Equity Income & Capital Appreciation Strategies

In the third quarter of 2007, many investors reconsidered their investment in more speculative stocks, sending the prices of those securities down. This action, in large part, was due to volatility induced by subprime mortgage worries and a general real estate meltdown which occurred during the third quarter of 2007. Still, most of the major indices finished the quarter with respectable gains, with the exception of the Russell 2000 Index, a measure of smaller capitalization stocks, as seen below.

Amid a lull in the credit market turmoil, equity markets around the globe have recovered nicely from their mid–August 2007 lows. Central banks have injected hundreds of billions of dollars into the banking system, stabilizing the commercial paper market at the shortest maturities. And equity investors seem confident that continued Federal Reserve Board (Fed) rate cuts—following the weak labor report—will keep the economy on relatively sound footing.

Our well diversified, high quality client portfolios were positioned to withstand the volatility during the quarter, generating very favorable quarterly and year-to-date returns. We continue to be cautiously optimistic towards the US equity market, and therefore, we remain well diversified with no individual position over 4% of the portfolio at its cost. We continue to favor the following sectors: energy, telecom, industrials, healthcare, and consumer staples.

We have been underweighted for some time in the financial sector, which has become more attractively valued. We are looking to add to this sector. Of particular interest are some high quality financial institutions which possess the investment characteristics we seek, that is, positive free cash flow, strong returns on capital, increasing dividends, and healthy earnings growth that trade at attractive valuations. We are patiently waiting for opportunities and will add to client portfolios when appropriate. Please note that Bank of New York (BK) completed the acquisition of Mellon Bank (MEL), a holding in many client portfolios, during the quarter, and we chose to keep the combined Bank of New York Mellon stock.

One of our technology holdings, First Data (FDC), was recently acquired by a private equity firm, and many of our clients have seen cash coming from this acquisition into their portfolio. We also recently added a new technology position to client portfolios, a firm whose financial record few from any industry can match. Sales in this company have grown from $6 billion a decade ago to over $50 billion in fiscal 2007, and returns on invested capital have averaged a staggering 55%. This company faces a number of challenges, but we think the stock is a lower risk investment, given the firm’s dominant position in its major markets.

We recently sold a successful investment, Suncor Energy (SU), a Calgary-based oil producer and refiner, due to a recent announcement by a Canadian review panel that it may introduce sweeping changes to Alberta’s royalty regime. The panel reviewed the overall government take (royalties, taxes, leases) and concluded that Albertans do not get their fair share from the massive energy resources within their province. If enacted in its entirety, the proposal would have broad industry consequences, and we feel that there is too much risk exposure to continue holding this company. We therefore added a new company in the energy sector that is a leading provider of proprietary and patented services for the global petroleum industry. These services enable the Company’s clients to optimize reservoir performance and maximize hydrocarbon recovery from their producing fields.