Investment Recap Fourth Quarter 2007

It’s the Economy, Stupid! Remember that political refrain from 1992? Well, it is pertinent again in this campaign year. In our last quarterly letter, we referred to the “subprime mortgage meltdown” and the Federal Reserve’s preemptive actions in August. While these actions gave encouragement and created a market rally into the beginning of October, there was not a great deal of follow-through from the Fed, and the stock market has reacted poorly and defensively ever since. Our analogy is to that of an earthquake, which occurs, appears to end, and then is followed by a series of “aftershocks.” In essence, parts of the banking system have frozen up and lending standards which were too loose have gone to the opposite extreme of too tight, and this has had both a tangible and a psychological effect on consumers and businesses.
Are there any rays of sunshine in this picture? We believe they are starting to emerge. It appears that behind the scenes, the Federal Reserve is helping institutions like Citigroup, Merrill Lynch, and Countrywide Financial shore up their equity (some with money from sovereign fund’s petro dollars). As this process develops, the Fed will lower interest rates further, encourage realistic lending practices, and the severe pessimism gripping markets will abate.
Last year, we experienced four takeovers in our portfolio. Just last week, as an indicator that deal financing is still available, a deal for Bright Horizons Family Solutions (BFAM) was announced at a price representing a premium of 50% over its previous close. We are convinced that other value stocks in our portfolio are equally underpriced, and their potential appreciation is significant over the balance of the year.