2010 Fourth Quarter
Last year was a strong year for stocks and bonds. It is not very often one can say that about both asset classes. I hope you will be pleased with your returns as you review the enclosed reports. While many if not most of the funds in your portfolio kept pace with their respective benchmarks, there were a couple of laggards. All of our small-cap funds trailed their benchmark over the past 12 months; however, all of them beat the benchmark over the past three, five and ten year time periods. Obviously, we are more concerned about the long-term returns. Nevertheless, their 2010 returns were extremely strong. Moreover, all of the overseas funds we hold beat their respective benchmarks last year; some did so very convincingly. These international funds also outperformed their benchmark over three, five and ten year time periods. Instead of dissecting the past, I would prefer to focus this letter on some of my thoughts going into a brand new year.
There are a lot of places where an investor can place their hard-earned money at present. One could invest in gold or silver, emerging markets or right here at home in red-hot small companies. My personal thoughts are that the housing market may struggle this year due to the lack of the first-time home buyer tax credit and the slow adjustment to higher interest rates. I also believe the commercial real estate market will be mild: Apartment occupancy will continue to be near capacity, but office and retail space will be in abundance. Jim Rogers, a long time advocate for precious metals, recently mentioned in an interview that he continues to own gold, but would not be surprised if gold took a "rest." I would not be surprised to see silver do the same after garnering an 83.8% return in 2010.
As you may know, the bond market has been very strong since 2008. PIMCO Total Return (an intermediate bond fund run by Bill Gross) has averaged 8.77% per year over the past three years. That is a long way from the average bond return of 3-5%. Incidentally, the fear factor we all experienced over the past three years drove investors to bonds for safety. This in turn, drove the prices for the bonds higher and the yields lower. As long as you were holding the bonds everyone was demanding, you made a pretty penny. This area is a concern of mine and I will watch it over the next year to see if a resurgent stock market draws money from the fixed income side.
Speaking of the stock market, what should we expect in 2011? As Matthew McLennan, one of the co-managers of the First Eagle Funds, said in a January 2011 Smart Money interview: "We don't have a directional sense on things; the crystal ball is too foggy. But we prefer to be a buyer when world economies are below their potential. Now's typically the kind of environment where you want to be a buyer of businesses." An earlier article quotes him as saying stocks represent "the least worst choice". Not exactly a ringing endorsement, but it is what I happen to believe. The managers of the Vanguard Primecap Core and Primecap funds explained at the end of their October 20, 2010 letter to shareholders: "Finally, the balance sheets of corporate America are as strong and liquid as they have ever been. This will afford companies great financial flexibility during challenging economic times." Moreover, Goldman Sachs is predicting a year-end target price of 1,450 for the S&P 500 - about a 16% increase from where it ended 2010.
I will continue our emphasis on value stocks and value investing. While this approach may lag a bit during bullish stock market cycles, I believe it is fundamentally the best approach to investing your highly valued financial assets. Value investing incorporates a "margin of safety", which during these unpredictable times is needed as a back-up in case the market decides to go down instead of the direction Goldman Sachs suggests it might.
As we enter a brand new year, I wanted to thank you for your confidence and trust in our money management services. I have the utmost confidence in the mutual fund managers we have selected and I back that up by investing my family's money in the same securities that are found in your portfolios.