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Feinberg: What Held Us Back

Dan Culloton

Dan Culloton: I'd like to leave this review just talking a bit broadly about the funds you manage; Davis Financial, which is recovering from the bear market; Clipper which is also recovering; and NY Venture and Selected American, which had a period of recovery but seem to be, at least on a relative basis, seem to be slowing down relative to the other funds. Why is there difference between say Clipper and some of the more diversified large-cap funds, and for an investor who has stuck with you over these past five years, what can you say to them to give them the confidence that things are going to turn around or continue to turn around?

Ken Feinberg: Well, Clipper is a concentrated fund, as you know, Dan, and we generally own only about 25 stocks, and the top 10 stocks actually have about a 67% weighting. So, if we get one stock wrong in that top 10, the fund's performance is really going to feel it, and that's what happened with AIG in 2008. It was one of the top two positions in Clipper, and unfortunately, we were wrong. There were things going on at the company that were never disclosed, that we couldn't see, and our judgment about the housing decline, going down 35% in the U.S. and the trickle-down or the impact to mortgage-backed securities, and what AIG was really exposed to was much worse than we would have expected to occur.

So, that's really hurt Clipper. What's really helped Clipper now is that we have a few positions--Oaktree is one example, which is a large position. It's the second largest or third largest position in Clipper that is run by Howard Marks and his crew, and they actually have decided to list on the New York Stock Exchange in the fall, which has helped the stock go up 10%-15% in a short period of time, and it's a big position, so that has helped.

Clipper is a fund that we would expect to either do better or worse than NY Venture or Selected American, but not the same, even though a lot of the companies are the same, because the weightings are so different. NY Venture and Selected American, it's interesting, because I agree with your intro, in the sense that if you look at what's helped those funds, we've had a few positions that fortunately are up about 20%, and they have been in the top five. American Express is our largest. It's up about 19% before today, and EOG is up about 20%.

So, we are helped by some nice performance there, but we also have been hurt on the same side by some energy holdings. Even though the price of oil is still at a $100 today and gas has moved up to about $4.80, some of our energy companies have not done well, and one is Canadian Natural, where they had a fire at their Horizon Oil Sands play, and that sort of suspended production for many, many months now, maybe four or five months. They will get it back, but that was not good for the stock or for the near-term fundamentals, and we'll have to see if a fund that owns 80 companies where the top 10 are only about 35% is going to do better in a short period of time than a more concentrated fund.

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It's really hard to say, but I think to give our shareholders confidence, and I have been saying this for a few years now, is that I always understand people looking at their rearview mirror when they judge whether to make an investment, because as a portfolio manager, I do that, too. You have to see what the company has done, you have to see what management has done, and you have to try to think, if they've been doing well, will they still be able to do well in the future or maybe have they gotten too big? Are they going to "deworsify" to use Peter Lynch's term, or maybe they just run out of room to run the company, and they're going to make a big acquisition, which is definitely what you don't want.

So it's interesting that if you look at what hurt NY Venture and Selected American and Clipper in 2008, there were four holdings, and I'll talk about the big fund, Selected American and NY Venture, that all had ties to mortgage-backed securities, but in different areas. The biggest detriment to the fund's performance was AIG; we talked about that. And then there was Merrill Lynch, which also got hurt by having $50 billion of super-senior tranches of mortgage-backed securities, but had never been disclosed, unfortunately, on their balance sheet. It was an off-balance-sheet derivatives contract, the way they had disclosed it, and then Wachovia, which had sort of the run on the bank issues, also had some mortgage-backed securities, but that was just part of the problem. And then Citigroup, which clearly had a lot of mortgage-backed securities, and also SIVs that weren't as adequately disclosed, I would say.

So we don't own Citigroup anymore. We don't own AIG anymore. We have a 10-basis-point position in Merrill Lynch Bank of America, and we do own Wells Fargo, which owns Wachovia, and that's an important position. So I always look at what really caused the last three years of subpar performance; it's mortgage-backed securities fueled by a 35% or so decline in U.S. residential housing with a lot of the leverage in the system that has all been brought down, by and large. So if we're going to lag going forward, it's not going to be because of what made us lag the last three years, it just can't. It's going to be something else, and I always try to speculate what that something else could be and there are always three of four different scenarios you can posit that would cause it.

So I'm comfortable that what happened in the past isn't going to happen again, but time will tell. We want to show our shareholders that they should expect good performance from us over every rolling 10-year period. We've been able to do that, but the last three years and five years have not been as we would have liked.

Culloton: Well, thank you very much for your time today, Ken.

Feinberg: It's a pleasure. Thank you, Dan.