Securities with the highest betas, have tended to be those without earnings.  Interestingly, since the October and March market lows, companies without earnings have outperformed those with earnings by a wide margin.  In fact, during the second quarter of 2003, companies without earnings at all rose 31% compared to a 15% rise in profitable companies in the value index. 

Year to date, the best performing strategy has clearly been one of focusing on companies with high market exposure, no earnings and no dividends – a strategy that is contrary to the investing disciplines Westwood follows.  The strongest companies, those that generate significant amounts of free cash flow and shareholder value, posted only modest gains for the quarter and the year.  Companies that share their cash flow with investors through a dividend have not been rewarded by the market despite the recent changes in tax laws that favor dividend income.  

 

2Q2003 Performance by Dividend Yield

 

Alan Greenspan, in his recent testimony before Congress reflects that sentiment.

“The decline in longer-term interest rates and diminished perceptions of credit risk in recent months have provided a substantial lift to the market value of nearly all major categories of household assets…the lowered rate at which investors discount future business earnings has contributed to the substantial appreciation in broad equity price indexes this year, reversing a portion of their previous declines…households have been shifting the composition of their portfolios in favor of riskier assets…sizable inflows [into equity and corporate bond funds]…have provided further evidence of a renewed appetite for risk-taking among retail investors.” 

– Alan Greenspan in the Federal Reserve Board’s semiannual monetary policy report to Congress, July 15, 2003. 

The Federal Reserve has provided the liquidity, principally in the form of lower interest rates, needed to move markets higher, but most of that money has found its way into the riskier assets.  Inflows into risky assets have pulled the markets ahead while the ‘safer’ assets have fallen behind. 

We believe that a strategy focusing on strong fundamentals, with an emphasis on free cash flow and yield will reward investors over the long run.   While our strategy of focusing on the long term fundamental strength of a company has not outperformed in the current market environment, it has consistently lead us to undiscovered areas of value where real improvements are already in place.  The holdings in our portfolios today have already shown an ability to generate free cash flow and increased shareholder value in the absence of real economic growth.  We believe that when the market’s search for yield and fundamental strength brings investors around again to the concept of real “value,” our clients will be well positioned to benefit from periods of long term outperformance.  We know that the market environment has been challenging for everyone, but we believe that sticking to our roots will continue to serve our clients well. 

 

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