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Investment Management and Financial Counseling for ...

  1. 1. Prudent Wealth Management LLC Investment Management and Financial Counseling for Individuals January 20, 2003 To Our Fellow Shareholders, ___Annualized 2002 3YR 5YR PWM Composite -.45% +11.28% +10.60% S&P 500 -22.10% -14.55% -.59% Lipper MultiCap Value* -17.90% -3.35% +1.32% *Lipper Multicap Index is after Management Fees. For Additional Performance Data See Page 4. Not Your Typical Value Stock Portfolio Our best performing investment this year, by far, was Newmont Mining (+53%). In fact, it was the third best performer in the S&P 500 during the year. Happily, this was also our largest position in the portfolio (8%). We are optimistic about this investment for several reasons. The new mine supply of gold has been less than demand for several years. In addition, many gold mines were unprofitable at the $275/oz market price of two years ago thus forcing their closure further reducing supply. And finally, world central banks have sold much of their gold reserves (temporarily covering the supply shortfall) and replaced them with dollar denominated assets - a trend which seems to be ending. Furthermore, a weak dollar, weak stock market, and weak economy along with an increasing risk of monetary instability (inflation or deflation) are likely to support a higher price for gold. And when Greenspan himself chooses to speak about the virtues of a gold-backed dollar, as he recently did, you can be sure that gold has regained some of its former stature as an asset of value. After a twenty year bear market in gold, we suspect it still has plenty of upside left. Another strong performer this year (+3.2%) has been the Northeast Investors Trust. This is a high yield bond (junk bond) fund. During times of economic and financial market stress investors become fearful of a spike in corporate bankruptcies. Junk bonds, being of lower quality, are hit especially hard. Investors demand an extra amount of yield to offset the higher risk. In the last couple of years junk bonds have been sold off to the extent that they now offer yields 6-10% higher than Treasury bonds of similar maturity. Currently, the Northeast fund has a yield-to-maturity of 11.5% (duration of 5 years) which is 8.5% higher than the yield on 5 year Treasuries. We find this situation very attractive. In a particularly bad year there can indeed be a high default rate in the junk bond market, as there currently is, thus, offsetting the additional yield pickup. However, this is highly unlikely to persist. If the default rate averages 4-5% over the next several years, an investor might expect to receive a yield 3-4% greater than Treasuries each year for a 3-5 year holding period. When this yield premium is available through a fund managed by bright, conservative, value- minded individuals we are doubly excited. Such perspective should help the fund to steer clear of disasters such as telecom debt, which the fund deftly avoided. A quote from the recent annual report should give further depth to our argument. The fund’s relatively good performance has attracted new money which the managers have largely let accrue in cash. P.O. Box 2191, Corrales, NM 87048-2191 Phone: 505-899-3850 or 505-898-6923 Fax: 505-890-7402 P. O. Box 2191, Corrales, NM 87048-2191 Phone: 505-898-6923 or 505-899-3850 Fax: 505-890-7402
  2. 2. The fund manager reports, “Clearly, investing in Treasury bills yielding less than 2% is temporarily dilutive to the income of the Trust. However, our reading of financial market history is that investors have often stretched too much for extra yield during periods of low interest rates. Although we believe we see some favorable investment opportunities in the high yield market, we are trying to be mindful of the risk that yields on Treasuries will someday return to historical levels.” Is it any wonder we like these guys? They are doing the intelligent thing which is sometimes different from the easy or popular thing. They are as conservative and risk averse as we are and we feel comfortable with a portion of our assets invested with them. Isn’t a junk bond fund an odd investment for an equity oriented account? Yes it is but we view our job as broader than just picking stocks. We are ‘wealth managers’ as our company name implies. In our view, a conservative investment approach starts with cash (the safest asset) and deviates from that position of safety only when the risk/reward trade-off of a particular investment justifies doing so. Many mutual funds seem to view cash as a risky asset because they are very quick to get rid of it even if that means buying an unattractive stock. We try to only accept risk when there is an appropriate reward potential. We see such potential with the Northeast Investors Trust. We think this fund is likely to produce total returns far better than cash within an acceptable level of risk. This is more than we can say for many of the most popular stocks of today. That said, we do expect the vast majority of future investments to be common stocks. It is a bear market, you know… The bear market drags on. This is the third calendar year in a row of losses for the S&P 500 index. And yet, every time the market bounces there are dozens of commentators confidently predicting that this is THE turn. There still seems to be a widespread willingness to pile into the most speculative stocks on any whiff of positive news, or less- negative news. From mid-October the S&P 500 rallied about 22% while the PWM Composite rallied only modestly. The stocks that rallied the most were the formerly favorite tech stocks that were trading in the neighborhood of $1 in early October and promptly rallied to $2, $3 or $4. The poor quality and speculative nature of the recent rally leave us suspicious of any real turn in the markets. As Jeremy Grantham recently said, “Playable rallies in a bear market do not have the rational, cheap asset classes rallying very well. In fact, quite the reverse. Historically, they do the opposite, just to make your life difficult.” It seems many mutual fund managers are still afraid of missing the next rally in tech stocks and thus jump on to any perceived rally. Fear of missing the next speculative wave does not seem to us to be a sign of a healthy market. A healthy skepticism of the most speculative stocks would make us more optimistic. It is an immutable law of bear markets that most stocks will fall. If we had a crystal ball that would tell us which stocks will be big winners in the next bull market, and we looked at them today, they would almost certainly be falling. The wonderful book Reminiscences of a Stock Operator tells the story of Old Turkey. He was the older, wiser, more experienced speculator that the young ones asked for advice. After a youngster would tell Old Turkey about a particular investment and ask his advice, Old Turkey would often reply “’Well, this is a bull market, you know!’ as though he were giving to you a priceless talisman wrapped up in a million-dollar accident-insurance policy.” Of course he meant that most stocks rise in a bull market. To which we add, most stocks will fall in a bear market. Our job is to find healthy, well managed, undervalued companies that earn tons of money in a more P.O. Box 2191, Corrales, NM 87048-2191 Phone: 505-899-3850 or 505-898-6923 Fax: 505-890-7402 P. O. Box 2191, Corrales, NM 87048-2191 Phone: 505-898-6923 or 505-899-3850 Fax: 505-890-7402
  3. 3. normal economic environment even if their stocks are currently weak. In our view, such stocks are the most likely to make successful long term investments. Since the bear market has most acutely punished stocks with high investor expectations, the promise of fast growth, and high financial leverage (debt), it seems unlikely that such characteristics will be rewarded by the market again anytime soon. The leaders of the next bull market are more likely to exhibit characteristics such as: low financial leverage, real growth (although modest by 1990’s standards), old fashioned business lines that are easy to understand, and conservative, experienced management teams. Companies such as Norfolk Southern (railroads), Hubbell (electrical products/lighting), and Newell Rubbermaid (household consumer products), all of which we own, are likely to be sought and rewarded by investors in the next bull market. We must be aware of, but not overly put off by, the fact that the stock of a seemingly attractive investment is currently falling. It is a bear market, you know. For those of you that are making IRA contributions there is good news from the IRS. For 2002 and 2003 annual contribution limits have been increased to $3,000.00. For those of us 50 and older by 12/31 of the tax year to which the contribution relates, we can take an additional contribution of $500.00. Remember that tax deductibility of traditional IRA contributions is a function of Adjusted Gross Income and whether or not you are an active participant in an employer-sponsored retirement plan. Contributions for the tax year 2002 can be made up to April 15, 2003. For additional information see IRS Publication 590, the retirement area on Fidelity’s website,, or give us a call. Thank you for taking the time to read this update. If you find it lacking in some key area, please let us know! Your feedback is appreciated. If you find it worthwhile, Please pass it along to a friend. We want to thank you for your business and assure you that we will continue to watch over your money as carefully as we watch our own. Sincerely, Clayton Bryan, CFA Doug Manz, CFA Principal Principal *This letter is for informational purposes only. Nothing contained herein shall be construed as an offer or recommendation to buy or sell individual securities. Data has been obtained from sources believed to be reliable but there can be no guarantees concerning errors or omissions. Performance PWM S&P 500 Number Total Percentage Non-Fee Total Of of Firm Paying Year Total Total Portfolios Composite Composite Assets Assets as Firm In In Return Return Composite Dispersion Assets Composite % of Total Assets P.O. Box 2191, Corrales, NM 87048-2191 Phone: 505-899-3850 or 505-898-6923 Fax: 505-890-7402 P. O. Box 2191, Corrales, NM 87048-2191 Phone: 505-898-6923 or 505-899-3850 Fax: 505-890-7402
  4. 4. 7/31/97-12/31/9 7 3.4% 2.4% 1 0 $ 70,119 100% 100% $ 70,119 1998 3.5% 28.6% 1 0 $ 93,063 100% 100% $ 93,063 1999 16.1% 21.0% 1 0 $ 141,482 100% 100% $ 141,482 2000 16.2% -9.1% 1 0 $ 199,036 100% 100% $ 199,036 2001 19.2% -11.9% 1 0 $ 198,956 100% 100% $ 198,956 2002 -.45% -22.1% 21 .018 $ 2,440,046 55% 13% $ 4,409,101 Prudent Wealth Management LLC has prepared and presented this report in compliance with the Performance Presentation Standards of the Association for Investment Management and Research (AIMR-PPS®), the U.S. and Canadian version of the Global Investment Performance Standards (GIPS®). AIMR has not been involved in the preparation or review of this report. Notes 1. Past performance is no guarantee of future results. Data has been obtained from sources believed to be reliable but there are no guarantees concerning errors or omissions. 2. The Firm is defined as Prudent Wealth Management LLC, a Registered Investment Advisor established in 2001. PWM specializes in managing separate, equity based portfolios for individuals. Prior to the creation of Prudent Wealth Management LLC, the Firm is defined as Mr. Bryan’s sole account covering the period 7/31/97-09/30/01. 3. Performance has been calculated using time weighted rates of return adjusted for cash flows. Returns are calculated monthly and are linked geometrically. Trade date accounting is used. 4. Capital gains in the amount of $20,649.54 are included in the performance for the year 2001. These gains resulted from investments in a mutual fund designed to profit from a decline in the Nasdaq 100 index. Investments designed to benefit from stock or index declines are not expected to be used in the future. 5. The composite was created on 12/31/02. A complete list and description of all of the Firm’s composites is available upon request. 6. The dispersion of returns is measured by the standard deviation across equal weighted portfolio returns, measured for the period and then annualized. 7. Portfolios in the composite range in size from $23,057 to $365,369. 8. Performance is reported before management fees but after all commissions. Fees are described in Form ADV Part II. The Client’s return will be reduced by the management fee. A representative example of the impact of the standard 1% management fee is as follows: Annualized Total Return Period Gross of Fees Net of Fees 1 YR -.45% -1.28% 3YR +11.28% +10.27% 5YR +10.60% +9.60% ITD +9.81% +8.88% P.O. Box 2191, Corrales, NM 87048-2191 Phone: 505-899-3850 or 505-898-6923 Fax: 505-890-7402 P. O. Box 2191, Corrales, NM 87048-2191 Phone: 505-898-6923 or 505-899-3850 Fax: 505-890-7402