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Page 46 Jared Friedberg

Page 46 Jared Friedberg allowed us to buy groups of quality assets at significant discounts to intrinsic value where that value is realized in an idiosyncratic way. So the correlation to other assets and the markets is limited. Another area of opportunity is businesses that have assets in one country but are publicly traded in another. For example, we own a U.S. cinema operator with operating and real estate assets in Australia and New Zealand. The complexity makes these assets difficult to own, which has led to a dislocation in value. We also look to identify hidden assets that do not appear on the balance sheet of a company. For example, we were recently involved with a publicly traded restaurant franchisee, where the market did not appreciate that the company had a right of first refusal to buy other franchisees in their network. This right has tremendous value but is not recognized on the balance sheet. G&D: And what is your approach on the fixed income side? JF: On the fixed income side, we explore distressed opportunities, but our main focus has been on what we call stressed credit, a situation where we feel the bonds are pricing in real risk where we believe the risk is limited. We are looking for areas of stress, and this can come in a lot of forms. It can be idiosyncratic to the company, or our sourcing can also be more macro. For example, during the European crisis in 2011 and 2012, there was a lot of investor fear. The bonds of very stable businesses were trading at attractive yields with what we believed was minimal risk of capital impairment. Another area we source such opportunities is the publicly traded debt of private companies. We have found the debt of private companies can be particularly interesting as information is not readily available. Just having to get approval from the CFO of the company to get the information removes a lot of the competition of people looking at such opportunities. “We rarely make an investment decision that does not have a 12 to 36 month timeline.” G&D: Across all categories, how do you think about entry points? And how about catalysts and timing? JF: We rarely make an investment decision that does not have a 12 to 36 month timeline. Our stable capital base gives us the flexibility to not be pressured on timing. Even in those situations where there may be a catalyst, we feel like that catalyst being a year or two away often gives us an advantage. In terms of entry points, we are disciplined about the price levels where we get involved with any investment. We document where we would buy the security at such an attractive discount that we’re comfortable making it a predetermined size. If it trades down, the points at which we’re making it larger are also predetermined. The strategy is executed unless the thesis has changed. We have gravitated to this price discipline because we have also found that it helps us manage our psychology. We use the same discipline when deciding when to trim or exit. When other people are freaking out and an asset is on sale, that's when we want to have the psychological wherewithal to step up and buy it. And the converse, we’re reinforcing our psychological wherewithal to sell when others are too sanguine. G&D: For your stressed credit investments, how do you think about where you want to be in the capital structure? JF: We look across the capital structure of an enterprise. Take the special situation restaurant equity I mentioned before that had a right of first refusal to buy other franchisees. We felt that the equity was undervalued and we would be able to own it for a multi-year period. That company also came to the market to refinance its debt in March 2015. At the time, there was momentary fear affecting credit markets and the company had to settle for a higher interest rate than they expected. We already knew the business and the management, and with minimal risk we could earn an 8.5% return. In a sense, we looked at that and realized that 8.5% is actually more attractive than the double-digit return we're going to get in the equity. (Continued on page 47)

Page 47 Jared Friedberg Zach Rieger ’17 presents his winning investment idea at The Heilbrunn Center for Graham & Dodd Investing Challenge G&D: Regarding your quality compounders, how do you determine when they are too expensive? If it’s a truly dominant company, wouldn’t a ten-year or longer discounted cash flow (DCF) analysis with reasonable scenarios still show upside? JF: We always conduct a DCF on compounders, because it forces you to think through assumptions and about the growth trajectory and drivers of that business. We use a more conservative discount rate to be on the safe side. It boils down to whether we think the compound annual rate of return that we're getting, relative to the uncertainty of all of those assumptions that we just made, is worth the risk. It's more art than science, but I can tell you if I'm making an assumption on something that's five, six, or seven years out and I'm only getting a midto-high single-digit compound annual return, that’s not attractive enough for me. We can probably find ways to generate those kinds of returns, taking less risk, elsewhere. We always ask ourselves whether we can get those rates of return elsewhere with greater certainty and less risk. G&D: When you are looking at a special situation or a compounder, do you stack those up against each other or do you have more absolute metrics to judge by? JF: We don’t have any highlevel preset allocation among our asset classes. Our capital flows to investments where we have a high level of confidence in the risk of capital impairment we’re taking relative to the return we expect. So by definition, every idea is always being compared to the others. This dynamic is also what primarily defines our position sizing decisions. Something with a low risk of capital impairment and with an attractive return is apt to be sized larger than something where both the risk and return are higher. When we can’t find opportunities that meet our criteria, our allocation to cash is going to be larger. This approach has been heavily influenced by the family office emphasis on capital preservation and has allowed us to generate equity-like returns while taking less-thantypical equity risk. G&D: What is your decision process in buying and selling? Do you have a process to guard against thesis drift? JF: We make decisions collectively. We've tried to create an intellectually honest environment. It is not about being the smartest person in the room; we simply want to get to the right answer. Ideally, we protect each other from our own biases. Before we invest in anything, we’ve determined the price levels at which we're buying and selling. There's only one real question when the price hits our target, which is: has the thesis changed? If the answer is no, we are selling. This is about forcing yourself to be disciplined. It is not always easy but it is important to have a plan in black and white in front of you. That said, we're obviously not inflexible, but you can't cheat yourself. That’s why we write a memo with the thesis, risks, signposts, etc., explaining why we believe the asset is mispriced. If we are shifting our approach, we have to clearly explain why the thesis has changed—it may be that growth is accelerating or the company has a new development. I woke up one morning last week to see that one of our European compounders had announced a transformative merger with a complementary business. We went through the process of thinking about what it meant to put the businesses together and what value would be created. The thesis had changed and we couldn't, with a high level of confidence, get to a place where we were nearly as excited about the deal as the market. The intellectually honest thing to do was to sell the position and re-evaluate whether the combined entity met our standards as a compounder. G&D: Can you talk a little bit about how you get a research edge? JF: I think that MBAs often assume that most professional investors conduct a lot of primary research to gain real insights into a business and an industry. But we find it’s not always the case. For example, one great way to get an edge is to get off the island: to go to industry conferences and engage with industry participants. The reality is that many investors don’t go that extra mile. Let me give you a specific case. We have been (Continued on page 48)

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