06 Mar 2012 Torray Fund - Jan 26 Shareholder Letter ( Portfolio )
The Torray Fund gained 6.0% in 2011, compared to 2.1% for the Standard & Poor’s 500 Index. Since inception 21 years ago, it has returned 9.5% annually, turning $1 into $6.68. Comparable figures for the Index were 8.8% and $5.87. Given the performance of our economy and stock market over the last decade, we are pleased with the way things have turned out.

Last year started off well, with stocks advancing about 9% through the end of April. But then fears about the soaring Federal debt and a double-dip recession escalated, and the Middle East erupted in turmoil. In August, Standard & Poors cut the U.S.’s credit rating from AAA to AA, and doubts about the solvency of euro zone countries and banks sent stocks into a freefall. The sell off was marked by high volatility and increased volume, with daily price swings sometimes measuring two or three percentage points. Monthly gyrations ranged between a loss of 7% and a gain of 11%. Just when things looked the worst, stocks rallied 11% in October and limped along to close the year up 2.1%. Through it all, our Fund, with its quality investments and low 12.9% turnover, was hardly affected.

According to the New York Stock Exchange, an astonishing average of 4.4 billion NYSE-listed shares changed hands on the 252 trading days last year; annual volume was about 1.1 trillion shares, 2.6 times the 415 billion outstanding. As startling as these numbers are, they’re 10% lower than those of the preceding year. The collective value of all this paper shuffling amounted to approximately $32 trillion, a number twice the size of our country’s entire economy. Yet, in the end, nothing of value was created. In fact, after fees, commissions and taxes on trading gains — if any — investors as a group probably lost money. Only Wall Street and the tax collector came out ahead.

On the mutual fund front, turnover in domestic stock funds once again surpassed 100%, and shareholders continued to withdraw money — in this case $85 billion, extending the string of annual withdrawals back to 2007, for a total of $328 billion. By contrast, bond funds took in about twice that much in just the last three years, including $116 billion in 2011. Ironically, over a decade ago, when valuations on stocks were twice as high, investors largely ignored bonds and loaded up on stocks and stock funds.

Finally, reflecting the widely held view that emerging markets’ growth prospects are superior to those in the U.S., $34 billion shifted into international funds. While the potential of these markets may or may not be as advertised, last year was a bad time to try and find out. Brazil, China, Hong Kong, Japan and Singapore suffered losses of 12%, 18%, 15%, 19% and 17%, respectively. Germany, the European Union’s strongest country, lost 15%. Fortunately, we have avoided these venues and instead invested in U.S. companies that transact business in them. Many of our holdings generate 30% to 40%, and a few, 50%, of their revenues overseas. Our strategy is based on the belief that the long-standing records, superior finances, reliance on U.S. accounting standards and capable managements of these solid businesses outweigh the lure of less certain opportunities that are difficult to analyze from afar.

The stark reality of all this money jumping in and out of markets around the world, not to mention the popularity of exchange-traded funds, commodities and hedge funds, highlights today’s total disconnect between market activity and business fundamentals. While most companies did well last year, investors were just too frightened by what stocks were doing to notice. The earnings of companies in The Torray Fund grew almost 9%, and 26 out of 31 increased dividends. Combined, earnings growth plus dividend yield exceeded 11%. We think this is a better measure of the improvement in the Fund’s fundamental value than its closing share price, which is only a snapshot of what investors think our stocks are worth on a given day.

While we may be wrong, it appears to us the worst of the economic crisis has passed and that large, high quality companies trading at today’s conservative valuations offer some of the best opportunities we’ve seen in our Company’s 40-year history. If earnings and dividends gradually rise in line with current projections, we believe share prices will eventually follow suit, providing reasonable returns that should outpace readily available alternatives.