17 Feb 2011 Torray Fund - February 1, 2011 Letter to Shareholders ( Portfolio )
A recent analysis of the S&P, NASDAQ 100 and Dow Jones Industrial Average illustrates just how narrow last year’s list of winners was. Only 10% of the stocks in each index represented the lion’s share of their appreciation – 60% for the S&P; 73% for the NASDAQ and 48% for the Dow. Without them, the indices’ returns, including dividends, would have been in the 6% - 8% range. Even more telling, the top 10 S&P stocks – 2% of the total – produced 25% of its return, about equal to the difference between our Fund’s performance and that of the Index. In another sign of the market’s heavy concentration in a few names, Apple, Inc. accounted for 45% of the NASDAQ 100’s gain.

Finally, our relative result was impacted by outsized returns on high multiple tech stocks and small company stocks. The former soared 97%, compared to a gain of only one percent for moderate growth technology stocks like those in our Fund. (The price/earnings ratios were 36 and 12, respectively.) We think the stocks we own are a real bargain and the high P/E group is risky. Small company shares outperformed big ones by nearly 100%. The country’s top 50 stocks rose only 7%. We own 12 of them, accounting for 37% of our Fund. The largest is General Electric, followed by International Business Machines, Procter and Gamble, Johnson & Johnson, Wells Fargo, AT&T, Intel, Cisco Systems, Abbott Laboratories, 3M Company, Kraft Foods and American Express. These outstanding businesses sell at conservative valuations; their earnings, dividends and free cash flow have been rising, and long-term prospects remain excellent. The same goes for the rest of our holdings.

A number of big pension funds have reported sharp reductions in their equity holdings, some of them from as much as 70% of assets a few years ago, when the market was a lot more expensive, to 30% now.

While this makes no sense to us, it is understandable considering the market’s miserable showing over the last 10 years. People are scared; many have less money today than they did a decade ago, and the picture is worse when inflation is taken into account. Beyond that, paper thin money market rates have caused investors to seek alternatives in their search for yield and capital preservation. As usual, Wall Street has responded enthusiastically by creating increasingly speculative new outlets for the public’s money. Media business shows, with their endless market predictions, earnings forecasts and focus on short-term trading strategies have only added to investor confusion. This emphasis on knowing the unknowable undermines any value these programs might otherwise add.

Exchange-traded funds (ETFs) have become one of the most widely embraced Wall Street promotions. There are now nearly 1,000 such funds holding around $1 trillion in assets. These include U.S. and international stock, fixed income, commodities and currency portfolios, to mention only a few. Many can be sold short, and some can be leveraged 3-to-1, greatly magnifying their downside risk. In addition, new ETFs are constantly being created to meet popular demand for portfolios concentrated on narrow market sectors, often the speculative favorites of the day. Essentially these funds are little more than an inexpensive rapid-fire vehicle investors are using to chase a rising price. When trends reverse, they typically flee, illustrating once again just how short-term-minded people are these days.

“Absolute-return” funds are another relatively new Wall Street innovation. In simplest terms, these funds hold stocks their managers think are going up, and sell short those they expect to fall, while at the same time holding smaller positions in short-term investments for liquidity purposes. Proponents contend this combination of long, short and cash equivalent holdings will make money no matter what the market does. Implicit in that claim is that the managers can predict the direction of individual stock prices. We doubt even the marketers believe this. Anyone who could do it would simply buy winners in advance and ignore everything else. In our opinion this strategy has no chance of outrunning the long-term returns generated by sound, growing companies.

Finally, we mention gold and silver, which are on a lot of people’s minds these days. This comes as no surprise given that the prices of these metals have soared five and six-fold, respectively, over the last ten years. Adjusted for inflation, however, gold has lost nearly half its value from its peak 30 years ago. Silver’s record is even worse. It hit $49 three decades ago, driven by the Texas oil billionaire Hunt brothers’ scheme to corner the market. When the plot unraveled, silver collapsed to $5; ten years later it was $3.50. Nearly 20 years after that (2004) it was $5 again; today it’s $29. After inflation, the current price of silver would have to more than quadruple to $130 an ounce to match its 1980 high. Predictably, the promoters hawking these metals on TV avoid this history like the plague.