Ina word, the Salt Lake City, Ut-based Arlington posts return that could only be described as “staggering.” Since inception, the fund is up 873.2% gross versus 109.9% for the S&P 500. Then again, even a casual comparison of the fund to 2 broader index or benchmark isn't particularly meaningful, it would appear, as gravity might not apply since apart from 2015 it does nothing but report profits significantly above the index benchmark. in 2008, as markets seized and banks collapsed, Arlington did 15.2%; in 2009 as central banks and governments flooded the markets with liquidity, the fund posted 91.2%. Mind you, these returns have come without shorting a share of stock, either as an investment or for hedging, and no, there's no superstar bench of analysts in the wings ~- there are no analysts. Arlington is just two guys who spend most of their time studying filings and doing research. Over the years, ValueWalk has followed Arlington Value Capital, a fund at the center of conversation in the hedge fund industry due to their stunning returns. In media reports, Arlington's enigmatic founder, Allan Mecham, has been described as the “400 Percent Man” in reference to reported performance has eclipsed some of the all-time great fund managers, and called by some as the "Next Warren Buffett”. Not everyone shares this enthusiasm Gary Teran, CEO of First Western Advisors, a Utah-based broker-dealer, approached ValueWalk to conduct cursory due diligence. Teran filed a whistleblower complaint with the Securities and Exchange Commission regarding Arlington Value Capital. ValueWalk reviewed the evidence they provided and did its limited review, including an interview with Mecham's Partner at Arlington Value Capital. What follows is the story behind that limited due diligence, raising questions on both sides and illustrating the limits of what can be ascertained through public source data. Teran, himself had an entanglement with the Utah Division of Securities that ultimately resulted in the division head leaving. After dropping charges against Teran, the state also issued an apology. "Let's just say itis not the division's normal practice to issue apologies," George Robison, the securities division's director of licensing, who led the investigation that resulted in the charges, told the Salt Lake Tribune. "Welll let it go at that.”Performance Summary (1201/2016) DOPOD CPOE ‘Asc Under Managment 8.1 billion How can a long-only hedge fund deliver positive returns regardless of market environment? Gary Teran is a suspicious man. Having been registered with FINRA and the SEC a for more than 30 years running a broker-dealer and investment advisory business, the Utah man looks at Arlington Value Capital and claims of superhuman performance regardless of the market environment with caution. At the center of Teran’s suspicion is Arlington's celebrated performance. The Utah-based hedge fund, now with over $1.1 billion in assets under management and closed to new capital, has been nothing short of stellar. Since 2008, Arlington's reported performance shows it has more than doubled the performance of the S&P 500 through long-only investing strategy executed in mostly highly liquid large, publicly traded stocks ~- often significantly outperforming the returns of his largest holdings. This hedge fund's positive performance into the teeth of the 2008 global financial crisis is particularly noteworthy. While numerous noncorrelated hedge fund strategies delivered positive performance during the financial crisis ~ the Societe Generale CTA index was up 13% in 2008 - there is ne significant obstacle that Arlington overcame that most noncorrelated funds did not have: Arlington was one of the only known long-only hedge funds to deliver positive performance in 2008. Warren Buffett's Berkshire Hathaway, for instance, which Arlington fund manager Mecham acknowledges as for an idol, was down nearly 32% over the same challenging period. Not only was Arlington's performance positive, but it nearly doubled the S&P 500, historic milestone for a long-only fund.But the superhero act didn’t end in 2008. From 2008 to 2016, an investment in Arlington nearly tripled while the stock market performance of Mecham’s acknowledged idol, Warren Buffett ~ and Arlington's largest investment holding for much of the period, Berkshire Hathaway — only managed a 72% gain. For’ ‘a hedge fund to significantly outperform its largest investment holding is a notable feat. “Our enthusiasm for Berkshire Hathaway is underpinned by a culture that’s chock-full of unusual qualities that cause it to stand out from the herd,” Mecham gushed to investors in a 2012 letter. “The uniqueness of BRK’s ethos is only surpassed by its effectiveness in building shareholder value.” PERFORMANCE Asingtn Vee Management, LLC (AVM: De: 199 june 2011 15M Combed Rerun: Dec 199? Dee 2014 1s teeGentediiten Sem, Comte Baeen teams 12] Danae au mis sum | on ae Prior to AVM Ranges LP, Artington Value Management LLC (AVM) our plas Sand Prom mid 2008 hewogh mid 2011, AVMand AVM Range wert cme wd bys. Arter QQ 201, AVM LLC was ne i. The above chen shows he combed es Se To investors, such performance seems like the Holy Grail, the ultimate goal. To skeptics, it can seem too good to be true. Teran, who claims to have been approached by Arlington to sell the hedge fund to investors in 2005, looks at the performance claims and calls ther “ridiculous.”Allan Mecham: “The 400% man” as an all-American success story, an “ordinary man” conquering Wall Street As Allan Mecham and his longtime partner Ben Raybould sit in a small office in a tranquil part of Main Street in Salt Lake City, Utah, far away from the noise of Wall Street, they find a sense of satisfaction from defying the odds and seemingly enjoy thumbing their nose at the Wall Street elite. “Our office feels more like an abandoned library with a couple of bums loitering around,” a 2013 letter to investors opined. “We have yet to be swayed by the virtues of analyst teams and investment meetings. We're old school. We mostly just sit 2round reading, thinking, and waiting. A quip by Stanley Druckenmiller describes our process best: 'I like to be very patient and then when I see something, go a little bit crazy.” They have defied the odds by not only posting spectacular performance but also by playing and winning at a Wall Street game by disregarding the conventional rules of success. Mecham is known to wear T-shirts to client meetings and looking for the simple solutions to beating the market that makes it sound so easy. “We... look for lay-ups, or absolute no-brainer types of investments,” Mecham told investors in 2008, simplifying what is considered a complex and rare task. “The major advantage one has investing in the stock market is the ability to patiently wait for the slam- dunk opportunity.” Such simplifications tend to play well on Main Street but can raise suspicions, even if it is not warranted. Mecham, the stock picking wizard labeled by MarketWatch columnist Brett Arends as “The 400% Man” for delivering such rare returns performance over a 12-year period, decidedly does not meet Wall Street's elite fund manager checklist. While attending college, he worked at Wasatch Advisors, a well- known local mutual fund company, where he was known as an excellent employee with one great stock pick to his name. He decided to work there full time rather than finish college. Mecham is not particularly distinctive in his speech or attire. Arends described him as “soft-spoken” when ina New York city investor pitch with attire more suited for a dusty bookshop than a hedge fund. He does not discuss his strategy using overwhelming complexity or throw in unnecessary and sometimes indecipherable jargon to explain concepts. “Mecham has no secret sauce or amazing algorithm,” Arends observed. “What's extraordinary about this young man is how ordinary he is.” Ashby Monk, executive director of Stanford University’s Global Projects Center, explained Mecham's Success in 2013 Institutional Investor column. Mecham’s recipe that appeals to Monk includesconcentrated portfolios over broad diversification, qualitative understanding of quantitative modeling, investing for decades rather than quarters as well as understanding the business more than the market. ‘These thoughts generally coalesce with that of Mecham, who wrote in 2008 about the nize the industry just five short years | ax ae ) e expressed in neat, crisp numbers,” Mecham told investors. “One is le to gaining a false sense of security, which can result in mental slothfulness and neglect.” "You too can make 400% over the next decade, but be prepared for some big losses (i.e. noise) along the way,” Monk wrote. Since those words were published, Mecham has continued to deliver everything except the big losses. “Show me the documentation” Teran has a long history providing investment advice to clients, and his voice is weary when discussing Arlington, a feeling he had after first meeting Mecham's partner Raybould. When he was initially ‘approached to sell the Arlington fund to investors, something didn’t seer quite right to the financial advisor who built a career in wealth management. “Ben (Raybould) solicited our firm as a possible third-party marketer for Arlington,” Teran told \ValueWalk. “I asked repeatedly for additional information, certified audits (and other pertinent information to conduct due diligence). When discussions devolved into audited financials, regulatory oversight, leverage (usage) they continued to avoid answering simole questions. Transparency and showing your work could not possibly compromise Arlington's proprietary knowledge base or trade secrets for events that happened almost 5 years ago....or for any of the past years.” Teran points to a discussion of Arlington's investment in Overstock.com, a Utah-based company, as @ ‘cause for initial concern. “Ben told me that he knew the owner and pushed Arlington to make a significant (money losing) investment in the firm. He kept showing a positive track record since Inception but qualified it by saying, ‘if you take Overstock cut of the performance, Arlington did very well.” In an interview with ValueWalk, Raybould claimed they did include Overstock in their performance analysis, which resulted in a gross loss of 32.7% in 2005. In their initial meetings, Teran asked for detailed documentation regarding performance, but it never came, and because they were not reporting their positions to the Securities and Exchange Commission (as they were not legally required to do so) there wns wate vey remanent jeran says. Instead, he describes a game where Mecham was put on a pedestal, and tough questions were restricted. Mecham was described as a “savant,” but since they were still small in 2005, Teran assumed he could easily meet with Mecham, whose office was 2 few miles from Teran so ‘that he could conduct. in-person due diligence.“Ben gave me a litany of reasons why Allan wasn’t available... even implying that Allan was a bit of an ‘Or’ character,” Teran said. Mecham’s persona was carefully crafted to appear like he had a "beautiful mind” but at the same time was “a shy hayseed character from Salt Lake City whose primary concern was not being swept up in Wall Street mania.” This all painted a “Buffett-like, aw shucks” picture that was “so devastatingly effective” with certain investors. While this correlates with Mecham's reported personality, Teran wasn’t buying it. With a degree of hesitation, he asked if Arlington would “maintain separately managed segregated accounts on our Fidelity Platform so that we could ensure that we could prevent a co-mingling of our client funds; thus give us the ability to monitor for potential fraud.” For Teran, the calculation was easy. They had the potential to more than double Arlington's assets under management at the time ~ then estimated at near $10 million -- so he assumed Raybould and Mecham would jump at the opportunity. To his surprise, Ben declined. “We have never referred funds to a third Party manager where they wouldn't manage accounts on a segregated basis,” Teran said, noting that he was “not only perplexed, but getting suspicious.” Raybould, for his part, says they have turned down money from investors numerous times, indicating that would not sway them, {tis possible that Arlington may have declined because it was not worth the costs for maintaining a separately managed account (SMA). Likewise, fund managers are often resistant to such a request because it might expose their "secret sauce." Without a resolution to their issues, the two parted ways. But Teran always kept a close eye on the Performance claims being made by Mecham, which to him seemed to stretch credulity, particularly after 2008 and the stunning 2009 performance. “it’s like LeBron James claiming to average 50 points per game, but | watched all 82 games and he scored over 50 only once, and in the other 81 games he didn’t ever reach 50 again,” Teran commented. “How can he claim 2 50-point average? How can anyone, including regulators, not be alarmed?” ‘At this point, Teran was basing his suspicion largely on above-average reported performance, on Personal interactions and the fact he was unable to obtain audited performance. While he was suspicious, Investors ValueWalk spoke with were more positive. Matt Brice of the Sova Group, who is familiar with Arlington, disagrees with Teran’s assessment, praising Mecham and the fund. “You're barking up the wrong tree” regarding Teran's charges, he said, pointing to the secret to Arlington’s success. “He just hasn’t had many bad investments.”ames St i LD di ca ‘haneot ines petenee mewn ay metrwt Spntine Th es ‘veyatepo yuo mt Ta peas lini near a Aire RAN Sentence meine er Arlington is the everyman of investing, the anti-hero of Wall Street Reviewing nearly a decade of Arlington's investor communication, what becomes apparent is the homespun, Main Street USA philosophy Mecham projects. He doesn’t like Wall Street convention ~ in fact, appears to have disdain for it at points. Style boxes, sophisticated quantitative strategy or obtuse valuation methods don’t fit into his down-to-earth approach. Mecham speaks out against the Wall Street consensus and view of the world, which can make enemies. “We think our philosophy is an intelligent way to invest ~ regardless of whether we're characterized as ‘growth’ or ‘value’ investors,” he told investors in 2008. “Such style-box definitions are not germane to stock picking success.” ‘The fund has gone through several iterations of its management process; an investor document describes it as follows: Period 1: (5 Years: Dec 1999 - Dec 2004): Arlington's primary founding partner was responsible for all ‘investment activity. Period 2: (1.5 Years: Jan 2005 - June 2006): In January 2005, Arlington took on two new active partners which resulted in material changes to Arlington’s investment process. The altered investment process resulted in significant internal conflicts. The fund's performance during this period was extremely poor. Period 3: (8 Years: July 2006 - Current): In July 2006, Arlington went back to its original investment process and structure. The anti-hero of Wall Street plays on as he embraces values and moral principles in investing concepts while outwardly eschewing his personal enrichment. “Rest assured, we have no interest in trading our Principles for assets; we gain more satisfaction from producing top results than from the size of our paychecks,” he wrote in 2009. “Our old-feshioned style embraces humble skepticism and is wary of most ‘modern risk management tools and ideas (i.e. broad diversification, financial models, derivatives, etc],’” he wrote in 2008. “Our concern is such tools and ideas can act like mental shortcuts and subtly diminish ‘one’s appetite for critical thinking.” {in his 2012 letter when the fund's exposure to Bank of America, for instance, he praised CEO Brian Moynihan for his return to “old-school banking values” and leverage reduction. “BAC’s freewheeling days of extreme leverage and loose credit are a thing of the past,” he later wrote in 2013. ‘There is one exception he makes when discussing leverage.“Though not advocates of leverage, we believe the low cost and modest amount, combined with Berkshire Hathaway's iron-clad safety and cheap price, makes our action sensible,” he wrote in 2011. “The key concern (when operating with leverage) is being able to play out our hand under unforeseen scenarios.” But while he talks down leverage, those monitoring his reported stock positions wonder how he can double or triple the performance of his underlying stock picks without using significant leverage. “just don’t understand” Now close to a decade after he was initially approached to sell Arlington investments to his clients, ‘Feran sits puzzled. He looks at the performance in 2013, stitched together by compiling position ‘exposures from SEC 13F reports and modeling his performance on Whale Wisdom, a website that tracks the actual performance of a hedge fund’s reported long holdings. This summer, Teran ran the numbers from ARLINGTON VALUE Whalewisdom 2013 to YTD 2017 08-22-2017, and they pointed not to outperformance, but rather to a loss over the period and an underperformance versus the S&P 500 by -12.54%, Whale Wisdom calculates performance based on the fund's 13F reporting. \ValueWalk then conducted limited due diligence with a specific focus on one recent year, 2014. Using the stated assets under management of $725 million and a combination of 13F and Whale Wisdom and providing the most beneficial buy /sell prices from quarter to quarter, our performance estimate showed a cumulative gain of just over $135 million on the year, nearly half their reported performance based on the stated level of assets under management. As confirmed buy and sell prices during the quarter could not be determined due to the 13F reporting limitations, ValueWalk used the mostpair-o» 5 oat 670% 185450 ann ae. 030% Whale Wisdom’s reported performance for the period was close to ValueWalk’s estimates. Further, Whale Wisdom shows Arlington underperforming the S&P 500 from the point the fund began their positions to the SEC. It should be noted, however, that calculating performance based on public 13F reporting is not conclusive in determining fraud for many reasons. Brice defends the fund’s performance claims, Pointing out the fund began 2014 with near $400 million under management. Thus, assuming nearly $135 million on a near a $400 million account plus dividends the fund’s performance reporting is “pretty accurete...or at least passes the smell test.” There are several points to consider in performance calculation methodologies. It is unclear through the 13Fs if the assets under management reported by the fund were calculated using leverage (notional) or actual cash (nominal) levels. Likewise, itis impossible to precisely calculate even for an equity-focused fund's performance without knowing leverage and exact buy and sell transaction details that took place during the month along with dividends accumulated — all information not ascertained through 13F reporting. One Arlington investor with whom ValueWalk spoke emphasized leverage when explaining the outperformance. To further complicate performance estimating from public reporting, transactions that were initiated and completed during the quarter, and thus not in the portfolio at the end of @ quarterly reporting period, would not be included in 13F connie ae red in 2015 when Arlington said it purchased gust Precision Cast ar dA An et later sold it t efter Berkshire Hathaway announced a. ‘takeover bid, all occurring in-between reporting periods. “A 13F analysis that can be explained with leverage and high returns is not enough to demonstrate that something is a Ponzi scheme,” said one hedge fund due diligence expert focused on forensic research.He notes that an analysis based only on 13F analysis is but a start. If a whistleblower “really had the goods he'd have more detailed specifics of how to back up claims like Teran is making.” Such analysis might include details about fake service provider relationships, how the fund was skirting cash controls, or how specifically the reported representations were false based on internal documentation, which is all not the case here. 2008 performance While digging into the 13F performance reporting provides more questions than answers, another issue some critics cite regards a period before Arlington began reporting being required to report its positions to the SEC legally. Critics consistently wonder how itis @ long-only fund can deliver positive performance during 2008, up 15.2% on the year in Arlington's case, while the S&P 500 wes down 29% from the inception of Arlington's fund. Peeformance Summary (1251/2014) AVM Ronges, LP Amun! Re Sie ton Combo Retr Sie lcon | ae a wom = 196 | 108 vs PP PPPS PPP Ppe ° ILPPEEL EPIL AS ES Calender Yur xo deo 012 a AVM Range LP Gm Net S850 CCanmtve Retin Stace Tncepion | TOSS 478366 | SON ‘Aamidtl ae Ants Mager $725 non

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