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December 2003 performance review

January 15, 2004

In December the Conservative portfolio climbed 3.45% to end the year up 19.2%. More conservative stocks were hot in December, of the ilk found in the Vanguard Dividend Growth fund (VDIGX) – the fund was the best performer in the portfolio, up just over 6%.

Nipping at Vanguard’s heels was the American Century International Bond fund (BEGBX), up a surprising 5.18%. For the year the fund gained just under 20%. Since we placed the fund in the portfolio in 2002, it is up 41.6%. The cause is a falling dollar, which slipped in December to the lowest level yet against the euro. My how far the dollar has fallen since we wrote our “Go Go euro” piece a few years back. Euro’s could be had for close to $.80 a couple years ago, now they are fetching some $1.30. When will the carnage stop? We think very soon. In fact, we don’t see the dollar falling much further then current levels. We will likely always have some foreign bond exposure in this portfolio, but we may lower our allocation soon. There has been quite a bit of new money flowing into foreign bonds of late, as investors follow their usual performance chasing, buy high patterns.

Bonds in general were hot in December, with even the low-volatility Vanguard Short Term Corporate fund climbing .59%. Seeing that the Harbor Bond fund (HABDX) was up just 1.06%, and seeing how other types of bonds have done in December, leads us to believe that Bill Gross, the Harbor Bond’s manager, is playing things very safe. He must have a good deal of the portfolio in shorter term bonds. He certainly can’t have much foreign unhedged debt, junk bonds, or longer term government bonds, given the mediocre performance last month compared to most bond categories. Stick with Gross - he knows more about bonds than most, and he is reassuring us about our recent moves to shorter term and out of higher risk bonds. 

If you think we’re too pessimistic on occasion, take a gander at Mr. Gross’ monthly outlook column posted on the PIMCO (www.pimco.com) website. In fact, after reading his most recent outlook he confirmed the allocation we assumed based on the recent performance. He likes short and intermediate term treasuries, especially TIPS, or Treasury Inflation Protected Securities – default free government bonds that adjust with inflation. He paints a bleak picture, but facing reality early is better then late as an investor. For the record, Warren Buffett, is about as pessimistic about stocks as Gross is about bonds. It’s going to take some fancy footwork (not to mention low fees) to eek out gains for the foreseeable future.

The Pictet International Small Company fund (PISRX) is now being distributed by Forward funds, a fund family like Harbor that assembles funds from different managers. The new name is the Forward International Small Company fund. Still no-load. Same manager. Same great returns. Last month the fund scored another 5.5%, for a crazy 17.9% 3-month return and a whopping 61% for the year – one of the hottest funds in the business. Now we’re getting worried the small-cap foreign rally is getting long in the tooth, along with the U.S. small cap move. Maybe we worry too much, but that’s our job. We’re due to give the good people of Pictet another follow up call about the fund and the holdings. We’ll report back soon.

The Aggressive Growth portfolio was up 4.77% in December, finishing up a good year on a positive note. In 2003 the portfolio was up 44.56%, our top performing portfolio. Don’t forget its our second highest risk portfolio too, and can fall fairly sharply as well. 

Japan had a strong month, with the T. Rowe Price Japan fund (PRJPX) up the most in the portfolio, a 7.1% gain. We’re glad, as Japan is one area that we have not cut back on after fairly big gains. If the U.S. dollar were to fall significantly further from these levels we would be concerned about the Japanese economic recovery.

Emerging market bonds weren’t particularly hot in December, but the dollar slipped, leading to a gain in the Fidelity New Markets (FNMIX) of almost 4% for the month. The fund was up just over 31% for the year. This move makes it the #4 no load, non institutional bond fund in the business by performance in 2003 out of over a thousand choices. For the record, the #2 bond fund (Excelsior High Yield UMHYX) was a fund we wrote about favorably on the MAXfunds website a year ago – just so you know that this wasn’t a fluke. And you just though of us as stock fund experts… OK, maybe it was a bit of a fluke, there are almost 1,000 no load taxable bond funds – don’t expect us to pick #2 and #4 again next year.

Small cap foreign stocks were hot again. The now-closed Artisan International Small Cap (ARTJX) fund was up 6.41% for the month, and a whopping 63% for the year. The substitute choice, the Pictet International Small Company fund (PISRX) is doing equally well. Frankly, the asset class is red hot. Now we’re getting worried the small cap foreign rally is getting long in the tooth, along with the U.S. small cap move. Maybe we worry too much, but that’s our job. For the record, the Pictet fund is now called Forward International Small Company fund, same ticker, same manager.

One of the hottest areas around in December was emerging markets. The SSgA Emerging Markets fund (SSEMX) was up 9.28% for the month, a remarkable run. The fund is up over 53% in 2003. Valuations are still somewhat reasonable, but getting stretched. We’ve come across some examples of stocks in emerging markets trading for similar valuations to U.S. based companies in similar businesses. This doesn’t make sense as these economies are really not growing that fast, and there are added risks involved in this type of investing. Emerging market stocks should be less costly than U.S. stocks to reward investors for the extra risk. When that discount slips away, it gets time to move on as an investor, or at least lighten up.