Strategy Update Q1 2007

4/2/07

The first quarter of 2007 marked the end of two quarters of strong returns with the major indices close to flat on the year. The main driver was the growing realization that the real estate bubble may finally be getting ready to burst. Not surprisingly, the first cracks appeared in the sub-prime mortgage sector, but we fully expect higher grade mortgages to be affected as well. It is hard to predict how significant the impact on the overall economy will be.

How do our strategies respond to these changing conditions? A desirable feature of our strategies is that they are designed to adapt as conditions change. Our Dynamic Value portfolio has no built-in sector or Capitalization bias. It simply attempts to identify companies with attractive valuations and prospects, regardless of size or type of business.

Two years ago, Dynamic Value had a fairly significant exposure to home builders and some mortgage lenders, but at the end of the first quarter 2006 the portfolio had rolled out of these sectors. The main exposures were 31% in the Consumer Discretionary sector, specifically car-related companies and assorted retailers, and a 26% allocation to the Financial sector. This exposure consisted exclusively of insurance companies. The median market capitalization of the portfolio was $2.7bn, which places it between the Russell 2000 ($0.5bn) and the S&P 500 ($8.6bn). The absence of strong concentrations in any one sector or industry group reflects the fact that there were no pronounced trends the strategy could identify at that time.

A year later, the median market capitalization of the most recent tranche has increased to $4.1bn and the main sector exposures are now in the Financial sector/Insurance (24%) followed by Consumer Staples such as medical services and food (18%). It is also worth noting that the exposure to the Utilities sector has tripled to 7%. The portfolio has taken a more conservative stance both in terms of capitalization and also in its sector exposures.

These examples show that while the core objective of this portfolio remains unchanged, the character of the portfolio in terms of sector and market capitalization exposures can change significantly. In the past, this has enabled the portfolio to participate in some of the major value driven trends while steering clear of over-extended sectors and bubbles. We hope that our strict adherence to the core objectives, coupled with a disciplined and adaptive strategy, will continue to generate attractive returns for our clients.

Dynamic Value

The Dynamic Value Portfolio was well positioned to avoid the worst of the mortgage-related sell off in February. Based on preliminary calculations it returned about 6.9% for the quarter compared to 1.9% for the Russell 2000. This is mainly due to its defensive stance and zero exposure to mortgage-related stocks.

Performance

To view detailed performance information, please click here (Requires free registration to access).

Current Holdings

Diversified Income

The Diversified Income portfolio performed well in the first quarter of '07, returning 3.3% compared to 0.6% for the S&P 500 (based on preliminary estimates). As with the Dynamic Value portfolio this performance is mainly due to the conservative stance of this portfolio and the lack of exposure to housing and mortgage-related stocks.

Performance

To view detailed performance information, please click here (Requires free registration to access).

Current Holdings