• Bill Bullock

2011 Fourth Quarter

When we look back at the financial year that was 2011, there was one event that helped shape our returns for the year: the downgrade of the U.S. debt by Standard & Poor's. Immediately after this downgrade we witnessed investors clamor for the very securities that were downgraded. How ironic was that? Neither the downgrade nor the intra-government bickering could stop the flood of money into our treasuries and - in the fourth quarter - domestic stocks. It seems America is still considered one of the safest places to invest in the world.

Of course, Europe is a mess. I have concluded that everything that has been proposed to this point is nothing more than a band-aid. Martin J. Whitman, the Chairman of the Board for Third Avenue Value funds says in his most recent quarter-end letter: "There is one macro point in which I believe strongly, and of which you should be aware. There is no way that I can see that those countries involved with the Euro can be made credit-worthy unless all European Sovereign Debt is assumed, or guaranteed, by each member country including, especially, Germany. Such an amalgamation would make Euro Sovereign Debt more comparable to U.S. Treasuries than is now the case." While I can see why the German citizens do not want to back the debt issued by their free-spending Greek counterparts, I can't help but think of how the Germans are benefiting from a low Euro for all of their exports. If Euroland broke apart, the currency Germany would end up with would certainly increase and make their products more expensive.

Obviously, the story of the last several years has been the unwinding of debt, or deleveraging, from both a micro and macro perspective. Whether you are an individual, a corporation or a sovereign government, over the past three to four years you have focused on paying down your debt. Corporations are hoarding cash and families - fearing the unemployed will eventually include them - are building up their emergency funds. Speaking of the unemployed, that number is still hovering at 8.5%. With all of this in mind, is it difficult to imagine why our economy is only growing at 2% when consumer spending accounts for a significant percentage of GDP (i.e. what we produce)? People are not spending - unless it is an Apple product - and, therefore, the U.S. is barely growing. We need sustained growth for that unemployment number to drop. I am lead to believe that the catalyst for this growth will be the housing sector, which is starting to show some positive signs.

As you are all aware, the global investment climate is pretty dicey right now. You have Asia slowing down due to the lack of demand for their products from the U.S./Europe and you have Europe slowing down to a point where they will most likely fall into a recession this year - and that is probably the least of their concerns. So I thought going into 2012 it would be important to emphasize corporations that are selling at a discount, but these corporations must also have a global reach - especially when it came to the foreign portion of your portfolio. In other words, I did not want an international fund within my model portfolio that was made up of corporations that had regional or local sales.

With that as the background, for most of you I decided last month to move your international weighting from 23% to 20% of your total equity allocation. I shifted about a quarter of this foreign allocation into IVA International, which is managed by a former First Eagle manager. I dropped the First Eagle portion to half of the foreign with Third Avenue Value making up the other quarter. I also sold down the Oakmark Equity & Income fund within many of your portfolios and added most of the proceeds to First Eagle U.S. Value. IVA International and First Eagle U.S. Value probably will not do as well when we are in a raging bull market, but if the market is flat or down, these two funds will hold up better than most.

Why sell First Eagle Overseas to purchase a former First Eagle manager in IVA International? The reason is that I believe they will complement each other. While they share the same value discipline, there really is very little overlap among the stocks they selected. I want to make sure your portfolios are well diversified...even among mutual funds.

I also made some changes to the fixed income side of things, but the underlying result is that you will still have about 50% of your fixed income allocation in intermediate bonds and 50% in short-term bonds. The intermediate bonds were some of our best performers last year, but as you all know the short-term bonds will be safer in a rising interest rate environment

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