market folly

Christopher Begg is out with East Coast Asset Management's third quarter letter to investors.  Entitled "Inventing a Flying Machine," the letter discusses investment process, something we try to focus on in addition to tracking hedge funds.

On Investment Process

Market Folly is a big proponent of saying that "investing is a continual education" and so today we learn from Begg who writes that, "In order to produce superior compounded returns over time I believe one must not only have a differentiated view but more importantly a differentiated investment process."

East Coast uses checklists to 'invert' their thinking and how they see an investment.  While they will be drawn to something that has cheap valuation, they want to look at why it's priced cheaply.  This falls directly in line with what Charlie Munger likes to say: "invert, always invert."

East Coast looks for a margin of safety in each investment and try to drill down an investment to the critical data points that drive the company's underlying fundamentals.


3 Types of Investments They Focus On

East Coast categorizes their investments in three ways:

1. Compounders - These typically have the longest duration and highest return potential.

2. Transformations -  These benefit from tailwinds either due to secular dynamics or a business' competitive advantage.  They note that many investors often don't have the patience or investment timeframe for these to pay-off.  These could also be labeled 'time arbitrage' plays, a type of investment the likes of John Griffin at Blue Ridge Capital makes.  East Coast has more than two-thirds of their portfolio allocated to compounders and transformations.

3. Work-outs -  These are investments that trade at a discount for whatever reason and they look for this gap to close.  These types of names typically have catalysts and are often invested in by various hedge funds.  East Coast allocates less than a third of their portfolio to these ideas.


Where East Coast Looks For Ideas

Here's their list of places to start:

- Market sell-offs
- Post-bankruptcy reorganization
- Spin-offs
- Industry transformations
- Political and economic clouds

We'd also toss in that in addition to during proprietary research, it doesn't hurt to look at what other investors are doing as well.  Bruce Berkowitz of Fairholme Capital has recommended this as it's a great place to find ideas to do further due diligence on as well.  Tracking hedge funds is the main purpose of MarketFolly.

Lastly, East Coast emphasizes the importance of thorough research.  They recommend finding competitors of the company you're looking at and talking to people involved in each respective industry to gauge the dynamics and competitive landscape.


Embedded below is East Coast Asset Management's Q3 letter:




For more from this firm, we've also posted up East Coast on what defines a great business as well as their past letter on mispricings.