Back to Quarterly Commentaries


2008 First Quarter All-Cap Value Commentary
April 9, 2008

The last 12 months have been difficult for the market, especially for sectors previously benefiting from excessive credit, such as commercial and investment banks, credit guarantors, REITs, home builders, and retailers.    Our low exposure to these sectors allowed us to avoid some of this risk, with our accounts falling 6.7%1 (gross) last quarter, versus 8.5% for the Russell 3000 Value and 9.4% for the S&P 500. Similarly, over the past 12 months, our accounts declined an average of 5.0% (gross), versus 10.6% for the Russell 3000 Value and 5.0% for the S&P 500.

Crisis markets are not unusual. We have now experienced eight in the 22 years since our inception in 1986, with most of our out-performance versus the indices coming during these periods. Our comments after the Asian crisis of 1997 are particularly relevant today, as reprinted below:

“The causes of financial crises . . .. are similar from generation to generation and fairly predictable. Over-confidence leads to over-investment financed by aggressive lending. Easy money fuels poor investments and eventually loans cannot be repaid. Banks begin to fail and depositors rush for safety. The ultimate outcomes from financial crises, however, are not similar and are not predictable. Chance, political tensions, and survival instincts combine so that some financial crises prove to be summer storms, while others set in like Chicago winters.”
(Source: EIC Quarterly Commentary, January 22, 1998)

From our perspective, our successful navigation of these past crises was more a matter of proper preparation than reaction. Part of that preparation involved sound investment principles, while part was an awareness of the environment and its risks. This awareness led us to largely avoid the areas of credit and banking risks so much in the news today. Going forward, the more likely contributor to performance in our holdings will not be the under-weighting of financial risks, but rather the over-weighting of companies with less cyclical risk, where earnings can be sustained in difficult times. These include our large exposure to insurers, healthcare, and consumer staples (about 40% of our holdings). We believe our portfolio is positioned to withstand the type of economic cycle that may be before us, something more like a long Chicago winter than a brief summer storm.

Sound principles, proper preparation, awareness of the risks in the environment, and the flexibility to invest in the best values regardless of capitalization allowed us to largely avoid periods of double-digit declines so often experienced by the market indices over the years. For example, since 1986 there have been 256 rolling 12-month periods. We experienced double-digit declines in only five2, which is about 60% to 75% fewer than the various Russell Value indices and 85% to 90% fewer than the Growth indices, as shown below.

Reducing the number of double-digit declines has been a key part of our success, but it is important to distinguish between a decline in price and a decline in value. Prices rise and fall as investors respond to current events with hope or fear. The value of owning a business, however, rises and falls according to its normalized earnings power over a business cycle and its ability to sustain a strong return on capital versus the rate of inflation. Because our investments tend to have much greater stability of earnings and returns on capital than the typical company, we believe they likewise have more stable value.

While declining prices do not necessarily mean a decline in value, absence of a market price does not equate with stable value. The risk of overstated model-based pricing followed by unexpected write-downs, which occurs when parties with vested interests determine an investment’s carrying value (instead of third-parties via auction), has begun to emerge in banking, insurance companies, hedge funds, and private equity. This is particularly dangerous when leverage is involved, since the mis-statement may well exceed investors’ equity, resulting in an overnight collapse when the residual equity can no longer support previous leverage. In this sense, auction-market pricing can be viewed as an ally since it invites third-party scrutiny as a check on stated values.

Booms and bubbles are experienced as being times of great capital creation. Given the underlying leverage usually involved in fostering such periods, however, much capital is actually destroyed when more difficult environments expose misjudgments of risk and misallocations of capital. We believe this is occurring now, and have tried to avoid these risks among our holdings.

Portfolio Review
During the quarter, we added new positions in Duke Realty and Newmont Mining. REITs have fallen significantly in price and now offer attractive value. Likewise, with gold prices near $1000 and inflation a rising threat, gold mining should be more profitable. Finally, retailers in general have fallen dramatically in price, and we increased our exposure through additions to Office Depot and eBay. We trimmed AFLAC and Wal-Mart, which had risen in price, and sold our position in PartnerRe due to a rise in price and less transparency in its investment holdings compared to our other insurance companies.

The market’s difficulties are presenting more attractive buying opportunities, and ultimately this is a positive for prospective returns. We continue to look primarily among financial and retailing companies, where declines have been most significant. The companies we are looking at tend to be smaller than our existing holdings, and we believe our exposure to large-capitalization stocks has peaked. A year ago this exposure was 70%, versus 60% today. We believe this gradual decline will continue as large-cap stocks outperform smaller companies, and the market presents more interesting buying opportunities among medium and smaller companies.

Conference Call
Our quarterly conference call is scheduled for Wednesday, April 16, 2008, at 4:30 p.m. (Eastern Time). If you would like to participate, the call-in number is 800-977-8002, and the password is 200414#. A replay will be posted on our website at www.eicatlanta.com approximately 24 hours following the call. As always, we appreciate the confidence placed in our investment approach and investment team, who may be reached at 404-239-0111, or via E-mail, as shown below.

James F. Barksdale (jbarksdale@eicatlanta.com)
W. Andrew Bruner, CFA, CPA (wabruner@eicatlanta.com)
R. Terrence Irrgang, CFA (tirrgang@eicatlanta.com)
Ian Zabor, CFA (izabor@eicatlanta.com)

¹ For Financial Professional Use Only.  Not approved for presentation to wrap program clients.  Such presentations should reflect EIC's wrap composite information, which is available upon request.   EIC’s returns represent a composite of non-wrap All-Cap Value equity accounts and are presented as supplemental information to a full GIPS® disclosure presentation, which is available upon request.  All returns include reinvestment of dividends and interest.  Index returns exclude fees and commission costs. After-fee returns for EIC were –6.8% for Qtr.1, 2008, and -5.6% for the past 12 months. Return figures are as of March 31, 2008.

² These figures illustrate the number of periods that the rolling 12-month returns for EIC and various market indices resulted in double-digit losses.  There have been 256 rolling 12-month periods from inception of EIC’s All-Cap Value product (January 1, 1986) through March 31, 2008.   All returns include dividends and interest.  Index returns exclude management costs and commissions, while EIC results are after commissions, and before management costs, based on EIC’s composite of non-wrap All-Cap Value accounts.  After management fees EIC experienced 6 rolling 12-month periods with double-digit declines.

All results are historical and do not imply future rates of returns, incidence of loss, or volatility for EIC or the indices, which may be materially different from the past and from one another.  Individual account results may differ relative to the past and to composite figures.

Marketing Contact: Mr. John P. Stewart, Jr., CIMA