More Excellent Portfolio Results

Despite continued weakness in the domestic residential real estate market and ongoing woes in the sub-prime lending space, the second quarter of 2007 produced very fine results for our clients’ portfolios. Very strong performance in April and May was more than enough to withstand erosion in June.

Many client portfolios are already enjoying year-to-date results which we’d find quite respectable for the whole year. This is a happy continuation of the superior portfolio results we’ve been able to achieve for clients generally since the market began its broad recovery more than four years ago in early 2003. Some caution is in order, however, since the returns of this recent past are far greater than long term averages. A large part of this recent good news is the strong recovery following the three year collapse of equity prices in 2000, 2001, and 2002. From that “catching up” perspective, it’s probably not too much of a good thing, reflecting, appropriately, solid real economic performance around the world. Still, it’s at an absolute pace that almost certainly cannot be sustained. So, even though the global economy continues to perform well, we believe that expectations for continued portfolio results should be a good deal more modest than what we’ve recently enjoyed.

Interest Rates Regain Their Curve…Well, a Little

Markets rejoiced in the final days of the quarter as the Federal Reserve held short-term interest rates constant. Any change in rates would probably have been ill-received: a raise indicating concerns about mounting inflationary pressures and a drop suggesting too slow economic growth…or even a retraction. Stable rates, instead, reflect the Fed’s view that these opposing risks are in rough balance.

Longer term interest rates, however, have increased. The 10-year Treasury was at 4.65% at the start of the quarter; it’s now at 5.11%.

While this upward movement in longer term rates was, in the end, modest, its initial spike was enough to rekindle concerns over higher mortgage rates spawning new real estate woes as well as removing some of the support for the robust equity markets, particularly in the private equity arena. Domestic real estate holdings, on cue, turned-in the only losing asset class performance this past quarter.

A Cautious But Still Optimistic Longer View

In the closing weeks of this quarter, we had the good fortune to attend two excellent conferences devoted to very long range global economic issues. The first, sponsored by the Federal Reserve Bank of San Francisco, the Asia Society, and key academic departments at Berkeley and Stanford, focused on the risks and opportunities the world faces in the continuing economic, market integration, and currency dynamics well underway among Asian nations and between Asia and the developed West. The second, sponsored by the Charles Schwab organization, included a truly stunning presentation by Eric Peterson of the Center for Strategic and International Studies, on seven crucial areas of change the world will face over the next twenty years and beyond: population, resource management, technology, information, economic integration, conflict, and governance.

Like it or not, the future is likely to present us with a wider range of potential outcomes, bad and good, and the only way to have a confident expectation of being on the successful end of those outcomes is to be able to embrace that change. As managers of our clients’ wealth, we eagerly accept the responsibility of assisting our clients in this embrace through our innovative, flexible, and ongoing planning and by the development and disciplined execution of portfolio asset allocations that are likely to succeed in future environments. We are more convinced than ever that clients should:

• devote substantial commitments to overseas opportunities, especially in developing markets;

• very broadly diversify since no-one can predict where and how the great innovations of the future will occur; and

• despite the risks of short-term volatility, maintain heavy long-term commitments to equity investment, since it will only be by owning the whole world’s productive enterprise that clients can confidently expect to be able to comfortably afford the future’s goods and services – things we can’t even imagine today.

In the articles to follow, we explore some of these factors, and our response, in greater detail. Our Chief Investment Officer, Jason Thomas, discusses the often subtle impacts of the dollar’s role in the world economy and Karen Blodgett and Jason describe the work we’ve done with Goldman Sachs to create what we believe will be a superior and highly tax efficient means of participating in global commodities returns. Further on this theme, we spotlight the mutual fund we primarily use for our client’s investment in emerging markets - a fund that DFA engineered specifically in response to our design specifications.

Karen also collaborated with Leigh Shimamoto and Greg Schick in providing guidance to our clients in the usually very difficult discussion about whether...and if so, how...to acquire earthquake insurance.

Tim Kochis, Editor