29 Aug 2011 Torray - Q2 2011 Commentary ( Portfolio )
Despite the current seemingly endless list of global problems, we are convinced that quality U.S. companies offer compelling value for long-term investors.

As noted in our 2010 Annual Report, the fallout from this confidence-shattering decade has prompted a number of so-called “experts” to declare long-term investing dead. In its place, they recommend actively trading stocks, options, commodities, exchange traded funds, and so on. We continue to think this is bad advice. Over the last 70 years, our country has endured incredible challenges—World War II, Korea, Vietnam, Iraq, Afghanistan, the Russian debt default, recessions, the World Trade Center tragedy, stock market panics and crashes, financial industry bankruptcies and the sub-prime mortgage and real estate collapses. We suspect the average person, if asked how they thought stocks did in the face of all this, would probably answer, “terrible.”

Thanks to Ned Davis Research, Inc., a well-respected independent firm, we can report otherwise: during the same 70-year period, the S&P 500 with dividends reinvested returned 11.2% compounded, turning $100 into $168,785. By comparison, Treasury bonds yielded an average 5.6%, producing only $4,534. Yet investors persist in buying bonds at yields that have been falling for 30 years and now stand at historic lows. Meanwhile, the economy and financial system are on the mend, and earnings and dividends are heading up. Twenty-six of our 31 holdings have increased dividends over the past year, and 10 of them have done so for 25 straight years. (The portfolio’s yield is about one percentage point above the return on five-year government bonds.) In addition, analysts project the earnings of these companies, as a group, will grow 10% a year for the next five years. While we are highly skeptical of such forecasts, the long operating histories, competitive strengths and sound finances of these businesses make us confident there is potential for meaningful growth along with dividend increases.

However, none of this will matter if investors aren’t on board for the ride. On that note, we have recently analyzed The Torray Fund’s accounting of share purchases and redemptions. The disheartening results confirmed our sense that despite 40 shareholder letters urging investors to stay the course, money has poured in when stock prices were rising and then out just as fast when they fell. The largest sums came in during the late stages of the 1998 speculative boom. These inflows were almost surely a response to media accounts of the 21% per year returns our Fund posted over the preceding eight years, multiplying an initial investment 41⁄2 times. We also found the ins and outs tended to track our shorter-term investment performance relative to market averages and that of other funds.

The eight-year record referenced above was totally unsustainable, and we said so in our 1998 Annual Report, pointing out that $50,000 earning 21% a year would grow to $10 trillion in a century, roughly equal to the stock market’s entire value at the time. Ironically, this was also the year of our largest redemptions. In this case it seems likely departing shareholders were attracted to other funds heavily concentrated in the vastly inflated stocks that drove the Index up 29% that year. We owned none of them. When the market collapsed a few years later, the S&P and NASDAQ sank 38% and 67%, respectively. Our Fund’s loss was 16%.

Finally, in 2008, stocks were decimated again, causing another round of redemptions across the fund industry. The proceeds flooded into banks, money market funds and bonds where they remain today, indicating the shock has still not worn off. Investors so-positioned and approaching retirement are facing an uphill battle trying to recover the wealth they’ve lost. By contrast, Torray Fund shareholders that held on have recouped their losses and, in our opinion, are well-situated to benefit from the market’s historically conservative valuation.

Having said this, the financial uncertainties plaguing the world’s economy are serious, and we do not by any means discount them. Turmoil in the credit markets is only the latest manifestation of today’s mind-numbing worries. Against this backdfocus is on containing risk as best we can, and achieving a combination of earnings growth and dividends that will produce reasonable returns for you in the years ahead.rop, we feel it is particularly important to invest only in first-rate businesses or mutual funds that own them.