4th Quarter 2007 Commentary

7/31/2019 4th Quarter 2007 Commentary

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Asset mANAGemeNt

Our Year in Review

In absolute terms, portolio perormance in 2007 turned

out reasonably well or our clients. Depending on the mix

o equities and xed income, portolio returns ranged

between 7% and 9%. Compared to our perormance

benchmark, stock results in the Nelson Roberts portolios

were outstanding. Our stock portolios beat the S&P 500

return o 5.49% by about 300 basis points (~3.0%).

(See the box below or index return data.)

The perormance o our portolios was aided by decisions

on sector allocation weightings as well as individual stock

selection. Specically, our decision to limit exposure in the

nance and consumer discretionary sectors, which were

down -17% and -12% respectively, beneted our port-

olio returns. Additionally, our light allocation to small

capitalization stocks also helped. We cut our small stock

exposure in hal in late 2006 to 2.5% o client equity

allocations. The Russell 2000 Index o small stocks was

down -1.6% or the year.

Our selection o individual stocks also aided portolio per-

ormance. Beginning with the sale o Goldman Sachs at

$211 per share on July 19th, we signicantly reduced our

already underweighted nance holdings. At the time we

eared the momentum in credit market problems would

disproportionately aect large money center banks, like

portolio holdings Goldman Sachs and Citigroup. A sale

o Citigroup, at $48 per share, would ollow in the ear

all as the cloud over money center banks darkened. O

August 23rd, we added a position in Brown & Brown,

a mid-market insurance broker with no exposure to th

subprime mortgage mess. On October 23rd, we bough

shares in American Express on the belie that the spend

habits o its typically more afuent customers would no

be signicantly impacted i an economic slowdown act

ally occurs. While both Brown & Brown and American

Express declined rom our purchase price, neither was a

weak as Citigroup, which closed the year at $29.44 per

share. Goldman, ater trading as low as $169, closed th

year just above our sale price at $215.

Portolio activity was not limited to the nance sector.

During the year we sold a long-held position in Avery

Dennison in exchange or 3M. Since then, Avery has

allen and 3M has risen, resulting in 41% more return o

this position. Another successul exchange, selling a pos

tion in Dupont and buying Monsanto, yielded an even

more impressive 59% improvement. Uncharacteristical

we sold our Monsanto position or a short-term capita

gain on the belie that the shares had quickly become

overvalued, achieving during our three month holding

period what we expected over two years. The act that

Monsanto closed the year at $111 ($20 above our sellinprice) argues that our valuation parameters may have

been too stringent. We kick ourselves or not holding

on or the momentum ride, though as Phil Nelson used

to say, You cant go broke taking prots.

We selected the right managers to buy international

stocks or our clients portolios. The index or interna-

tional market returns, the EAFE Index, was up 10%. Th

two actively managed unds we hold, Masters Select

International and Matthews Pacic were up 34% and 19

fOUrtH QUArter 2007QUARTERLYCommentary

INDEX PERFORMANCE Q4 07 YTD

Dow Jones Industrials -3.91 8.87

Standard & Poors 500 -3.33 5.49

EAFE (international stocks) -1.70 11.73

Russell 2000 (small stocks) -4.57 -1.56

Lehman Intermediate 2.91 7.39

Lehman Municipal 1.36 3.36

Inside this Issue

Asset mANAGemeNt

: : Our Year in Review

firm perspective

: : Nothing is Certainbut Death and Taxes

meet A memBer Of

tHe firm

: : Terrence Boyd, Jr.

www.nelsonroberts.com | 650.322.4


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WeexpecttheFedwillcontinuetoerronthgrowth,andequityreturnswillsurprisewithstocksreactingtoeasy money.

Largest

Fiteen Equity

Holdings

Schlumberger

Mathews Pacifc Tiger Fund

iShares EAFE Index Fund

Procter & Gamble

Masters Select International

Chevron

Marathon Oil

Utilities Sector SPDR

Texas Instruments

General Electric

Emerson Electric

State Street Corp

Intl Business Machines

WalgreenMicrosot

Some o the best decisions we made this year were ones

that resulted in no activity. We stayed clear o the value

traps oered in the carnage o the subprime mortgage

mess and homebuilder stocks. Both types o investments

continued to decline. We passed on several stocks that

continued to all throughout the year including Washington

Mutual and Trex, a manuacturer o synthetic wood used

or decking. Each o these stocks was down over 60%

or the year.

While we are pleased with the value we delivered to our

client portolios, we also have to acknowledge the oppor-

tunities missed. Gold, which we do not own, rose 30.5%

and our technology stocks, though strong, underperormed

the index as we missed the trio o the best perorming

technology shares: Apple was up 133.5%, Research in

Motion, the maker o the ubiquitous Blackberry, was up

126.6% and Google was up 50.5%. Yes, picking stocks

is always a humbling experience.

W Lan o Ou pa

Back in early 2000, we did really well or clients by

cutting back on technology stocks and increasing our

exposure to the healthcare and consumer staple sector

In 2001, the nancial markets were very weak and our

eorts were ocused on mitigating the risks in our equit

portolios. Heading into 2002, we got back into the

market too early with the expectation that a bull marke

would return. During the 2000-2002 period, the equity

market had the worst returns in 2002. A change in ma

ket leadership oten takes longer than most prognosti-

cators expect. We do not believe this time is dierent.

Recall the popular cocktail party chatter about attractiv

investment opportunities in real estate in mid-2005.

Compare the current bursting bubble in housing to the

last one in technology. Were in the midst o the housin

bubble bursting and in our opinion it is not over yet.

i wa a na od ya o h aoun o aal gan w ook. to w,

w ll holdng bau:

Investmentsreachtargetedvaluesandbecomeovervalued.ExamplesofthiswereMonsanto,

Stericycle and SunOpta.

Wendabetteropportunity.Forexample,sellingAveryandbuying3M,orsellingDupontand

buying Monsanto.

Ourdesiretodecreaseourexposuretooneparticularsector,suchasnancethispastyear.

Anunfavorablechangeinthebusinessstructureorcompetitivemarketplace.Forexample,inMay

we sold our position in Equiax, a company that primarily makes money providing credit reports

to mortgage lenders. This stock ell precipitously in July as the subprime problems widened. Poorexecutionorchangeinacompanysmanagementstrategy.Wesoldanunprotable

position in Motorola this year because o its continued management missteps that resulted in

poor stock perormance.

Uniquecircumstances,suchasapendingmergeroracquisition,thatresultinastocksrapid

rise and make it simply an arbitrage on whether the deal is completed. We typically will avoid this

risk, take our gains and move on. Our sale o Caremark early in the year is an example o this.

We are less reticent to take gains at present because we have a sneaking hunch that we have

seen the low in capital gains tax rates. It will be interesting to see how a new Administration in

the White House infuences tax policy in 2009.


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of

upside

Best Holdings

o 2007

Schlumberger +56

Monsanto +45

Matthews Pacic +34

Intel +33

Marathon Oil +33

Worst Holding

o 2007

McGraw Hill -35

Volcano Corp -30

Amgen -24

Motorola -19

Zimmer Holdings -16

www.nelsonroberts.com | 650.322.4000

V

v i s i o n

What is money?

At its simplest, it remains a orm o barter, an exchange o energy or good

At its most complex, its a symbol o mastery, a measure o power. At its ce

are people with vision, talent, skill, amilies, children, hope and dreams.

[vizh en] n. the ability to perceive or foresee through mental acuteness

eono and fxd ino

The Lehman Brothers Intermediate Government Corpo-

rate Bond Index exceeded our xed income portolio

returns o 4-5% by close to 2.5%. The Federal Open

Market Committee (FOMC) cut rates three times this all

in an eort to stabilize the banking and housing indus-

tries. We positioned our portolios to protect against

rising infation that would result in rising interest rates

and alling bond prices. In the second hal o 2007 when

rates declined in reaction to economic concern and FOMC

action, the xed income component o our portolios

went up less than the overall bond market. We continue

to believe the greatest risks in the xed income markets

are low credit quality and infation. Thereore, we con-

tinue to maintain high quality, short-term bond holdings

to oset these risks.

The Fed is walking the knies edge between infation

and defation. Three cuts in short term rates still have

not solved the credit markets liquidity problem. Is the

growing infation problem being masked by the Feds

ocus on core statistics (infation less the impact o ood

and energy)? Commodity prices have run up signicantly

in the last ew years. Industrial metals seem to have

peaked but oil and ood prices continue to rise. The 200%

increase in the cost o oil during the last our years will

eventually push the broader infation statistics higher.

The opposite side o the knie is a debt-extinguishment-

through-deault scenario. Many parts o the credit

markets have become near rozen. Specialized o-bal-

ance sheet investments known as Structured Investment

Vehicles (SIVs) were created by many o the money center

institutions. SIVs used extensive borrowing to leverage

the return opportunity by borrowing short-term in the

money markets and lending long-term in the nance and

mortgage sectors. As the short-term borrowings come

due, these SIVs have been unable to access capital in

the commercial paper market because the value o their

collateral, oten subprime mortgages, has dropped. The

subprime mortgage problems are spreading and many

(including us) ear we have seen only the tip o the

iceberg. It remains to be seen how much more o the

iceberg is yet to be revealed. The extreme volatility in

both the stock and the bond markets is a refection o

how market participants abhor uncertainty.

exaon

As we begin 2008, the markets are aced with possible

weaknesses, but we believe there are also some corre-

sponding strengths:

WeAKNesses streNGtHs

Weak housing markets Stable job growth

A tired consumer worriedabout alling home equityand rising ood and energycosts

Stable wages(personal income)

A liquidity mess in manyparts o the fxed incomemarket

Federal Reserve actions =TAF (Term Auction Facility)injections o $40 B to aidliquidity

We expect the Fed will continue to err on the side o

growth, and equity returns will surprise on the upside

with stocks reacting to easy money and continued

strength rom international revenue sources. Dramatic

price movements will continue, but equities will nish the

year in positive territory. Fixed Income markets will suer

rom the buildup o infationary pressures and the con-

tinued fight to quality with credit risk uncertainty.

Though we believe the strengths will overcome the weak-

nesses, we have positioned our client portolios more

deensively to hedge the rising possibility o an economicslowdown. On aggregate, our portolio companies have

signicant exposure away rom the U.S. consumer. Our

holdings are in companies with very low debt and strong

cash positions. We have increased our exposure to histori-

cally more deensive sectors like healthcare, consumer

staples and industrials. We have opted to avoid interest

rate or credit risk in our bond portolios and will continue

to hold short-term high quality issuances.


4/4

firm perspective

Nothing is certain but death and taxes...but today neither is certain.by Brian Roberts

Benjamin Franklin has been attributed with saying, In this world nothing is certain

but death and taxes. While we would agree with Mr. Franklin that we will all pay taxesand eventually perish, he might have been surprised to learn how much uncertainty

surrounds these events these days, specically regarding timing and amounts.

One o the rst actions o the Bush Administration in 2001 was to pass the Economic

Growth and Tax Relie Reconciliation Act, which included the adjustment o the personal

estate tax exemption. From 1987 through 1997, the estate tax exemption remained

unchanged at $600,000. As asset values infated (most notably homes), an increasing

number o Americans were subject to an estate tax liability upon death. With the revi-

sion o the tax code, this exemption amount was upwardly adjusted, growing rom the

$675,000 in 2001, reaching $3,500,000 in 2009, with estate taxes being eliminated

entirely in 2010. The catch, however, is that in 2011 the exemption would return to

$1,000,000 per person. The anticipated joke about the new estate tax plan o pushing

Mom and Dad out o the Learjet in 2010 soon ollowed.

When the sunset provisions o the new estate tax exemptions were put in place in

2002,many speculated that a more permanent revision would be reached in Congress

relatively quickly. It is now 2008 and the status o estate tax exemption beyond 2009

remains a mystery. The consensus opinion o estate planning attorneys is that a perma-

nent resolution will be reached in 2008 with the exemption settling at $3,500,000 per

individual. Until there is certainty in the tax legislation, estate planning conversations

will be ull o speculation.

This uncertainty in the tax code is not isolated to estate settlement issues. Even the

Internal Revenue Service (IRS) has aced challenges. While Congress hotly debated

deense spending and adjustments to tax legislation during its summer and all sessions,

the IRS encouraged a speedy resolution by indicating it would need ten weeks to

implement any changes. Congress did nally come to a resolution that would again

x the increasing number o tax lers who were subject to the Alternative Minimum

Tax (AMT) by upwardly adjusting the AMT exemption. The late resolution compromise,

reached on December 19th, will result in the potential delay in processing or more

than three million U.S. citizens. Ater Congress adjourned or the holiday, the IRS went

to work reprogramming its system to comply with the new tax laws. The tax lers who

will be most aected are those subject to the AMT and qualiy or a reund. The IRS

has estimated it will be unable to process AMT related returns until February 11th.

While 2008 will continue to be lled with uncertainty regarding taxes, we at Nelson

Roberts hope with certaintyyou enjoy a Happy New Year lled with health, happiness,

and prosperity.

Meet a Member o the Firm: : As the rms Trading and Portolio Accountant, tn Boyd provides

management and oversight o day-to-day transactions or clients, record-

keeping, account reconciliation, and client service compliance. He works

closely with the custodian rms to ensure a successul client experience across

organizations. Terrence has been with Nelson Roberts since he graduated rom

Santa Clara University in the spring o 2006. He recently sat or Level I o the

Chartered Financial Analyst exam. Clients and colleagues alike appreciate

Terrences attention to detail and proessional demeanor.

2000 University Avenue, Suite 601

East Palo Alto, CA 94303

l 650-322-4000

wb www.nelsonroberts.com

al [email protected]

Kimberly Carlisle, Images o Light Photography

iNvestmeNt ADvisOrY teAm

Brooks Nelson, CFA

Brian Roberts, CFA

Stephen Philpott

For additional inormation on the services o Nelson Roberts Investme

Advisors, or to receive our Newsletters via e-mail or be removed rom

our mailing list, please contact Elizabeth Fannon at 650-322-4000 or

[email protected].

2008 Nelson Roberts Investment Advisors

CP Larson Photography

Documents

4th Quarter 2007 Commentary