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That said, we may limit comments about specific investments if premature disclosure of too much detail might impact our ability to buy at depressed prices. Nevertheless, we do want to convey – in clear language – how we are thinking about the money you have entrusted to us. We spent much of the last decade helping to build a well-known investment advisory firm whose growth resulted primarily from generating attractive returns. While past success is no guarantee of future results, we have drawn deeply on our experiences and have returned to our roots – by taking time to cast a wide net for what we think are great investments and putting our significant experience and resources to best use. Debt or equity, large or small, foreign or domestic – we are agnostic about where we find opportunity.
Given this is our first letter, we should restate our basic long-term approach: our primary preference will always be to find a financially attractive business, run by honest and talented owner/managers, and where a part-ownership interest (common stock) can be purchased at a price that offers prospective high returns. From time to time, we also will consider other disciplined and value-oriented strategies as described more fully in our prospectus.
If opportunities are few, we are not afraid to remain liquid. In all investments, we will always try to minimize the potential for permanent loss. Although we will make mistakes, we always try to minimize the chance that we have materially overpaid. As one of us likes to say, perfection in avoiding losses is impossible, but it is a worthy goal. The Fund's capital is being deployed judiciously and we still have a chunk of cash – we are optimistic, but cautious.
Although our cash position will decrease as we find new and appropriate investments, the world is still a troubled place and we are mindful that many of the causes of the 2008-2009 financial crises have not yet been addressed. Government finances are in shambles. Many European banks are stuffed with sovereign paper of questionable value and many domestic institutions are struggling with troubled assets, depressed markets, and costly legal issues. Most derivatives remain unregulated and unlisted on exchanges, where collateral and counterparty risk might be reasonably gauged. U.S. growth is subdued and the housing ATM shut down long ago. And although interest rates are bumping around historic lows as the Federal Reserve maintains its policy of zero percent, they are almost certain to rise in future years, perhaps meaningfully.
Typically, these sorts of conditions do not make for easy sailing in financial assets. So why are we optimistic? Tough markets and troubling headlines allow us to plant the seeds of capital growth that may be harvested in future years. Rather than dwell on difficult to predict macroeconomic negatives about which we can do little, we focus instead on finding sensible things to do with money other than a near zero interest bank deposit or low-yielding and long-dated bonds having enormous risk of loss should interest rates rise even modestly.
Part ownership of a good business, at the right price, is a better way to deal with either inflation or deflation than many of the alternatives. We are mindful that sooner or later, public markets create opportunity for the prepared. As we start out, it is entirely fitting that our largest investments are in the technology arena – in a group of companies we refused to touch more than a decade ago when the world was enthralled with all things Internet and related securities were priced beyond perfection.
Today, some of these same businesses have achieved a measure of dominance in their areas of specialty, have extraordinarily strong and liquid balance sheets, operate around the world, continue to grow, and now sell at low multiples of earnings and low prices compared to our estimates of intrinsic value. We have established meaningful investments in Microsoft, Google, and Hewlett-Packard. We believe all are capable of generating attractive owner returns over time from present prices irrespective of near-term economic conditions and doubts about the persistency of their franchises, which our research leads us to believe are stronger than most realize.
We also own some smaller businesses whose results are not overly dependent on the strength of the American consumer or U.S. economic growth. For example, Walter Investment is a sub-prime lender and servicer whose experience has been far better than the rest of its industry throughout the downturn. Walter has agreed to purchase Green Tree Financial, a quickly growing and privately held business that services loans for some of the country's largest financial institutions.
While Walter is leveraging to do so, we judge the risks to be manageable. Importantly, neither Walter nor Green Tree appears to have meaningful exposure to the charges of servicer or foreclosure abuses plaguing the large banks, nor are they assuming credit exposure on new servicing business. Once the deal is completed, the company's biggest risk will be a return to rapid appreciation of home prices – something that has yet to appear as even a speck on the horizon.
Federated Investors is an investment management firm whose largest product category is money-market mutual funds and which manages more than $300 billion in total assets. The Donahue family, which started the business more than fifty years ago, continues to have a meaningful management and ownership interest. Despite being forced to offer large management fee waivers on money funds whose yields are close to zero, Federated continues to generate decent cash profits and high returns on invested capital.
We believe that with a modest rise in interest rates, assets are likely to increase and a meaningful percentage of those waivers will be reclaimed and drop to the bottom line – demonstrating that the earnings power of the company is significantly higher than current results would indicate. While redemptions and unexpected regulations are always a risk, we believe the persistency of money market fund balances even at exceptionally low short-term interest rates is a testament to the strength of the company's franchise.
Another example is Spectrum Brands, a company we began to buy upon its emergence from Chapter 11 bankruptcy after its previous owner borrowed too much. The company owns, among others, such well known consumer staple brands as Rayovac batteries, Cutter and Spectracide insect repellants, Remington shavers, and George Foreman appliances. In each of their categories, Spectrum products tend to represent the "value" segment, where consumers get similar performance to the category leaders at a lower price – a compelling proposition for today's more frugal shoppers.
Importantly, a two year price war in batteries appears to have ended. Under new senior management, we expect the company to generate large amounts of cash relative to our purchase price that can be used to rapidly pay down postbankruptcy debt and build equity for owners. In an evolving world of millisecond trades, worldwide markets, and 24-hour financial commentary, long-term investors are often seen as dinosaurs – unable to adapt and headed for extinction. We disagree.
Although not easy to execute, a disciplined value investing approach, when done well, has historically held out the prospect of increasing wealth in a more favorable fashion when compared to many of the alternatives, albeit in a lumpy manner. We believe that most business is a lumpy process and that taking advantage of volatility is a big part of our job. Our best opportunities may come when markets are volatile or headlines are scary.
We also want to reiterate that the Fund has a relatively low total expense ratio and does not pay any marketing expenses. There are no 12b-1 fees here, nor other expenses normally borne by shareholders so that a fund's investment advisor can expand its empire. We want to grow, but intend to accomplish it the old-fashioned way – through performance and word of mouth. If an advisor wants to spend money on such efforts (including ourselves), Fund shareholders should not pay the freight. Lastly, we believe it is important to understand that shareholders come first and that we are significant shareholders ourselves – we each have invested seven figure sums in the Fund and expect to increase these amounts over time. While our personal investments will never guarantee positive results, they do help to correctly align our incentives as managers.
You should always expect to see a chunk of our money with yours. Here is the link to their semi-annual report: [www.goodhavenfunds.com]
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