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   Interview

    Guest Interview:

   Oristano Capital

    The Pilot House
    Lewis Wharf,MA 02110

    Telephone: 617-854-3761
    Fax: 617-854-3763
    E-mail: jpickard@oristanocapital.com

 

    Interview Quarter: 3Q2007

 Joe Pickard

 Principal and Chief Investment Officer

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  Joe, what is Oristano Capital Management’s overriding investment philosophy?  
  Peter, Oristano Capital is a long-term, global, multi-sector, balanced absolute return investment adviser. This style is based on the premise that we think we’re in a long-term secular bear market and that one has to dig a little deeper to get performance. The days are long gone when you could just put eighty percent in Spyders ( S&P 500 Index ) and twenty percent in a Government Bond Index, and expect to get above average returns. That was the right thing to do in the eighteen-year secular market from 1982 through 2000, but not today. When you think about it, if we were in a secular bull market today, the market would have to surpass 100,000 by 2020, and we don’t believe this to be in the cards. Fortunately, at Oristano, we like secular bear markets, and although that sounds like a provocative statement, it gives us a chance to find real value across the globe, as opposed to chasing yesterday’s stocks. If we’re right in our analysis, these sectors that were neglected in the last secular market in the US will grow up to be the next long-term secular bull markets. We’ve concentrated our efforts in small cap value, emerging markets, and natural resources for the past five years and that has been the primary reason for our impressive performance.  
  What is your investment background and why did you decide to start your own firm?  
  After graduating from Wesleyan University in Middletown, Connecticut, in 1966, I started my career with Bankers Trust as an assistant portfolio manager in the pension trust area now known as the employee benefits department. The timing was interesting, and proved to be a good learning experience, as 1966 was the beginning of the last secular bear market that lasted until 1982. From BT Co. I joined EF Hutton & Co. as a registered representative in 1970, and in 1975, I joined their personal financial management division where I consulted with the firm’s high net worth clients. In 1988, I was invited to join Alex. Brown & Sons in Greenwich, Connecticut, working in the corporate services group, and in 1999 I joined Hambrecht & Quist in Boston in the same capacity. I stayed with Hambrecht & Quist through their acquisition by Chase Manhattan Bank and then merger with JP Morgan until 2001, at which time I joined Oppenheimer & Co. It was at Oppenheimer that I decided that if I could outperform the S&P 500 (over a five-year period) with considerably less risk, I would open my own advisory firm. I think the results speak for themselves.  
  What advantages does your global balanced style have over other traditional domestic managers?  
  First of all, we like to be balanced (approximately forty percent fixed income or fixed income equivalent) because down markets kill you. To take the old adage, if you have a dollar and you are up fifty percent, you have one dollar and fifty cents, but if you’re down fifty percent the next year, you’re are left with only seventy-five cents. A perfect example of this happened in the year 2002 when the S&P 500 was down over twenty-two percent, and Oristano Capital was up over seven percent. It took the S&P the next two years just to break even while we were up a healthy forty-five percent.

Second, because we are global, we have so many markets to choose from. The beauty of being in a secular bear market, or as I like to say a secular flat market, as most of the damage was done in the early (i.e., 2000–2002) years, is that it enables us to invest in markets that have been neglected for so many years. In my most recent newsletter, I commented that stronger currencies and lower interest rates are having a real positive impact on emerging market domestic economies, while a weak currency and higher interest rates are having the reverse effect on the US economy. I went on to say that this is leading to a decoupling of global markets and their US domestic counterparts. (To sign up for my free newsletter please go to www.OristanoCapital.com.) If I can get high single-digit growth from emerging markets at the same P/E multiple as domestic markets, it makes sense that I can get a bigger bang for my dollar, and the best part is that I don’t have to make a huge commitment to the sector.
 
  You describe yourself as strictly a “top-down” manager. Please explain what you mean by being top down.  
  Including myself, Peter, we have three employees at Oristano Capital. I believe it would be an inefficient use of my time to do research on individual stocks. Therefore, we have chosen to invest in closed- and open-ended mutual funds, a couple of exchange traded funds (ETFs), and currently, just two stocks. This then frees up my time to read several newspapers and pour into research. This is where the top down comes in. I’d rather spend my time in determining where to invest globally, what sectors to be in, and what capitalization I want to be in. I’ll give you an example: In March of 2000 when all hell broke loose, I was fortunate to have had put protection on my portfolios, but I also realized that the momentum game was over, and I asked myself, Where could we make money in what would become a secular bear market? As Mark Twain once said, “History doesn’t repeat, but it often rhymes.” The answer came when I remembered where we made money in the last secular bear market: small cap value, emerging markets (back then, the emerging market was Japan), and commodity-related assets. Why were these assets so inexpensive? Because they were neglected in the preceding bull market. I’m even using the same guy, Chuck Royce, to run my small cap value portfolio.  
  What is “global strategy” and why does this style of investing make sense for today’s investment climate?  
  We believe that a global strategy is necessary in today’s investment world if one is to achieve superior performance. As I mentioned earlier, if you’re in a secular bull market, all you used to need to do was buy an index fund representing the Dow Jones or the S&P 500 average . The market was trading at eight times earnings in 1982, and by the time the bull market topped out in 2000, it was trading at over thirty-two times earnings; this is called multiple expansion, and if you factor in an average profit growth of twelve percent, that is how you get a market to rise from one thousand to almost twelve thousand. Not a lot of brain work here, just buy the Index and hold on.

Not so today. When the market topped out in 2000, one of the areas that was highly undervalued, and that I mentioned earlier, was small cap value relative to large cap. We took advantage of that discrepancy and took a rather large position in small cap value. The problem now is that small cap is no longer inexpensive relative to large cap, and more importantly, it is more dependent on the sagging US economy. So where do we go next? Well, we have this once-in-a-lifetime event going on where most of the world is becoming democratic and capitalistic, and in turn we are creating a whole new middle class outside the US. With strong currencies, and lower interest rates, we believe that the opportunity in small caps is clearly overseas. If you are limited to US domestic issues, by definition, you are going to miss out on this opportunity.
 
  How do you determine how to invest in your international sectors?  
  That is a very good question, because unlike 2002, when all you had to do was to buy emerging markets, today you have to be more selective. As the US economy slows, it only makes sense that the large cap global stocks are going to be affected in a negative way. On the other hand, small cap foreign stocks are going to be less affected as they sell into the domestic economies, which are holding up quite well. As far as sectors go, you want to be in exporters when the US is economically strong, and just the opposite when the US economy is weak, as it is today. Although sticking to country funds for the most part, we do to a degree buy sectors in that certain emerging market countries might be more resource oriented, such as Russia, Indonesia, and others might have a more financial bias, such as Singapore). If we want to be in small caps, we’d probably be emphasizing Malaysia over Korea, for example. In the big picture though, we tend to pick the country fund, and let the manager decide the sectors that are most appropriate to invest in.  
  As a multi-sector manager, how do you choose which industrial sectors to include?  
  Again, Peter, what we try to do is determine where we are in the economic cycle. A secular bull market generally starts with very poor economic conditions but with some visibility that things might be turning around. In the seventies, we had high inflation, high interest rates, and a boom-and-bust economy that had a name called “stagflation.” In comes Fed Chairman Paul Volker with some tough medicine that created a lot of pain with two back-to-back recessions in 1980 and 1982. But guess what, he stemmed inflation, and in August of 1982, the journey was on.

I was at EF Hutton at this time, when one of the greatest calls was made by two of the firm’s chief strategists: to move out of hard assets and into soft assets. The meaning was clear: Volker had broken the back of inflation, and the Fed finally had some maneuvering room to loosen its monetary grip and add liquidity to the system. This was positive for soft assets (equities) but negative for hard assets (commodities), as the journey of disinflation would spur the market to increase by almost twelve fold over the next eighteen years, and all you had to do was to buy the market at 780 and buy government bonds with yields in excess of ten percent. Interesting enough, it is at this time (the year 2000) when everything looks rosy, with low interest rates and an economy that’s humming but where speculation has taken valuations to extremes, that the journey is over, the economy enters into a severe recession, and the long reflation process starts anew. It is at this time (history doesn’t repeat but it generally rhymes), when investors should be out soft assets (equities), and back into hard (commodities and natural resources).

It sounds simple, but that is generally how we go about choosing what long-term sectors we want to invest in. Obviously, it is not quite that simple, because as I mentioned earlier, there are other soft asset sectors (small cap value, emerging markets) that have been so neglected in the last bear market that they become good long-term buys as well.
 
  Which global economic factors are most important to you?  
  That’s an easy one. We look to the Global Universe to find countries with high domestic demand, low interest rates, and low inflation rates that enable monetary authorities to provide adequate credit for continued above average capital expenditures (capex). This was the case in the US in the sixties when Disney soared over twentyfold; it was the case in Japan in the eighties when their market climbed to almost fifty times earnings, and it was again the case in the US in the late nineties when worried about Y2K the Fed flooded the market and set off the dot com bonanza. I think this is the case today in emerging markets. The problem with the US economy is that even though the Fed has provided liquidity in an attempt to prevent a sub-prime meltdown, the individual investor is tapped out and the corporations are not willing to spend on capex until they can see the light at the end of the tunnel. But as long as the US doesn’t go into a recession, I’m fairly optimistic that consumer spending and corporate capital expenditures should continue at a rather nice pace in emerging markets, and that their markets should continue to do well.  
  What are the sources of your investment research?  
  Because I’m a top-down guy, I’m fortunate that I don’t have to spend much time researching stocks. My day is spent primarily reading domestic and foreign papers, business periodicals, and a few internet sites that I find quite informative in keeping me present on global markets and hopefully some insight on what to expect in the future. We don’t receive any research outside of what we have at our clearing firm, Fidelity. I do, however, spend a good deal of hard money on outside research and I believe this is one of the keys to my success. When I was with EF Hutton, in my early days, we had a buffer between our clients that was called research, and clients were willing to pay steep commissions in order to receive it. In today’s world, it seems that the client has as much or more than we have, and so you have to perform if you expect clients to pay you a fee to handle their serious money. That is why I’m willing to pay research boutiques for their superior proprietary research.  
  Please explain what you mean by being an “absolute return” manager.  
  I don’t believe in relative performance. Although my benchmark is the S&P 500, that is only a reference. When I take on a client’s serious money, he or she expects to make money every year and I think they have that right. Many of my clients have entrusted me with one hundred percent of their liquid assets, and so I have a lot of responsibility on my shoulders. I’m proud to say that I also have one hundred percent of my own liquid assets invested exactly like the separate accounts that I run for my clients, and how many managers can make that claim? Now, because of that, I make every attempt to show positive returns each and every year. I go back to the point that I made earlier as to how down markets kill you and how tough it is to recover if you have a serious drawdown.

Even though I am extremely bullish at this time in emerging markets and resource-related investments, it would be irresponsible for me to put too heavy a weighting on these sectors, as there is no science in investing and things can go wrong in a hurry. So to answer the question, I set up portfolios in a diversified and balanced manner. The fixed income portion of the portfolio gives me a stable return, and then I go for the performance with small positions in what I believe to be potentially explosive markets. If I’m wrong, I’ve cushioned the blow, but if I’m right, it doesn’t take a big position to have a very positive impact on performance. Obviously, there can be no guarantees, but in the twenty-three quarters of our existence, we have had only three down quarters versus six for the S&P.
 
  What do you mean when you say that you correlate some of your investments away from the S&P 500?  
  I think the best way to explain this is that when I wake up in the morning and turn on the TV, normally there will be something in the news that will enable my portfolios to have a chance at making money. If there is bad news from Iraq, Iran, Africa, etc., my resource positions may do well. If it’s bad news on the dollar, my commodity positions have a good shot at doing well, and if it’s Ed Yardeni (economist who coined the term “Goldilocks economy”) talking about a Goldilocks economy, then the equities that correlate positively with the market should do well. If I place all my bets on positions that normally track the S&P 500, then I’ve lost control of my portfolio and am setting myself up for a big drawdown, if the market cracks. This technique of adding assets that normally correlate away from the S&P 500 was a key to my positive performance in 2002 when the market was down over twenty percent.  
  You hedge your portfolios periodically by buying stock puts. What indicators would cause you to hedge your investments?  
  All secular bull markets start with low valuations. The bull market of 1982 started with a price-to-earnings ratio of less than eight times earnings. The current bull market in resources and emerging markets began with single digit multiples. During this initial phase, I normally will not hedge the portfolios as volume and volatility are generally low at this stage in the cycle. As the bull market progresses, however, more and more investors will crowd into the sector, and that is when the momentum phase begins. It is at this stage that multiples become meaningless and growth is the only factor that drives the particular market. I think we are at the beginning stages of this phenomenon in emerging markets, and now I will be looking to buy some insurance through buying puts below the market. The cost of this insurance is still rather low (approximately twelve percent annually), so it gives us the opportunity to ride the wave and hope that momentum will turn into a full-blown mania. Of course, all manias end the same way: Disney in the sixties, energy in the seventies, Japan in the eighties, technology in the nineties, and unfortunately, it is usually when the public gets fully invested that the bubble bursts. While there can be no guarantees, Peter, we hope to have that put protection secured when the next mania comes to its inevitable end.  
  Other than stock puts, what other ways do you minimize investment risk?  
  The best way, in my opinion, to avoid risk is to not be greedy. I mentioned that my two favorite sectors were emerging markets and natural resources, but because I’m dealing, in many cases, with the entire net worth of many of my clients, it would be irresponsible to invest one hundred percent of our assets into these two sectors. Even if you are right in a particular sector, that sector still can be subject to sharp downdrafts. So, I believe the best way to hedge against risk is to put together a well-balanced (investments in equity as well as fixed income), diversified, and well-correlated portfolio. Last week was a great week in the market, but if you were too over weighted in natural resources, you didn’t perform well. In 2002, if you didn’t have fixed income and some commodities in your portfolio, you probably had a negative year. Keeping control of your greed is the best way that I know of in controlling risk. You may not perform with the market if it goes straight up for a year, but in the long run, the tortoise usually wins out.  
  How have your portfolios done in bear markets?  
  Glad you asked. In addition to your number one ranking for performance and efficiency, I am most proud of the Up/Down ranking by a friendly competitor of yours. In a table entitled “Upside Downside Market Capture,” we are compared with the S&P 500 over the past five years. The results show that Oristano Capital captures 83.6% of the market’s up moves, but only 15.5% of its down markets. In 2002, this statistic was dramatically demonstrated, as we were up 7.64% while the market was down 22.10%. This is also the reason why we are up 129.85% versus 47.33% for the S&P 500 over the past five-and-three-quarter years.  
  What part does international debt play in your decision making?  
  We have an approximate ten percent position in International debt. Our objective is twofold: First, it is a fairly stable investment, as the debt is sovereign and is either in very short maturities or incorporates a floating rate. Second, it gives us a currency hedge against the US dollar, as the funds we use are all invested in local currency. As I mentioned earlier, our portfolios have a forty percent position in fixed income or the equivalent, and this provides us with a nice cushion when the market gets a little turbulent.  
  How do changes in international currency values affect your strategy?  
  This is a good question, because it has a lot of relevance to today’s market. By having positions, both fixed income and equity, in foreign markets we have benefited by their currency appreciation over the US dollar. Even Canada, as we speak, is at parity with the US. Now as long as the US dollar’s weakness is gradual in its descent, this is not a bad thing, as the domestic demand is picking up in these countries, and so they are not as dependent on exports to the US. Although global markets are diversifying away from the dollar, they are not abandoning it, and if the slide becomes more severe, it is most likely that there will be global support for the dollar. Once again, the descent of the dollar against other global currencies has been good for us-not only are we benefiting from the stronger global markets, but we are getting a bonus from the appreciation of their currencies, as well.

There is a caveat, however, and this is a big one. If there is a run on the dollar (odds are low at this point in the “super debt cycle”), then that would spell deep trouble for the rest of the world and particularly for emerging markets, because while strong, the domestic economies are still too dependent on US imports, and a run on the dollar would spell runaway inflation and ultimately global recession. This is something definitely to be concerned about down the road, but the odds of avoiding it this time around are good.
 
  Do you invest in emerging markets and, if not, why not?  
  We have approximately a twenty percent position in emerging markets, because we think that this is an area that is going into a momentum phase and likely to emerge into a full-blown mania. Unlike ten years ago when if the US sneezed, emerging markets would catch a cold, today these markets have their own domestic economies that are not nearly as dependent on the US to sustain their growth; in fact, it is kind of like ”the tail wagging the dog” in that the emerging markets are helping keep the US from entering a recession as a result of their imports of products from our multi-national companies. The attraction to emerging markets is valuation and growth. Five years ago, we had single-digit multiples and double-digit growth. Although we don’t have the same low valuations today, as the sector has become recognized, growth has become the new driver as we enter the momentum phase. It now becomes more important to select the fastest growing emerging markets as opposed to the most attractive valuations.  
  You have talked about long-term market cycles. What types of industries or businesses would qualify as being good or bad for long-term investments?  
  When I talk about long-term cycles, I’m really talking about two different cycles. The first is the super debt cycle that has been talked about recently with respect to the sub-prime problems leading to a credit crisis and eventual bailout by the Fed. The last credit crisis was caused by Y2K fears, and its bailout led to the parabolic rise in housing prices. The question now is: Where will this newly injected liquidity flow to, and my answer would be to emerging markets. Eventually, this super debt cycle will end as the Fed and other fiscal measures will run out of maneuvering room, and the consequences will not be good.

The other long-term cycle that I refer to revolves around secular (long-term) bull markets and secular bear markets. Secular bull markets invariably end in the bursting of some kind of sector bubble (e.g., nifty fifty and dot com), and so it is only natural that the ensuing bear market is severe and secular in nature as valuations have been propped to unrealistic valuations, and even after the bubble is popped, investors are leery of getting back into the market. It is in this kind of market, when you have to dig a little deeper, that we thrive, as we are global investors, and if we can find value, it will eventually be discovered by others.
 
  Who are some of the other principals in your firm and what are their investment backgrounds?  
  Dave Armstrong is the other principal in the firm, and he comes to Oristano with seventeen years of business experience, twelve of which were in the private client area. Dave is known for his conservative approach in creating and maintaining risk adverse portfolios for his clients, performing this service as director of investments for Oppenheimer & Co. before joining Oristano Capital. Dave is the director of marketing. Amy Rogala is the operations manager for Oristano. Prior to Oristano, Amy was an associate at Oppenheimer & Co., where she worked in many different capacities and developed the necessary skill sets to run the operation for our advisory firm.  
  How can someone interested in your services receive your newsletter or get additional information about your services?  
  Peter, we like to say that becoming a client with us is as easy as it is rewarding. If someone would like to receive our newsletter they can visit our Web site at www.OristanoCapital.com and find our contact information, or they can call me directly at 617-854-3761.  
 
 
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