40 Gigabytes and a Stool vs.

40 acres and a mule

OMG, the Titanic sank. (See Link to 2004 article Its About Time) Thousands of people killed for simple pilot
error – no wonder Captains go down with the ship. Some Hedge fund managers would say that is an easier
fate than what they face now in terms of high water marks, new regulations, and horrible investor relations.
Few people cared five years ago when the alarms were set off, and now that the boat has sank, even fewer care
to go back and see who was at fault. In fact, our federal government has chosen to put the very people
responsible for the system break-down in charge of the repairs. The stampede for the market’s exit has nearly
killed the herd. The quantifiable logic that market forces are outside quantifiable boundaries is now plain to
see, and no one seems to know what to do. Many lead steers are dead, others penned for slaughter by the
Cowboys at the gate.

The system that created unimaginable wealth is somehow unimaginably gone. Or is it? The basics of life are
still produced and available at the supermarket. The electronic means of moving value p.k.a. Cash, is still in
tact. As long as you don’t have to use a wheel barrow to carry your bank notes, no one can tell the currency is
debased. The issue at hand is connecting the American dream with American reality. The bridge between
dream and reality is and always has been the indefatigable American spirit; the ingenuity, the innovation, the
entrepreneurial DNA that we inherited from our fore-fathers, who had the gumption to leave the status-quo
and opt for self-reliance in the world of the unknown. The equivalent of enormous natural resources available
to our fore-fathers is today’s networks and distribution systems of products and information. 40 acres and a
mule is now 40 gigabytes and a stool. America will plow forward despite the lack of automatic liquidity from
financial markets.

The current reality requires we deal with many significant market imbalances.
Consider the trillion dollar plus imbalances:
1) Supply and Demand for residential real estate (inning 6?)
2) Supply and Demand for commercial real estate (inning 1)
3) Supply and demand for corporate credit facilities (inning 7)
4) Government expenditure and revenue (inning 3)

Consider the $100 billion dollar plus imbalances:

1) American Automotive manufacturing capacity and demand
2) City and State government expenditure and revenue
3) AIG Portfolio assets and liabilities
4) Major Banks and Insurance company assets and liabilities – Goldman, Morgan, BOA, Merrill,
5) Foreign governments expenditure and revenue

These imbalances will take years to level out. If real estate pricing follows the example of the 20th century,
land prices paid in the 20’s were not seen again until the 1950’s. For reasons beyond explanation, today’s
lenders believe they are better off to foreclose than make loan modifications that will enable productive use of
the assets involved. It is tantamount to the debtor’s prison of centuries past when if a man could not pay his
debts he would be locked in jail where he could never pay his debts and his family was left completely
dependent on society for their support. Lenders will likely sell these properties for far less than the current
debtors-in-possession would be willing to pay, expanding the imbalance of supply and demand. My sources
indicate that current foreclosure recoveries are roughly 25% of mortgage balances. The truth hurts doesn’t it?

The financial market Tsunami of 2008 resulted from the issues we pointed out in January of 2004 in our pre-
blogosphere article “Its about time”. The implosion of the markets resulted from significant irrational pricing
of risk. The resulting wave has hit us, and now we are dealing with the ebb tide that is ripping every industry
off its moorings. Successfully navigating the ebb tide will require a combination of innovation and careful
risk management – not risk avoidance, but management.
What then is an investor to do? Faced with insurmountable declines in all leveraged asset prices, extremely
low yields on risk free assets, and doubtful veracity in many financial instruments, is it any wonder so many
are holding on to their cash? Is there any asset class that can generate positive returns with any probability?
The short term “wave action” will require steady hands at the helm and active investment management is
clearly the favorable style. Serious due diligence combined with sensitive analysis of cash flows and growth
opportunities will result in solid investment returns for the informed investor over the next several years.
Embracing the notion of 40 gigabytes and a stool will be hard for many, but the future of capital growth is in
identifying the beneficiaries of the network age and plying them with capital. The future is about information
and its abundance not about legacy businesses of construction, manufacturing, and print media.

5 years ago there was literally no access to the leaders of the venture capital industry, titans who spawned
Amazon, Google, and a host of other household names. Today these investment managers are readily
available through secondary purchases of their funds from many of the largest portfolios in the world. New
capital is generally unavailable for any team desiring to fund innovations and work with entrepreneurs. The
hottest investment market is healthcare, where revenues are peaking and profitability is suspect. High returns
have always resulted from where investment dollars are least likely to go.

The havoc wreaked stems from misguided loyalty to pure capitalism, NOT capitalism with moral restraint. It
is interesting to note that leading corporations are finding that by aligning their brands with socially important
(and popular) causes actually improves employee productivity. The moral values of brands are actually a
differentiating factor hence the popularity of being green and sustainable. The rise of Social Capitalism as an
industry is remarkable and I think here to stay. As the world discovers Eric Schmidt is correct that “the right
way to run human systems is transparency,” invalid and conflicted value propositions will diminish, and our
global citizens will be better off.

In the meantime investors need to “pay attention to the tension” and carefully consider the incredible spread of
potential outcomes we face. Owning secure knowable cash flows needs to be a priority for every portfolio and
balance it with thoughtful research and investment in innovation based businesses. I expect in 2014 you will
be very glad you did. (proxy graphs available on our additional info link)

Note the graphs below show proxies for our asset classes identified in 2004 compounded capital at around
50% until the crash of ’08 and while hopefully readers sold these assets pre-crash, they were still postively in
double digit return vs. a negative S&P index.

Wilshire REIT Index

Plum Creek – Timber Proxy
American Tower – Wireless Comm
Proxy