Small-C November & December Letter

Because we've been so slow to report these months, we're combining November and December into a single note.

The portfolio gained 1.6% over the period, bringing the return for the year to 6.7%.* The total return on the S&P was about 15%, so we must apologize for missing our benchmark by a mile.  We can point out that over the longer term, we have still outperformed the equity index, but that feels like small consolation when we really ought to have 10% more money in our pocket.

Some of our biggest calls failed us this year.  The Other January Effect failed to materialize for the second year running, and the market finished up signficantly after falling first month of the year.  Market timing trades, mostly playing to the January theme, therefore lost around 1% across the board.  Our China- and Asia-related shares made a 15% return, but we note that we count the US-listed YUM! Brands in that category, which made a stunning 42% over the year (making it the best performer of any consequence).  High-yield bonds returned  13%, but only just beat their interest rate hedge; we lost money on our short bonds trade, bringing the historical P&L for that trade close to flat.

Broadly, our main mistake was not to have enough equity exposure and too much fixed income and like instruments.  We continue to favor yield; instruments that put money in our pocket today that we can choose to reinvest, versus speculative plays based on future growth.  We feel having liquidity to judge entry points, and wealth preservation in the face of a difficult financial environment, will be increasingly important going forward.

Looking into 2011, we see some of the same themes we have been following for years.  Inflation data is starting to show the effects of loose monetary policy, and the rate adjustments can't be far behind.  In Europe, there a shell game going in which sovereign debt is being passed from one borrower to the next, evidently calming solvency concerns while the debt burden only grows.  The US is doing nothing serious to deal with entitlement spending.  Western investor are concerned that China is overheating and will suffer some sort of crash.  I believe that view is heavily influenced by our experience of low growth Western economies, where every several years a bust follows a boom.  Surely economic development in China will experience bumps the road, but the nation has fifty years of solid growth ahead.  We look forward to what 2011 will bring.


* We report the percentage gain or loss during a month in an additive sense for ease of comparison, however the year-to-date returns are reported as a chained series. As the total return become greater, and as inflows have an effect on the portfolio, the two will diverge. Adding up the monthly returns for the year may not give the precise total return.