August 15, 2013

Part I: MPMG – A perspective on the markets

How conventional wisdom failed investors in the past

• There are numerous cases in recent history where following the crowd proved to be a mistake for investors.
• †The “Nifty 50” stocks of the 1960s were considered stocks every portfolio manager had to own. But once they reached peak valuation (and peak popularity among investors), their prices dropped by 80% to 90%.
• Technology companies were highly coveted in the 1990s, but investors lost 78% of their wealth in these stocks between 2000 and 2003.
• Home ownership was considered to be one of the “safest” investments available until the housing market collapsed in 2007.

Conversely, the bond funds that invested in the bonds of companies with such excessive levels of debt that their credit was considered to be “junk” would see their initial investments grow by over 25 times during the next 30 years.

Price is the key determinant of the success of an investment

• †In today’s investment environment, much of the focus has been on choosing investments that are perceived as being safe and defensive in nature. This has resulted in a heavy flow of funds out of equities and into bonds and high dividend/low growth stocks.
• Risk is not avoided by selecting specific asset classes. The best defense against market risk is paying the right price for an asset.
• While U.S. Treasury bonds and technology stocks as represented by the NASDAQ are viewed as being on opposite sides of the risk spectrum, the price of both eventually rose so significantly that they both became incredibly risky.

• Today, U.S. Treasury bonds appear to be tracking the rapid ascent and subsequent decline that NASDAQ stocks experienced in the early part of the 21st century.
• This is a recent example that risk is not avoided through the selection of specific asset classes. Rather it is the price that one pays for an asset that is the principal determinant of its riskiness.

12 Month total return through June 30, 2013*

Protecting you from risks yet to play out

• We at MPMG have been warning about the risk that currently exists in the falsely perceived safe-havens of bonds and bond-proxies (stocks that pay out most of their earnings as dividends and have meager growth prospects).
• The performance of different investment classes in the last 12 months (through June 30, 2013) demonstrates what we anticipated.
• Gold and 10 Year U.S. Treasury bonds, considered safe havens by many investors, have lost money in that period.
• Stocks have recovered, and the MPMG All Cap Value portfolio has exceeded the stock market’s impressive returns.

Where MPMG sees value today

• We believe that quality, multi-national businesses that sell products and services to meet many of the necessities of life around the globe are well positioned to prosper given their current valuation levels.
• These are quality companies, but the key is that we’ve been able to add them to the portfolio attractive prices.
• †Examples include:
  • Cisco Systems – considered t0 provide the “backbone” of the Internet.
  • Xylem – equipment and services to help manage the world’s precious water resources
  • Chicago Bridge & Iron – an engineering and construction company to the energy industry
  • Ingersoll Rand – a global leader in HVAC, capitalizing on a booming global middle class
  • NCR – industry leader in ATMs, airline kiosks and business software

Part II: Billy Beane

From the baseball diamond to Wall Street
How a “Moneyball” approach succeeds in building investment portfolios and baseball teams

Billy Beane – Moneyball and finding value in the marketplace
Billy Beane was once one of the highest rated baseball prospects in the country. His experience as a can’t miss prospect that ended with an unimpressive, six-season major league career(part of it with the 1987 Minnesota Twins) taught him that the conventional wisdom that dominated baseball management was wrong.

Mr. Beane’s value approach to building a baseball team was made famous by Michael Lewis bestselling book Moneyball, which inspired the Oscar-nominated major motion picture that starred Brad Pitt.

Mr. Beane’s approach to buying quality players at the right price is similar to MPMG’s style of selecting businesses to invest in. Here is a summary of Mr. Beane’s comments at the MPMG Speaker Series event on August 15, 2013 and how his approach to baseball player selections can be related to investing.

Billy Beane’s unique and successful – approach

• • In retrospect, Mr. Beane viewed himself as a prospect that looked like a baseball player based on superficial methods of evaluation, but failed to possess overlooked characteristics that were critical to succeed in professional baseball.
  • Conversely, Mr. Beane saw other players during his era that did not seem attractive based on a cursory review, but possessed valuable and overlooked qualities that would enable them to be successful professionals.
  • He realized that the baseball market tended to undervalue players who did the important things well most notably to get on base (by whatever means)at a high rate.
  • Mr. Beane recognized that there was a way to capitalize on over 150 years of baseball statistics in order to identify ways to garner wins from a value approach to baseball.
  • Specifically, he says, We were trying to mimic what goes on on Wall Street, especially with somebody like Warren Buffet, and MPMG, who focus on finding quality companies at a good price.
  • Mr. BeaneÓs analysis showed him that a team’s on-base percentage was the most influential variable in producing a winning team.

Billy Beane on the transformation of the Oakland A’s

• • Prior to becoming the General Manager, the 1992 Oakland A’s had the second highest
    pay roll in baseball($48 million).
  • 20 years later during an era of significant salary escalations in baseball, Oakland’s payroll was just $594 million second lowest in the league, compared to $223 million for the New York Yankees.
  • Given Mr. Beane’s budget limitations, he focused on players who were outstanding at the most important skill (getting on base), but were deficient in other less important skills (stolen bases). If a player was deficient in enough less important areas or woefully deficient in just one, Mr. Beane believed that he could acquire that player at a discount to his true value and assemble a high performing team made up of under appreciated and over-looked cast-offs.
  • While many ridiculed his approach, his methods proved to be highly successful. In 2012, Oakland won its division for the fifth time in 15 years since Mr. Beane took over as GeneralManager.
  • Between 1999 and 2012, the total payroll for Oakland was $764 million while the highest paid team, the New York Yankees, spent $2.5 billion.
  • Mr. Beane says the Ðcost-per-win during this time was $618,000 for Oakland versus $18 million for the Yankees.

Billy Beane on where to find value

• • Mr. Beane recognized that baseballÓs amateur draft was a highly inefficient process where no team had demonstrated consistent success.
  • Part of the problem was that despite there being decades of data on the draft, few teams ever paid much attention to studying the data.
  • Mr. Beane and his team conducted several analyses of this data and concluded that players drafted out of college and from bigger cities have a much higher success rate than players drafted out of high school.
  • The important distinction is that college players, in general, are better prepared to make it in the majors with fewer variables that affect their likelihood of success.

MPMG investment parallels with Moneyball

• Stocks that at first glance appear to be attractive frequently the most popular stocks can be traps for investors.Oftentimes they are expensive to own, which means that too often they will deliver disappointing performance.
• By contrast, stocks that are often overlooked by most investors often offer good value. Strong companies that can be owned at a bargain price create great potential for investment success.
• Identifying characteristics of a successful stock, like those of a successful ballplayer, will help investors find more winners over the long run.
• Overpaying for assets can lead to a large number of mistakes and underperforming assets in your portfolio.
• The market can be unpredictable in the short term. There will be periods when choosing
  unloved stocks will not prove effective. But by trusting your judgments about valuation, the market will reward quality stocks in the long run.
• Choosing value stocks that have a good chance of success is not simply a matter of
  finding the cheapest stocks. It is also important to focus on companies that are of high quality and in industries where the potential for strong performance is high.
• Well-managed companies that have a strong position in their competitive marketplaces have fewer variables that could lead to negative surprises down the road.

Although the information in this document has been carefully prepared and is believed to be accurate as of the date of publication, it has not been independently verified as to its accuracy or completeness. Information and data included in this document are subject to change based on market and other condition. All prices mentioned above are as of the close of business on the last day of the quarter unless otherwise noted. Market returns discussed in this letter are total returns (including reinvestment of dividends) unless otherwise noted.

The information in this document should not be considered a recommendation to purchase any particular security. There is no assurance that any of the securities noted will be in, or remain in, an account portfolio at the time you receive this document. It should not be assumed that any of the holdings discussed were or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable. The past performance of investments made by MPMG does not guarantee the success of MPMG‘s future investments. As with any investment, there can be no assurance that MPMG‘s investment objective will be achieved or that an investor will not lose a portion or all of its investment.