Moderated by Bill Miller

Lee Cooperman
CEO, Omega Advisors

Caryn Seidman-Becker
CEO, Arience Capital

Brian Posner
CEO, Hygrove Partners

Bill Miller: ...What's been very helpful for me is that although I've known the people up here on the panel for some time, being an investor in their funds creates an incentive to stay in touch with them and talk with them about how they're thinking about investing. They're three of the best investors in the world, and it's always useful to bounce ideas off of other people whom you admire and respect, and it's also a great opportunity for us to improve our results for you, whether its directly through the investments we have in their partnerships, or in helping us understand the companies we own. There's a great similarly of style at the theoretical level between what each of these investors does. At the practical level that caches out in very different ways.

Let me introduce the panel members.

Lee is going to make some initial remarks. Lee was a partner at Goldman Sachs for many years. He ran the research effort there for many years, and I think he was the top ranked strategic for all the time he was at Goldman Sachs. He started the asset management business there, and he built it into a multi-billion dollar business, 20, 30, 40, 50 billion dollars or more, and then he left to form Omega Advisors, which is where he is the principal.

I have known Lee for many years, and I regard him as one of the great thinkers and great strategists that Wall Street has ever seen. He has an exceptional passion for the business and exceptional tenacity, and he is going to make some opening remarks.

Caryn Seidman-Becker is a partner of Arience Capital. I've known Caryn for 5 or 6 years. Adjusted for age Caryn is about the best investor I know. But you have to keep improving.

Brian Posner I known for years. Brian managed the Fidelity Equity Income fund which he took from $800 million $15 billion. He had an exceptional record there. He's been successful at everything he's ever done. He graduated from the University of Chicago, and was the Chief Investment Officer at Warburg Pinkus, and then founded Hygrove Partners. Brian has a special expertise in financial stocks. He developed that expertise in the way that many of us do, by having an experience with a company called First Executive. If you a buy a stock and it goes up, and it goes up for the reasons that you think, you think you're pretty smart. You only develop expertise with your disasters, because those are the ones you really have to figure out. I once told people I was an expert on the Mexican economy because I've lost more money there than anything I'd ever seen before. It really improves your analytical capability and all of these can be learning experiences. Brian is a terrific investor and a terrific analyst. We'll start with Lee.

Lee Cooperman: Good morning. I want to thank Bill for his very gracious comments. I'm honored to be here. Over my 36 years of investment experience, 25 on the sell side with Goldman Sachs, and eleven years, now closer to twelve years with Omega, Legg Mason and Bill Miller are in that very select group of special firms and individuals that I have been privileged to work with over my career, so the fact that they were willing to expose me to you, their important clients, honors me.

I've been given about 12 minutes in my formal remarks to quickly discuss my views on the economy and stock market, and Bill's instructions were very specific. He said, "These are very important folks here. Be precise and be accurate in your forecasts. Don't make any mistakes." Whenever I get instructions to be precise and accurate, it reminds me of a story that I've often told that is very relevant to forecasters.

It's a story about a Scottish professor of medicine, who while lecturing to his class at the University of Edinburgh Medical School posed a question. The question was, "What organ of the human body expands to six times its normal size under stimulation?" Rather than waiting for a volunteer the professor immediately singled out Miss McCafferty who upon being singled out turned beet red, got very flustered, very embarrassed, and said "Professor, I'm very sorry but I just cannot answer that question." At which point the professor turns to a Mr. McDougal. Mr. McDougal stood up and said "Professor, it's the pupil of the human eye." And the professor acknowledged the correctness of the response, and said: "In a dark room the pupil of the human eye will expand to six times its normal size." At which point the professor turned to Miss McCafferty and said, "Miss McCafferty, I have three things to say to you. Number one, you did not do your homework. Number two, you have a dirty mind, and number three you're doomed to a life of unfulfilled expectations."

I guess the relevance of the story is obvious. The relevance of the story is if you think I really know what's going to happen to the economy and the stock market you'll be experiencing some unfulfilled expectations. But I work cheap and hopefully I'll lay out the important issues.

I should warn all of you in advance about a few things so you can better understand my biases, and therefore gain some better insight into my forecasts. I don't even call what I'm going to tell you this morning a forecast, but rather the issues that I'm looking at. After all, many years ago, the great Warren Buffet observed that forecasts of the future tell you more about the forecaster than they tell you about the future. I'm the managing partner of a $2.5 billion investment partnership. We seek absolute, as opposed to relative returns, and approximately one-quarter of our assets under management are the capital of the general partners of the firm. There are about 15 of us. Warren Buffet popularized many years ago the notion of eating one's own cooking, and we're eating our own cooking at the firm.

My approach to arriving at a view of the market historically has been to pull out the proverbial yellow pad, write down what I call the pluses and the minuses, the so-called assets and liabilities, and apply 36 years of investment experience to what I think the appropriate conclusion is.

Let me say in advance, I don't have hard copy, but if any of you would like a hard copy of these slides, but if you'd give me your email address I'd be happy to send you the full package.

I've decided to organize my remarks according to what I like, so called assets, and what I don't like. I'll give you a very specific conclusion, but I wanted to touch on issues and share with you what I'm looking at.

On the like side, clearly the economy is in the midst of a cyclical recovery. I don't want to get too precise in terms of decimal points, but GDP should grow about 3% this year, close to 3.5% next year. All the underpinning of this improvement, of a cyclical expansion, are in place. This exhibit you have in front of you, number 2, shows you a pretty significant and steady decline of the dollar, which is aiding the competitiveness of manufacturing industry.

We have significant stimulus being injected into the economy, as part of the recently-passed $350 billion, ten-year tax cut. $125 billion was September of this year to September of next year, and then you get another kick in. Deficit as a % of GDP is scheduled to continue to rise, which is a measure of economic stimulus.

Importantly with respect to stock prices, the maximum tax rate on dividends has been cut to 15% from 37%, and the long-term capital gains tax rate has been cut to 15% from 20%. Monetary policy, whichever way you look at it, has been quite stimulative. Money growth has been quite strong.

The Federal Funds Rate in real terms is a negative number. So the Fed through its interest rate policy and its money creation policy has been extremely stimulative. My conclusion from all these observations thus far, and what's kept me out of trouble this year - we've having a particularly good year this year, is that at the beginning of the year I said, "You know, the government wants me to own stocks, and I don't want to ignore them in 2003." What I mean by "the government wants me to own stocks" is that they're running a half a trillion-dollar deficit which is stimulative to growth and corporate profits. We have a monetary policy as I discussed is extremely stimulative, and really has reduced the alternative rates that you and I can earn in money market instruments, and is forcing money towards equities. Tax policy is highly positive for equities. Let's be realistic - if we can keep 85% of our dividends and 85% of our capital gains from what our genius would produce, that's an awfully attractive deal, and more recently we've pursued this policy of dollar depreciation designed to stimulate economic activity.

So all policy makers are moving in the same direction.

In addition to these governmental initiatives which have spurred the economy, other underpinnings to growth include the following:

Inventories are still relatively low in corporate America, as indicated by the Inventory to Sales ratio.

Yield spread have narrowed significantly, which means that the lesser quality credits have very good access now to capital, something they did not have 12, 18, 24 months ago.

Economic growth also has brought about, as you'd expect, a recovery in earnings. We expect S&P 500 earnings this year to advance about 12% after gaining about 6% last year, and in 2004 we're looking for another gain, to where S&P 500 earnings could be about $60 on the index, which would imply that next year's earnings on the S&P is about 17 times earnings, and frankly not unreasonable.

Inflation is benign on the plus side and should remain so given declining unit labor costs, competition from increased localization, particularly the exporting of deflation by China, and low levels of capacity utilization.

We've been through an awfully severe bear market, and if my grandchildren ask me what a bear market looks like, I tell them it's a period of time when more stocks are declining than rising, when the decline persists for a year or longer, and when the decline averages about 25%.

In this bear market, admittedly from much more over-valued levels, we were down a shade under 50% from the peak to the October trough, and we were down for about 31 months, which is almost 2-1/2 times longer than the average historical bear market cycle. So a lot of that damage is behind us, and it's comforting to know that.

Stocks are cheap relative to interest rates and inflation. We do a great deal of work relating stock prices to GDP and inflation and profits, and everything we look at suggests that stock market is cheap relative to inflation and relative to interest rates.

There's still plenty of firepower out there. Household equity ownership as a percentage of their financial assets has dropped quite a bit, still relatively high. And money market mutual funds relative to the Wilshire 5000 index shows you that there's still plenty of capital out there in the marketplace.

Also on the plus side, dividend payout ratio on the S&P 500 is low, giving you scope for significant increases in dividends, particularly given tax policy. Right now the dividend on the S&P 500 is about $17, and we're looking at a $60 estimate, so the payout ratio is about 30%, the historical long-term average has been closer to 45%.

This is a very potent list of positives, and perhaps I should stop here, sit down, take Bill's questions, or maybe give you our favorite stocks, which wouldn't mind some help. But I don't think it's that easy. Frankly, I have to admit - and I hope I'm dead wrong - I'm more impressed by the liability side of the balance sheet, and like I say I hope I'm wrong because I'm more long than I'm short as an investor. I'm long-biased, and I'm a good citizen and I'd like my country to prosper.

There are a lot of things I see going on that I don't like. The first one is obvious. The whole geopolitical situation is very troublesome. In Iraq the war is over but we're now facing the significant challenge in rebuilding Iraq, including a significant military and monetary commitment by the US.

We have the ongoing terrorist threat that we facing. 9/11 changed the world for us. We have the whole instability in the Middle East, and we have the North Korean wild card.

To me on the analytical side, the most significant risk to the stock market is the issue of whether or not the current cyclical economic recovery is a sustainable one. Will the economy grow for four, five or more quarters at an above-trend rate, or does economic growth quickly revert to sub-par, less than 3% growth. While I'm not of that position yet, that recovery is unsustainable. But I am sufficiently concerned that this outcome is possible that it warrants very careful monitoring.

Consumer spending in the US, which has been responsible for virtually all of the recovery year-to-date, is expanding well in excess of real income growth. Wage and salary growth is approaching zero, whereas real consumption is closer to 4%. This is unsustainable, particularly when one recognizes that the savings rate is very low, and there is virtually no pent-up demand in the auto and housing sectors.

This has been a job-loss recovery. August employment grew by 35,000, September by 125,000, and October by 126,000, but if the in the next five months employment grew by 150,000 per month, you would merely be back to where we started. The average of the nine previous business cycles, employment grew by close to 6%, 22 months off the trough, and we have not seen any growth in employment.

Obviously this is the worst job creation cycle of the post war period. Importantly, this lack of job creation brings forth two concerns. One, protectionist sentiment is increasing. There are two bills in Congress currently proposing substantial tariffs on imports from China. Second, President Bush has become vulnerable to challenge owing to this lack of job growth.

The problem of job growth is obvious in this localized economy. The US labor force is roughly 110 million people who make roughly between $5 and $50 per hour, with the exception of the folks sitting at the table here. They're now competing with a localized labor force of a billion people in China and India that are probably working for something that looks something like $1 per hour or less. I don't know the answer to this but it's a very significant problem that results from the world globalizing.

Consumers have been able to spend in excess of their income growth by incurring substantial debt. I find this troublesome. Consumer debt relative to disposable income, the coverage ratio, is near record high. What's counter-intuitive is that it's at a record high when interest rates are at a record low. It shouldn't be that way in my view, so when interest rates begin to rise the debt burden will certainly begin to constrain consumer spending.

Also, I think a big plus to the economy has been the large rise in the value of homes and the refinancing activity, but I think that this game is largely at an end. I think interest rates have bottomed out and will begin to rise, and secondly home prices seem to have risen more than they should have risen. The value of a home is a function of the capitalized cost of renting. If apartment rental are coming down in cost, and vacancy rates are rising, which I think has generally been the case, you should not continue to see home price being driven up.

These would be some of the things that concern me.

Other big picture issues are the trade deficit, which is something in the area of 5% of GDP, creating tremendous reliance on foreign capital. That will go on as long as our trading partners are willing to hold our dollar-denominated liabilities. It seems to me that our trade deficit is unprecedented for any country, let alone a superpower like the United States. You can get more insight from a much more intelligent person than myself if you read the most recent issue of Fortune magazine, where Warren Buffet for the first time indicates that he is making investments in foreign currencies.

I told you the stock market was cheap relative to current interest rates and current inflation, I operate with the notion that the stock market has a memory, it knows where it comes from, and it knows its history, and the stock market is not cheap relative to its own history.

The S&P 500 PE relative to various inflation periods, and we're in a 1-3% zone of inflation.

The multiple has been historical about 17.3, and we about 17 times net year's earnings, pretty much in line.

This is typical valuation levels of market peaks. We're currently slightly above the average peak in PE ratio. In price and dividends we're off the chart.

These are not characteristics or statistics that basically are associated with major bull market beginnings. And that would be my point. I don't think this is an opportunity for a major league advance from here, because I don't think bull markets begin from 19 times current year earnings, 1.6% yields, an equity mutual fund cash ratio of 4%, and an economy which is not yet fully cleansed itself of the post-bubble excesses. We have a low savings rate, large trade deficit, highly leveraged consumer.

I'd also add, every bull market I know of has always begun from high interest rates, not from record low interest rates. I have a cynical view. Where all this winds up is that for three years I've been giving people a little analogy, a little homily that describes my view of the market, and when I tell it to my son he says "I'm not interested in your Horatio Alger story." I graduated from Columbia University Graduate School of Business on January 31, 1967. I had no money in the bank, I had a national defense education act student loan, my oldest son was six months old. I did not have the luxury that kids today have today of taking a six month tour or Europe. I had to go to work, and I had to go to work quickly. So the very next day I started my 25 year career at Goldman Sachs. On February 1, 1967 the Dow Jones was 1000. Fifteen years later it was 1000. I made my money by finding companies that were selling at 600 or 700 or 800 on the Dow, and avoiding the ones that were 1100 or 1200. I think by and large that that's the kind of environment we're in. I'm not making 15 year forecasts, or ten or five. The world doesn't allow for that. But I would be very surprised if you had a significant sustaining rise. I think we're in a stock picker's environment. The vulnerability to the down side of consequence will only come if the economy rolls over - I'm leaving out any kind of a terrorist action or anything like that. But if the economy grows as it looks like it's set to grow, I think that the worst case scenario is a sideways chop and modest upside move to it.

Thank you.

Bill Miller: Thanks very much Lee. I know you're having a good year, but why don't you tell us what kind of year you actually are having.

Lee: We're up 51%. We're having a bit of luck.

Bill: Caryn, would talk a bit about your firm and what your investment approach is.

Caryn Seidman-Becker: The name of our firm is Arience Capital. We named the firm Arience because our view of investing is that it's part art and part science, so we've put the two words together to come up with Arience. It's a highly qualitative and highly quantitative investment approach, so we build our own models, but we also spend a lot of time trying to understand the businesses, the companies, the industries, and the management, and making qualitative judgments about is this a good business or a bad business, is this a good management team or a bad management team, someone will be a good steward of shareholder value and the capital, and we put that together with our models. We are looking out longer term, value-oriented investors looking out across a broad spectrum of industries, so we're trying to look out 2 - 3 years understanding what a business can become, both on the long side and the on the short side, so we are absolute return investors.

We tend to focus on companies and industries where we can have a competitive advantage, so we shy away from a lot of technology and a lot of energy that for us tend to be shorter life cycle businesses and are harder to build long term models.

We are focusing on 40 to 60 stocks. We want to have more concentrated positions. We've been in business since March 2003, so we started with about 45% gross exposure, and we're now at 100% and moving higher.

It takes us a lot of time to dot our i's an cross our t's, and go out and visit our companies, and their competitors, and their vendors and their customers.

To generalize our portfolio, it's 40 to 60 stocks across a broad spectrum of industries, not so much technology, more hardware and energy.

It's longer term investing. When we're looking at a company we're looking for a 50% return over 12 to 24 months, sometimes 36 months - long term - on both the long and short side, with a 20% risk.

For instance, this year one of our largest winners was Hasbro. When we bought the company it was at $12.5 and trading at 8 times cash flow, and the question we asked ourselves was "How does this company appreciate to the $18 to $20 range, and how does it not go below $10." So I would not at all classify us as catalyst investors. We think that the market is made up of a lot of short term, and who knows when the street finally recognizes the value.

From an organizational standpoint right now we're five people on the research side, a trader, a CFO, and an assistant, so we're eight people in total.

We are very fundamentals based. We spend a lot of time trying to understand our companies, their competitors, the long-term secular opportunities for these companies both on the long side on the short side. We go about it in a differentiated way.

I very much agree with the point that someone raised yesterday about the herd mentality, so everyone reads the same fact set and so you tend to have everyone going in one direction. We tend to be a little bit more contrarian, and are going different places for information, so whether it would be going to customers or vendors or competitors or industry experts, reading local newspapers, reading trade rags, really trying to go different place. That helps to give us a different point of view. We have a saying at our firm - this would help Amazon - that if there's a book on our company's management team we need to be reading it.

That gives us more insight into the people. We spend a lot of time - and I think it's a competitive advantage for Arience, that we spend time understanding the management. At the end of the day they're the ones who will create the value, so we spend a lot of time analyzing those people and their goals and how they're incentivized. So it's about deep fundamental research reading Ks, Qs, proxies, annual reports, but it's also spending a lot of time thinking about where businesses can go on both the long and the short side. I like the fact that we're absolute return. I come from a long only background, but the opportunity to think about shorts, to be a little bit more cynical on businesses, brings a balanced approach to the research process.

From a culture perspective this is about a team organization, a team culture. It is very important to us that it's one P&L. We think of ourselves as an asset management firm in a hedge style, not a hedge fund. This is one organization, we're all trying to build an organization for the long term. So the same way we would want the longs in our portfolio to invest back in the business and grow for the long term, that's what Arience Capital is trying to do. It's one P&L, it's one team approach, and we're investing for the long term.

Brian Posner: Thank you. Good morning. First I want to thank Bill and Legg Mason for this opportunity to sit before you. It's a real honor to sit on this panel.

Just a brief side note that Bill didn't mention in his comments at the beginning. You know Bill is often referred to as the Peter Lynch of this generation, and as someone who had a chance to be hired by Peter and work for Peter when he was still at Fidelity and Bill through the Opportunity Trust, and I'm probably the only person in the world who's had the opportunity to work for both men. Bill is a limited partner of Hygrove Partners.

I can define us a number of ways, and the sound byte is quick simply that we are diversified, value-based, long-short investment managers. But before I launch into what I think that means, there's a quote that I think is very important, and it drives how we think about our business, not just how we think about stocks and investing in stocks and analyzing companies, but the business. It was written by Justice Samuel Putnam, who wrote in 1830 in a landmark court decision, "Those with the responsibility to invest money for others should act with prudence, diligence, intelligence, and a regard for the safety of capital as well as for income." This ruling became known as the "prudent man rule," which even today the NYSE refers to as the investment standard for responsible money management, and it's kind of ironic and sad the rule is prominently displayed on the web site of the firm that bears his name that was founded by his great grandson 100 years later. That is what drives us. That is what motivates us.

So the core of our philosophy, how we think about investing, has three main components, two of which are general, one gets to how we think about stocks and the actual action of manufacturing performance. First, we are involved in a risk business, and Lee articulated very well that this is not a risk-free business, it is not a game, although it is often referred to as such not only by people in our business but by the press. It is also a journey. We view investing as a marathon, not a sprint, and the way we think about companies and the way we expect to achieve our returns, and the way we know we will maximize our returns is by approaching it as such.

We define ourselves as value-based investment managers. What do we mean by that? To us, value is a function of the real economic returns that a company can generate relative to the risks specific to that company. When I say "real economic returns" it is a concept that has been discussed here very broadly for the last two days and I think it's very important. It's cash-on-cash returns, it's the net present value of long term cash flows. That is what drives the ultimate value of companies over the long term, and that is what we focus on.

Our process is very much what has been described for the last two days, and by Lee and Caryn as well. It's a very rigorous process. We're financial analysts, but we're also fundamental analysts. It takes 3 stages. In the first is analyzing the company, and it is essentially a process of assessing probabilities, by understanding the financial statements, by meeting with management, but understanding the competitive universe, and all that sort of stuff, what we are trying to do is assign certain probabilities to certain events happening in the future and the value of those events to us. The second part of the process is understanding the expected returns that we should expect to derive from owning that enterprise going forward, and understanding that as a function not only of understanding that company's fundamentals. But it's also a function of understanding the market's expectations. It was discussed yesterday that if there is a certain set of expectations embedded in that company, that will have a direct and dramatic impact on the returns that one can achieved.

The final part of the process is the portfolio construction. It is really only through a diversified portfolio that we can manage the unexpected and unintended. That should give you a general sense of how we do things.

There's a quote that was directed to me by Mike Mauboussin, it was in one of his most recent Consilient Observers, it came from Robert Rubin and a commencement address at the University of Pennsylvania in 1999, and it gets to the core of how we think about investing. Rubin said, "First, the only certainty is that there is no certainty. Second, every decision as a consequence is a matter of weighing probabilities. Third, despite uncertainty we must decide and we must act. And lastly we need to judge decisions not only on the results, but how those decisions were made." Thank you.

Bill Miller: Could each of you please tell us your minimum investment, and holding period, and describe your ideal client.

Lee: The minimum investment is technically $1 million, but I have the right to waive that. We normally haven't. At this stage of our business development we're not really looking to capture a lot of assets, but someone who could be helpful to the firm and was interested, we would love to talk with them. I think I would probably want to cap the size of the firm around $3 billion, and we're $2.5 billion and if we have another year like this year we'll have to give back money. My ideal client - that's a good question. I've never really thought about it. Someone that's more long term oriented than short-term oriented, that has realistic expectations. I tell our investors, "This is what would make me happy as senior partner of the firm. I want to have no down years; I want to beat the S&P net of my fees; I know you can buy the S&P return for 10 or 15 basis points. Third, I would like to make something in the area of 15% a year, so I want to appeal to people who have realistic expectations, and fourth I would like to have an acceptable level of volatility. If any of you in the audience and you have close to the minimum amount and you think those are reasonable expectations and you don't want to talk to me every day or every week, and you're happy with a 25 page quarterly letter and an occasional call, come talk to me.

Caryn: We have a $2 million minimum investment, but like Lee we can waive it. We have a one-year lockup, but we do offer monthly liquidity with a small penalty, which gets reinvested back into the fund. Our ideal client is someone who is longer term; someone who clearly understands who we are and what we do. We view our investors as our partners, and I think no different than it's very important for our companies align themselves with the right customers to grow with, we view it in a very similar fashion so that we want the right partners because we too would like no down years, would like no down months, would like no down days, but that's not realistic. It's very important that we have investors or partners who understand who we are and what we do, and that they can look out long term. Because we're looking out 2 to 3 years, we offer 2 and 3 year lockup periods for lower fees, because we're going to put our money where our mouth is.

As we've built our business we think transparency and communication with our partners is incredibly important, so we registered with the SEC when we got started, and we built a web site where our longs are listed alphabetically, and our gross and net exposure is updated on a bi-weekly basis. It's very important to me that we do what it is that we said we would do, and it also serves as a checks and balances system. As you're going to the trading desk to do something you're making sure that this is what I told my investors, and I'd better be proud to put it up there and show it to them. Even though we're small and young we've turned down money from people who we didn't think understood this is who we are and we wouldn't want to talk to on a bad day, week, or month.

Brian: Our terms are quite standard and not materially different from Lee's and Caryn's. The point of the ideal investor is an important one, and I think it goes two ways. Whether you're listening to us or listening to Bill and his team, and the myriad of competitors that are out there, it is at the end of the day a people business. The people who have been here for the last two days and the people who are sitting before you, all of us strive to do one thing, and that is to win, to make money. We are putting a dollar of capital at risk with the expectation that we will receive in excess of a dollar in return. I think what has been lost in our business over the last two years or so is that it is a people business, and in effect you are buying into the persona and the expertise of the people who have been appearing at this conference and the people on this panel, and it is incumbent upon us to articulate our approach and our views in such a way that you are comfortable with that. We like to think that we're right all the time, but it doesn't necessarily work that way, certainly not day-to-day or week-to-week.

Every once in a while, hopefully on a twenty-year basis we have those first execs as well.

Bill Miller: Can each of you give us a couple of stocks that you like and why you like them. I just want to emphasize, these are not sell-side analysts, these people are not recommending - well, we'll leave it to them if they think they are recommending these stocks. What I want to do is give you a flavor of what they like and what reasoning goes into what they like. And if there are things you don't like then tell us that too.

Lee: We have a decent-sized position in the catastrophic reinsurance business, for example. Partner Reinsurance, Platinum Reinsurance, Renaissance Reinsurance. Generally we've been through a tremendous draw-down of capital in this industry with 9/11 being one example, and a number of natural disasters in Europe, and we can still consider the industry somewhat under-capitalized, which is enabling them to drive pricing reasonably aggressively.

Look at the S&P 500 as an example, as a stock. Right now the S&P 500 as a stock is growing about 7% on a trading basis, earns 13% or 14% on its equity, about 30% of its capitalization is accounted for by debt, yield 1.7%, for those statistics I'm basically paying 19 times this year's earning and 17 times next year's earnings. So I try to identify companies that have a better set of statistics at a much lower valuation.

In the case of the catastrophic reinsurance, and there are other examples I can give, these companies are selling anywhere between 6 and 8 times earnings, with strongly rising earnings, and they average about 1.5 times book, and I think they're too cheap. We're getting closer to the end of the cycle, but we're not there.

I think we're late in the game, but I happen to like some of the HMOs. One that I've owned for a while, I bought in the low 20s and I'm still buying at 41, 42, Oxford Health. This is a company that should earn I think $450, $460, $470, this coming year. The stock is 40, so it's about 9 times earnings. If you look at a composite of this industry, Oxford has the highest return on equity, highest return on capital, and lowest Price-Earnings ratio. It has the lowest Price-Earning ratio because it's New York-centric, and the market isn't growing right now. What's happening in HMO industry in my opinion is because of the very low growth in employment in this country, if these HMOs want to grow they're going to grow through consolidation, through multiple arbitrage. A higher-multiple HMO will buy a lower-multiple HMO. That's a little bit what we saw in the case of Wellpoint and Anthem. The idea of mutual blues converting to public companies, that not happening and state governments aren't allowing it to happen. If I could buy a 50% ROE with 9 time earnings, and if Oxford didn't buy back stock or pay cash dividends, in 6 months they'd have no net debt, they'd be in a net cash position. If I could buy it at 9 times earnings with a very significant repurchase program I don't see how I lose money. I think one day I'm going to wake up in the morning and get lucky because somebody's going to want to buy them.

Caryn: Our largest position is Tyco. We started buying Tyco this year at $13, and here at $22 we still like it a lot. We think it's worth between $30 and $35. First and foremost with Tyco we think that they are very decent businesses. They are B+ to A- businesses, but they have A+ management now, so we knew the management team, Ed Breen and his group, from when they were the management team of General Instrument, a cable equipment company. It's the set-top box on top of your television. We were invested with them in 1998, 1999, and they ultimately sold the company to Motorola in 2000. At the end of the day, Ed Breen and his organization come from an LBO mentality. They were owned by Forsmann Little, so for them it's all about cash and cash returns. They were great stewards of shareholder value, they were great capital allocators. They bought the stock back at the right time, they shut down businesses at the right time, and ultimately they sold their company to Motorola at exactly the right time. I've known Ed and his team, who he brought with him to Tyco for a long time. He's always done what he said he was going to do, so from a moral and ethical standpoint, as opposed to former Tyco management, he was very strong. People love working for him, and he understands capital allocation, which is to us the ultimate driver of shareholder value.

Ed got there and started doing all of the things that you would want your management team to do. He started evaluating the businesses, he brought in the right managers to run the businesses. He was focused on the generation of free cash flow. The one mistake that Ed made, and that's probably caused a bit of volatility to the stock this year, was giving guidance, which we are not a fan of. At the end of the day we viewed the company as four different businesses - health care and fire and security being the two most important ones. So we did not meet with Ed and his CFO, who came from United Technologies, but we went out and met with different divisions.

One of the things Lisa Rapuano talked about yesterday at the conference was the sum of the parts. So we broke down Tyco into the sum of the parts, and we came away from the Health Care division, which had great management, untouched by Koslowski's corporate culture that took place in New York City. These were great operators who were running a business for the long term. They were generating a lot of cash. They actually had the number two diversified US health care business, behind Johnson & Johnson. I think that was not an appreciated fact.

We thought the business was worth $25 billion. When we started buying Tyco the market cap was $26 billion, plus about $20 billion of debt. Which meant if you took out Health Care, which was purely a franchise that you could get your hands around, it meant you were paying $21 billion for the rest of the businesses. We then went down to Fire and Security, which was the most controversial business, and clearly if you were reading the newspapers it was the one you could be most negative about. There is a new manager there who came from General Instruments who we knew very well, who understood that it's a subscriber business similar to a cable business, and we came away very comfortable that that business was worth going out 3 to 5 years, some where between $10 and $15 billion. So if you added up those businesses, you got everything else for free. So there can be a lot of noise and a lot of controversy, but I like getting things for free.

Now you have a company that is trading at about 13 times next year's free cash flow, and I would almost say going out to the end of next year an under-leveraged balance sheet, shrinking their company by getting rid of unprofitable sales, getting rid of money-losing businesses. Great management.

One of the opportunities that Ed had was during a tougher economy when he could grab people out of GE and United Technologies, and great companies with great cultures, and apply that to Tyco to fill the new franchise going out 5 years. So we think that the company is worth $30 to $35. We think you have a lot of options in the out years depending on what Ed does with the free cash flow. That's why we like Tyco a lot. We think that people still have a lot of emotional baggage, which is all the more opportunity, so when you say to some people Tyco's good they say, "Don't talk to me about Tyco." Those people will be buying the stock at $25 to $27.

We are evidence-based investors, and the evidence says that it's safe. So we like Tyco a lot.

Our number two position, right behind Tyco, is Commscope. Commscope is very different than Tyco. We bought it at $600 million market cap. We tend to go from the $1 billion to $15 billion, but as opportunities present themselves we skew either higher or lower. Commscope was trading at 7 times trailing free cash flow when we bought it. It's a hybrid-fiber coax company, so they really make the cable for cable television that run under the street or over the street on top of poles. They're run by great management. They actually used to be part of General Instrument.

At the end of the day, it's trading at 7 times free cash flow. Cable companies started to come back, and equipment companies tend to lag service companies, so Commscope was still sitting there even as cable was up 20+% this year, and clearly they were in a growth mode. Commscope was depressed because international cable companies had gone bankrupt because a US cable company had gone bankrupt and another one was deeply distressed, so their capital expenditures were way down. As capital expenditures came back, we saw a lot of operating leverage in the business, but most importantly again, great management who understood how to be capital allocators. They had generated so much free cash flow that they had a debt-free balance sheet. Clearly that was not the optimum capital structure, so the question was, "What could good management do to create shareholder value?" Two weeks ago you woke up and they had doubled the size of their company by buying an asset from Avias, so they want from $500 million of revenues to $1 billion of revenues. Avias business was a very poorly run asset, so they had enormous margin opportunity. We tend not to like investments where we have to predict enormous top-line growth to make money. It's more difficult, at least for us, to predict that. There's now a lot of cost savings. The business was 20% accreted because you had cash sitting on your balance sheet making 1%, and you used that cash to buy this asset.

Now we have the company even here trading at 9 times 2005 free cash flow, so the stock's gone from 10 to 16, but we think it's worth in the mid-20s.

Brian: By way of background, we like to look for a certain set of financial characteristics. Often there are companies where the share price is depressed for some reason. It may be cyclical, it may be secular, it may be a real or perceived past sin. Today I would say our portfolio is really a combination of companies that had these common financial characteristics, and that is significant cash-generative capability, if not today certainly in the future, and optionality in terms of operating leverage in the event that revenues begin to increase. We tend to run a weekly weighted portfolio, so I'd like to say I love all my children equally, but the top 2 positions - one is an insurance company and it represents the only theme in the portfolio and it's Travelers Insurance and the other is a consulting-based, research-based services company, Gartner Group.

Travelers being one of the largest insurance companies in the country. 1.5 times book, 8 times earnings, all that sort of stuff. I think the important thing is that the pricing cycle, this insurance cycle right now is likely to be protracted in a more solid and tangible way than it had been in the past. It's not just a function of premium growth rates, it's a function of the terms and conditions. So for all of you who are small business owners and are involved in your insurance transactions for your company, and when you see the components of the policy being taken away with the price going up - it's the little components that they take away, like the legal fees as the change in the terms and conditions.

Gartner was a very interesting restructuring as a totally different example. $600 or $700 million market capitalization company. They provide consulting and research for tech buyers. Obviously that market had been under significant pressure for the last few years, and this was a company that just focused on getting the fixed cost structure in place. It's actually put them in a position that when revenues begin to improve, there's significant operating leverage, and by that I mean the incremental dollar of revenue is 50% or so should drop to the bottom line. We were able to buy it cheaply. Those are the types of things that we look for.

Bill: Brian, do you have a view on Capital One, Providian, or Metris, or the sub-prime sector in general?

Brian: I do. My general point of view about investing in financials is never ever forget that by definition these are the most highly leveraged companies on the face of the earth. The other thing is that they're regulated businesses. So you're talking about a lot of leverage and it's regulated, meaning that at a certain point in time when the equity gets to a certain low level, the government puts it out of business. I generally don't like companies that have had capital issues in the past, and when it comes to a company like Metris, there's enough of a capital issue there that I just don't think I need to play right now. Similarly Providian.

Capital One is a very interesting company. They've done a phenomenal job in terms of growing their balance sheet. I think they have matured emotionally in such a way that they have slowed the balance sheet growth despite the protestations of growth investors, which is really what they need to do. They were stretching the capital a little bit too much from my perspective given the underlying quality. The thing about financials in my mind, because of the underlying leverage which results in significant volatility in the underlying stock price, there's rarely a reason to get too aggressive in terms of the credit quality curve.

Bill: Lee, you mentioned the trade deficit. Do you have a view of the budget deficit and what's likely to happen in the next few years and how much of a problem is it?

Lee: Here's a story. During my years as a partner at Goldman Sachs we had a very distinguished partner, former Secretary of the Treasury Henry Fowler, who when he retired from government he returned Goldman Sachs as a general partner. A few of you with enough gray hair will recall the seventies. He and Pete Peterson used to take full-page ads preaching the problem of the deficit and the ultimate problems for our grandchildren. I would just observe over the last 20 years that it really didn't mean anything. The deficit has no effect on economic growth, it didn't have an effect on valuations, and it turned out a short 3 years ago we were worried about what to do with the surplus.

On the surface I think we're creating so much debt in the economy that it ultimately is going to be a problem. I think that deficit is becoming structural in nature, and I think historically it manifested itself with higher interest rates and higher inflation, and the question is when, and it's something that I would be guarded about. I think it's going to create a depreciation of our currency. I think it is an issue, and the timing of when it manifests itself very unclear.

Bill: Is there any theme that you see in the market that you see is investible. The word that the audience member used was exciting, but let's just say investible, that would last several years. This might be a long or a short theme.

Lee: I mentioned catastrophic reinsurance companies, but to me the enduring theme is buying undervalued securities and being patient. Every publicly traded company has two values. The so-called public market value, and auction market value. When you see 100 shares traded on the New York Stock Exchange that public market value, but the same business also has another value, and that's called private market value. That price informed investors pay for 100%, and if you can identify companies in the public markets that sell at a substantial discount to their private market value, and you have patience, and you're not on margin, you'll hit 7 or 8 out of 10 times, and you'll have a very great end value. I don't want to sound trite, but buying undervalued securities and being patient is the best way to win.

Caryn: I know we've talked about this, I think the theme over the next few years, which is the result of the past few years, which is why you want to buy companies with management who are running their companies and not their stocks. I think there are so many people in the past few years manipulating their stock for short-term value. As we are looking at management teams right now we are very pro managers who are pulling guidance, because we think guidance proved to be pretty worthless over the past few years and we want to be with people who are building long term franchise value for investors, and not sacrificing that for the near term. I know Jeff talk about that too. This requires a lot of patience, and a lot of independent research, and I think that that's an opportunity on the long side as well as the short side, because companies that give guidance and then need to stick to it do things in the near term to sacrifice for the long term, and ultimately it catches up with them. We think that a lot of people are short term, so if you're willing to be patient on both the long and the short side, and do differentiated research, and be with managers who are really committed to being great capital allocators and maximizing long term business value that ultimately you will get paid for that. I think that is a theme that would be different than the past few years.

Brian: I agree with what Lee and Caryn said. In relation to a certain industry I mentioned insurance so did Lee. I also think there is going to be an emerging theme in US natural gas. We've had a situation in this country in which gas production has been declining at an accelerating rate. The number of rigs that are working has also been declining. There is the potential for a continuation of the types of spikes that we have seen in the past in price, but what I see at the company level is a much more mature way of approaching exploration and production as well as the service companies. So I would look at energy as a potential theme over the next 3 to 5 years.

Lee: There's a lot of popularity about hedge funds. I would just advise you to be very careful. This is a new trend, it's a popular trend, and when something becomes popularly embraced it's probably the wrong thing. First of all, I want to say about hedge funds, it's not an inexpensive form of money management. There are 6000 or 7000 mutual funds with some very capable people. I'm not saying this because you're standing here - his record says it for him. They manage money for something like 1%. You're paying a typical hedge fund 1 in 20, and increasing now they're raised it to 2 in 20, or 2 in 25.

Number two, you're buying into a blind pool. You have to know who you're investing with. You don't know what they own.

Number three, you don't know how much leverage they're using in generating those returns. You should also be aware that the fee structure is very asymmetrical, in the sense that when they do well you give them 1 in 20 or their 2 in 20, when they lose money I have found that increasingly with these young kids, present company excluded, they close up their shop and go away. One of your principal assets is their high water mark, and one of the justifications for the fee schedule is that if they lose money they have to work to get back where you started, and not get compensated again. Increasingly I see these people that have no real soul, they just basically say, "If I'm down I can't make any money. I'll see you later."

So I would be very careful. I personally think hedge funds make a great deal of sense, but as an asset class they will under-perform because there are not enough qualified, competent people who can take 20% off the top and beat the market. So I'd be very careful.

Bill: As a follow-up on that, can you talk about what kind of transparency you offer your investors, and what kind of leverage you use.

Lee: Other than 1993, where I had a fabulous year in foreign bonds, we've evolved into very little use of leverage. I find there's very little use of leveraging for.

On transparency - we don't have a web site. It's an idea to think about, but basically we write a 25 page letter every three months to our investors and we tell them what the returns were, where the returns were by asset class, the 25 largest holding in the portfolio, and also a very detailed discussion on investment thinking. I'm very user-friendly. We take calls from our investors. If they want performance weekly they can get performance weekly. They can get performance daily as long as they don't call me for it. I have a different horizon. And mostly importantly as I mentioned, it's a pretty significant number, 25% of our $2.5 billion is our money. Not only do we value our reputation, but we value our capital. As I say, I'm too fat and too old to start all over again.

Caryn: Right now we are not operating on leverage, which is not to say that we would not. Typical gross exposure for us if we were idea rich would be 125% to 150%. From a transparency standpoint that's been a big focus point for us, I think it will help through good times and in bad if our investors really understand what we own and why we own it, and why performance is what it is good or bad. We do have a web site that's password protected for investors. Our longs are updated daily on an alphabetical order, not a position size. Some investors ask for daily or weekly NAVs (net asset valuations), and we give that to them happily. We also send out a monthly spreadsheet that breaks down our winners and our losers, our exposure by sector, our number of positions, and our returns for that month.

Anybody who comes in or calls, we're happy to share our longs and our shorts. Our shorts are a little bit more sensitive so we do ask that people sign confidentiality agreements, because we do have relationships with management, and at times we may be short their company, and we wouldn't want that to hinder our long term relationships with them - it's not necessarily anything personal against them, although sometimes it may be. Transparency is a big thing with us. One of the things we ask our companies to be is very transparent. The more transparent a company is with us the more we feel about the job the they're doing, so we try to pass that along to our partners.

Brian: We don't use leverage, period. With regard to transparency, I spent 13, 14 years in the mutual fund business, for the final years running Warburg Pinkus' asset management operations, and what I try to bring to our firm is an appreciation and understanding for the policies and practices that mutual fund industry had, and bring it to the hedge fund industry, at least our business in terms of disclosure, in terms of talking about names. We're stock geeks and we'll talk about stocks with anyone, and we'll present the data. The other thing is we recognize the thing that makes us unique are the minds within Hygrove, and there's no black box. We want you to believe in us, we want Bill to believe in us, and the reason that I made the move from the mutual fund industry after so many years to the hedge fund industry had absolutely nothing to do with fee structure, or being able to do arcane trading strategies or anything like that. It just had to do with a stage in the mutual fund business at many fund companies. I had reached a stage in my career when I believed I was going to be immune to the pressures that 99% of the fund managers feel out there, outside of this firm, which is not to worry about performance but to worry about things like tracking error and stuff like that. If performance is not the name of the game then don't invest in the person.

But when my firm was purchased, it was purchased by an organization that really didn't care about performance. 10% of the capital of Hygrove belongs to general partners and friends and family. It's something that we take very seriously. People who have joined us from the outside to be part of that ride we welcome as dear friends.

Bill Miller: Thanks. Just in closing, one of the best things about being invested with people of this quality and stature is that it's really exciting to talk about the market and about their names. It really helps our investment team, and it really helps your results. Thank you very much.