968.

When I was getting out ofgrad school, I had no ideawhat I wanted to do, so Iinterviewed with one large

(Continued on page 2)

Howard Marks is co-

founder and Chairman of

Oaktree Capital Manage-

ment. Founded in 1995,

Oaktree manages over

$60 billion of investments

in a variety of less effi-

cient arenas, including

High Yield Debt, Dis-tressed Debt, and Private

Equity, among other as-

set classes. Oaktrees

excellent long-term track

record and Mr. Marks

unique investment phi-

losophy have resulted in

a loyal following of in-

vestment professionals.

Since starting his career

in 1969, Mr. Marks has

seen a range of ups and

downs in the financialmarkets, from the

growth of the high yield

bond market to the cur-

rent leverage meltdown.

G&D: Can you tell us aboutyour early career and whatgot you interested in invest-

ing?

HM: Well, Im not one ofthose guys who started buy-ing stocks at the age of six.

The key is that unlike therest of the guys you talk towho liked investing all oftheir lives, I did not. It wassomething I discovered late.My dad was an accountant. Iwent to Wharton andplanned on majoring in Ac-counting, but I got moreinterested in Finance andchanged majors. In thosedays we went straight tograd school, so I went to the

University of Chicago whereI did major in Accounting tocompliment my degree in

Finance.

Do an Excellent Job at a Few Things Howard Marks

Welcome Back to Graham & Doddsville

As we enter our fourth year,we are pleased to presentyou with the seventh issue ofGraham & Doddsville, Colum-

bia Business Schools student-led investment newsletterco-sponsored by the Heil-brunn Center for Graham &Dodd Investing and the Co-lumbia Investment Manage-

ment Association.

This edition features an in-terview with Howard Marks,the founder and Chairman of

Oaktree Capital Manage-ment. His client memoshave become must-reads fortheir insightful thoughts andentertaining commentary.We are privileged to havehim share his investment

philosophy with us.

Dave Samra 93, a CBS alumand portfolio manager forArtisan Partners Interna-tional Value and Global Valuefunds, provides some uniqueinsights into his investment

philosophy. Mr. Samra andhis co-Portfolio ManagerDaniel OKeefe were named2008 International-StockFund Manager of the Year by

Morningstar .

Finally, we interview KevinDreyer 05, a recent alum ofthe Applied Value InvestingProgram to gain the insightof a recent alumni whosecareer has spanned a veryinteresting time in financial


Fall 2009Issue VII

Editors:

Matthew MartinekMBA 2010

Clayton WilliamsMBA2010

James DunavantMBA2011

Garrett JonesMBA 2011

Dan KaskawitsMBA 2011

Inside this issue:

Amedysis HomeHealth Svc. Stock

Analysis

p. 12

Care Investment

Trust Stock Analysisp. 14

Dave Samra

Artisan Partners

p. 16

Kevin DreyerGAMCO AssetManagement

p. 22

Howard Marks, Portfolio

Manager - Oaktree Capital

Contact us at:[email protected]

Visit us at:www.grahamanddodd.com

www0.gsb.columbia.edu/students/

organizations/cima/

Graham & DoddsvilleAn investment newsletter from the students of Columbia Business School


2/29

markets. Kevin provides aninteresting perspective for

investors and students alike.Along with providing ourreaders with insightful inter-views, we also aim to offerspecific investment ideasthat are relevant today.Inside are two student in-vestment recommendations,Amedisys (AMED) and Care

Investment Trust (CRE).

Please feel free to contactus if you have comments or

ideas about the newsletter,as we continue to refine thispublication for future edi-

tions. Enjoy!

(Continued from page 1)

Welcome to Graham & Doddsville (continued from page 1)

Howard Marks (continued from page 1)

took place during this pe-riod. Citibank was a growthinvesting shop and practicedwhat was called nifty-fifty

investing. As a result, eve-ryone who was in the non-growth areas oil and gas,basic materials and so forth

kind of slipped away, andby the time the embargohappened, we had no en-ergy analyst, forest productsanalyst, chemicals analyst,metals analyst, etc. So I wasasked to put together en-ergy and basic industry re-search groups, and it was

great to study the cyclicalbusinesses to compliment

the growth research.

In 1975 I became director ofresearch and that was a jobthat I sorely disliked. I wasa 29 year old guy with what

were considered major re-sponsibilities for bothbudget and people, and itwas my job to know two

sentences on three hundredcompanies which I foundvery unsatisfying. It was aperiod in which I would saythat I was disaffected. Oneof the great challenges ininvesting is captured in thesaying that an analyst issomeone who knows agreat deal about a fewthings and learns more andmore about less and lessuntil he knows everything

about nothing. And a port-folio manager knows a littlebit about a lot of things andlearns less and less aboutmore and more until heknows nothing about every-thing. That is a dilemma,


management consultant, onesmall management consult-ant, one investment bank,

one public accounting firm,one corporate treasury op-eration, one investmentmanager, and in the end, Iended up going back to Citi-bank because it had been a

good experience.

So I started off 40 years agoin September of 1969 as anequity analyst following con-glomerates and office equip-ment other than computers,

which meant mostly copiersand facsimile. I did invest-ment research from 1969until 1975 when I becamedirector of research. Oneof the things that reallyadded to my experiencewas the oil embargo that


Page 2

Seth Klarman, David Abrams, and Howard Marks at the 2008

Security Analysis 75th anniversary symposium.


3/29

able and know it better

than others do.

High yield bonds have givenme the best possible seatfor observing what tookplace in finance over the last

31 years.

G&D: Why do you say

that?

HM: Everything interestinghas taken place via the highyield bond market buy-outs, recaps, and leverage.The private equity industryhas had a very significanteffect on altering the finan-

cial landscape. For all ofthese things, the high yieldbond market gave you a

front row seat.

In 1980 I asked the bank tomove me out to Californiabecause I didnt like NewYork anymore. I said tomyself, Ill have a great

The single

most important

adage in the

investment

world is what

the wise man

does in the

beginning, the

fool does in the

end.

Page 3Volume III, Issue 1


quality of life, but there goesmy career. However, it is

very important to be doingwhat you like in circum-stances that you like if youcan arrange it. I stayed withCiti until 1985, and then Iwas hired by Trust Com-pany of the West (TCW) tobuild their high yield bonddepartment. In 1987 mypartner Sheldon Stone and Idecided to start a fund fordistressed debt, and thatswhen I joined up with Bruce

Karsh.

It helps to be early. I thinkboth our high yield bondfund at Citi in 1978 and ourdistressed debt fund atTCW in 1988 were the firstfunds of their kind to beoffered by mainstream finan-cial institutions. The singlemost important adage in theinvestment world is whatthe wise man does in thebeginning, the fool does in

the end. I dont know howwise it was maybe itshould be what the luckyman does in the beginning,the fool does in the end.But by the time all the fools

jump on a trend and take itto excess, it is a disaster. Ileft TCW in 1995 with theMDs who reported to meand we started Oaktree.

The rest is recent history.

G&D: When did you readSecurity Analysis?

HM: While at Wharton, Itook an undergraduatecourse in investments in1965, when there was notalk about CAPM or effi-cient markets or any of that


and I was very unhappy

knowing a little about a lot.We had a new chief invest-ment officer join in 1977,Peter Vermilye. Since wehad been practicing nifty-fifty in a terrible environ-ment for it, our perform-ance was terrible, so thewhole existing team de-served to be sacked. I wasvery fortunate that he askedme to start up a portfolio ofconvertible bonds, which Idid on August 1, 1978.Then a couple of monthslater Peter came to me andsaid, there is some guynamed Milken or somethingout in California and heworks with junk bonds whatever that is and canyou figure out what that isbecause one of our clientsasked for a junk bond port-

folio.

So I started managing both

high yield and convertibleportfolios. I went from hav-ing these big organizationalresponsibilities to just beingme at a desk, knowing all Icould about some narrowmarket niches, and I wasecstatic. In our business,success is a relative game. Ifyou know X and everybodyelse knows X, then youhavent succeeded becauseyou dont have an advan-

tage. The key to success inour business is beating theother people. To do this,you have to know morethan the other people. Thesmaller the arena you try toknow about, the more it ispossible to know more thanthe next person. So ourmotto is know the know-



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Page 4


write about it, I was pleasedto find that my recollection

was erroneous.

G&D: You have mentionedin your memos that thenumber one priority atOaktree is to avoid losses.Can you talk a little bitabout the role of risk man-agement in your processand how you think about

risk?

HM: I wouldnt say preventlosses. I would say controlrisk. The two are different.You can make sure that younever have a loss in a bondportfolio by buying Treasur-ies. What we want to prac-tice is the intelligent bearingof risk for profit not theavoidance of risk. Investingdeals with the future. Deal-ing with the future means

dealing with risk.

What does risk mean? Im

not talking about standarddeviation or volatility. PeterBernstein once said thatrisk means more things canhappen than will happen.That is the way to thinkabout risk. There is a rangeof possible outcomes.What does that range looklike? What is the breadth ofit? How many of the poten-tial outcomes are positive?How many are negative? Is

it a narrow or wide distribu-tion? How many outcomesare in the middle, and howmany are in the tails? Theseare the things that an analystor portfolio manager should

think about.

The other question is what

is your attitude toward tak-ing risk (and what is the

attitude of your clients)?Are you a high-risk, high-return manager or a low-risk, low-return manager?And if you think you can bea low-risk, high-return man-ager - Good luck! It is nothard to have a beta of 0.5and return half of what theindex does, or a beta of 1.5and return 150% of whatthe index does. The chal-lenge is to have a returnthat is more than commen-surate with your beta. Thedifference is alpha, and ifyou produce it consistently,then that is the mark of atrue professional: producingreturn that is more thancommensurate with risk. It

is hard to do.

So we are not a low-riskinvestor. It is easy to saylow risk. It only takestwo words. It takes a lot

more words to say riskless than commensuratewith our return, but that is

our objective.

G&D: It seems that mostinvestors focus more on thereturn side of the equationthan on risk, whereas youtake the opposite perspec-

tive.

HM: That is important, and

that is one of the reasonswe are still around. Sun Tzusaid if you sit by the riverlong enough, youll see thebodies of your enemies floatby. The key is longenough. If you live longenough, you have to be the


stuff. You learned security

analysis. They held up apiece of paper and said,this is a security certifi-cate and they held up apicture and said, this is thestock exchange. And if youwant to buy this, you callover there. It was verynuts and bolts, like being intrade school. This is anincome statement and this isa balance sheet. You takethis number and you multi-ply it by six and divide it bythat very real world andnon-theoretical. So yes,Graham & Dodd was re-quired reading in my first

investments course.

G&D: Did it have any im-pact on your investment

philosophy or discipline?

HM: I would say, not in itsspecifics. Remember, I readit in 1965 and started man-

aging money in 1978. Thatsa lot of water under thebridge, and I forgot a lot ofthe specifics. Have you readmy chapter in the new edi-

tion?

G&D: Yes

HM: The main thing I re-membered about Grahamand Dodd was the feelingthat there were too many

absolute rules. Do this. Dothat. Multiply by three.Divide by six. Dont buy ifthe ratio exceeds 1.7x. I aman enemy of generalizationsand constants. As I men-tioned in my commentary,however, when I re-readthe book in preparing to


What we want to

practice is the

intelligent bearing

of risk for profit

not the avoidance

of risk.


5/29


Columbia Business School is

a leading resource for invest-

ment management profession-

als and the only Ivy League

business school in New York

City. The School, where value

investing originated, is consis-tently ranked among the top

programs for finance in the

world.


opinion like operating with-out a net. You can do it

spectacularly . . . for a littlewhile. Theres an old sayingin the business There areold investors, and there arebold investors, but there areno old, bold investors. It isvery simplistic, but I think

that its true.

Back in the days when wewere trying to get businessin US high yield bonds,which we largely stoppeddoing in 1998, we used tocompete in dog-and-ponyshows that the consultantswould run. Consultantswould bring in ten high yieldmanagers and they wouldcome to us afterwards andsay, Howard, you got the

job of being the core man-ager the steady-Eddie, thedull guy and youre getting$50 million. Bob and Carolare each getting $25 millionand they are the satellite

managers. Their job is tohave more aggressive port-folios and juice up the re-turn. I cant tell you howmany times those peopledisappeared. To have the

job of being a high-risk man-

ager is risky business.

G&D: On your website youcontrast inefficient marketswhere Oaktree operateswith so-called efficient mar-

kets where it is hard to gainan advantage. Why doesOaktree not do more withpublic equities, and do youbelieve that public equity

markets are efficient?

HM: There are no marketsthat are perfectly efficient,and there are no markets

that are completely ineffi-cient. It is all a matter of

degree, but I do think thatthe public stock market isgenerally more efficient especially as you get intothe larger stocks. It is cer-tainly more efficient thanother markets. We are notin public stocks and we arenot in high grade bonds. Ifyou go back 30 or 40 yearsago, saying that you were aninvestor meant that youbought high grade bondsand stocks. These are thethings that people have beenvery comfortable doing forthe last hundred years. Inef-ficiency largely comes fromthe fact that people dontknow about a market, dontunderstand it, dont havethe relevant information,arent comfortable with it,or have some kind of preju-dice against it. These arethe factors that create ineffi-ciency. Youre less likely to

find that in the mainstream

markets stocks and bonds.

G&D: I think that a lot ofvalue investors would saythat their key advantage istheir time horizon. Theyplay a so-called time horizonarbitrage by being willing tolook a little further downthe road and wait. That iscertainly something Oaktree

does as well.

HM: I think that is true, andone of these days we couldconclude that being a long-term value investor in mid-cap or small-cap stocks isconsistent with our philoso-phy. It is not impossible.Up to now though, weve


survivor. When I was a kid,

we didnt have the videogames you have today, sowe used to listen to comedyrecords. One of the great-est ones was Mel Brooksdoing the 2000 year oldman. Carl Reiner says tohim, how did you get to bethe worlds oldest man?And he says, Simple. Dontdie. How do you get to bethe worlds oldest investor?The answer is dont crap

out.

So if you look at distresseddebt where we started in1988, I could tell you whoour number one competitorwas in every year through1995 and not one is a maincompetitor today. And itsnot because of what we did;all we did is perform consis-tently. They crapped out.It sounds simplistic to say,but the first requirement for

success is survival. And Ithink the best way to en-sure your survival is to putan emphasis on risk control

not on achieving high re-turns. Controlling risk isour number-one goal, and Ibelieve if more people hadthat as their number-onegoal, we wouldnt have ex-perienced the crisis of thelast two years. People for-got about risk control and

risk aversion, and they em-phasized return maximiza-tion. Return maximizationand ensuring investmentsurvival are mutually exclu-sive. That is very important

to bear in mind.

Being a high-risk, high-return investor is in my


Theres an old

saying in thebusiness There

are old investors,

and there are bold

investors, but there

are no old, bold

investors.


6/29

Page 6


thats fine. Thats a legiti-mate point. On the onehand, there can be return

from reallocating capital.We understand that somepeople are interested inpursuing that. On the otherhand, we think theres meritin setting up individual pools

of capital so that the clients

know what they are goingto get and managers dontchange the composition ofthe portfolio without theclients knowledge and whenthe client doesnt want it to

change.

Our approach also lets thepeople who work in differ-

ent areas know how muchcapital they have. Howwould you like to be in the

leveraged loan departmentat a fund and all of a suddenthe manager says, Im notgoing to own any loans forthe next two years, so havea nice life. Or, you cancontinue doing your analy-sis, but regardless of whatyou suggest, Im not goingto buy any of it because Ithink MBS is cheaper. Atour firm, each team has itscapital. They know what

their capital is. They donthave to fight for capital. Allthey have to do is optimizethe investment of that capi-tal. Neither approach isright or wrong in my opin-ion. Theyre two differentbut potentially valid ap-

proaches.

G&D: Switching gears alittle bit: You have said inthe past that the third and

last stage of a bear market iswhen everyone believes thatthings are only going to getworse. Do you think thatweve had that point and

that it happened in March?

HM: When you say March,you are talking about thestock market, which is notmy main area of operation.I equate the final stage ofthe bear market with the

fourth quarter of 2008,when most people thoughtthat the world was going toend and the credit marketsbottomed. If company XYZhad been bought by a buy-out firm one or two yearsearlier at $10 billion, youcould buy a senior claim on


had a lot to chew on in themarkets we are in. Every-

thing we do is pretty muchrelated to credit, and wevegotten pretty good at that.I dont know that wevemilked all of the opportuni-ties with that. It is not im-portant to do everything. Inthe investment managementbusiness, there are twokinds of people: investmentmanagers and asset gather-ers. We dont want to bethe latter. The latter have

an emphasis on doing every-thing and getting every dol-lar that is available for it.Point one under our busi-ness philosophy is excel-lence in investing, and wedrather do an excellent job ata few things than try to

cover everything.

G&D: You offer special-ized, niche products andallow the client to handle

portfolio weightings andallocation. Many investorslike the flexibility of movingto the markets where theopportunities are the best.How do you think about

that?

HM: That is certainly avalid discussion point. I canthink of one investor in par-ticular that said, we arentgoing with you because you

have these separate poolsand we have to decide on afixed allocation betweenthem. That is too rigid forus because you wont movefrom A to B if B getscheaper. We like Bob overthere; he can do A, B, and Cand hell move the moneyaround and so forth. I say


In the

investment

management

business, there

are two kinds of

people:

investment

managers and

asset gatherers.

We dont want to

be the latter.

Howard Marks at the Secu-rity Analysis 75th Anniver-

sary Symposium.


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Page 7Volume I, Issue 2

Howard Marks (continued from page 6)saying it today . . . and the

markets continue upward.We have macro opinions,but we dont base our ac-tions on the assumptionthat they are correct. Sowe havent been selling orrefusing to buy in the lastfour or five months. Weve

just been increasing our

level of scrutiny.

G&D: Given the rebound inthe markets, are you seeingany investment opportuni-

ties?

HM: I dont think that thereare great opportunities, interms of whole assetclasses. You can find greatindividual opportunities, butnot the opportunities yousee in phase 3 of a bearmarket. We have alreadypassed that between Sep-tember 15 and December15 of last year in the world

of credit.

G&D: During that time,there were lots of disloca-tions in financial institutions.That must have createdsome interesting investmentopportunities. Were youable to capitalize on whatwas going on in financialsgiven your historical exper-

tise in more industrial areas?

HM: We remain fairly aller-gic to financials because

financials are very, very hardto analyze compared toindustrials. Under the con-ditions of the fourth quar-ter, most financial institu-tions existed largely at thepleasure of the government.The ones that they decidedto support survived and arenow doing better, and the

ones that they decided notto support went bankruptor were bought out at low

prices.

It is very hard to analyzefinancials. They just donthave analyzability. Earlierthis year, there was an arti-cle in the New York TimesSunday Magazine sectionabout the last weekend ofLehman Brothers. Bank ofAmerica and Barclays werethe two primary candidatesto buy it. They took a lookat it and saw there were

two million interest rateswaps. How long would ittake you to figure out thenet exposure of two millioninterest rate swaps, forget-ting about all of the otherderivative positions they hadon the books? In total theycould be very strongly bull-ish on rates, very stronglybearish on rates, or neutral,but you would have to ana-lyze them all to know which

was the case. That is a her-culean task if you are insideand have access to the data.If you are on the outside,then how can you ever fig-ure it out? That is just oneexample from one part of

the balance sheet.

We generally consider theanalysis of financials incom-patible with our approachto investing. What is a fi-

nancial institution? Numberone, it is opaque. Numbertwo, it borrows short tolend long. Number three, itis subject to a run on thebank. Number four, it is inthe risk assumption busi-ness. How do you makemoney doing financing? You


it through the first-lien bankdebt for $2 or $3 billiondollars in November of2008. That was a bear mar-ket blow-off. The funda-mental outlook was terrible.The psychology was miser-able. The technicals werehorrible, because there wasa lot of forced selling fromhedge funds getting redemp-tions and CLOs getting mar-gin calls. That is the kind ofbuying opportunity thatevery value investor dreamsof: people assuming that the

outlook was terrible andcould only get worse for-

ever.

G&D: Do you think thependulum has swung too far

in the other direction now?

HM: Well, that is my per-sonal view. The reason wegot into this crisis was thatup until the middle of 2007,everything was priced for

perfection. Then of courseby the end of 2008, it gotpriced for the end of theworld which so far hasnthappened. Now it isntpriced for perfection, but itis priced for prosperity.Everybody is comfortableassuming that there will be arecovery and it will be avigorous, normal recovery.When the expectations thatare factored into prices are

overwhelmingly sanguine, asI think they are today, thenthe risk is on the side ofpaying too much. Anotherimportant investment adageis Being too far ahead ofyour time is indistinguish-able from being wrong.We started saying thisaround April and we are still



We remain fairly

allergic to financials

because financials

are very, very hard

to analyze

compared to

industrials.


8/29

Page 8


dont kill people; peopleusing guns kill people. Lev-

erage kills people if usedwrongly. Leverage does notimprove investments. Itonly magnifies gains andlosses. So when people getsilly and think leverage is agood thing and forget to berisk averse, they take ontoo much leverage. Whenyou take on too much lev-erage and things go bad,

then it can be a disaster.

I mentioned two adagesearlier what the wiseman does in the beginning,the fool does in the end,and being too far ahead ofyour time is indistinguish-able from being wrong.Well, the third importantadage is never forget theman who was six feet tallwho drowned crossing thestream that was five feetdeep on average. It is notsufficient in the investment

world, or any other world,to survive on average.You have to get through thelow points and the bad days.What leverage does is thatit reduces your ability tosurvive the bad day. So youhave to realize that using

leverage is a tradeoff.

Its interesting if you thinkabout it. As investors, weonly enter into investments

that have positive expectedreturns, right? If somethinghas a positive expected re-turn and you add leverage,then the expected returnwill be even higher. This isthe trap. All of these thingsare very simple. This is nota complex business. People

say, I expect 15%, and if Idouble up by borrowing at

5% and investing at 15%,then Ill get 25%. But theyforget that part of theirprobability distribution con-sists of losses, and leveragewill more than double thelosses. This is why peoplemust remember that maxi-mizing returns and ensuringinvestment survival are in-

compatible.

I think another importantlesson that has been under-stood at Oaktree for a longtime is that the key to in-vesting is not the art calledportfolio management. Thekey is risk management.You cant just buy some USand some foreign, somelarge and some small, andsome industrial and somefinancial and then thinkyoure safe. You cant be sosimplistic. You have tothoroughly understand the

risks in the portfolio.

G&D: Some say that onething that the US needs todo is to reduce consump-tion both at the individualand governmental level andincrease savings. However,it seems that much of whatthe government has done sofar has been to avoid thatadjustment by spurringgreater consumption. Do

you think this action mightbe setting us up for an evengreater correction in the

future?

HM: This is a great chal-lenge. One example of theconundrum is that we want


put it out at returns that

exceed your cost of capital.You borrow at low risk andlend at high risk. You are arisk assumption machine.We rarely get comfortablewith that. The things that Isay dont imply that we areright and others are wrong.There are lots of ways toskin a cat, and thats whythere are so many kinds of

investment firms.

However, in the fourthquarter of 2008, there wereglaring opportunities, evenin financials. We boughtdebt of profitable non-banksubsidiaries of banks andinsurance companies. Webought debt of holding com-panies that had unprofitablebank subsidiaries, becausewe thought that there wasenough value in other as-sets. We invested in non-bank finance companies out-

right. So, there were thingsfor us to do in financials, but

limited in number.

G&D: What lessons do youthink we should learn fromthe crisis and what changesshould be made in re-

sponse?

HM: I wrote a memo calledThe Lessons of 2007.Most of the lessons sur-

round risk aversion. It isimportant to remember tobe skeptical. It is importantto not invest in things youdont understand. It is im-portant to remember thatleverage is not a good thingor a bad thing. It is like theysay with gun control. Guns


It is important to

remember to be

skeptical. It is

important to not

invest in things you

dont understand.

It is important to

remember that

leverage is not a

good thing or a bad

thing.


9/29


P r o f e s s o r B r u c eGreenwald

Bruce C. N. Greenwaldholds the Robert Heil-brunn Professorship ofFinance and Asset Man-agement at ColumbiaBusiness School and isthe academic Director of

the Heilbrunn Centerfor Graham & DoddInvesting. Described bythe New York Times asa guru to Wall Streetsgurus, Greenwald is anauthority on value in-vesting with additionalexpertise in productivity


thoughts on this trend andits importance to our eco-

nomic outlook?

HM: That scares the hellout of me on the eco-nomic side more thananything else. I wrote amemo in August of last yearcalled What Worries Me.Its not that the market isgoing to decline by a fewpercent, or that Oaktreewill lag by a few percent, orthat some employee willquit. It is not that bus thateveryone asks about what happens to Oaktreewhen you go under thebus? One of the thingsthat worry me is this: whatdoes it mean to have aneconomy that doesnt makeanything? I do your taxes.You do my legal work.Somebody else cuts my hair.Somebody else flips the bur-gers, or drives a taxi. Butwhat supports all of us if

our economy doesnt makeanything? I am not smartenough to know the an-swer, but I worry about

that.

In addition, in the industrieswhere we are still trying tomake things like cars, ourworkers expect the highestwages and highest standardof living in the world. Howdo you compete in a world

where everything is fungibleand transportable and yetyour salaries are the highestin the world? How are yougoing to be able to competewith your higher wagesunless your cars are vastly

superior? It is not clear.

G&D: There has beensome finger pointing, argu-

ing that investment manag-ers should have been muchmore conservative leadingup to the crisis. However,only near-Armageddon sce-narios would have preparedpeople for what actuallyhappened. So how do youat Oaktree balance beingconservative with remainingcompetitive in a more nor-

mal environment?

HM: The main thing is thatwe tell clients that we arenot high-octane investors. Ifyou want high-octane, thereare managers you can call.There are clients who dontwant to optimize and en-sure survival, but we donthave any difficulty populatingour clientele. We say wegive good returns with lessthan commensurate risk. Ifthe market booms, thensomebody else may do bet-

ter. But if the market col-lapses, well probably losefar less. The good news isthat, once weve enunciatedthat position, the peoplewho come to us are thepeople who want that.Then, if we give it to them,

they say, thanks a lot.

There might be a boom yearin which we do 25% andsomebody else does 30%.

Ill call up the client and saysorry it wasnt 30%. Theysay, we got what I ex-pected. There is nothingbetter for a money managerto hear than, thanks, wegot what I expected. Itwould be great to be able to


consumption at the macro

level, but at the micro level,we need savings. The USwill be a risky place until wehave more savings, but theprocess of creating thosesavings will be a drag on theeconomy. So what do wedo about that? That is areal conundrum. Everybodyknows that the economyneeds a stimulus, but thestimulus will be designed to

support consumption.

If I run a business and myrevenues are off becausethe economy is bad and Iwant to support my profit-ability, then the best way todo that would be to fire afew folks. That would begood for my business andbad for the economy. Sothe government might cre-ate a tax credit for everyperson that I hire. Thatwould be good for the

economy and bad for mybusiness in the long run,because it might cause meto keep employees that Iotherwise wouldnt. Thereare no easy answers tothese problems. If you be-lieve we need more savingsand less consumption, thenthat implies that we are notgoing to have the usual snapback in business, and weshould be cautious at the

prices at which assets arenow selling.

G&D: Over recent dec-ades, manufacturing indus-tries have been declining inrelative economic impor-tance versus service indus-tries. What are your



10/29

Page 10


You never see a picture ofthe manager who had the

lowest risk, or the best risk-adjusted return; just theone with the highest return.People flock to him, and thenext year he drives off of acliff. It is part of the popu-larization of investing. Wehad a long period from 1982to 2007, with a couple ofmonths of exceptions,where investing worked andaggressive investing workedbetter. So people tended toforget to be scared. Butrisk aversion is the mostimportant element in a ra-

tional investment market.

You know that in the capitalasset pricing model, the lineslopes up to the right. Thereason is that people arerisk averse and demandhigher returns on riskierinvestments. When theyforget to be risk averse,then the line flattens out as

it did in October 2004,when I wrote my memoRisk and Return Today.

What I said in the memo is:

Not only is the capital mar-ket line at a low level todayin terms of return, but inaddition, a number of fac-tors have conspired to flat-ten the line. That is to saythat the slope of the line islow. Meaning that for each

unit of additional risk as-sumed, you get little incre-mental return The com-bination of low expectedreturns on safe investmentsand high recent returns onrisky investments is pushinginvestors to dangerouslyhigh branches of the invest-

ment tree. Those branchesare subject to cracking un-

der all that weight. There-fore, until conditionschange, I suggest something

closer to the ground.

G&D: That is a great anal-

ogy.

HM: People forget. That iswhy Buffetts greatest quoteis, the less prudence withwhich others conduct theiraffairs, the greater prudencewith which we must con-duct our own affairs.When other people arepetrified, then we can beaggressive. When otherpeople are aggressive, thenwe should be scared stiff.People forgot to demandrisk premiums in 2005-07.The great thing is that riskaversion is observable. Youcan see it in the yield pre-mium on high yield bonds.When people are feeling

sanguine, high yield bondsyield 250 basis points morethan Treasuries, and whenpeople get terrified, theydemand 1000 basis pointsmore than Treasuries.Thats an indicator of riskaversion. Your relative re-turns improve as the riskpremium at which you buyincreases. That is a simpletruth which is very impor-

tant.

We say we are not markettimers we are marketobservers. We try to ob-serve the behavior which isgoing on in the market andfigure out what that meansfor risk premiums. We try


beat the market when it

does well and fall less whenit does poorly, but it is al-most impossible. What wegenerally deliver is marketperformance or a bit betterin the good times and dis-tinctly above-market per-formance in the bad times.The clients who want thatcome to us, and we give itto them. The best formulain this business is to tell theclients what you can and willdo, and then do it. If you

just follow that formula,youll avoid 80% of theproblems that arise betweenclients and managers. Ivebeen in the money manage-ment business for 40 years,and I have never had a clientsay that wasnt what weexpected you to do. Tome, if a client says that, itsthe kiss of death. Thatmeans you mis-advertised

what you were going to do.

G&D: Why do you thinkyour clients are so differentfrom shareholders? If DickFuld or Chuck Prince hadsaid something similar, theywould have been fired.They would not have lasted,because they would have

been underperforming.

HM: Right. To some ex-tent there has been a

dumbing down of the main-stream investment business.Too much emphasis on theshort term, and too muchon return rather than riskcontrol. It is too easy toput the highest returningmanager in a given year onthe cover of a magazine.


The best formula

in this business is to

tell the clients what

you can and will do,

and then do it. If

you just follow that

formula, youll

avoid 80% of the

problems that arise

between clients and

managers.


11/29



ments are meant to be all-inclusive. There are good

guys and exceptions to eve-rything I say. If you look atthe mutual fund industry,how many of them beat theS&P? How many of themproduce a superior risk ad-

justed return? How do theyadvertise? They say, ourmutual fund does betterthan the other mutualfunds. Few hold them-selves to an absolute stan-dard. Are the fees the rightfees? Do they charge thesame fees to the mutualfund as they do to theirinstitutional clients? If not,why not? Some mutualfunds charge clients 150basis points. Is that really areasonable price for the

service?

Some money managers for-got their role as a fiduciary.When you are a fiduciary,your first responsibility is to

someone other than your-self. How many peopleacted that way in the lead-up to the crisis? Not very

many.

G&D: Your memos havebecome must reads in theinvestment community.What investors do you like

to read and tend to follow?

HM: I like to read Jim

Grant a lot. I read SethKlarman at Baupost. Forcolor, I read the Gloom,Boom, and Doom Report.However, if you read otherguys, you have to be careful.When I read Seth Klarman, Isay, this guys a genius.But what I am really saying

is, he thinks the same asme. When I was a kid fol-

lowing Xerox in the 1970s,a portfolio manager at Citi-bank came to me and asked,whos the best Xerox ana-lyst on Wall Street? And Isaid, the one who agreeswith me the most is so-and-so. Isnt that our definitionof someone whos bright:the one who agrees with us?You read other people andyou dismiss those who dis-agree with you and respectthe people who agree with

you.

I spend a lot of my timereading newspapers andmagazines, because I thinkthe most important thing isto try to figure out what isgoing on around us. When Iwas a kid in the early 1960s,there was something called,I think, the Johnson Infer-ence Service. I always lovedthat title, because what we

should do as an analyst is totry to infer what is going on.Everybody can see the head-lines. The challenge is toinfer what they mean.When you saw a headline in2006 saying that there was aworldwide wall of liquiditycoming toward us and itwas going to raise the priceof assets and lower riskforever, the most importantthing was to infer from that

that we were living in aworld in which there wasntenough worry and enough

respect for risk.

G&D: Thank you Mr.

Marks.

to be aggressive when risk

premiums are high and de-fensive when risk premiums

are low.

G&D: With the dumbingdown of investors and eve-rything that investors havebeen blamed for over thelast year, do you think in-vestment managers serve a

societal purpose?

HM: I have more bad tosay than good to say.Theres a problem: An in-vestment manager has lotsof occasions where his in-terests are in conflict withthose of his clients. Whenthose moments arise, thequestion is, how does hedeal with those conflicts?Does he put the client firstor himself first? Who wasringing the bell in 2005,2006, and 2007 saying thisis risky, you shouldnt do

it? Who was turning awaymoney? Who was returningmoney to clients? Somemega-buyout funds keptraising more and moremoney as the prices of thecompanies they were buyingwent higher and higher. Didthey serve the clients? Theyeither didnt know what wasgoing on or they knew and

didnt cut back anyway.

In theory, it is helpful tosociety to help people par-ticipate in the profits fromthe capitalist system and, intheory, money managershelp them do that. In prac-tice, I dont think the indus-try has always done such agreat job. None of my com-


I spend a lot of my

time reading

newspapers and

magazines, because

I think the most

important thing is

to try to figure out

what is going on

around us.


12/29

Page 12

Kenneth Leslie September [email protected]

Thesis Summary: The current AMED share priceimplies little to no revenue growth, presumably due tomargin contraction as a result of potential Medicarereimbursement reform. I believe that margins will remainstatic to expansionary in the near future. These perceivednegatives present an opportunity to buy a best in breed,regional to national growth story with a reasonable margin

of safety.

Investment Overview:Underestimated Growth Opportunities: Amedisysis growing revenues and earnings through acquisitions, adeep pipeline of startup agencies, new services targetingpreventative medicine, a growing Medicare beneficiarypopulation and improved operational efficiencies.

Amedisys is capitalizing on the inability of smaller agenciesto operate efficiently without economies of scale orknowledge of how to navigate changing Medicareregulations. Amedisys has ~160 pipeline startup agenciesawaiting regulatory clearance, which would grow theiragency number by nearly 30%. New startups require~$300k in investment, and the payback period for theseagencies is ~2 years. After 2 years, these agencies contribute more than $250k of EBIT each year. At thesame time, established locations are growing revenues by treating a sicker patient population and providingpreventative services such as their Balance for Life program targeting falls in the elderly. Lastly, largeacquisitions in both 2005 and 2008 hide the true operational efficiencies realized by established Amedisyslocations. As the large 2008 acquisition is fully incorporated, margins should exceed 15%, and may even

reach 16% in my estimation.

Information and Infrastructure Advantages: Amedisys has developed a proprietary Point of CareIT infrastructure which standardizes treatment protocol, documents services performed and provides aframework in which to remain in full compliance with Medicare standards. Additionally, this system ensuresthat physicians can view services rendered to prevent accusations of up coding patient conditions. Theresult is excellent transparency, superior patient outcomes and expanding operating margins. This systemallows for rapid integration of changing Medicare regulations and faster accretion of acquisition and startup

locations.

Uncertainty is an Opportunity: Uncertainty of the direction of healthcare reform and the reasons forrecent management departures weigh on AMED shares. Home healthcare and hospice represent a cheaperalternative to traditional inpatient hospital care and represent a solution to the Medicare liability. I expectany healthcare reform to incorporate proposals by the Government Accountability Office, theIndependence at Home Act of 2009 and the Baucus Bill. Any of these measures would be neutral topotentially positive to Amedisys. I believe that any Medicare reform will adopt a pay for performancereimbursement structure. This would also benefit Amedisys, as their care profile displays better outcomesthan the national average in spite of the fact that they treat a higher acuity patient (Amedisys has >10%Case Mix Acuity Index relative to the industry average; http://www.medicare.gov). Further scrutiny into

compliance and billing practices should not affect Amedisys. Their IT systems lend transparency of billing

and services to the referring physicians and ensure that up-coding and overbilling are avoided.

The previous corporate structure was sufficient for a small to mid cap company. Amedisys is now a billiondollar company and needs management with experience and an understanding of operations on this scale.The market sold off 25% (intraday) of the AMED market cap with the announcement of the COOdeparture. I feel that this magnitude of drop was in expectation of greater problems in either compliance

or financial manipulation, but neither are on the table.

Background: Medicare pays providers under a prospective payment system for 60 day episodes ofcare based on assumptions of the severity of each patient. Episodes of treatment with higher acuity patients

Amedisys (AMED)Price: $39.55(Sept 11, 2009)

Amedisys Home Health ServicesBuy RecommendationPrice Target: $54 (37% upside)

Enterprise Value Calculation

Share Price (09/11/09) $39.55

x Shares Outstanding 27.78

= Market Capitalization ($MM) $1,099

+Net Debt 240.8

= Total Enterprise Value $1,040

52-Week High $59.24

52-Week Low $25.20

Ken is a second year MBAstudent and a participant inColumbias Applied Value

Investing Program. Overthe summer he worked inthe Specialty Pharmaceuti-cals and Generics equityresearch team at UBS.Prior to school, Kenworked in breast cancerresearch at the MemorialSloan Kettering Cancer

Center.

Ken is a New York Nativeand received a BA in Mo-lecular Biology from Ken-

yon College.


13/29


(sicker) are reimbursed at higher rates. Amedisys is one of the largest providers in the highly fragmented home healthcare andhospice industry with ~7% market share. They have made accretive acquisitions to increase their geographic footprint from a regionalplayer in the southeast United States to a national enterprise. Revenue growth is fueled by increased admissions, increased patientacuity and increased recertifications for additional episodes of treatment. New trends in healthcare and proposals by government

officials focus on preventative medicine. Amedisys is in tune with this trend and is rolling out multiple programs, including theirBalance for Life program, which focuses on preventing falls among the elderly. This program is reimbursed at higher than averageMedicare rates and has already been introduced to 50% of Amedisys agencies. Non-organic growth is accomplished by acquiring non-performing, smaller home healthcare and hospice agencies. These agencies are unable to operate efficiently without economies of

scale and an understanding of how to navigate Medicare regulations, yet can be easily integrated into Amedisys Point of Care system.

Risks to Thesis: Healthcare reform could induce cuts to Medicare reimbursement rates, lowering operating margins acrossthe sector. In years past, any cuts have been offset by increases in the market basket (inflationary index). A second risk is thatAmedisys may be unable to successfully integrate future acquisitions. Finally, the recent management departures could have a negative

affect on the efficiency of operations going forward or be an early indication of issues yet to be realized by the public.

Catalysts: Medicare reimbursement for 2010 should be announced in October, and further clarity into healthcare reformlegislation should be forthcoming. The announcement of a succession to the COO/CIO positions would impact AMED shares. Theannouncement of additional acquisition targets in more profitable geographic regions, or an illustration of further accretion of past

acquisitions would also benefit shares. Finally, opening of agencies in their startup pipeline would fuel growth in the immediate future.

Industry and Competitive Overview: Home healthcare providers operate at lower costs to the Medicare systemthan inpatient hospital care while maximizing patient comfort. There were 9200 home healthcare agencies and 3000 hospice agenciesin the United States as of 2007 and 2006 respectively. The industry is highly fragmented and consolidating. There are few barriers toentry, although some states require a Certificate of Need (CON) to operate under an agency number. Agency numbers allowproviders to service patients within a 50 mile radius of the agency. Many agencies are single site locations which lack the scale andability to navigate a changing Medicare reimbursement landscape. I predict that healthcare reform as it pertains to this sector willfocus on improving transparency, limiting the ability of companies to game the system through overbilling and focusing on reimbursing

providers based on the quality of their care and the outcome of their patients.

Valuation: I approached the valuation of AMED shares in three ways:1) I acknowledge that forecasting operations into the future is a

difficult exercise. To be conservative, I used an earnings powervaluation based on expected 2009 revenue and a trailingtwelve month EBIT margin. I used an 11x multiple for this

calculation.2) I utilized a DCF sensitivity analysis with 10% WACC and 2%

terminal growth rate. My terminal rate is in line with adoubling of the number of Medicare beneficiaries over thenext 40 years. A 13% EBIT margin reflects a 2.5% Medicarereimbursement rate decrease without a concomitant increasein the price basket. I see this as a worst case scenario for thenear future. I utilized a 14% margin to reflect the impact ofnew acquisitions and pipeline growth opportunities operatingat lower margins. I project that Amedisys will grow at 15%over the next 5 years due to acquisitions, pipeline startups,

preventative services and a higher acuity population.3) Finally, I used a comparative multiple valuation to value AMED

shares using the industry average forward P/E of 11x based on

2009 estimated earnings.

Amedisys Home Health Services (Continued from previous page)

Company Price

Market

Cap EV

P/E

LTM P/E For EV/EBITDA P/B

Levered

FCF

Margin

Gross

Margin

Op.

Margin ROE ROA

Amedisys $39.50 $1,098.7 $1,340.4 9.6 8.0 6.0 1.7 10% 52.5% 14.6% 19.7% 12.0%

Gentiva Health Services $22.75 $662.3 $797.1 4.0 10.6 6.3 1.2 6.90% 49.1% 8.4% 38.0% 6.6%

LHC Group, Inc $29.53 $544.8 $561.9 1 3.1 13.4 6.7 2.6 11.30% 50.9% 17.1% 22.6% 21.0%

Almost Family, Inc $28.42 $232.4 $261.9 1 1.0 10.3 7.1 2.2 5.80% 53.7% 13.6% 22.4% 16.8%

Earnings Power Valuation

2009E Revenue 1484

EBIT margin (TTM) 14.3%

EBIT 212

Tax rate 38.7%NOPAT 130

Earnings Power at 11x 1431

2009 EPV Valuation $51.47

DCF Sensitivity Analysis (10% WACC; 2% Terminal Growth Rate)

Forward 5 Year Operating Margin

13% 14% 15%

5 year 10% $46.51 $51.86 $57.22

Growth 15% $57.77 $64.32 $70.87

Rate 20% $71.07 $79.02 $86.97

DCF Valuation $61.05

11x Industry Earnings Multiple Analysis

EPS 2009E $4.922009E Multiple Valuation $54.12


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Page 14

Eric DeLamarter September [email protected]

Thesis:I propose a long position in the common shares of Care Investment Trust (NYSE: CRE or the Com-pany) as the stock is meaningfully undervalued on the basis of its assets and near-term catalysts lead-

ing to value realization are probable.

Background:Care Investment Trust is a healthcare focused REIT. Following the evaporation of the securitizationand repo markets the Company has repositioned itself from a finance/ mortgage REIT to an equityREIT focused on direct ownership of property. The Company has a high quality asset base consistingof $101M in first mortgages to skilled nursing and assisted living facilities with a weighted average LTVof 78% and coverage ratio of 1.5x, $106M in wholly-owned, single tenant, triple net leased assistedliving facilities and a $61M JV (85% equity interest) in third-party managed class A medical office build-

ings. CRE itself is externally managed by CIT Healthcare, a subsidiary of troubled CIT Group.

Investment Overview & Catalysts: Depressed Stock Value: CRE is an under-followed orphan and mis-priced for the following rea-

sons: 1) most coverage has been discontinued and interest has been lost as it is no longer classi-fied as a finance REIT; 2) analysts that do cover CRE value it on FFO, seem to overlook the un-derlying asset value and likely lack an understanding of the healthcare sector; 3) concerns sur-rounding the solvency of external manager CIT and; 4) misperceived risks associated withhealthcare reform/ regulation. Consequently, CRE currently trades at 63% of book value and

70% of my estimated NAV. Catalysts: CRE is in the process of harvesting assets and returning capital to shareholders. Start-

ing on December 31, 2008, CRE reclassified its mortgages from held-to-maturity to held-for-saleand has subsequently sold-off $67M or 35% of its mortgage portfolio (representing $101M of its$268M in real estate related assets at 6/30). The Company has an agreement to put an additional$80M of mortgages to CIT by September 30, 2009. There is pressure to realize value in the near-term by: 40% shareholder CIT Group who is facing insolvency and a looming deadline from

regulators to present a capital plan and hedge fund groups (GoldenTree and SAB) holding 35% ofCREs shares.

Strong Balance Sheet & Liquidity Position: Unlike many REITs, CRE has no debt due before 2015,

over $53M in cash and total debt of $83M. Its current fixed charge coverage ratio is 1.5x . Dividend: The Companys dividend yield is 10%. Should a partial or complete liquidation occur,

this would obviously increase meaningfully.

Care Investment Trust

(NYSE: CRE)Price: $7.40(Sept 21, 2009)

Care Investment Trust (LONG)

Trading Summary (US$ in Millions)

Ticker CRE

Stock Price $7.40

Book Value per Share $11.79

Est. NAV $10.53

Shares Out. (Basic) 20.1

Market Cap $148.4

Net Debt $28.4

Enterprise Value $176.9

Price / Adj. LTM FFO 13.5x

Price / 2009E FFO 13.7x

Price / Book Value 0.63x

Price / NAV 0.70x

CRE - Stock Performance

3

4

5

6

7

8

9

10

11

12

13

9/08

10/08

11/08

12/08

1/09

1/09

2/09

3/09

4/09

5/09

6/09

7/09

7/09

8/09Eric is currently a member

of the Applied Value Invest-

ing program at ColumbiaBusiness School. This lastsummer, between his firstand second year, Eric was asummer analyst at the long/short hedge fund StelliamInvestment Management inNew York. At Stelliam hefocused on the transportsand industrials sectors.Prior to Columbia, he spenttwo years as an associate inprivate equity and threeyears an analyst in invest-

ment banking.

Eric holds a BA from the

University of Michigan.


15/29


Valuation:On the basis of conventional FFO, CRE is trading slightly above most of its peers. However, FFO is notthe appropriate metric to use. The most likely scenarios facing the Company over the next 6-months are

an outright sale or liquidation. Assuming a 90% recovery value, the implied value for equity holders is$9.92 per share, representing an upside of 34%. CREs discount to book (which should be a good repre-sentation of value since mortgage loans are marked-to-market) and estimated net asset value providesubstantial margin of safety should assets sales not materialize or if operating results were to deteriorate.It should be noted that CRE is one of only several REITs identified that is not facing solvency challenges

and is still trading below book value.

Risks to Thesis: CIT Bankruptcy: The original impetus for the CIT-CRE relationship was to enable CIT to take ad-

vantage of REIT tax benefits and concurrently provide CRE with access to CITs loan originationnetwork. Since CRE no longer originates loans, CREs reliance on CIT has declined. If CIT Groupwere to file for bankruptcy the external manager may need to be replaced at an estimated termina-tion fee of $15M (3x average annual management fee received during two years). Depending uponthe scope of the bankruptcy and terms of the arrangement, this compensation could potentially beavoided and even serve as a catalyst for the sale of the Company. CRE also has a mortgage purchaseagreement with CIT whereby it has agreed to buy $80M of CREs mortgage loans. CREs depend-ence on this source of liquidity is mitigated by the fact that it could sell these mortgage assets orsimply its entire business in the open market. CRE has already marketed its mortgage portfolio to83% of cost (ie. taken $23M of valuation allowances), so a sale would likely result in minimal dilution

to book value/ NAV and possible accretion given the recovery in the mortgage market.

Care Investment Trust (Continued from previous page)

NAV / Portfolio Liquidation Value(US$ in 000s)

Liquidation - Percent Recovered

Est. NAV 100% 90% 85% 80% 75%

Mortgage Loans 101,199 122,501 110,251 104,126 98,001 91,876

Owned Real Estate 103,116 106,020 95,418 90,117 84,816 79,515

JV Investments 54,758 60,842 54,758 51,716 48,674 45,632

Less: Est. man. Term. fee (15,400) (15,400) (15,400) (15,400) (15,400)Less: Accrued exp. payable (1,137) (1,137) (1,137) (1,137) (1,137) (1,137)

Plus: Accrued Int. Rec. 557 557 557 557 557 557

Less: AP (6,029) (6,029) (6,029) (6,029) (6,029) (6,029)

Less: Other Liab. (2,803) (2,803) (2,803) (2,803) (2,803) (2,803)

Plus: Cash 53,751 53,751 53,751 53,751 53,751 53,751

Less: Total debt (83,445) (82,183) (82,183) (82,183) (82,183) (82,183)

Net Value 219,968 236,119 207,183 192,715 178,246 163,778

Value Per Share 10.53 11.30 9.92 9.22 8.53 7.84

Premium to current Stock Price 42.3% 52.7% 34.0% 24.6% 15.3% 5.9%

Notes:

Mortgage loans are classified as held-for-sale and listed at book value for NAV calc

Owned RE is undepreciated with 10.2% cap rate applied to NAV calc

JVs almost exclusively consist of interests related to Cambridge Holdings, discounted 10% in NAV calc

Debt for NAV calc is the LTM average


16/29

Page 16

David Samra is the lead

Portfolio Manager for

the Artisan Interna-tional Value Fund and is

also a Portfolio Manager

for Artisans Global

Value portfolios. Mr.

Samra and co-Portfolio

Manager Daniel OKeefe

were named 2008 Inter-

national-Stock Fund

Manager of the Year by

Morningstar. From its

2002 inception through

2008, the Artisan Inter-

national Value Fund has

returned a total of 126%

vs. 43% for the MSCI

EAFE index. Prior to

joining Artisan, Mr.

Samra was a portfolio

manager and a senior

analyst at Harris Associ-

ates. Mr. Samra holds a

BS from Bentley College

and an MBA from Co-

lumbia Business School.

G&D: Tell us a little bit

about your background,how you got interested ininvesting, and how yourtime at Columbia BusinessSchool has influenced your

investment philosophy.

DS: I first got interested ininvesting when I was an un-dergraduate, when I realizedthat my finance professorswere, in general, muchwealthier than my account-

ing professors. That at-tracted me to the finance

business.

It became immediately ap-parent to me which style ofinvesting I was interested inbecause of the first projectthat I had in my finance

class. The project was toselect a pharmaceutical firm

to analyze and I was pairedup with a guy who pickedMerck. At that time, Merckwas a growth business thattraded at a very high multi-ple. I selected a companynamed A.H. Robbins; acompany I think eventuallywent bust. They were beingsued for problems with oneof their products. But if youlooked through the litigationand looked at the valuationyou were paying for theunderlying business, it wasextremely cheap. For what-ever reason, my naturalinclination was to look for

cheap equity.

When I finished under-graduate school, I started aninvestment club with somefriends. Four or five yearslater, with mainly just ac-counting experience, I ap-plied to Columbia. It was

the only school I applied tobecause of its rich invest-ment history and becauseits where Benjamin Grahamtaught and Warren Buffettwent to school. I spent twoyears there and worked forGabelli [GAMCO AssetManagement] on Fridays. Ialso wrote the newsletterand ran an investment clubduring that time period.When I got out, I took a job

at a place called Montgom-ery Asset Management.

The interesting part aboutColumbia while I was thereis that it was more or lessan efficient market program.Back then, the value invest-ing concept had been lost by

the faculty. So we tried topromote value investing

through the Investing Cluband we brought in JimRogers, Chuck Royce, LeonCooperman, Mario Gabelli,and other investors tospeak to us about value in-

vesting.

Shortly after we left school,the Robert Heilbrunn seatfor value investing was en-dowed and filled by BruceGreenwald. Once he gotinvolved, he turned thatprogram into something ofmuch higher quality thananything we had while wewere there. I think the ad-ministration eventually real-ized that there was an un-derlying base of interest in

value investing.

While I was at Columbia,the most profound influencewas actually an adjunct in-structor named Joel Stern,

who was basically an effi-cient markets guy. Joel wasmainly a management con-sultant who worked withsomeone named BennettStewart, who wrote a terri-fic book called The Questfor Value. They coined theEVA concept that, from afinancial standpoint, helpsyou to understand the dif-ference between a goodbusiness and a bad business.

What matters to you as aninvestor is how that differ-ence, compounded overtime, can be very beneficialas it accrues to the share-holders of that business.Marrying the concept ofinvesting in a good business


Points of Leverage - Dave Samra

Dave SamraPortfolioManager, Artisan Partners

International Value andGlobal Value funds.


17/29

Page 17

Dave Samra (continued from page 16)

at a cheap valuation is what

has driven my philosophicalapproach to investing, bothas an analyst and now as a

portfolio manager.

G&D: Thats a great transi-tion to some questionsabout your investment phi-losophy and style. Youmentioned that you look toinvest in good businesses.What are some of the char-acteristics that you most

like to see in a business?

DS: In business school youhave to sift through all ofthe concepts to find what istruly valuable. The conceptof investing in good busi-nesses is what I gravitatedtowards. Once you get outin the real world, identifyinggood businesses using ratiosis the easy part. Identifyinga great business by under-standing the reality of the

marketplace in which acompany operates and thesustainability of that model,along with how much youshould pay for it, is the artwhich we exercise on a day

in and day out basis.

The way to generate re-turns over and above mar-ket returns over time has todo with leverage. There area lot of points of leverage in

which to operate in theinvesting world. The easyone to identify is financialleverage, where if a com-pany has a lot of debt and isgrowing rapidly, the equityvalue of that company willgrow in a magnified way.Theres also operating lev-

(Continued from page 16) erage where you have a highfixed cost base, so when

revenue grows, profitabilityswells and you benefit fromthat form of leverage. Thethird point of leverage is

through valuation.

Lets say you identify a busi-

ness with economics thatwould imply a relatively lowmultiple on earnings, be-cause in the short-term thebusiness is being hampered,either cyclically or for com-pany specific reasons. How-ever, the work youve donesuggests that the valuation

multiple should be muchhigher because, longer-term,

its actually a high qualitybusiness and has the abilityto grow and the returns onthe business will becomevery high. Thats what I callmultiple leverage. The lastpoint of leverage is earningsgrowth on a non-financially

leveraged basis.

As you develop your stylewithin investing, you eventu-ally pick a point along thatscale. If you are a growthstock investor, often timesyoull buy a company at afair valuation and look tounderlying earnings growthto generate returns as thevalue of the business grows.Another style, if you dontmind financial leverage, is tobuy highly operational andfinancially leveraged busi-nesses on a highly diversifiedbasis. Then you just playthe odds that if you pay low

enough multiples, enough ofthem will work out, and you

will do well overall.

What we have developedover the years is a style thatis much more reliant onunderlying earnings growthon a financially unleveragedbasis combined with lever-age that we are gettingthrough valuation. So whatwe try to do is to skim off

the top by running a rea-sonably focused portfolio ofcompanies that fit betweenthe juxtaposition of highquality and cheap valuation.The way we generate ourreturns is from growth ofthe underlying value of the


Marrying the

concept of investing

in a good business

at a cheap

valuation is what

has driven my

philosophical

approach to

investing, both as

an analyst and now

as a portfolio

manager.


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Page 18

business, along with valua-

tion leverage because weare buying at a cheap price.

The reason we invest theway we do is because ofrisk. If you look at theother ways to generate re-turnstake financial lever-age for example. The obvi-ous consequence of owninga financially leveraged busi-ness is that, if you get itwrong, you can put thebusiness in a challengingposition. It may not be ableto raise capital and becausethe equity is a relativelysmall portion of the capitali-zation, very small move-ments in the operating per-formance of that businesscan have a damaging impacton the equity value. Wehave a very broad and largeuniverse, so we dont needto get involved in thosetypes of investments. We

can find cheap equities

across the spectrum.

With regards to investmentstyles that rely on leveragethrough earnings growth, inmost time series, youresubject to valuation risk. Soif the high rate of earningsgrowth declines, the multi-ple is also likely to shrink,which results in a perma-nent loss of capital. We shy

away from those two formsof leverage, financial or op-erating leverage and earn-

ings growth at a high P/E.

We want to build a portfo-lio of undervalued busi-nesses that are good com-panies that generate cash

(Continued from page 17) flow. We also want to seestrong management teams

that are wisely allocatingthat capital. We think thistype of portfolio will gener-ate very good absolute re-

turns over time.

G&D: You want to findhigh-quality businesses atlow valuations, but theoreti-cally, these opportunitiesshould be rare. Where do

you find these ideas andwhat types of situations give

rise to these opportunities?

DS: The world is a largeplace and we have a verylarge universe from whichto choose. We typicallyhave 40-50% of our portfo-

lio in ten equities, so wearent looking for hundreds

of stocks. There are lots ofreasons that a good busi-ness can trade at cheapvaluations. One of the obvi-

ous reasons is macro issues.

One example was late lastyear;s we bought Googlebelow $300 per share,which was implying around13x earnings. You couldargue that the whole marketwas undervalued and itprobably was. But the pointis: we were picking up agreat business, with a terri-fic secular profile, thatdominates its industry, witha very high level of profit-ability, and we picked it upat a very un-demandingprice. Clearly, it was amacro shock that led to anundervaluation of the busi-

ness.

Other events can lead to

these situations: manage-ment makes a bad acquisi-tion or poor strategic deci-sion, the governmentchanges the rules on a busi-ness, management changes.There are a variety of differ-ent reasons good businesses

can get cheap.

G&D: A lot of value inves-tors fared poorly in 2007-08, but your fund per-

formed very well despitebeing fully invested through-out the period. To what doyou attribute your stronger

performance?

DS: We dont feel that weare particularly good at call-


Dave Samra(continued from page 17)

I would argue

that the single

most common

error in the

investment

industry is a

failure to

distinguish

between

fundamentals

and

expectations.


19/29

Page 19


ing market tops and bot-

toms. What we do is iden-tify certain investment pro-files that make sense to us.We always make sure toreally look under the hoodof the companies we are

buying.

For example, we werelargely absent in the highly-leveraged financials space,such as banks and insurancecompanies. We were un-comfortable with theamount of leverage that hadbuilt up in these companies.We viewed this as nothingshort of a carry trade exer-cised by borrowing shortand lending long, particularlyin an environment whichwas much less liquid outsidethe US in terms of securiti-zation. In the end, earningsgrowth was overstatedquite a bit because therewerent enough loss provi-

sions going through the bal-ance sheet. A lot of valueinvestors thought theylooked cheap. For instance,the price-to-book lookedout of whack. But the rea-son they were cheap is be-cause of their considerableleverage and their earnings

were overstated.

G&D: When the financialstocks collapsed earlier this

year, did you look at that asan opportunity to buy themat really cheap prices orwere you just not comfort-able with the highly lever-aged financial model at any

valuation?

DS: We didnt step up into

(Continued from page 18) any traditional banks. Wespent an enormous amount

of time going through a lotof the banks, but becausethe financial system was soclose to melting down, itcame down to pure specula-tion. Instead, we took ad-

vantage of financial servicescompanies outside of thetraditional leveraged finan-

cials.

We bought a meaningfulstake in IGM Financial,which is in the money man-agement business in Canada.It is a terrific business thathas a strong balance sheetand a very good marketposition. That turned out

to be a terrific investment.We also have a long-term

holding in Arch Capital,which is one of the pre-mium franchises in theProperty & Casualty insur-ance business. We boughtArch at a cheap price-to-book, at a time when thebook value was understatedbecause some of the invest-ments they had in theirportfolio had been markeddown unnecessarily, in our

opinion.

We didnt buy equities inthe areas with the mostleverage points, though wedid increase our weight inthe surrounding area.These turned out to be

good investments.

The oil industry is anotherarea we were largely absent.What we knew about theprice of oil at $150 per bar-rel was that it was way

above the marginal cost ofproduction. When com-modities are priced at thatlevel, it typically encouragesproduction and discouragesconsumption. This is a les-son in value investing: youcant just look at the num-bers. All of the oil stockslooked really cheap when oilwas at $150 per barrel. Wedidnt know if oil was goingto $200 per barrel, though

we didnt think so. Eitherway, we didnt take much ofa position on the directionof oil at all. We did makethe determination that theprice of oil was well abovethe marginal cost of produc-tion and that we did not


Commodity

businesses are

not good

businesses at the

end of the day;

theyre capital

intensive, the

products dont

have any

differentiation,

and returns tend

to be low over

time.


20/29

Page 20

want to own these stocks

with oil at those prices.Commodity businesses arenot good businesses at theend of the day; theyre capi-tal intensive, the productsdont have any differentia-tion, and returns tend to below over time. Weve de-cided that we would onlyget involved in commoditybusinesses if we can identifythe low cost producer, thecommodity is priced wellbelow the cost of produc-tion, and the balance sheet

is clean.

As we went into the com-modity downturn, we pre-ferred to own a companylike Samsung Electronics.We believe thats the sametype of business as oil orcopper; at the end of theday its a commodity. Mostof Samsungs competitorswere operating with nega-

tive gross margins. Samsungwas break-even or barelymaking money, so they arethe obvious low-cost pro-ducer. They also have avery strong balance sheet.We were simply waiting forwhat inevitably happenswith a very low-priced com-modity: consumption is en-couraged and capacitystarted coming off-line. Theincreased consumption and

decreased production even-tually moves the marketback in-line. As this oc-curred, Samsung turned outto be a good investment

through the downturn.

G&D: Back to the oil indus-try, you have been buying

(Continued from page 19) some of the integrated oilcompanies more recently.

Do you need to get com-fortable with macro back-drop before you can beconfident enough in theirsustainable earnings power

to invest?

DS: We havent found it tobe a valuable use of ourtime to try to forecast anymacroeconomic outcome.We did look at the marginalcost of production per bar-rel of oil and compare thatto the price of oil that wasimplied in the equity valua-tions. We made the deter-mination that $40 oil, whichwas where the price of oilwas when we bought theseequities, was below themarginal cost of production.Oil reached nearly $150 perbarrel and bottomed near$35, but over the last tenyears, our internal modelshave assumed that the mar-

ginal cost of production hasmoved up to $75-$80 perbarrel. There has beenabove trend inflation in thecost of doing business in theoil space, so we estimatethat a more accurate mar-ginal cost is probably closerto $65-$70 per barrel to-

day.

G&D: Your cash positionhas moved up to approxi-

mately 10% of the portfolio,which is the top of therange you target, accordingto the funds prospectus. Isthis an indication of yourview of valuations in the

equities markets currently?

DS: Obviously, valuations

are higher today than theywere in the earlier part of

the year. But we have tran-sitions that we go throughfrom time to time in whichour cash position may buildtemporarily. Typically, weare either working onsomething new or waitingfor better entry points onparticular stocks. The cashincrease is not a call on themarket; its more a reflec-tion of what we currentlyhave on our plates and alsofrom exiting a couple of bigpositions. IGM rallied fromthe mid-$20s to the low-$40s, which we think isfairly valued, so we sold outof that position. As we gothrough the process of rein-vesting that capital, the cashposition will increase some-what as part of that process.Its definitely not a market

call.

G&D: You made an inter-

esting comment in one ofyour shareholder commen-taries, regarding the govern-ments impact on the econ-omy and financial markets.Your point was that themassive government inter-vention is emerging as animmediate risk to earningspower and valuation. Whatdid you mean by that andhow have you adjusted yourinvestment process to ac-

count for that risk?

DS: Government changesare slow and they frequentlyencroach on businesses inless than obvious ways. Themost obvious impact is onour healthcare stocks.




21/29

Page 21


Weve seen bills come out

of congress and a proposed$4 billion per year tax in-crease on medical devicestocks. Covidien is one ofour largest positions andone of the largest medicaldevice companies in theworld. Its a global business,but a meaningful portion ofits revenues come from theU.S. The question becomes,how much of any tax in-crease gets passed on to theend consumer. It couldreally hurt the business inthe sense that there will beless money to spend onR&D and that profitabilitywill simply decline. Wethink current valuation mul-tiples already reflect themarkets concerns aboutthe resulting impact ongrowth, profitability, andcash flows associated with

these businesses.

Were also hearing a lot ofnoise about clamping-downon compensation structures,not only in the US, but alsoacross the globe. I alsothink the cap-and-trade billcould do significant damageto the Midwest manufactur-ing base, because it penal-izes smaller power compa-nies that rely on coal plants.Sometimes I dont under-stand what politicians are

thinking: on one hand, theywant to create jobs, butthen they are doing thingsthat are obviously bad for

job creation. Im concernedthat the current administra-tions strong focus on laborcould start to have a nega-tive impact on operating

(Continued from page 20) profitability.

We share others views thatROEs will be lower, growthwill be slower, consumersneed to deleverage, and thegovernment is going to be

more interventionist. Thegovernment is imposingitself on the economy moreand more, which will havean impact on the underlyinggrowth rates of businesses.As a result, it is ever-moreimportant to make sure thatyou own good businesses,

that are attractively priced,that have good managementteams, that can creativelyfigure out ways to growtheir businesses, whateverthe headwind might be whether its macro, micro,or government. The key forus is to make sure we own

businesses that are wellplaced to grow, even if

someone builds a brick wallin front of them.

G&D: Given our huge andgrowing national debt, an-other issue we potentiallyface down the road is infla-tion. In another share-holder commentary, youreferenced a 1977 piece byWarren Buffett regardinginflations negative impacton stock returns. Do youthink we could be headingfor a similar environment tothe 1970s a period of highinflation and poor equity

returns?

DS: We just dont makemacro projections. Whatwe wanted to do was createawareness among ourshareholders that this is onepossibility that couldemerge as a result of thecurrent environment. We

havent changed anythingthat we own in our portfo-lio. We think that if youown competitively well po-sitioned businesses thathave a relatively low level ofcapital intensity, you arebetter placed than most toretain the returns of thebusiness. It doesnt meanthat you wont be impacted,

just that you are better po-sitioned. We arent sure

that this will happen; we justthink the odds are highernow than they were whenwe were running smallerdeficits. It is very hard to

predict these things.

G&D: Thank you Mr.

Samra.

We share others

views that ROEs

will be lower,

growth will be

slower,

consumers need

to deleverage,

and the

government is

going to be more

interventionist.


22/29

Page 22

Kevin Dreyer is an Asso-

ciate Portfolio Manager

of both the Gabelli AssetFund and the Gabelli

Healthcare and Well-

ness Fund. Mr. Dreyer

received his undergradu-

ate degree from the

University of Pennsyl-

vania and holds an MBA

from Columbia Business

School.

G&D: Can you tell us alittle bit about your careerbefore business school andhow you got interested in

investing?

KD: After completing myundergraduate degree inengineering at the Univer-sity of Pennsylvania, I wentinto investment bankingwith Bank of America Secu-rities. I worked in M&Aadvisory for three years,which gave me a good intro-

duction to finance and un-derstanding companies.After some time, I decidedthat I wanted to actually usethat analysis to make invest-ment decisions as opposedto just giving advice. I readthe Intelligent Investor andstarted getting hooked onthe value investing books

and applied to Columbia.Fortunately, the value in-vesting program was just

starting to become formal-ized. I was in the first classto go through the programin its current form. Follow-ing school, I went to workfor Gabelli covering foodand beverage companies.The first companies I lookedat were confectioners.

There are only a handful ofpublicly traded firms glob-

ally, so it is a pretty smallsub-industry, but Mariowants us to dominate theknowledge of an industry. Itturned out to be an activearea since 2005, with Wrig-ley being acquired by Marslast year and Cadbury in thenews right now with Kraftoffering to acquire the com-pany. We were involved in

both of those companies.From there, I ended up fol-lowing a broader section offood and beverage compa-nies globally. In addition tomy analyst role, I took on afew Associate PortfolioManager duties on theGAMCO Global Opportuni-ties Fund and a sector fundcalled the Gabelli Health-care and Wellness trust. Asof last month, I am also anAssociate PM on the Gabelli

Asset Fund.

G&D: What was the jobmarket like coming out of

school?

KD: There were some op-portunities. In my first yearat school, the hedge fundindustry was just starting toboom. The big mutual fundcompanies and some hedgefunds came to campus torecruit. Investment man-agement has always had a

much different recruitingprocess than other businessschool career paths likebanking, trading, and con-sulting. A lot of internshipsand jobs were securedthrough job postings andnetworking rather than for-mal recruiting. It is really

important for students totalk to a lot of people at

firms for informational in-terviews. Some people Iknow didnt find their jobsuntil late in the spring oreven until the end of sum-

mer after graduation.

G&D: What was your ex-perience with the AVI Pro-gram and how did that helpprepare you for your cur-

rent role?

KD: It helped me get usedto doing full and completeanalysis on companies andwriting them up and talkingabout them. The AppliedValue Investing course that Itook with William vonMueffling was the bestcourse I took in school. Ireally learned how to be ananalyst. We were essen-tially functioning no differ-ently than if we were work-ing as analysts following an

industry, and we met somegreat guest speakers. TheGreenwald value investingseminar was also terrific. Itwas interesting to hear theperspective of all of thegreat value investors. Eve-ryone has their own flavorof investing and it helps tocrystallize where you wantto gravitate towards andwhat makes the most sense

to you.

G&D: Is there any investorthat made a particular im-

pression on you?

KD: Well, obviously MarioGabelli. The whole notionof Private Market Value with


Lessons of an AVI AlumKevin Dreyer, GAMCO

Kevin Dreyer (05) Associate Portfolio Man-

ager, GAMCO AssetManagement.


23/29

Page 23

a Catalyst was not that

much different than the waythat I had looked at compa-nies as an M&A banker.That was helpful for me intransitioning into investmentmanagement. Tom Russowas also very interesting.He follows a lot of the samecompanies that I do. I alsoliked how he took a global

approach.

G&D: Do you still interactclosely with the other AVI

students from your class?

KD: I do. Right out ofschool, a group of us wouldtry to get together everyfew months or so to talkabout stocks and how our

jobs were going. As you getolder, it becomes a bit moredifficult to meet up, but Idefinitely still keep in touchwith quite a few people

from the AVI program.

G&D: Are there quite a

few AVI alums at Gabelli?

KD: There are a few. Werecruit at Columbia everyyear so we are always add-

ing people from Columbia.

G&D: It sounds like youhave been pretty successfulin your career, progressingfrom being an analyst to

having an increasing amountof portfolio managementresponsibilities. Can youtell us some more aboutyour progression and howyou think about those two

different roles?

KD: I dont know that I

(Continued from page 22) view being an analyst or aportfolio manager very dif-

ferently. It is just that youare looking at more compa-nies and more industries.Mario would probably stillconsider himself an analyst.We are very stock specificand bottom up. We focuson what private market val-ues are, particularly if thereis an opportunity to realizethose values through eithera financial or strategic trans-

graham and doddsville - issue 7 - fall 2009

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