Why, In the Morningstar database of over twenty four

thousand mutual funds, only nine funds with stock

exposure delivered a comparable return at a
comparable level of risk? 3
November 11,2011
The answer lies in human nature. Although the above
Conviction portfolio had modest volatility, constituent parts were
central cogs in the meatgrinder market we’ve seen over
It should be clear that among the causes of the recent the past few years. Gold, the greatest single contributor
financial crisis was an unjustified faith in rational to the above model, as well as to our own portfolios, fell
expectations, market efficiencies, and the techniques of from over $1,000/oz in March of 2008 to under $700/oz
modern finance. … All the seeming mathematical that November. Emerging Markets lost half their value in
precision that was brought to investment, all the 2008, and even the Lehman Aggregate Bond Index was
complicated new products, including the explosion of off 16 percent peak to trough that year. It’s hard to
derivatives, that were intended to diffuse and minimize
remain dispassionate when the market mauls equally
risk, did not work as had been claimed.
Paul Volker, your hedges and speculations.
NY Review of Books, Nov. 2011
Our stay-put behavior reflects our view that the stock
market serves as a relocation center at which money is
Like our clients, we spend a lot of energy examining the moved from the active to the passive.
value proposition of our work. How much better off is Warren Buffett
the portfolio from our involvement, and is there a better Berkshire Hathaway 1991 Report
alternative? This is no idle question, it is existential, both
career-wise, and because a goodly portion of the funds Buffet wrote this ten years into the greatest bull market of
we manage are our own. Recall that a principled our generation, well before “irrational exuberance,” the
investment advisor builds wealth alongside his clients, not internet bubble, the housing bust, and several sovereign
off of them. debt crises. Yet it still rings true.

Our central focus is on activity. While diligence is explicit Terry Odean of U.C. Berkeley has spent the past 20 years
in the role of a fiduciary, could we expect better results describing the substantial underperformance of active
from a more passive approach – a handful of low-cost traders, finding the shares investors sell on average far
index funds, arranged in a textbook pie? The answer outperform those they buy in exchange. And it’s no
should not surprise you. better with mutual funds -- an oft-cited study by Dalbar
Inc. found over a seventeen year period ending in 2001,
Over the past five years, an indexed portfolio of Stocks, the average stock fund investor earned less than six
Bonds, Gold and Cash in rather conventional proportions percent of the gain of the S&P 500!
would have shown forty percent less volatility than the
S&P 500 with roughly one hundred thirty times the return.1 But do we want the returns of the S&P 500? 2008’s forty
percent drop was not at all improbable. Recall Statistics
Fig 1. Five Year 101: there is a 47 percent likelihood of a two standard
Performance
Initial Ann. $ Weighted deviation outcome. Heads – we win; tails - our million
Allocation Std. Cumulative Ret. dollars is now $600K.
November 2006
(%) Dev. (%) (%)
Through October 2011
iShares Barclays The goal is not to beat the market; the goal is to avoid
30 3.7 10.53
Aggregate Bond Fund having the market beat us –that is to maintain a portfolio
iShares MSCI Emerging of securities which collectively and individually inspire
15 28.5 4.83
Markets Index Fund confidence to stay the course.
iShares MSCI EAFE
Index Fund
15 22.5 (1.77) Charles Ellis describes this process of winning by not losing
in a 1975 essay “The Loser’s Game.” 3 He contends that
iShares Gold Trust 10 20.7 18.00 investors prevail like amateur tennis players: by giving up
fewer points, not through aggressive shot-making. Former
iShares Russell 3000
Index Fund
20 19.6 0.45 Chairman of the Yale Investment Committee, Ellis later
expanded these ideas in a book “Winning the Loser’s
Barclays Capital U.S.
Game,” well worth a read. Above all, Ellis tells us:
Treasury Bills 1-3 10 0.6 0.79
Month Index
The hardest work in investing is not intellectual;
Total 100 11.2 32.84 it’s emotional.

Notes:
S&P 500 100 18.9 0.25 (1) Does not reflect fees or trading costs. You cannot invest directly in an
index. Source data: www.iShares.com.
(2) All funds with equity holdings with cumulative 5 year returns in excess of
32.84 pct and standard deviation less than 11.2 pct. Souce data:
If it’s that simple, then why have so few investors seen www.morningstar.com
their portfolios grow by one-third over the past five years? (3) TheFinancial Analyst’s Journal, July/August 1975.

Copyright 2011 Farragut Resources, LLC. The material presented is for informational purposes only and is not intended to recommend a specific investment strategy or the purchase of
securities. All opinions are those of the author, and do not reflect the policies of Farragut Resources or Capitol Securities Management, Inc. Investment advisory services and brokerage
provided through Capitol Securities Management, Inc, Member FINRA/SIPC.
What to Do
Your Portfolio
Tasked with ensuring security for our families as well as a
dignified retirement for ourselves, what is to be done? Aside from an obscure reference to the Greek Isles, we
have avoided a rehash of the relentless media flow.
Our solution is to own shares of high-confidence firms, Sure, the world economy is in crisis, 45 million Americans
tempered with funds invested in harder to access rely on Food Stamps to eat, and the Great Bank Robbery
markets, such as Corporate and Foreign Bonds, Emerging continues, with a former U.S. Senator looting $630 million
Markets or Commodities. Less elegant than textbook of customer accounts, with apparently no personal
indexing, we feel this approach improves an investors consequence. Life goes on. As a German girl told us
likelihood of staying invested through full market cycles. once, after three weeks of rain in Frankfurt: there’s no
such thing as bad weather, just the wrong clothing.
A focused selection of high-quality stocks can be central
to a responsible portfolio. The contribution these shares We continue to invest in high-quality blue chips,
make is as much emotional as financial. To own shares emphasizing Consumer Staples, Energy and Utilities. On
in a representative slice of industry engages the investor the whole, valuations have come down smartly from the
in a far richer manner than the ticker of an index highs of the past decade, and the long-view investor
fund. So engaged, we may be less prone to react faces much better prospects than those of the recent
rashly to the inevitable short-term disappointment. past. Marquee technology shares show promise and
reasonable value. Wally Weitz, Omaha Nebraska’s
The central guidepost is price. A superb firm, overpriced, second-most respected investor, said recently “if you told
has modest promise as an investment. For example, the me ten years ago I’d own these stocks I’d have laughed
nation’s largest retailer has tripled earnings over the past at you.
decade, but as its price to earnings ratio fell by two-thirds,
investors have seen little return beyond a modest Foreign Markets are no longer foreign to industry or to
dividend. investors. The Emerging consumer will brush and floss,
have a beer, and plug their refrigerator into the grid just
like us. They’ve much more experience with debt crises
What not to Do and sovereign risk, so it’s conceivable they won’t abuse
credit as we have. Certainly growth and profits can be
While forever may be the preferred holding period, as
found in these regions, and our investments reflect this, in
elsewhere in life, at times we must acknowledge
the sales mix of US firms, and in Foreign shares and funds.
something as not working out. Cutting losses is the
hardest part of investing. It is far more gratifying to sell a
Bonds continue to play a role in our portfolios, as much
winner, banking a capital gain, than to recognize a
an anchor to the windward as for income or gain. With
thesis as wrong, or that conditions have changed, and
interest rates at year 29 of an epic decline, longer-dated
then to act positively.
bonds are more volatile than we’ve seen in, well, 30 years.
We continue to invest in a Foreign Bond fund, mostly as a
The extreme volatility of today’s markets makes selling
dollar hedge, and a Corporate and Mortgage Bond fund
decisions harder. Price only fleetingly reflects the value
run by one of the industry’s brightest minds.
of an investment, and extremes are most pronounced.
Butterflies in the Cyclades can cause a trillion dollar
Gold has made a terrific contribution to portfolios over
moves overnight. High-frequency trading and other
the years. If three decades makes a bond bull market
manipulations have cheapened the information value of
long in the tooth, one decade may be too early to write
a price quote, rendering the stop-loss, a classic selling rule
off the barbarous relic. We’ve long discouraged
based on deterioration in price, unreliable as a risk
wanting a run-up in gold, as it implies something else is
management tool.
very wrong. It’s not gratifying to be right, but it is to be
long. We hope the world is getting better; but we are
So we return to conviction. If the facts supporting an
not selling gold.
investment remain true, and the costs of being wrong are
sustainable, investors should accept that over the short-
term their account balance may not reflect the value of What to Expect
what they own.
Expect effort from your advisors. Expect prudence and
We must understand the human element: the gap expect discipline. We are committed to the intellectual
between theory and practice because one’s financial and technical side of investment, yet mindful of the
security depends on it. Newsletter writers and internet emotional core. Above all, we are committed to you.
touts may crow hypothetical returns; investors with capital
at risk inevitably experience a different outcome. Frank J. Ruffing CFP
Accepting ones humanity is a prerequisite to successful
investing.

8180 Greensboro Drive, Suite 1150, McLean, Virginia 22102

Telephone 703-283-5220 www.farragut.us.com
Copyright 2011, Farragut Resources, LLC. The material presented is for informational purposes only and is not intended to recommend a specific investment strategy or the purchase of
securities. All opinions are those of the author, and do not reflect the policies of Farragut Resources or Capitol Securities Management, Inc. Investment advisory services and brokerage
provided through Capitol Securities Management, Inc, Member FINRA/SIPC.