5.0 Pose Id On Perspective May 2010


THE POSEIDON PERSPECTIVE
… sound navigation through perilous cross‐currents …

29 May 2010

Dear Investor,
The time for equivocation is past and the brief scan of Table A reveals that, except
true test of wills begins. The past fourteen for the DJ Transport Index, global equities
months have been a period of reflexive have now retreated Year‐to‐Date (YTD). In
response; fiscal stimulus supplied without fact, all listed indexes are down over the
restraint, monetary easing unleashed past year. As we consider price changes in
without precedent, and financial markets three US equity market indexes, DJI, S&P
embracing risk in a rush of desire. 500, and Nasdaq, not including dividends,
Unconventional and excessive central bank they have produced negative returns if
policies across the globe have unveiled an held over the past decade. This is the
apparition of recovery shrouded in future primary reason why we continue to be
inflation. In the US we have surpassed the adamant about dividend yield as an
TARP, the TALF, the cash for clunkers, and evaluation metric. We have included the
the new homeowner’s tax rebate. We have Shanghai Stock Exchange Composite
shuddered at the shenanigans of the FASB (SSEC) in Table A in order to accentuate
changes to accounting standards. We have the impact of a severe bubble which
witnessed the “perfect” (no losses on the peaked in October 2007.
prop desk) trading days of Goldman Sachs
and the end of quantitative easing. Yet, we TABLE A
are not beyond the economic consequences YTD 1 Year 5 Year 10 Year
of excessive consumer debt and endless DJ Indus (2.79)% (9.39)% (0.64)% (0.37)%
government deficits. S&P 500 (2.31)% (10.7)% (1.78)% (2.62)%
Nasdaq (0.54)% (4.66)% 1.76% (4.02)%

DJ Tran 5.77% (6.43)% 3.79% 4.81%
The equity markets have roared. The MSCI‐EAFE (13.7)% (15.5)% (1.32)% (1.69)%
further the drop; the higher the bounce. MSCI‐EM (6.37)% (2.99)% 11.1% 7.93%
Now these markets appear to have lost SSEC (20.9)% (14.2)% 19.6% 3.18%
their spring and begin to show signs of *Results are thru 28 May 2010 and 5&10‐year values are
annual compound rate of return
retrenchment on a global basis after a near‐
vertical ascent in the past 14 months. A
THE POSEIDON PERSPECTIVE 29 May 2010
The markets are best viewed with a wide‐ and may signal a new decline which could
angle lens. Chart 1 is the work of Doug surpass the market low on March 9, 2009.
Short and reveals how bad a really bad We believe, at this time, that a correction is
“bear market” can be. While the S&P 500 both overdue and necessary. Yet, a drop
has performed in line with other serious below the March 2009 level is beyond our
market downturns there remains a valid ken. Prior to reaching that level the Fed,
concern that the current economic recovery The Treasury, and the President’s “Plunge
is very weak and the equity market is Protection Team” would step in to prop up
susceptible to a renewed downturn. markets by any means necessary. Thus, a
Determining the true bottom in real time is 20% drop in equity prices followed by a
an exercise in futility and would be a lower trading range is, in our opinion, a
matter of luck. However, multiple risk very realistic model for equity market
factors are unabated and we do not believe activity over the next 12‐18 months. Under
that equity returns going forward provide such a scenario we would consider
adequate compensation. Some strategists purchasing various equity securities which
contend that a correction was over‐due, meet rigorous “value” criteria.

CHART 1 HOW THE S&P 500 MEASURES UP OR, PERHAPS, DOWN?

Source: dshort.com
Page 2
We present Chart 2 as a surrogate for the surrounding “down” days which are the
YTD performance of US equities. We have declines indicated in red along the price‐
constructed the daily price and volume line. These are mandated “distribution”
numbers for the NYSE Composite Index days on which volume increases compared
which incorporates 3,257 securities. Daily to the previous day and closing price is
volume is presented as a bar chart with lower or after there is an advance there is
Left‐Hand Scale (LHS). The blue line is a little or no gain at the closing. Hence, not
100‐day Moving Average (MA) which all distribution days result in solid price
neatly mimics the approximately 100 declines. Most institutional selling takes
trading days thus far into 2010. We view place over numerous days of small
the MA (100) as a running mean for this increases in volume and small or no price
period; it is a visual guideline by which to declines. We believe that institutional
measure price volatility over the past 5 selling has been taking place throughout
months. The NYSE composite, visualized 2010. In brief, we believe that the market is
below, experienced a price variation from signaling a great deal of uncertainty going
high to low of 20% during April and May. forward. The three drivers of market
weakness are the uncertain US economy,
We invite you to closely examine the the Euro sovereign crisis, and growing
volume measures which indicate higher skepticism of the Chinese growth miracle.
volumes of shares traded on and

CHART 2 IS VOLATILITY RISK OR OPPORTUNITY?

Source: PSI; StockCharts
Page 3
SOUNDINGS CHART 3 DOUBLE DIP? NO WAY!

We are bombarded daily with economic
statistics on housing, employment, interest
rates, market gyrations, etc. The frequency
and load of this information has exceeded
meaningful digestion and the result is a
constant generation of noise around
random events with momentary impact.
Our path on the information avenue is to
choose discriminately and ruminate
cogently. Maybe we are not always correct
or timely but we find the process much
more relaxing. Thus, we attempt to apply
some meaningful interpretation to current
economic conditions in the US and the
recent discord in European sovereign
finance.

Source: newyorkfed.org
While the sovereign credit concerns and

austerity programs in Europe will
From their sister branch in St. Louis we
challenge growth going forward the largest
find some more useful informative data to
unknown is the impact on the two largest
evaluate the current business environment.
exporters to the Euro‐zone, the US and
Chart 4 is the most recent graphic of loan
China. We look at the US first. Chart 3 is
reserve ratio to total loans for banks with
the product of the New York Fed to
assets over $15 Billion. As a ratio this
explain their probability assessment of
amount will increase if loss reserves are
economic recession in the US using
increased in relation to Total Loans.
Treasury spreads. As the chart clearly
Increasing reserves is prudent business
indicates given the recent collapse there is
even if it means that the quality of assets is
about 0% chance of a new recession. The
deteriorating.
record for this interest‐spread

prognostication looks pretty good.

However, we find this simplistic method
about as useful, other than as a PR

gimmick, as their continuing fixation on
ZIRP.

Page 4
CHART 4 GROWING LOSS RESERVES greater than one] divided by [the sum of

all assets held by those banks with Total
Assets in excess of $20B]. Our
interpretation of this demise is that the
banking system in the US is woefully
under‐capitalized by way of allowances to
provide the cushion necessary given the
amount of non‐performing loans in the
asset base. Further, we view this as an
indicator that the need for restructuring in
the US banking system will continue
throughout 2010 and well into 2011. This
is bad news.

CHART 5 ONE EXPLANATION

Source: St. Louis Fed

However, the ratio will also increase if
total bank credit is diminished as it has
over the past year. Bank Credit for US
commercial banks was down (6.4)% in
2009 and down (6.7)% in 1Q2010 according
to the Fed’s H.8 statement dated May 28,
2010. The same H.8 indicates that Total
Assets were down (15.9)% at an annual
rate.

So, if reserves are rising and total assets
(lending) are declining, what does this say
Source: St. Louis Fed
about quality of assets? For this we look to
Chart 5, St Louis Fed’s LLRNOT5, which is Unfortunately, in an economy where credit
an indication of allowances for non‐ is the life‐blood of growth a cessation in
performing loans within the system over the growth of lending results in worse than
24 years. This graphic presents a ratio stagnation. The result is strangulation.
which equals = [the sum of all assets in Banks are still in trouble and a deflationary
banks where the ratio of allowance for loan spiral cannot be ruled out.
and lease losses to non‐performing loans is
Page 5
In Chart 6 we view the contrasting of a recession should be very robust. We
opinions from the Bureau of Economic point to the contrast of our current
Analysis and John Williams’ Shadow recovery with the 2001 recovery and we
Government Statistics. If we choose the still have some room to move. The
middle‐way the US GDP growth is still optimistic, “Official” reading is weak; the
about null while the rate of change has SGS Alternate is veritable gloom.
been impressive. Yet, growth coming out

CHART 6 EITHER WAY GDP IS VERY WEAK

Source: shadowstats.com

The Economic Cycle Research Institute portend for disaster this is a reversal of
(ECRI) has produced a solid record for trend and may signify continuing
economic prognostications which usually weakness into next year. Information is
contravene convention in their boldness. available at their website,
We like the fact that their US Long Leading www.businesscycle.com.
Index (USLLI) does not incorporate the
equity markets which they do not believe We provide a monetary view from
is a leading indicator. Their research ShadowStats by way of Chart 7 which
indicates US GDP growth in 2010 of displays three measures of the money
around 1.5%. While both Weekly Leading supply. M1 and M2 are in accordance with
Index (WLI) and Future Inflation Gauge the St Louis Fed and M3 is a ShadowStats
(FIG) are up for the year both are down compilated estimate in accordance with
over the previous quarter. While not a previous Fed parameters. M3 is no longer
Page 6
released by the Fed. A simple law of been less than accommodating. Obviously,
banking and finance is that an expanding at this time bankers prefer to rebuild
economy requires more money, ceteris shabby balance sheets with the aid of risk‐
paribus. While the Fed has done its best to free, zero‐rate Federal funds.
grow the money supply, the banks have

CHART 7 THIS IS A DEFLATIONARY TREND

Source: Shadowstats

These monetary and production trends produce a double‐dip recession, we expect
indicate potential deflation. Some a very stagnant economy as global events
implications are an above normal level of continue to exacerbate the burden of
unemployment, continued stress in excessive debt.
consumer spending, deteriorating credit
quality, increasing credit card default, and Therefore, we believe that there is very
continued house foreclosures. The system little possibility of an interest rate increase
is deleveraging. This in turn will exert before 1Q11. The big question regarding
pressure on banks to reduce consumer the Fed’s FOMC is whether there will be a
lending and more closely re‐examine the return to quantitative easing before the end
assets and securities sections of their of 2010 or shortly thereafter.
balance sheets. We also believe that
without further government support there While the US is struggling, the European
will be renewed deflation in housing sales Union is imploding. Traders contend by
and prices. While all this gloom may not measure of credit default swaps (CDS) that
Page 7
Greece is only the tip of the iceberg. We Chart 9 reveals the growing demand for
concur. Most measures of liquidity and long‐term US Treasuries in relation to the
credit quality are under duress. Chart 8 cresting of Libor. The price of the US Bond
details the fall and rise of Euro rates over 30‐year is rising as indicated by the drop in
the recent 16 months. In the past 10 weeks yield to 4.22% over the past eight weeks.
the TED spread and 3‐Month Libor have Once again Treasuries succumb to money’s
tripled. This surge in the cost of short‐term demand for a “safe haven” in the face of
money is disconcerting amid the credit thunderheads. Reduced liquidity flows
market’s revaluation of sovereign risk. among banks reflect a turn to funding from
central banks. This in turn leads to greater
The TED spread is the difference between reserves. As has happened in the US
3‐month Treasuries and 3‐month euro‐ interest rate arbitrage greatly reduces
dollar Libor rates. As such, this rate is the lending and monetary growth. Charts 8 &
difference between the risk‐free rate and 9 are indicative of severe credit
money‐center bank creditworthiness. contraction.
Therefore, it produces a clear reflection of
liquidity and willingness to lend. CHART 9 TREASURIES BLINK
However, we must note that rising Libor
rates or rising TED spreads are much more
important than commercial credit analysis;
interbank loans are club trading among
usually high‐rated creditors. When these
closely‐linked parties step back from each
other the system is staggering.

CHART 8 TED SPREAD LEAPS


Yet, some fixed‐income traders and
strategists contend that this measure and
other Libor‐based metrics are useless as
they do not accurately reflect the market
for bank funds in the London market.
Inter‐bank lending has been replaced by
cheap central bank and IMF funding.
Source: PSI; StockCharts There are also insinuations that the Fed
attempts to manage US$ Libor thru
Page 8
currency swap lines which have been Financial Folly” and others that over the
reopened with BoE, ECB, and other central past 100+ years many banking crisis’ are
banks. We believe this view has some followed by sovereign debt defaults.
credibility due to the fact that any credit‐ These consequences may not occur in the
worthy bank is borrowing from the central same country where the banking crisis
banks of Europe, England, and the US. occurred. A prime example would be
However, Libor is still the benchmark for Mexico in 1985 when the banking crisis
trillions of US$ interest rate‐based was in the US but the real pressure was on
derivatives, primarily interest rate swaps. the Latin American debt which was
Any sudden change in Libor has an denominated in US$’s. Credit volatility
inordinate impact on the stability of moves quickly into currency instability
financial markets. which brings adversity to trade and
development. Other than trade protection
It has been historically detailed by Carmen barriers currency fluctuations are the
Reinhart and Kenneth Rogoff in their book, greatest hindrance to global growth and
“This Time Its Different: Eight Centuries of development.

CHART 10 MORE VOLATILITY IS COSTLY TO MANAGE


Chart 10 depicts the exchange rates for the inclusion of China requires greater
Euro and Yen in relation to US$. This currency equilibrium in order to maintain
triage of economic power with the the fragile trade balances which are the
Page 9
economic life‐line global market. The rise exporting power at any cost. Hendry
of the Japanese yen (FXY), an appreciation details the rise of Japan post‐WWI and
of 32% over a 3‐year period, has the much of his argument could also be
potential to crush Japanese exports and applied Japan’s post‐WWII growth.
trade balance. On the other hand, the Beyond economics is the political flaw that
depreciation of the euro over the past 6 may be common to both economic
months should bring pressure on Chinese flagships. This is the hubris which
imports. prevented bureaucrats from seeing the
“obvious and immediate dangers arising
WEATHER WATCH from the fall‐off in demand.” Instead,
From the Occident to the Orient we move “they pressed on, raising the stakes
from the Euro‐World to the manufacturing further, by directing the private sector to
and export conflation of the East, China. borrow and invest in yet more excess
We have previously commented upon the production capacity and to build and store
boom in China and those who are betting more inventories.” The undoing was that
on the deleterious repercussions upon its the excess capacity never “produced the
inevitable slowdown. cash flows necessary to service or retire the
debt and with unsold inventory piling up,
Those concerns were voiced by James the companies began to default on their
Chanos, Edward Chancellor, and Kenneth loans.” The current case in China reflects
Rogoff. We now look closely into the May an economy which “represents 7% of
2010 letter from Eclectica Asset global GDP is now responsible for 30% of
Management’s Hugh Hendry. He is an global aluminum consumption, 47% of
outspoken hedge fund manager who has global steel consumption and 40% of
shown very astute maneuvering in the global copper consumption.” China may
volatile global markets of the past decade. have exceeded its fundamental strength in
The first basic question that he poses is the “frenzied doubling in domestic bank
whether we are “in the midst of a vigorous lending last year.” This exuberant credit
yet typical economic recovery, or near the creation and hard‐to‐manage “hot money”
end of an inventory‐led and rather short have “strengthened the twin problems of
business cycle bearing testimony to an commodity hoarding and property
ongoing debt deflation.” We agree with speculation.” Hendry goes on to detail a
the question but are prejudiced in the valid argument for a slowdown in China.
answer. Hendry skirts this issue by He also notes a major stumbling block in
introducing a strong case for a flawed China’s development, its non‐convertible
business model in Asia, previously in currency.
Japan and now in China. He contends that
China’s “economic transformation” He believes in two Asian “game‐changers:
springs from Japanese heritage of a slump in China’s rate of economic
growth and a sudden and dramatic
Page 10
appreciation in the yen that would overdependence.” Obviously, the tremors
bankrupt its [Japan] domestic export base.” from a slowdown of any substantial
As Hendry admits “opinions are cheap” magnitude would be felt across the globe.
and he backs his up with an investment A fundamental plank for Hendry’s
thesis and program. Eclectica Asset strategy focuses on commodities. We
Management has announced a major surmise that the type of businesses that he
“short credit portfolio” to exploit these may be considering are giant commodity
major economic transitions. His and materials providers such as BH
investment team has developed a list of Billiton, Rio Tinto, Vale, and similar
“over 20 single‐name industrial, cyclical suppliers of major raw materials to China.
businesses that have the dubious Hendry is also creating a new fund to
distinction of suffering from gigantic focus exclusively on this opportunity.
financial leverage and Asian/commodity

CHART 11 ESTABLISHING NEW MEANS?


Chart 11 reveals the past decade of pricing commodities have been in a “bull market”
for the US$ exchange and the Reuters‐CRB since 2001. Since most are priced in US$’s
Index (CCI). The CCI contains a major the decline in the exchange rate has
energy component which is reflected in its supported this appreciation in prices. As
2008 eruption and collapse. However, the US$ has shown recent vigor in
Page 11
conjunction with the Euro demise The implications for China of the Euro‐
commodity prices are vulnerable to this crisis may be a sudden drop‐off in demand
currency revaluation and the any decline in the case of rising prices. A sudden
in demand from China. We must cogitate imbalance in trade between Europe and
on timing and magnitude for any China will have major ramifications for
commodities break‐down as the US$ rises other trade nations whose currencies have
in value to meet the demand of global appreciated against the US$. Without the
liquidity. There are many factors at play; expected revaluation of the yuan these
true inventories are unknown, China nations’ exports are at a pricing
seems determined to maintain its growth, disadvantage. However, the “cheaper”
hedge funds gather to exploit stress, and euro will support a trade advantage to
investors seek out a hedge against European exports; perhaps, greatly
inflation. improving the balance of trade for Europe
and producing a substantial trade surplus.
The leadership role of the US$ in world This leaves the US with the increased value
financial markets is undisputed. However, of its currency as the “consumer of last, last
stability of the US$ across markets is more resort.” This will not be a pleasant
important than any specific exchange rate. experience for a nation which already
The US Treasury allowed the US$ to slide sports the largest trade deficit, around $380
substantially between 2002 and 2008; billion, in the world. The only certainty at
commodities and the S&P 500 benefited this juncture is that the hard negotiations
from this devaluation. The recent will be delayed, trade tensions will flare,
volatility, rise‐decline‐resurrection, during and a viable solution will grow more
the past two years is a bane to US$ based complex.
asset classes. Markets abhor instability.
As stated above numerous fund managers
The challenge lies in any delay to an are seeking to exploit any slowdown in
appreciation of the yuan which is currently China. They are doing so by shorting
tied to the US$. As the US$ rises against those suppliers whom they deem most
the Euro, so also the yuan; this makes vulnerable to a crash in the property
Chinese goods more expensive in the Euro‐ bubble and infrastructure boom. Those
zone. The depreciating Euro lowers the suppliers are primarily world commodity
costs of exports, especially from the and materials producers. Chart 12 reveals
German powerhouse. Additionally, the the 5‐year track of Chinese equity markets,
new austerity measures in the GIIPS as viewed thru SSEC, and the Goldman
economies and parts of Eastern Europe Sachs Industrial Metals Index (GYX). In
will exacerbate pricing pressures on the US after investors were scorched in the
Chinese exports. tech meltdown money rapidly gravitated
to real estate. The same movement has
occurred in China. Money flows rapidly
Page 12
toward the greatest achievable return. We term path for commodities is the same as
believe that a correction in commodity inflation. When the deflationary spiral has
prices in the short term will be followed by subsided for whatever reasons inflation
the resumption of a rising trend in the face will return with a vengeance; commodities
of future inflation expectations. The long‐ will follow course.

CHART 12 CHINA AND THE INORDINATE VOLATILITY OF METALS


Chart 13 exhibits two major implications more expensive to global customers as the
from the rising value of the US$. The first US$ appreciates. Modeling for these
is the decline in interest rates as global impacts is beyond our capability, however,
money flows seek the strength and as Mr. Hendry, noted above, points out
liquidity of Treasuries. The 10‐year rate “From its nadir in 1987, the US trade deficit
has declined 15% since March 2010. The contracted from $151 bn to just under $31
second is commodity prices, especially oil bn four years later as exports jumped
which drives continuing US trade deficits. 65%.” The obverse may also be true. We
As a side‐note both of these effects can be would never under‐estimate the
read as traditional signals of a deflationary exponential power of an under‐valued
trend in the economy. However, these currency and very low interest rates. This
potential benefits are offset by the is China’s current hand.
contraction of US exports which become
Page 13
Mr. Hendry’s missive references the further rise in the yuan by a very small
wsjonline.com report on March 18, 2010 magnitude might cause fundamental
that many Chinese exporters are in a changes.” Unfortunately, to preclude a
“fragile situation” and may be trade war and protectionist tactics from
approaching a “tipping point” due to importers China may be forced to begin
razor‐thin margins on exports. Mr. Zhong buying the Euro since we find it highly
Shan, Vice Commerce Minister, explained unlikely that it will devalue the yuan in the
“Water doesn’t boil if it is heated to 99 midst of the current currency market
degrees Celsius. But it will boil if it is pandemonium.
heated by one more degree.” Thus, “a

CHART 13 CONTRACTING TRENDS


The most imposing result of the continuing financial networks. Yet, since this
stagnation in the US economy, the relatively new amalgam of conflicting
increasing credit and banking turmoil in relationships has not been stressed, tested,
Europe, and an arrest of the China and reconfigured the truly weak links are
property bubble is the uncertainty within unknown. Every potential soft spot will be
the realm of unintended consequences. probed as pressures grow and new
The global marketplace is now intimately constructs must be created to channel
connected through communications and increased money flows throughout the
Page 14
system. Money, like water seeking its level period of extended low growth, a
or electricity racing to ground, will find its deflationary trend with rising inflation
adequate return or stronghold of safety. expectations, and unconventional
Eighteen years ago, September 1992, monetary policies. This is not your father’s
George Soros’s Quantum Fund “broke” the investing environment.
Bank of England. The cost to the UK
Treasury was estimated at about US$ 5 We were amazed at a recent article in CFA
billion at today’s rates. The stakes are Magazine, “Asset Allocation in Crisis” by
much higher now. Brian Jacobson, CFA, chief portfolio
strategist, Wells Fargo Funds Management.
PROVISIONING He asserts three main lessons from the
The challenge of asset allocation has grown credit crisis (1) Strategic asset allocation is
in complexity over the past decade. The not static allocation. (2) An awareness of
US financial markets have been rocked by economic and market conditions should
two asset bubbles and traders are able to inform portfolio allocations. (3) Risk
move capital in and out of global markets management goes beyond “checking the
24/7. The traditional moorings of US stocks box” of size and style exposure. This is
and bonds, expected returns, and simple scary because if these are the lessons
asset class correlations are no longer learned from the current credit upheaval;
sufficient shelter from the storm. The what were people thinking previous to the
evolving growth of alternative strategies crisis. Many investment professionals
and incessant use of leverage have must have been really operating in the
diminished the previously simple metrics dark. The article goes on to discuss the
of investing for retirement. As we work to importance of qualitative factors, “human
develop a strategy and tactics for the next capital” which is the individual’s earning
two years, five years, and ten years the power, the option of using risk‐return
research available has been enlightening. optimization programs, et al. Mr. Jacobson
However, what we have found most makes a good point for more active
alarming is the parochial simplicity that management: “If markets are not static,
major asset management firms proselytize. then allocation should not be static.” This
“Stocks for the long‐run”, simplistic sector fine use of understatement is followed
plays, general long‐term indexing, 60/40 with mandates such as “short‐term
US stock/bond allocation, munis for tax deviations create tactical opportunities to
purposes, and TIPS for inflation, are a few reduce risk and add value to a portfolio”
of the plebian dictates from mainstream and “An important consideration in any
advisers and managers. These stratagems asset allocation decision is the investor’s
may suffice for short periods at end of life investment time horizon.” Yes, and then
but to protect and build capital something what? Our point is that it appears that not
more is required. We have entered a much has been learned by large
institutional managers who advise
Page 15
individuals. This is sad given the focused on investors who expect to retire
tumultuous market gyrations and massive around the year 2020. The fund invests in
investor losses over the past decade. a combination of underlying Fidelity
Rapid growth, moral hazard, and greed equity, fixed income, and short‐term
have infected the industry with conflicted funds. The fund becomes increasingly
interests, biased incentives, excessive conservative after reaching 2020 and is
compensation, and severe ethical lapses. ultimately expected to merge with the
The mea culpa from the central bank, Freedom Income Fund. We find this an
money center banks, investment managers, interesting marketing concept premised
and wealth advisers is “we’ll do better next upon a long‐time Pimco strategy. The
time.” Well for many, there may not be a surprise is Fidelity’s nifty use of Foreign
next time. The loss of substantial capital is Equity and High Yield, in an otherwise
crippling. Hedge funds know this well. traditional sandwich of two asset classes.
This may account for the fund’s 10‐year
Table B lays out the asset allocation average annual return of 1.8%. The
schedules for five large investment funds. expense ratio is 0.74%; however, each of
The purpose is to glean a more intrinsic the funds in which this fund invests has its
understanding of current practice among own selected manager(s) and expenses and
those who have a fiduciary duty on behalf fees. Fundamentally, this fund with 62%
of large groups of savers. We begin our equity does not vary from the old “60/40”
examination with a vanilla mutual fund model. This reflects the pace of
which attempts to match a timed liability institutional progress on behalf of the
horizon. Fidelity Freedom 2020 (FFFDX) is individual investor.

TABLE B ASSET ALLOCATION IN ACROSS SEVERAL PORTFOLIOS
Fidelity New York
ASSET CLASS Freedom1 State2 CalPERS3 Yale Univ4 GMO5
Domestic Equity 47.9% 31.5% 66.8% 7.5% 29.9%
International Equity 14.1% 12.4% 9.8% 23.6%
Emerging Equity 8.9%
Private Equity 9.7% 24.3%
Absolute Return 2.2% 24.3%
Fixed Income 24.8% 26.3% 22.9% 4.0% 34.1%
High Yield Income 7.4%
Inflation‐Link Bonds 3.0% 11.4% 2.3%
Real Estate/Real Assets 6.5% 7.0% 32.0%
Short Term & Cash 2.8% 0.9% ‐1.9% 3.6%
Source: Individual Institution website
1. Fidelity Investments, April 30, 2010
2. Common Retirement Fund; March 31, 2009 Actual Allocation vs Policy; Cash and mortgages are included in Fixed
Income figure
3. Actual Allocation vs Target; March 31, 2010; Equity is Global and includes Alternative Investment Management
which is private equity; Fixed Income is Global;
Page 16
4. Effective June 30, 2009; Real Assets include real estate, oil & gas, and timberland.
5. GMO’s Global Balanced Strategy at March 31, 2010

The New York State Retirement Fund and or bankruptcy restructuring to achieve a
the California Public Employees target price. The other half is value‐driven
Retirement System are funds for large strategies which involve hedged positions
numbers of state employees. As one in assets or securities that diverge from
would expect both funds have large boards underlying economic value.” The
(councils), actuarial advisors, advisory diversification factor in this strategy is that
commissions (panels), and consultants. historically absolute return strategies are
These pension plans exemplify the independent of the market moves in
allocation of funds into less efficient traditional marketable securities. Finally,
markets, real estate and private equity, Yale directs a hefty 32% to Real Estate/Real
which offer the opportunity with superior Assets which is the endowment’s inflation
management for greater returns. hedge. No TIPS here.
Demographics and size allow the fund to
trade liquidity and cash commitments for We conclude with GMO’s, formerly
greater asset performance. While the fund Grantham, Mayo, VanOterloo, Global
provides some strong diversity at the edge, Balanced Strategy. As expected there is
at heart these funds are very traditional. nothing really exotic here. However, we
We note that CALPERs which had a fund point out the equity allocation allows a
value of $198B in 2010 recorded a total strong weighting to International and
exposure to private equity of $47.9B on Emerging Markets. Likewise, the Fixed
Dec. 31, 2009. At 24.2% of total funds this Income includes focus on Inflation
allocation looks exactly like Yale! Indexed, Emerging Country Debt, Alpha
Only, Special Situations, and Strategic.
On to the infamous Yale endowment While the portfolio is 97% GMO Funds
which led to David Swensen’s book, assets do include CMBS, CDO, equipment
“Unconventional Success.” In relation to leases, and student loans. There is much
many funds Yale is unconventional, the more diversification that at first sight. The
allocation to domestic equity is very low portfolio maintains a low duration strategy
and overall equity is 17.3%. There are in fixed income in spite of current
outsized allocations to private equity and steepness in the yield curve. We read this
absolute return. The absolute return as an expectation of future inflation.
strategy is “designed to provide significant
diversification.” It seeks “to generate long‐ We believe this panel provides some
term real returns by exploiting market industry vernacular for asset classes,
inefficiencies … 50% to event driven styles, and strategies utilized by astute
strategies which rely on a very specific fund management entities. In pursuit of
corporate event, such as a merger, spin‐off, slightly more esoteric thought we also look
Page 17
at the allocation undertaken by portfolio Net Equity Strategy 26.5%

manager Robert Arnott for the Pimco’s All Fixed Income Strategy 28.5%
Commodities 1.8%
Asset Fund. Mr. Arnott utilizes Currencies 29.0%
proprietary analytics to achieve a Cash 14.2%
maximum real return. Since the All Asset
portfolio is an amalgam of other Pimco Here we would point out three aspects of
funds Arnott breaks his allocation into the fund. First, the net equity position
strategies. As of year‐end 2009 they were: which reflects the long balance of a long‐
short equity barbell is substantially
Long Equity‐Related Strategies 5.0% underweighted in equity. Secondly,
US Bond Strategies 27.4%
Alternative Bond Strategies 13.7%
introduction of currencies as a major
Inflation‐Related Strategies 36.8% allocation in the fund indicates a truly
Alternative Equity‐Related Strategies 11.2% “macro” focus playing to fund
Short‐Term Strategies 6.0% management strength. We read this
substantial weighting to the expectation of
Arnott, by means of the myriad volatile currency markets going forward.
possibilities in the Pimco stable is able to Finally, the large allocation to cash may be
produce a uniquely complex investment partially due to potential redemptions but,
vehicle. We note that with a very small in our opinion, the management goes to
allocation to “long equity” Arnott is able to cash when lacking a solid investment
wager heavily on inflation (real estate and thesis. This allows firepower for their next
commodities) and alternative strategies major move. This resolve demands a
(developing markets, emerging markets, trenchant discipline in order to accept
high yield, convertibles, etc. We happen to negative returns in the current cash
like a manager who will go stronger “Short markets.
Term” than “Long Equity.” What is Bob
thinking? Full details are available at the Allow us to note that none of the portfolios
pimco.com website. we have addressed mentions precious
metals. Except for the hedge fund with a
Finally, we would like to include a commodities allocation which may include
straight‐ahead hedge fund with an precious metals this “asset class” is beyond
“Absolute Macro” strategy. This well‐run the purview of traditional and
fund with the founders’ capital side‐by‐ unconventional investment management.
side with investors reveals the distinctive
competitive advantage of the investment Much of investment management is
team. Additionally, this is the allocation dealing with expectations, the markets’,
for a London‐based fund. the manager’s and the clients’. Going
forward we envision a vengeful reversion

to more normal credit and business cycles.
Page 18
If the past 25‐year bull market in equities important aspects of money management
from 1982 until 2007 was boon for will be astute active management in global
investors; the 5 year stretch from 2002‐2007 markets, careful timing, inflation
was a rare event during which everything protection, and tactical allocations. In
went up. In that period of abundant order to avoid the changing tides and
liquidity and geometric leverage every aberrant currents investors must steer clear
asset class prospered. As we enter a of the crowds and settle down to the hard
period of economic retrenchment and work of research and due diligence.
credit contraction we believe that the most

We remember many years ago our first sighting of the Gulf of Mexico. We were on a late
winter road trip to New Orleans. We rolled south thru the night along Interstate 85. No time
for the BarB‐Q hospitality of Raleigh Durham, the bright lights of Atlanta, or the genteel
invitation of Montgomery. We cruised onward merging into Interstate 65. We were focused;
we were headed for the Mardi Gras celebration. It was early morning when we hit Mobile,
Alabama; we rolled west onto Interstate 10. There was little traffic and we were immersed in
the soft salty air coming in from the Mississippi Sound. We wheeled across Biloxi with the
rising sun at our back. The road flows neatly into the old Route 90, Beach Boulevard, onward
to Gulfport. The quiet avenue gives forth the beach and old sturdy palms growing side‐ways
into the sky. While not completely uprooted they never really recovered from the hurricane
winds three years before, but they were to strong, to grand to die. We were there in a time
long before the casinos and the condos, and well ahead of the noise and and non‐stop neon.
We stopped at a roadside Dairy Queen. We walked across the highway slurping coffee. At
the beach we paused looking out across the gentle sea into a southern horizon askance to a
rising sun, quiet, comforting, and very old. The lightly lapping waves washed across the
beige sands. Time stood still, wavering gulls were muted. The far water touched the sky.

We now must ponder the desecration of the land and sea with a foul and toxic need. The
result will be a local tragedy and ecological nightmare. There are no easy choices. What’s
done is done. The world has changed again. Yet, the flow of oil continues. The massive
plumes wallow below the surface in the currents and tidal flows, spreading amoeba‐like in
many directions. However, the gentle breezes of a torpid summer will change and the rain
will come. When the wind shifts and the temperatures rise, as they do every year, the
complacent Gulf will become a cauldron of froth and chop. The oil, the chemical dispersants,
and defiled waters will lash out against the sky, onto the shore, and back again, over and
over. At that time the real test will begin.

Page 19

Sincere regards,
Brian E. Shean, CFA
PRINCIPAL
POSEIDON STRATEGIC INVESTMENTS
_________________________________________________________________________________

The views expressed in this commentary are those of the author at the time of composition. The assumptions, analysis, and
conclusions are subject to change in conjunction with changes in the securities’ markets or discovery of additional or
conflicting information. All information conveyed herein has been deduced, compiled or quantified from sources thought to
be consistently reliable. This informational report is produced for general circulation and is not to be construed as a
solicitation to buy or sell securities, financial instruments, or investment products. Prior to entering any transactions for
investment products please consult a competent financial adviser and undertake proper due diligence. AMDG
Page 20

5.0 Pose Id On Perspective May 2010

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SOUNDINGS CHART 3 DOUBLE DIP? NO WAY!

CHART 4 GROWING LOSS RESERVES greater than one] divided by [the sum of

at the allocation undertaken by portfolio Net Equity Strategy 26.5%

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