Bill Miller himself once said: “This is a brutal business, success equals survival. If you have survived, you will have succeeded”. We have said it a little differently since 1988: to finish first, you must first finish.

Mr. Miller, famous for his 15-year streak of beating the S&P 500, has announced that he will step down as co-manager of the Legg Mason Value Trust in April 2012 (he will remain at the firm as Chairman). Investors of a certain age have certainly read a lot about this fund. Is Mr. Miller’s rise and subsequent fall a matter of genius becoming overconfidence or simple probability theory playing out as per Taleb? Not knowing the inside workings of Legg Mason Capital Management, no one can really claim to know the answer. To help us think about it, we collect several links inside.

The summary: Bill Miller took the reins of the Value Trust on April 16th 1982, and in the time since then he has “produced an annual return of 11.25%, according to Lipper“. The S&P 500 in the same period returned 8.3% p.a., not including dividend reinvestment. But in the 15-year period from 1991 to 2005 the fund beat the S&P 500 every year, which made the fund’s (and Bill Miller’s) fame global. Fortune Magazine called him “the greatest money manager of our time” in November 2006.

Well, ever since then it’s been downhill and the fund is now down a compounded 9.7% per year. The list of “mistakes” is all over the web, and it included Eastman Kodak, the mother of all case studies on cultural chains that bound a company to its past. As early as 2008 the press, so happy to boost him before, was calling for his head. Just remember that it’s always hard to call if it is a research, sizing, timing mistake or simply a matter of probabilities playing out unfavorably despite a good process.

Either way, even though the company did beat the S&P 500 over 15 years starting on Jan. 1st 1991, the returns are actually slightly lower than the S&P 500 from that same date until Bill Miller’s announcement on Nov. 16th (7.4% p.a. vs. 7.7% for the S&P).

Is this a case of people/ press deifying a man and a team because they were measuring “performance” as simply “outcomes” and forgetting about “processes”? In other words, was Bill Miller an “articulate coin flipper”? Here’s the odd part: Bill Miller and his company have always been concerned about investment as a multi-disciplinary, psychologically-driven, incentives-based field. He has studied widely and fostered innovative thinking in the industry – he has even hired Michael Mauboussin to be a “chief instigator” of sorts (official title: Chief Investment Strategist). Legg Mason, Mr. Miller, Mr. Mauboussin and others have been active members (Mr. Miller was Chairman of the Board and is Chairman Emeritus) and supporters of the Sante Fe Institute, a research powerhouse focused on “complexity research expanding the boundaries of science”. That doesn’t mean their processes were above questioning, nor that they couldn’t fall prey to some of the traps of success, but there’s at least the appearance that they had it covered at Legg Mason.

Overconfidence? Here’s an excerpt from Bill Miller’s letter to Value Trust shareholders in January of 2006, only days after completing the 15th straight year beating the S&P: “I thought it might be helpful, in addition to saying how much we appreciate your confidence in allowing us to invest your savings, to say a little about the principles…” (…) “You are probably aware that the Legg Mason Value Trust has outperformed the S&P 500 index for each of the past 15 calendar years. That may be the reason you decided to purchase the fund. If so, we are flattered, but believe you are setting yourself up for disappointment.” – Sure, it could be just lip service. But for over 12 years we have been reading his shareholder letters and he seems to really be the person who gave this interview to Money Magazine in 2007.

Could it be the old problem of size trumping performance? At its peak in 2007, Value Trust ballooned up to $27 billion in assets (when Mr. Miller resigned it was down to $2.8 billion). Again, not necessarily since there is evidence of long-term market outperformance with even larger assets (e.g. Berkshire Hathaway).

Mr. Miller has been rumored to be retiring and had been complaining about two things: “The huge rise of exchange-traded funds, which allowed people to buy baskets of things which caused correlations to rise, and of course the rise in algorithmic trading.” And this Financial Times LEX article on November 18th checks that out and says yes, correlation is going steadily up. But this is also certainly not enough.

Finally, it is worth noting that Mr. Miller is another one in a list of recent departures: George Soros and Stanley Druckenmiller have also recently quit. And in a big story in August of this year, the Financial Times noted that “several of the industry’s most prominent names have had a disastrous year so far.” That list in 2011 also includes John Paulson (the best of all active money managers in the five years that ended on December 31st, 2010) and Bruce Berkowitz of Fairholme.

There are no easy lessons here, no fingers to point. Remarkable, yet just another occasion to provoke thought, rekindle humility and remember once more that to finish first, first you must finish.

Nice quote from one of the videos, in which he explains why he and his wife have joined Buffett and Gates’ ‘Giving Pledge’: “I think anyone who doesn’t give credit to the system that they’re born into is taking an awful lot into themselves. I really think that people have sacrificed a lot more than a little tax money to make that system available for all of us. And I would be ashamed of myself if I didn’t give some credit to them”.

Hedge fund chief takes major role in philanthropy – NY Times, Sept. 15th 2011

Tom Steyer is interviewed in the 2007 Endowment Management Seminar, and you can find the transcript in this PDF, beginning on page 7. Interesting stuff on Farallon, people, training, incentives…

California’s hedge fund king – Fortune, Sept. 22nd 2008

Wikipedia pages: Tom Steyer and Farallon Capital

Example of Tom Steyer’s energy activism – NY Times, March 2011

Tom Steyer, the jolly green banker – Fortune, Dec. 8th 2010

Tom Steyer joins Buffett and Gates’ “Giving Pledge” and gets emotional about it (video, also embedded below):

“Fair and just banking for low income communities”: a speech found in video, part one and part two linked here (and embedded below).

This wasn’t the first time we profiled one of the managers we keep track of: Glenn Greenberg was the first (the order doesn’t imply anything, by the way).

Quotes from the story:

“Reporters work, in many ways, like authenticators. We encounter people, form intuitions about them, and then attempt to verify these impressions. I began to review Biro’s story; I spoke again with people I had already interviewed, and tracked down other associates. (…) As I probed further, I discovered an underpainting that I had never imagined.”

“Forgers usually succeed not because they are so talented but, rather, because they provide, at a moment in time, exactly what others desperately want to see. Conjurers as much as copyists, they fulfill a wish or a fantasy. And so the inconsistencies — crooked signatures, uncharacteristic brushstrokes — are ignored or explained away.”

“Connoisseurship is rife with flaws. It is susceptible to error, arrogance, even corruption. And yet there is something about that ‘strange breed of cat,’ (…), who could truly see with greater depth — who, after decades of training and study and immersion in an artist’s work, could experience a picture in a way that most of us can’t. Connoisseurship is not merely the ability to discern whether an art work is authentic or fake; it is also the ability to recognize whether a work is a masterpiece. Perhaps the most uncomfortable truth about art is that such knowledge can never be truly democratic.”

The similarities between the job description of an analyst (at IP) and the one of an investigative reporter have already been mentioned several times in our intranet and discussions, but also here at Buysiders.com.

The documentary’s siren song is quite enchanting. But what seems to be an independently produced film, might end up becoming the marketing tool for a well-packaged scam. In a certain way, the buyer of a fraudulent piece is not a victim, but an associate of greedy pseudo-experts. He wants so dearly to proceed with the buying that he overlooks the imperfections of the case. Impossible not to think of the piles of IPO prospectuses that are dispatched to our company in certain “bullish” times, displaying brands and names that refer to much of what has been depicted in the article.

Toolboxes that systematize the analysis & investment process, technical analysis (~ “fingerprints” of the behavior of securities prices) and the likes can be viewed as means in favor of the democratization of the stock markets (in “three easy steps”). Rephrasing the author: “perhaps the most uncomfortable truth about [investment process] is that such knowledge can never be truly democratic”. This reminded us of what we once wrote in a portfolio report:

Many seem to believe that valuing a company diligently consists of setting young men who have recently graduated or concluded their MBAs to read prospectuses, half a dozen annual reports and the same amount of conference calls, to talk two or three times with the company’s management, ask about their “sustainable competitive advantages”, apply Porter’s 5 strengths model, and the grand finale: process a discounted cash-flow model, making a cut of 10 to 15% in the management’s projections in order to avoid, of course, potential “execution errors”. To lend an even more “professional” aspect to the process, one adds to this basic “conservative” scenario another more optimistic one and a pessimistic one, and – voilá, the cake is ready.

In our experience, evaluating investment opportunities is not limited to this type of mechanical proficiency. It does not assume training by means of analysis manuals and “kits” that, once learnt by heart, are applied on an industrial scale by anyone, as the occasion dictates. This “pasteurization” leads, in the best of cases, to consensus, to the average.

After all, “analysis” does indeed involve discipline, sweat and hard work, but it is more finesse and interdisciplinary integration than brute force.

Evaluating investments is a much broader, richer and more interesting process than the idea evoked by the word “analysis”.

This Richard Feynman-inspired “difficulty of getting to KNOW something”/ “having to pay the tolls to achieve knowledge” has been the subject of other posts here as well (this link is a good starting point). Munger phrases this as the objective of an intelligent man’s life: making sure you lie down in bed everyday a little smarter than your were when you woke up.

The good news is that this road never ends.

Finally, and this can’t be stressed enough (it’s the typical “last but not least” situation), there’s an underlying issue of eschewed incentive systems in the article. We’ve discussed this in our Q4 2oo8 report, specifically in a section called “Dolus Bonus”. Some quotes:

The experts were true authorities. For the appraisal of a work of art, they would receive a commission, a percentage of the sales price that could range from 5% to 25%. Obviously, if they confirmed it as genuine, they would earn astronomical figures. If they belittled it as false or as a work by some other, “lesser” painter, their earnings were much more modest.

(…) Berenson was, in fact, the greatest authority on Renaissance painting at the time, and used all his connoisseurship and reputation as a historian and “independent” critic to validate the authorship of dozens of works of art in support of Duveen. A secret contract with the dealer guaranteed him the payment of a fat percentage for each work sold in the course of 27 years.

(…) In short, during the formidable “bull market” in the art sector at the beginning of the last century, a real virtuous circle of incentives was closed: the favorable opinion that made the professor rich also endorsed the dealer and the seller. What is more, the buyer was not left out either: with the expert’s guarantee, he became the owner of a certified work of art. To have a “Raphael” certified by the seal of Berenson was worth much more than just a “simple Raphael”. Finally, if we add to all that the tax benefits granted at that time for donations to public collections, we have a true “heavenly feast”.

(…) The similarity between this “virtuous” circle of fees and commissions and the merry-go-round led by brokers, investment banks, rating agencies, investors and companies of the modern world is evident. So is the vast range of misalignments and conflicts of interest inlaid in the model. And if Duveen went so far as to sell the work “Aristotle contemplating Homer’s bust” four times, always pushing the price up, Avis, the car rental firm, has been bought and sold no less than 18 times since it was founded in 1946 – probably handing to lawyers and banks, in fees and commissions, a good deal more than the value of the whole company at today’s price.

Of course, so is this commencement speech by Steve Jobs (the 5th video in the post): on a very different note and yet just as good.

Should make for very good reading material!

We posted an interview with Mr. Klarman back in September, also worth the read.

Update (Feb. 17th, 14:00 ET): Bloomberg Business Week magazine published a lengthy profile on Bill Ackman in its last issue. Always be wary of stories about controversial people, be it favorable or unfavorable.

In the first section below, there’s a good defense of short-term traders in the stock and financial markets in general. They provide liquidity and different opinions due to many different reasons – but mostly, of course, the long vs. short-term focus arbitrage.

In this next section, Mr. Ackman discusses JC Penney in more detail, especially and most interestingly in comparison to Target and even Eddie Lampert’s Sears. As with the other two, JC Penney is an older retailer which owns a lot of its real estate or has long-term leases with very low rent. While it is a good aspect, he notes that having “free rent” can actually cause less discipline with costs and general operations that leads to inefficiencies. Having seen firsthand many such examples over the years, we agree when he says that “you have to run your business as if the rent is high”. There’s a bonus after some 8:30 where another HBS professor – Clayton Rose – is discussing GSE’s such as Fannie Mae and Freddie Mac (he’s in the Board of Freddie Mac). Mr. Ackman then drills him on where his fiduciary duties lie: shareholders, the government, etc. A very interesting exchange follows. Later on, he attacks rating agencies, with an interesting idea about the role of rating agencies.

Plus: since Mr. Nygren highlighted one of the best Michael Jordan TV commercials ever, we’ve posted it here alongside other sports-related TV ads we think carry important messages for investing, working and – dare we say it – life in general.

Michael Jordan “Failure” ad (0:30 – with subtitles in Portuguese):

Michael Jordan “Maybe” ad (1:02 – with subtitles in Portuguese):

Lance Armstrong “What are you on” ad (0:32):

As we said in the “Why we write” page of Buysiders.com, “risk is much more about knowing very well who you’re dealing with than it is about greek letters”. We also say: “with this site we aim to show potential investors and investees a “live” window into most of what we look at and how we think. We hope it will spark connections with the right people over time, in an efficient way”.

We’ve obtained permission from Exame to translate and publish the interview and here it is.

The Portal Exame interview in full:

We prefer stocks of oligopolies, says Investidor Profissional

Brazil’s first independent fund manager says that in the long term, it’s better to invest in companies that have few rivals and low capital needs

By João Sandrini at EXAME.com

Rio de Janeiro-based Investidor Profissional, the first independent asset manager in Brazil, has a lot to teach those who invest in stocks. Since its inception in 1988, IP’s managers have looked for stocks of oligopolies or near-monopolies in the sectors where they operate, with low bankruptcy risk, low capital needs for investments and run by people who understand the importance of treating well minority shareholders. It’s not easy for a company to comply with these criteria, and even that is not enough. The few businesses left will only receive IP investments when the stock prices are attractive, in a true exercise in “patience and discipline,” according to partners Christiano Fonseca Filho and Fred Trigueiro.

Founded when the Comissão de Valores Mobiliários (the equivalent of the Securities & Exchange Commission) didn’t even recognize the role of the independent manager, the firm has today 1.2 billion reais under management. Since 1993, IP’s flagship stock fund has recorded a return of 26% per year, in US dollars. The investments are carried out with a long-term outlook in terms of return. The most profitable position, in Saraiva shares, was set up 15 years ago and is still in the fund. Itaúsa, Dimed, OdontoPrev, Amil and Aliansce also make up a relevant part of the fund. About 30% of the money, however, remains readily available, on the lookout for attractive prices. In this interview, Trigueiro and Fonseca Filho explain the investment philosophy, the process of picking the best stocks and the story behind the creation of IP:

EXAME – What does Investidor Profissional seek in a company in order to make an investment?
Trigueiro – We’ll always prefer a company whose business model is less capital intensive, and which has real assets backing its share value. A large position that we have at present is Aliansce. We have a greater degree of comfort with the company’s governance compared with that of other firms in the shopping mall industry. We also think there is an asymmetry in terms of information and expectations. Aliansce’s IPO took place more recently and people are little familiar with it. We began studying the company before the IPO. We already tracked the shopping mall industry and we knew the competitors. So we quickly gathered the necessary knowledge to set up an important position.

EXAME – What other companies are you optimistic on?
Trigueiro – Besides Aliansce, I like Totvs and OdontoPrev very much. We had the opportunity to buy them at a third or a quarter of their current prices. We have scaled back the OdontoPrev position recently because it has already risen a lot, but we still like it in the long term. We also like the financial services industry and Itaú Unibanco, which is our largest position.

EXAME – What do these companies have that the others do not?
Trigueiro – We tend to like companies that are oligopolies or near monopolies. In Brazil, the cost of capital has always been very high. The companies that survived are more vertically integrated than the international average and are oligopolies. The markets usually have three or four dominant companies. So you look at our portfolio and see Itaú Unibanco, which is an oligopoly. The shopping malls are almost monopolies in the areas where they operate. Amil has a very strong position in the health insurance market. OdontoPrev also dominates its field. I don’t even know whether it would be possible for a business like OdontoPrev to go bankrupt.

EXAME – Most of these stocks in your portfolio surged in the past few months. How do you behave in this case?
Trigueiro – We are very judicious and thorough, and we emphasize patience and discipline. Today, 30% of the portfolio amounts to cash. Many people have started asking whether we should have waited longer to sell part of the portfolio. We say that we are not pessimistic, we are just exercising patience and discipline. Our principle is to not lose money. As a result of all the crises Brazil has been through, we learned to guard ourselves and make money when the market is booming and not lose money in lean times.
Christiano – This made for an incredible performance for our fund compared with the Ibovespa. Since 1993, our stock fund has yielded 26% per year, in dollars.

EXAME – What risks do you see in the market in order to keep so much money on hand?
Trigueiro – The world is weird currently. There are sovereign risks in Europe. The outlook for the United States is complicated. The story that China will be able to offset the decrease in the purchasing power of U.S. consumers also doesn’t convince me. There are problems in China that will not be solved with a five-year plan. And there are also things which we don’t know that we don’t know. But we like to respect our own ignorance. We know the world is experiencing excess liquidity, which will attract more money to Brazil. But in fact just a few opportunities survive our filter. We think that there are many capital-intensive companies that might raise funds easily and therefore could appreciate at present. But if things don’t go as planned, they may suffer. One such example is [car-rental company] Localiza, which I love because of its fantastic management. However, their business model is not the best thing in the world. They need a lot of capital to buy cars, and they need to sell them later. So far they have been shrewd. But I don’t know what the limit is. It’s a company I’d invest in, but not at current levels. Natura, Drogasil and Renner passed through our filters in that they have good business models and governance. But combining this with price, I see few options on Bovespa.

EXAME – Investidor Profissional was the first independent asset manager in Brazil. Where did the idea to set up such a company come from?

Christiano – IP was founded in 1988, at a time when the CVM did not even acknowledge the role of the independent manager. Our corporate name is Investidor Profissional Gestão de Recursos, but at the time it was Investidor Profissional Consultoria. Until 1993, investors hired us to manage their portfolios. They signed powers of attorney so we could buy and sell stocks for them. We managed about 35 portfolios independently, which was really hard work. Tax calculation was the worst part. The fund is not taxed, only the withdrawals are levied income tax. But some of our portfolios were taxed every month. Only in 1993 did the CVM change the rules. We changed the corporate name and launched our first fund, IP Participações.

EXAME – What was the fund industry like at the time?
Christiano – At the end of the 1980s, the fund industry was in the hands of large banks. There were good reasons for that. As soon as we founded IP, we realized that things were not so easy. Asset management is an activity that depends deeply on credibility, and we were kids without any track record. Our company was comprised of three partners and a secretary. Roberto Vinhaes was the oldest one, at 24 or 25. He graduated in engineering and worked on his family’s cocoa farm, but he was self-taught in stock investing and had been an investor since he was 15. I worked at the brokerage company Nacional. What we did was to hire good services in a way for the investor to understand that he was not taking on our credit risk. It was only the risk that the investment could turn sour. Itaú, for example, was the custodian of the stocks. Withdrawals could only be made into the investor’s account. So it was clear that we could not just take someone’s money and run.

EXAME – Was this format of independent asset management already well known abroad?
Christiano – Roberto Vinhaes studied the international market before we started the company. He was my client at Nacional, which had nothing to do with Banco Nacional. At the time, it was the largest brokerage in Brazil by number of clients. Some investors spent the days following the market and gave their orders from there. My father had a small stake in the brokerage and Roberto used to go there. One day he told me: “These guys [the clients] buy and sell stocks and have no idea who they are investing in. Why don’t we set up an investment fund manager?” I didn’t even know how it worked. So he gave me a Businessweek article that explained the appearance of asset management firms and investment boutiques in the United States throughout the 1970s. The article said that the managers were people who left the big banks to set up their investment firms, bringing along some clients. It is obvious that the vast majority remained with the bank, where they felt safer. But those who understood more about it knew that investment management depends on people, not on institutions. Therefore some investors monitored the movement, which led to the creation of more such firms. Even the banks realized at some point that they couldn’t compete, and established partnerships with the asset managers. They offered to their clients their own funds and also funds of others. Today it’s normal for an Itaú client to be able to buy funds of the bank or of several other companies. Back then, it was interesting and innovative. But when you’re near the floor, you’re not too afraid of falling. They offered to their clients their own funds and funds of other companies. Today it’s normal for an Itaú client to buy Itaú funds or funds of many other companies. At the time, this was interesting and innovative. But when you are near the ground, there’s little fear of falling.

EXAME – Did IP start to make money quickly?
Christiano – No, it took a long time for the business to take off. IP started with a very small base of about 35 clients, who delivered to us a total of 500,000 dollars. It was difficult to raise more capital without a track record and we did not have any money for marketing. With the 10,000 dollars that we invested in the business, we bought telephone lines, computers and a laser printer. The printer enabled us to create a weekly magazine about the market and to publicize IP’s work. The idea was for the magazine to carry inflation-adjusted data, charts and stock prices. As inflation was very high, that was important at the time.

EXAME – And how did you distribute this publication?
Christiano – Bovespa helped us. I scheduled a meeting and brought a manuscript of the magazine to Eduardo Rocha Azevedo, then the president of the exchange. He already knew that Brazilian investors used to lack specific knowledge and he thought the idea was fantastic. We decided to start it in direct mail format, which would be distributed through Bovespa’s 20,000-investor mailing list. Eduardo also ordered the production of a letter using Bovespa’s letterhead with his own signature, introducing the Investidor Profissional magazine to clients. That rapidly attracted a good number of subscribers. When the Collor administration’s economic plan came in 1990, people were left with no money to invest and sales plunged. At that time, the magazines “Bolsa” and “Enfoque Gráfico,” our main competitors, went under. We decided to make it a monthly publication, instead of weekly, and we survived. In all, the magazine lasted six years and brought many clients to IP. In 1995 we decided to stop it because we no longer needed it to raise money.

EXAME – And in the investment area, did you know what you wanted to do from the beginning?
Christiano – At 24, Roberto already knew in detail what investment philosophy our stock fund would have. Back then, I thought there were two types of funds: stock funds and fixed-income funds. Roberto explained to me what “value-oriented” funds were, which had been made famous by Warren Buffett. He knew that was what we should do. Before IP, when Roberto invested his own money only, he tracked 15 companies. For each of them, he had a folder with his handmade charts, inflation-adjusted balance sheets and all the news. The difference is that with IP, we started to track another 74 companies in order to run the magazine.

EXAME – And how did this “value-oriented” philosophy work?
Christiano – “Value oriented” means trying to identify the fair price of a certain company and, in a very disciplined way, to wait for the market to swing in order to buy these stocks below that price and sell them near their fair price. At that time, we already had in mind that, when we buy a company, we were becoming its partners. So our first task was to identify whether the owner was honest, because back then the companies did not have such a high level of governance.

EXAME – In regard to what Buffett taught, what needed to be adapted to the Brazilian model?
Trigueiro – Given that there are only a few companies with liquidity on Bovespa, the asset managers need to perform a very extensive research initially. It is necessary to investigate the people, the controlling shareholders, what their life goals are, if they will be market leaders or just want to chill, if they are willing to share growth benefits with the minority shareholders, if they know what to do with the capital. This demands time because you can’t find out whether someone is dishonest by asking him. Since it was harder to buy and sell a company, we needed to be very sure that we were not buying a pig in a poke. During the process, we had the opportunity to learn a lot, sometimes even by making mistakes.

EXAME – Where did you lose considerable money?
Christiano – We participated in many deals that involved corporate governance issues. With Lojas Renner in 1999, for example, we learned a lot. In the end we made a lot of money, but the profit could have been heftier. We had a position in the company and we considered the controlling shareholder to be trustworthy. In 1999, I received a phone call from Cristiano Renner, with whom I had talked just once. He told me he had sold Renner’s controlling stake to J.C. Penney and that the agreed price for the voting shares was much higher than that offered to preferred shareholders in a public offering to delist the company. It was a bad time for this operation because the stocks had fallen sharply and the offered price was just a little higher than that on the day the deal was announced. Even so, most of the shareholders sold their shares. Only us and three other funds stuck to the shares and decided to fight for a better price. The bank coordinating the operation threatened us, saying we would be shareholders of a publicly-held company with no liquidity. Meanwhile, we reminded them that they could not delist the company without our support. We fought so much that we ended up selling at a price almost twice that offered to us initially. We had a very good relationship with José Galló, who already was the company’s CEO. This relationship was unscathed, and in fact we consider Galló the greatest retailer in Brazil. In fact, when J.C. Penney went through a bad period abroad and decided to sell its Renner stake, we came back. We remained as relevant shareholders until this year, but we sold most of the stock because the price rose steeply.

EXAME – One lesson that could be learned from this is that it’s important to buy the same stock held by the owner?
Trigueiro – The closer to God, the better.
Christiano – At Itaú Unibanco, for example, we prefer to own Itaúsa shares instead of Itaú because that’s where God is.
Trigueiro – In theory, the rules of Bovespa’s New Market can protect the minority shareholders from this type of event. But new, creative ways allowing a premium for control always come up. The companies we believe that have bad governance will take up very small positions in our fund, even if they are great deals. In order for a stock to account for 3% or more of the fund, we will demand superior governance.

EXAME – What was the most profitable company for IP?
Trigueiro – Saraiva, which is our longest-running investment. To show you how low our portfolio’s turnover is, we have a 15-year-old investment there. When we started, it was a publishing company that had just two bookstores. Presently they have 100 bookstores and a Web site. We helped them change because we already tracked Amazon. We also took them to the United States so they could visit Barnes & Noble. They did a very good job setting up a retail business, and managed to take advantage of the Saraiva brand on the internet. The result of this transformation is that at present the publishing company sells 300 million reais; the site, 400 million; and the bookstores, 500 million.
Christiano – We were rewarded for our role in this process. Saraiva was the first company in Brazil to voluntarily give “tag-along” rights to minority shareholders in case the controlling stake was to be sold.

EXAME – How do you pick stocks?
Christiano – We consider our investigative work an important differential. In order to really know a company, we think that the least valuable action is to talk to the company’s investor relations director. You’re going to hear a speech that the guy has practiced a thousand times and has already delivered to everybody. Those who know only what the guy will say are on an equal footing with many competitors. We seek different information and talk with suppliers, former employees, current employees and customers. We hired a professional just to help the analysts prepare their calendars, to schedule meetings. Another differential at IP is that information circulates very well within our own fund. Besides the investment meetings, we developed an intranet that works as a big blog. The analysts post and discuss interesting information that they obtain in their work meetings.
Trigueiro – In the seven years since we set up our intranet, we managed to gather an enormous data base. If we want to begin studying a company such as Cyrela, for example, it’s not necessary to start from scratch. It’s very fast for someone to understand the company. We also save information from companies we don’t currently follow because we can’t keep track of everything, but one day they can be on our radar.

EXAME – Where else do you obtain information?
Christiano – For 10 years we have been making trips abroad to understand how companies and industries work internationally. We don’t go only to conferences, neither do we just visit companies. A few weeks ago, we did something unprecedented. Our eight analysts spent 15 days in Asia.
Trigueiro – On this trip we investigated the microeconomics in order to understand how China works. We wanted to understand the country that is considered one of the engines of the global economy. We didn’t travel to listen to the companies’ investor relations area, neither to hear the official agencies. We talked to lawyers, accountants, real estate companies, local governments. One group was tasked with analyzing infrastructure. Another group checked what Brazilian companies such as Fras-le, WEG and Iochpe are up to there. We learned more about the accounting at the companies and banks, the specifics of the stock exchanges. It was a very enriching process to check several hypotheses we were building in our heads and to understand if any structural risk might jolt the Brazilian market.

EXAME – Does today’s China pose a risk to Brazil?
Trigueiro – Money is flowing towards them as if China were a capitalist, protected and well-regulated economy. Our view is slightly different. They have considerable real estate investment because the cost of capital is low. They can quickly construct 10,000-apartment buildings. The problem is that when the local banks fund this growth with external investment, a bubble-like condition is created, which is potentially dangerous for the Brazilian capital market.

EXAME – What else did you look for when you were abroad?
Trigueiro – It is very important to understand what goes on abroad and compare it with what the Brazilian companies are doing. Totvs is a good example. If we didn’t know how difficult it is for a company to stop using management software after it’s already installed on their computers, maybe we wouldn’t have invested in Totvs. When OdontoPrev and Amil debuted on the Bovespa, it became easier for us to invest because we already followed the health sector in the U.S. People who don’t look outside won’t be able to tell if BR Foods will be a world-class company in the consumption goods industry or if it will remain a cyclical company focused on exports.

EXAME – For individuals who have smaller positions and don’t need to worry about liquidity, what would be the best investment strategy at this moment?
Trigueiro – I’m afraid of people who don’t buy stocks through a fund. This person has no idea about what he doesn’t know about the stock exchange.

EXAME – What do the people who make money on the market do?
Trigueiro – There are four sources of gain. One is informational advantage. I know something you don’t know. This is becoming increasingly uncommon and is often illegal. So that’s something we prefer not to cultivate. The second source is analytical advantage. Having seen China, been on the bullet train, understood the local real estate market, obtained information on corruption, all that will give us an advantage in assessing what is going on there. We like to fish where no one is fishing. The third source of gains is patience and discipline. That’s easier said than done. We have an investment committee just to analyze that. It’s very common for the best companies to be expensive, and we always have to think on the price that will be paid. The fourth source of gain is to find the right vehicle to invest. Looking outwards, there are more options. One can invest in debt, convertible securities or stocks of a company. In Brazil this is still uncommon, but we think there will be more options in the future.

EXAME – Within this strategy of patience and discipline, when is the time to start buying?
Trigueiro – There are three types of opportunity. One of them we call “rerating.” The company delivers bad results for two or three quarters, but the market perpetuates this movement and price the stock exaggeratedly lower. There are also companies that we call “compounding machines,” which consistently generate returns above 20% per year. We prefer these in our portfolio. And a consumer’s dream is when you have the opportunity to “rerate” a “compounding machine.” In the 2008 crisis, we bought Renner at 15 reais and Itaúsa at 5 or 6 reais. To take advantage of these opportunities, it’s necessary to have some cash on hand.

EXAME – How much does IP manage?
Trigueiro – About 1.2 billion reais.

EXAME – Why do funds created after IP have more assets under management presently?
Trigueiro – Within the stock fund, there is an optimal limit to execute our investment strategy. We think it wouldn’t be possible to do the same thing if we managed 3 billion reais, for example. We’ve eyed a few possibilities, such as opening a private equity fund. It would be a way to manage more money doing something similar to what we do. But we realized that’s not our competency.
Christiano – There’s another fundamental factor. We don’t pay rebates to distributors and banks. If an institution offers our fund to clients, that’s because they like the way we manage money. Before the 2008 crisis, we reached 3 billion reais in assets under management, of which 1 billion reais were in a long-short fund with money raised from distributors. When the crisis came, everyone started to withdraw their money. Maybe it’s a coincidence, but the only two distributors who stayed with us never got rebates. So we don’t do that anymore. We think the maximum amount we could manage without losing agility is 1.5 billion reais. And we’ll reach that without rebates. One last factor is that 60% of the partners’ and executives’ assets are inside the fund. This makes us even more careful in managing the resources and I think it’s another reason for the investor to feel safe with us.