YPO FORUM

LINVILLE, NCSEPTEMBER 2014

2AG

EN

DA

Market Cycles

Current Valuation

Dont Fight the Fed

Current Sentiment

Thoughts on Allocation

A Few Good Men Ideas

MARKETCYCLES

4TH

EL

ON

GV

IEW

STOCK MARKET SINCE 1900

PresenterPresentation NotesPeriods of growth followed by periods of stagnation.What drives this?

5HIN

T: ITSNO

TTH

EE

CON

OM

YAVERAGE ANNUAL CHANGE IN THE STOCK MARKET & GDP

Source: Crestmont Research

PresenterPresentation NotesGDP growth during bear markets (6.9%) has actually been higher than economic growth in bull markets (6.4%).But the stock market has declined an average of 4.2% annually during secular bears and gained 14.6% annually during secular bulls.

6EA

RNIN

GSG

ROW

TH~

GD

P GRO

WTH

PresenterPresentation NotesEarnings growth is closely tied to economic growth over time. As a result average annual growth in earnings has remained extremely constant at about 6% through decades of cycles.

7MA

RKE

TR

ETU

RNSD

RIVE

NBY

VA

LUA

TION

PresenterPresentation NotesSo the economy doesnt drive stock prices.And the correlation between earnings and stock prices is weak at best.So how do we explain the massive differences in performance across cycles?One word. Valuation. At the end of the day, the most important driver of long term returns is the price you pay.

8VA

LUA

TION

DRIV

ESM

ARK

ET

CY

CLES

PresenterPresentation NotesHeres a look at the change in PE multiples in secular bull markets on the left.And secular bear markets on the right.

9LIV

ING

WITH

AB

EA

R

PresenterPresentation NotesThis is what a secular bear market feels like.

10

TH

ISSHO

ULD

FE

EL

FA

MILIA

R

PresenterPresentation NotesThis should feel familiar to you.

11

OBV

IOU

SLYN

OT

AB

UBBLE

Source: Hussman Funds

PresenterPresentation NotesBut dont worry.This is obviously not a bubble.

CURRENTVALUATION

13

TH

ISISN

OT

AH

EA

LTHY

STRATE

GY

PresenterPresentation NotesThis is a good illustration of how most investors feel today.This is not a healthy long term strategy.

14

TH

ESE

ARE

NO

TG

OO

DR

ESU

LTS

PresenterPresentation NotesThe results are predictable:Stocks returned 7.8% annually over the past two decades.Bonds were good for 6.5%.Inflation ran at 2.5%.The average investor . . . 2.1%

15

TH

ISISM

UCH

BE

TTER

AD

VICE

Risk is counterintuitive. The riskiest thing in the world is the widespread belief that theres no risk.

Fear that the market is risky can render it quite safe.

As an asset declines in price, making people view it as riskier, it becomes less risky.

As an asset appreciates, causing people to think more highly of it, it becomes riskier.

Holding only safe assets of one type can render a portfolio under-diversified and make it vulnerable to a single shock. Adding a few risky assets to a portfolio of safe assets can make it safer by increasing its diversification.

HOWARD MARKS OVER-ARCHING COMMENTS ABOUT RISK

Source: Oaktree Capital Management, Risk Revisited

PresenterPresentation NotesA value-driven approach can generate more consistent and acceptable returns.Heres an excerpt from the Howard Marks memo:The riskiest thing in the world is the widespread belief that theres no risk. As an asset appreciates it becomes riskier.This is common sense but most investors find it difficult advice to follow over time. There is nothing more difficult than standing idly by watching your friends get rich.

16

LOW YIELDST

WIN

CH

ALLE

NG

ES

PresenterPresentation NotesInvestors today face two impossible challenges.The combination of which makes for a risky investing environment.The first is the current low level of yields.

17

HO

WL

OW

CA

NY

OU

GO?

THE LONG HISTORY OF LOW YIELDS

PresenterPresentation NotesThe long history of yields is shown here.We are at the far right and about as low as weve been in history. As a result, investors across the globe are walking out on the risk spectrum to pick up little incremental return.

18

PEAK VALUATIONST

WIN

CH

ALLE

NG

ES

PresenterPresentation NotesSome are closer to the ledge than others.In addition to low yields on safe investments, stocks are priced to deliver subpar returns for the better part of the next decade.

19

TH

EO

NLY

CO

NSTA

NT

ISCH

AN

GE

THE LONG TERM GRAHAM & DODD P/E

PresenterPresentation NotesThe market is trading near peak valuations. In the past, buying stocks at these levels has produced very lackluster returns. The long-term average PE on the market is about 16. What this means is that if you buy the market at a 16x you can expect average returns. If you can buy stocks cheaper, you should expect higher returns. But if you pay more, expect lower (or no) returns.

In 1901, the market traded at 23x. The Dow was at 71 and closed at 72 20 years later in 1920.In 1929, the market traded at 28x. The Dow was at 300 and fell to 60 over the next three years.In 1966, the market traded at 21x. The Dow was at 969 and closed at 875 fifteen years later in 1981.Peaks in 2000 and 2007 were followed by 50% losses in stocks.The market currently trades at about 25x normalized earnings.

20

YO

UG

ET

WH

AT

YO

UP

AY

FO

RAVERAGE 10-YEAR S&P 500 REAL RETURN BASED ON PRICE/AVERAGE 10-YEAR EARNINGS

Source: Broyhill Asset Management, Ned Davis Research

PresenterPresentation NotesThe average return for stocks from these levels has been minimal. This is illustrated here.Buying stocks when the market traded at the cheapest quintile (far left) , has produced double digit annual real returns over the following decade.Conversely, buying stocks at the most expensive quintile (far right) , has produced marginal returns.Guess where we are today.

21

TH

EO

THE

RSM

ITHE

RS

There are two fundamental and very different ways in whichequity markets can be measured.

One of these is q, by which the market value of companiesis compared to the real value of their assets. This followsfrom the basic principle that, in any reasonably competitiveeconomy, the value of anything depends on the cost ofcreating it.

The other way treats equities as financial assets and valuesthem by discounting the expected future returns at anappropriate rate. Cape is based on this approach anddepends for its validity on the data for any particular stockmarket being consistent with the theory behind it.

In any economy where sufficient data are available to value themarket in terms of both q and Cape, the results must agree.

If different measures of value disagree; they cannot all be validand using demonstrably invalid measures must be absurd.

- FT, Andrew Smithers

PresenterPresentation NotesThe prior two charts showed valuation as measured by ten-year average earnings.Another fundamental measure of market valuation is the replacement cost of the assets. This is referred to as the Q ratio.In any economy where sufficient data are available to value the market in terms of both q and Cape, the results must agree.

22

MIN

DY

OU

RPS&

QS

PresenterPresentation NotesHere is what the Q ratio is telling us today.

23

TO

BINSQ STRE

TCHE

DF

AR

BE

YO

ND

TRE

ND

PresenterPresentation NotesAs shown, we can see it is currently stretched far beyond trend and at levels only seen near previous bull market peaks.

24

SEN

DIN

GTH

ESA

ME

ME

SSAG

E

PresenterPresentation NotesAs you can see, both CAPE and Q are sending the same message today and have done so consistently throughout history.

25

IRRATIO

NA

LE

XU

BERA

NCE

"As of yesterday my price earnings ratio was 26.3,"said Shiller to This Is Money. "There's only three majoroccasions in US history back to 1881 when it washigher than that. One is 1929, the year of the crash.The other is 2000, which I call the peak of themillennium bubble, and it was also followed by a crash.And then 2007, which was also followed by a crash.

Robert Shiller

CYCLICALLY ADJUSTED PRICE-TO-EARNINGS RATIO

PresenterPresentation NotesThere's only three major occasions in US history back to 1881 when normalized valuations where higher than today.

One is 1929, the year of the crash. The other is 2000 and it was also followed by a crash. And then 2007, which was also followed by a crash.

CURRENTSENTIMENT

PresenterPresentation NotesAnother way to think about valuation is to consider what it means for investor sentiment.

27

BE

ARS

INH

IBERN

ATIO

N

PresenterPresentation NotesSentiment has reached an extreme as Bears, according to Investors Intelligence, have fallen to the lowest level since 1987.A recent Barron's survey of market strategists highlighted this sentiment.Nobody thinks markets will/can go down.

28

ASSE

TA

LLOCA

TORS

ARE

FU

LLYIN

VE

STED

STOCK ALLOCATIONS AT RECORD HIGHS

CASH LEVELS AT RECORD LOWS

PresenterPresentation NotesWhen investors are willing to pay a premium for stocks, they are presumably so optimistic that they are probably pretty fully invested.At the other extreme, if they are unwilling to buy stocks, they are likely so pessimistic that there is a lot of potential buying power around.Today, investors are fully invested in stocks, just as they were in 2000 and in 2007.Cash levels are at record lows today well below 2000 and 2007 stock market peaks.

29

FU

LLYIN

VE

STED

AN

DL

EV

ERE

DU

P!!

PresenterPresentation NotesSpeculation higher than that seen in 2000 or 2007 is also a big concern. Not only are investors fully invested, they have levered up to do so. Margin debt is hitting new highs. If the market were to turn down, selling of stocks held on margin could exacerbate the decline.

DONT FIGHTTHE FED

PresenterPresentation NotesFalling interest rates have provided a tailwind for financial assets for three decades. What happens when this trend changes?

31

NOMINAL AND REAL 10-YEAR TREASURY YIELDSIN

VE

STING

INA

LO

WY

IELD

WO

RLD

Source: JP Morgan Guide to Markets

PresenterPresentation NotesNominal yields sit at about 2.5% today versus a long term average above 6% shown here. Theres nothing stopping them from falling lower, but Im fairly confident they cant fall more than 2.5%. So the downside for yields is limited by the zero bound, while the upside is . . . well, not so much.Rising rates arent just a problem for bonds. Historically, rising interest rates have been bearish for stocks because they have increased borrowing costs for companies and because they have provided competition for investors dollars. Look at the difference in real returns for the S&P during both periods.

32

CENTRAL BANK POLICY CAN CREATE DISTORTIONS & CONSEQUENCESH

OW

LO

NG

CA

NIT

LA

ST?

Source: Bienville Capital Management

PresenterPresentation NotesUnconventional monetary policy has pushed up asset prices and pushed investors further and further out on the risk curve.The Fed Funds rate has been stuck at ZERO for over five years now. This creates massive distortions in capital markets.It is a lot of fun for risk takers. But eventually, the party will end when central banks take the punch bowl away.Markets have historically reacted to Fed tightening and we suspect this time will be no different. We just dont know when.

33

FLA

SHB

OY

S

PresenterPresentation NotesFor the past five years, QE has suppressed all types of asset class volatility. As that accommodation has unwound, the Fed will begin to act as more of a headwind than a tailwind for asset prices. As a result, the potential for a sharper fall in asset prices should increase.Liquidity in the equity markets is horrendous and remains the biggest and most misunderstood risk factor facing investors. Michael Lewis latest book is a must read for anyone that wishes to understand what is going on here. Last year, HFT represented 50% of the volume on the market. ETFs were good for another 20% so real asset owners only represented about 30% of volume. The biggest risk is something like the flash crash. Any kind of exogenous shock may suck liquidity from the market or worse HFT will try to sell ahead of us. So take any stress test you are getting from a manager and multiply it by 3x to 4x because no one is taking liquidity into consideration.

34

FE

DP

OLICY

ISCRE

ATIN

GA

BU

BBLEIn the old days central banks moved interest rates to run monetary policy. By watching the flows, we could see how lowering interest rates stimulated the economy.

All that changed when interest rates hit 0% - "printing money" (QE) replaced interest-rate changes. Because central banks can only buy financial assets, quantitative easing drove up the prices of financial assets and did not have as broad of an effect on the economy.

The Fed's dilemma is that its policy is creating a financial market bubble that is large relative to the pickup in the economy that it is producing. If it were targeting asset prices, it would tighten monetary policy to curtail the emerging bubble, whereas if it were targeting economic conditions, it would have a slight easing bias.

We expect this limit to worsen. As the Fed pushes asset prices higher and prospective asset returns lower, and cash yields can't decline, the spread between the prospective returns of risky assets and those of safe assets will shrink at the same time as the riskiness of risky assets will not decline.

Said differently, at higher prices and lower expected returns the compensation for taking risk will be too small to get investors to bid prices up and drive prospective returns down further. If that were to happen, it would become difficult for the Fed to produce much more of a wealth effect. If that were the case at the same time as the trickling down of the wealth effect to spending continues to diminish, which seems likely, the Fed's power to affect the economy would be greatly reduced.

Source: Bridgewater Associates

PresenterPresentation NotesA few thoughts on Fed policy from Bridgewaters Ray Dalio.Dalio is one of the most respected macro thinkers in history. If you havent watched How The Economic Machine Works watch it.

35

ASSE

TP

RICESIM

PLYV

ERY

LO

WR

ETU

RNS

We think that US monetary policy is nearing a new test that will require wisdom and creativity alongthe lines of that which was required to deal with those problems. The basic issue is that quantitativeeasing is a much less effective tool when asset prices are high and thus have low expected returnsthan it is for managing financial crises.

Now, there is a flood of liquidity and asset prices are high relative to underlying fundamentals. Sothe impact of additional asset price increases on demand is much less. Quantitative easing today isdriving asset prices to unsustainable levels, without stimulating much additional activity. That leavesa much clearer tradeoff between driving up asset prices today and lowering future returns.

The dilemma the Fed faces now is that the tools currently at its disposal are pretty much used up, inthat interest rates are at zero and US asset prices have been driven up to levels that imply very lowlevels of returns relative to the risk, so there is very little ability to stimulate from here if needed. Sothe Fed will either need to accept that outcome, or come up with new ideas to stimulate conditions.We think the question around the effectiveness of continued QE (and not the tapering, which getsall the headlines) is the big deal.

In other words, we're not worried about whether the Fed is going to hit or release the gaspedal, we're worried about whether there's much gas left in the tank and what will happenif there isn't.

Source: Bridgewater Associates

PresenterPresentation NotesAgain, the key message here:Quantitative easing today is driving asset prices to unsustainable levels. That leaves a much clearer tradeoff between driving up asset prices today and lowering future returns.Its that simple.

36

QE

SEFFE

CTO

NTH

ER

EA

LE

CON

OM

Y

PresenterPresentation NotesQEs impact on the real economy has been much different than on financial markets.

37

QE

INL

AY

MA

NSTE

RMS

PROFIT RECOVERY EXCEEDING JOB RECOVERY ARE YOU SMARTER THAN A FIFTH GRADER

Source: Zero Hedge

PresenterPresentation NotesThe analysis is simplified a bit here.Take a look at that jump in EPS on the left.

38Investment Outlook | 38

QE

SEFFE

CTO

NE

ARN

ING

S

PresenterPresentation NotesSo QE hasnt done much for the economy.But look on the bright side, corporate earnings are booming. But one thing should be extremely obvious here earnings ALWAYS revert back to trend.

39

A P

ERM

AN

EN

TLYH

IGH

ER

PLA

TEA

U

PresenterPresentation NotesThis is an important point. If you believe that todays historically-high earnings can be sustained then US equities look mildly expensive. But if you think that earnings will mean-revert, AS THEY ALWAYS HAVE, then US equities are nose-bleed expensive.

40

MA

YBE

TH

ISTIM

EISD

IFFERE

NT?

HIGH MARGINS HISTORICALLY LEAD WEAK PROFIT GROWTH

Source: Hussman Funds

PresenterPresentation NotesA simple way to see the implications of elevated profits is to relate thelevelof profit margins to the subsequentgrowthin profits over a reasonable horizon. This is shown here.

The blue line (left scale) is a proxy for profit margins which is at all time highs today. The red line (right scale) is the subsequent growth in profits.

Note the tight fit of this relationship and also note that this line is inverted so that the current level of margins is pointing to double digit annual declines in profits over the next few years.

41

TH

ISISA D

AN

GE

ROU

SSITUA

TION

THE MOST IMPORTANT TEST OF ANY VALUATION METRIC IS THE PREDICTABILITY OF RETURNS

Source: Hussman Funds

PresenterPresentation NotesThe most important test of any valuation measure is how closely that measure is related to actualsubsequentreturns over a period of several years.This chart shows the S&P 500 price/revenue ratio versus the actual subsequent 10-year total return of the S&P 500 over the following decade.Market valuations on this measure are well above any point prior to the late-1990s market bubble. This is a dangerous situation.

42

NE

GA

TIVE

EX

PECTE

DR

ETU

RNS?

THE RATIO OF MARKET CAP TO GDP PROVIDES A SIMILAR VIEW

Source: Hussman Funds

PresenterPresentation NotesWe obtain a similar view, with equal historical reliability, from the ratio of equity capitalization to nominal GDP. On this measure, equities are already beyond their 2007 peak valuations, and are approaching the 2000 extreme.The associated 10-year expected return for the S&P 500 is negative on this measure.

43

SOU

ND

AD

VICE

BUFFETT PARTNERSHIP LETTER, 1959Most of you know I have been veryapprehensive about general stock market levelsfor several years. To date, this caution has beenunnecessary.

The present level of security prices contains asubstantial speculative component with acorresponding risk of loss. Perhaps otherstandards of valuation are evolving which willreplace the old standard. I don't think so.

I may very well be wrong; however, I wouldrather sustain the penalties resulting fromover-conservatism than face theconsequences of error, perhaps withpermanent capital loss, resulting from theadoption of a "New Era philosophy wheretrees really do grow to the sky.

BUFFETT PARTNERSHIP LETTER, 1960My continual objective in managingpartnership funds is to achieve a long-termperformance record superior to that of theIndustrial Average.

However, I have pointed out that any superiorrecord which we might accomplish should notbe expected to be evidenced by a relativelyconstant advantage in performance comparedto the Average.

Rather it is likely that if such an advantageis achieved, it will be through better-than-average performance in stable or decliningmarkets and average, or perhaps evenpoorer-than-average performance in risingmarkets.

PresenterPresentation NotesSo whats an investor to do?These quotes from Buffetts 1959-1960 Partnership Letters are timeless in my opinion.Perhaps other standards of valuation are evolving which will replace the old standard. I don't think so.I may very well be wrong; however, I would rather sustain the penalties resulting from over-conservatism than face the consequences of error, perhaps with permanent capital loss, resulting from the adoption of a "New Era philosophy where trees really do grow to the sky.So would we.

ASSETALLOCATION

PresenterPresentation NotesSo lets talk about what investors SHOULD do. Or can do.Or at least what we are doing.

45

TIM

ETO

TH

INK

ABO

UT

DE

FEN

SE

Its the job of investors to strike a proper balance between offense and defense, and between worrying about losing money and worrying about missing opportunity. Today I feel its important to pay more attention to loss prevention than to the pursuit of gain.

Todays ultra-low interest rates have brought the prospective returns on money market instruments, Treasurys and high grade bonds to nearly zero.

This has caused money to flood into riskier assets in search of higher returns. This, in turn, has caused some investors to drop their usual caution and

engage in aggressive tactics. And this, finally, has caused standards in the capital markets to deteriorate,

making it easy for issuers to place risky securities and consequently hard for investors to buy safe ones.

HOWARD MARKS OVER-ARCHING COMMENTS ABOUT RISK

Source: Oaktree Capital Management, Risk Revisited

PresenterPresentation NotesBack to Howard Marks on striking the right balance between offense and defense.It is time to put the defense on the field.

46

PLA

NA

CCORD

ING

LY: STRIVE

FOR

BA

LAN

CEIf I could say one thing to your investors, it's try to achieve balance.

As an investor you need to diversify your portfolio and understand that in the type of world we're living in, your returns are going to look like this: 1% on cash, 3% on bonds, 4% on equities.

It's a low yield world, and you should plan accordingly.

- Ray Dalio, Davos World Economic Forum

PresenterPresentation NotesSimilar advice from two of my favorite strategists: Mr. Miyagi and Ray Dalio.

47

SOU

ND

AD

VICE

"An investor cannot decide to think harder or put in overtime in order to achieve a higher return. All an investor can do is follow a consistently disciplined and rigorous approach; over time the returns will come."

-Seth Klarman

PresenterPresentation NotesAn investor cannot decide to think harder or put in overtime in order to achieve a higher return. All an investor can do is follow a consistently disciplined and rigorous approach; over time the returns will come.This is what a friend of mine calls the 0, 3, 5 paradox. No combination of 0% returns on cash, 3% on bonds and 5% on stocks (he is more optimistic than I) will get you to 8-9% returns. We need to think different today.

48

FORWARD LOOKING RETURNS AT HISTORIC LOWST

IME

TORE

SET

EX

PECTA

TION

S

PresenterPresentation NotesThis is illustrated here.The expected return on a balanced portfolio today, is well below most investors required return.

49

HA

LF&

HA

LF?

PresenterPresentation NotesA portfolio structured to limit downside risk while participating in the upside would have fared better than breakeven since the turn of the century. A portfolio that only captured half of the markets upside, while mitigating the downside would have generated significantly more wealth.This is simply because of the disproportionate impact of losses in relation to the gains required to recover losses. As the magnitude of the loss increases, the required recovery gain exponentially increases.

50

KE

EP

ITSIM

PLE

The investors portfolio of common stocks will represent a small cross-section of that immense and formidable institution known as the stock market. Prudence suggests that he have an adequate idea of stock-market history, in terms particularly of the major fluctuations in its

price level and of the varying relationships between stock prices as a whole and their earnings and dividends. With this background he may be in a position to form some worthwhile judgment of the attractiveness or dangers of the level of the market as it presents itself at

different times.

The sound reason for increasing the percentage in common stocks [beyond 50%] would be the appearance of bargain price levels created in a protracted bear market. Conversely, sound

procedure would call for reducing the common-stock component below 50% when in the judgment of the investor the market level has become dangerously high.

- Benjamin Graham, 1949 The Intelligent Investor

PresenterPresentation NotesOne could potentially enhance the results of a 50/50 portfolio by changing equity weightings with the opportunity set.This is precisely what we strive to do.

51

NIG

HT

MO

VE

SWEALTH CREATION VIA VALUE-BASED ASSET ALLOCATION

Source: Emerald Asset Management

PresenterPresentation NotesOur friends colleagues recently ran an analysis comparing a hypothetical investment in a static balanced portfolio to a strategy rebalanced according to the Shiller P/E, which we reviewed earlier.

When valuation was in the highest 25% of historical observations they shifted a portion of the portfolio from stocks to bonds. Conversely, when valuation was in the lowest 25% of historical observations, they shifted a portion of funds from bonds to stocks.A $100,000 investment in a balanced portfolio of half stocks and half bonds would have grown to more than $65 million from 1928 through 2013.

This sounds impressive. At least until you realize that a value-driven allocation would have nearly doubled theseresults, growing to more than $123 million,over the same period.

52

LIM

ITY

OU

RF

OCU

S

PresenterPresentation NotesSuccessful investing requires us to limit our focus on those things that matter.Ignore the headlines.Stretch your time horizon.And focus on value (what you get) rather than price (what you pay).

53

RANGE OF STOCK, BOND AND BENDED TOTAL RETURNSH

ISTORICA

LR

ETU

RNS

BYH

OLD

ING

PE

RIOD

Source: JP Morgan Guide to Markets

PresenterPresentation NotesA longer term horizon allows you to ride out short term volatility.But it will not produce superior results without a focus on valuation.

54

CA

SHISK

ING

Cash is like oxygen. You dont notice it 99% of the time, but if its absent its the only thing you notice.

PresenterPresentation NotesAnd in the absence of valuation, cash can provide an option on tomorrows opportunity set.

55

THE STRUGGLE FOR YEAR THREEG

OO

DN

EW

S: YE

AR

TH

REE

ARO

UN

DTH

EC

ORN

ER

PresenterPresentation NotesLets wrap up on a positive note before reviewing a few specific ideas.

The power of the Fed to move equity markets in particular is best demonstrated by the Presidential Cycle. This chart shows the average four year return since 1964 for the S&P 500 and the quarter of the market cap that is the most volatile. The bad news is that we are still in year two.

The good news is that Year Three is just around the corner. The data and logic strongly suggest that it is driven by moral hazard. Enough professionals hear and understand the subtext of the Feds message: if you speculate in year one and two and something goes wrong, you are on your own. But in years three and four, and especially three, we at the Fed will do whatever we can to bail you out in a crisis. We shall see.

A FEW GOODMEN IDEAS?

57

SOM

EC

LOSIN

GT

HO

UG

HTSBROYHILL ANNUAL LETTER

We have a long term objective of producing attractive returns, lightly correlated withhighly volatile stock markets a dual focus on income generation and capitalpreservation remain our priorities today as they always have. Over the short term,however, equities can and do exhibit periods of leadership. Our process does notattempt to catch every market twitch. Our discipline means we tend to be a provider ofliquidity rather than a taker of liquidity, buying assets that others want to sell and sellingassets that others are chasing higher. Today is a terrific time to be a seller of assets, butit is much more challenging to find compelling ideas that meet our return requirements.Tomorrow, we expect to be a buyer of assets as prices ultimately return to fair value andexpected returns increase.

One of the most underappreciated keys to generating consistent long-term returns is tominimize losses. Losses are almost always caused by taking too much risk, as manyinvestors feel forced to do today. If you avoid large losses, the gains take care ofthemselves. Our current positioning allows us to generate consistent income in a highrisk environment, while keeping our powder dry to seize more attractive investments thenext time opportunity knocks. When youre one step ahead of the crowd, youre agenius. When youre two steps ahead, youre a crackpot.

58

TH

EV

ALU

EO

FE

XTE

RNA

LM

AN

AG

ERS

Our external investments with like-minded, long-term investors complement our internal capabilities, expand our investable universe, and deepen our understanding of financial

markets. Simply put, External Managers, expand our circle of competence.

PresenterPresentation NotesWe are unique in the industry in that we are a hybrid.Many investment firms spend all of their time picking stocks.Others spend most of their time on the golf course and some of it allocating their clients assets to outside managers.We think there is value in both and believe external investments complement our internal capabilities. Ill wrap up with a few examples.

59

CRISISC

REA

TESO

PPORTU

NITY

PresenterPresentation NotesAs we see it, the best swimming in the financial markets is when panic breaks loose.

60

Source: BIS, The Asset Price Bubble in Japan

A B

RIEF

HISTO

RYO

FC

RISISFIRST STOP JAPANESE BUBBLE

THIRD STOP IRELANDS BOOM

SECOND STOP US RECOVERY

NEXT STOP SPANISH CASTLES

PresenterPresentation NotesBubbles have become an increasingly common feature of the economic landscape over the past three decades. We think these four charts make this point abundantly clear.

61

TO

DA

YSPO

STER

CH

ILDEUROPEAN EARNINGS REMAIN DEPRESSED EUROPEAN MARGINS WELL BELOW THOSE IN US

FALLING INFLATION FORCING ECBS HAND

PresenterPresentation NotesSo we actively survey the landscape for distress.Europe is a great example of that today as the economy and the markets remain quite depressed.

62

EU

ROPE

AN

DISTRE

SS

PresenterPresentation NotesWith European bad banks ramping up asset sales, we think the timing is particularly ripe to capitalize on European distress today.

63

WA

ITF

OR

IT

PresenterPresentation NotesEarlier this year, we published our work on Kennedy Wilson. The short story is that these guys are among the most opportunistic real estate managers weve come across.After putting a ton of money to work on the west coast amidst the US housing crisis, the company has focused its efforts in Europe since 2010.These efforts have ramped up aggressively in the past year and culminated in the IPO of their London-based fund in February.KW is a great example of the synergies generated by our unique investment approach.We bought the stock and invested in the European fund.

64

RO

UN

DT

RIP?

PresenterPresentation NotesLatAm has been another area of focus for us recently.Many of the economies in the region have come under pressure for a variety of reasons.

65

DO

NTC

RYFO

RM

E!

PresenterPresentation NotesPerhaps Argentina is the poster child?Weve followed events here closely over the years as some of our external investments have been involved with the sovereign debt restructuring.As this restructuring is reaching its natural conclusion, weve ramped up our research in the region.We think new leadership next year will be a significant catalyst for the economy.

66

NO

TW

ITHK

ETCH

UP, C

RISTINA!

PresenterPresentation NotesThings in Argentina got so bad that at one point in time, McDonald was short of ketchup. A tumbling Argentine peso, a shrinking supply of US dollars, and rising inflation have been making it increasingly difficult to import foreign goods.

67

UN

ITE

CON

OM

ICSARCO TAST FRGI PNRA CMG

Market Cap ($ millions) 1,370 255 1,330 4,060 21,180 Total Debt ($ millions) 884 150 67 (125) (470)Enterprise Value ($ millions) 2,254 405 1,397 3,935 20,709 Locations

2,062 564 320 1,777 1,681 EV per Store ($)

1,093,394 719,574 4,366,547 2,214,406 12,320,018 Equity per Store ($)

664,403 453,617 4,156,250 2,284,750 12,599,643 Debt per Store ($)

428,990 265,957 210,297 (70,343) (279,625)Sales per Store ($)

2,500,000 1,176,806 2,000,000 2,400,000 2,307,000 Operating Margin 6% 4% 9% 8% 16%Profit per Store ($)

150,000 47,072 180,000 192,000 369,120 FCF Yield 16% 5% 4% 9% 3%

Source: Company Filings, Broyhill Asset Management Estimates

You can build a McDonalds in LatAm for about $1.5 million. Or you can buy the companys LatAm store base for less than $1.1 million today and earn significantly higher returns on your capital if margins normalize.

PresenterPresentation NotesRegardless of how things shake out in Argentina and the rest of LatAm, we dont think MCD is going out of business.In fact, this is precisely the type of environment that sets up rare buying opportunities for long term investors in high quality companies.To this end, we recently purchased shares in the largest MCD franchisee. The founder owns a ton of the stock and has ran LatAm for MCD for decades.

68

BE

TO

NTH

EH

ORSE

PresenterPresentation NotesAs they say, sometimes it pays to bet on the horse.Warren Buffet has said that he likes to buy businesses with competitive positions so strong that even an idiot couldnt weaken its moat.

69

BU

YQ

UA

LITYA

TA

DISCO

UN

T

PresenterPresentation NotesIf you can find these businesses trading at a discount to intrinsic value, it is hard to lose.In addition to ARCO, weve also done work on several Coca Cola bottlers in the region, where demographic tailwinds remain strong.

70

BE

TO

NTH

EJO

CKE

Y

PresenterPresentation NotesBut there are exceptions to every rule.And sometimes a good jockey, can generate tremendous long term returns for investors.Buffett is one of the best examples of this himself. As are the other Outsider CEOs.

71

TH

EO

UTSID

ERS

PresenterPresentation NotesBill Stiritz, current CEO at POST, was highlighted in the book.We think what Sergio Marchionne is doing at Fiat is worth watching as well.And weve already mentioned Howard Marks. We are invested in the stock and are investors in OAK funds as well.

72

ABSO

LUTE

RE

TURN?

PresenterPresentation NotesSo despite our macro concerns, we are still finding things to do.Both in individual equitiesAnd in funds.

73

WH

AT

IF?

PresenterPresentation NotesOne last thought before going to questionsConventional wisdom sees the current level of US rates as unsustainable.Consensus has been incorrect for the past several years in looking for rates to go higher.What if they are right in that US rates are unsustainable? But what if they catch up or down - to the rest of the world?

74

WA

LKIN

GTH

EC

RED

ITT

IGH

TROPE

PresenterPresentation NotesAgain, this is where balance is so important.If you position the portfolio for rising rates and you are wrong, you get killed.And you must look for investments that can perform under multiple scenarios.Our current allocation to credit is focused on security selection rather than the direction of interest rates.

75

BU

YIN

GA

TA

DISCO

UN

T

Source: Matisse Funds

PresenterPresentation NotesIn addition to mutual funds and hedge funds, we begun allocating to closed end funds during last years panic selling.Few investment are more misunderstood than closed-end funds as the entire CEF universe does not command a great deal of attention.

76

MIN

DTH

EG

AP

HISTORY OF CLOSED-END FUND UNIVERSE

Source: Matisse Funds

PresenterPresentation NotesAs a result, sophisticated investors can pick up incremental returns when discounts widen as we saw last year.We think the opportunity is still present today although we are being more selective in our purchases.

77

WEV

ESE

EN

THISM

OV

IEB

EFO

RE

PresenterPresentation NotesWell close with one of our more socially irresponsible ideas.

APPENDICES

79

DISCLA

IME

RDISCLAIMER

PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.

This material has been prepared solely for the purposes of illustration and discussion. Broyhill Asset Management is the marketing name forthe investment management business conducted by Broyhill Asset Management, LLC. and its affiliates. Broyhill Asset Management, LLC is anSEC Registered Investment Advisor.

Under no circumstances should the information contained herein be used or considered as an offer to sell, or solicitation of an offer to buy anysecurity. Any security offering is subject to certain investor eligibility criteria as detailed in the applicable offering documents. The informationcontained herein is confidential and may not be reproduced or circulated in whole or in part. The information is in summary form forconvenience of presentation, it is not complete and should not be relied upon as such.

Any information, data, statement, opinions, or projections made herein may contain certain forward looking statements, projections, andinformation that are based on the beliefs of Broyhill Asset Management as well as assumptions made by, and information currently available to,Broyhill Asset Management. Such statements reflect the view of Broyhill Asset Management with respect to future events and are subject tocertain risks, uncertainties and assumptions (including, but not limited to, changes in general economic and business conditions, interest rate andsecurities market fluctuations, competition from within and without the investment industry, new products and services in the investmentindustry, changes in customer profiles, and changes in laws and regulations applicable to Broyhill Asset Management). Should one or more ofthese other risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from thosedescribed herein.

All information, including performance information, has been prepared in good faith; there are no representations or warranty expressed orimplied, as to the accuracy or completeness, of the information, and nothing herein shall be relied upon as a promise or representation as to thepast or future performance. This material may include information that is based, in part or in full, on hypothetical assumptions, models, and/orother analysis (which may not necessarily be described herein). No representations or warranty are made as to the reasonableness of any suchassumptions, models, or analysis. The information set forth herein was gathered from various sources which are believed, but not guaranteed, tobe reliable. Unless stated otherwise, any opinions expressed herein are current as of the date hereof and are subject to change at any time.Accordingly, neither Broyhill Asset Management nor its principals or affiliates make any representations as to the timeliness of any information inthis presentation.

Broyhill Asset Management

Christopher R. Pavese, CFA

chris@broyhillasset.com

YPO Forum Linville, NCSeptember 2014AgendaMarketCyclesThe Long ViewHint: Its Not the EconomyEarnings Growth ~ GDP GrowthMarket Returns Driven by ValuationValuation Drives Market CyclesLiving with a BearThis Should Feel FamiliarObviously Not a BubbleCurrentValuationThis is NOT a Healthy StrategyThese are NOT Good ResultsThis is Much Better AdviceTwin ChallengesHow Low Can You Go?Twin ChallengesThe Only Constant is ChangeYou Get What You Pay ForThe Other SmithersMind Your Ps & QsTobins Q Stretched Far Beyond TrendSending the Same MessageIrrational ExuberanceCurrent SentimentBears in HibernationAsset Allocators are Fully InvestedFully Invested And Levered Up !!Dont Fight The FedInvesting in a Low Yield WorldHow Long Can it Last?Flash BoysFed Policy Is Creating A BubbleAsset Prices Imply Very Low ReturnsQEs Effect on the Real EconomyQE in Laymans TermsQEs Effect on EarningsA Permanently Higher PlateauMaybe This Time is Different?This Is A Dangerous SituationNegative Expected Returns?Sound AdviceAssetAllocationTime to Think About DefensePlan Accordingly: Strive for BalanceSound AdviceTime to reset ExpectationsHalf & Half?Keep it SimpleNight MovesLimit Your FocusHistorical Returns by Holding PeriodCash is KingGood News: Year Three Around the CornerA Few Good Men Ideas?Some Closing ThoughtsThe Value of External managersCrisis Creates OpportunityA Brief History of CrisisTodays Poster ChildEuropean DistressWait For itRound Trip?Dont Cry for Me!Not with Ketchup, Cristina!Unit EconomicsBet on the HorseBuy Quality at a DiscountBet on the JockeyThe OutsidersAbsolute Return?What If?Walking the Credit TightropeBuying at a DiscountMind the GapWeve Seen this Movie BeforeAppendicesDisclaimerSlide Number 80