Needless to say, baseball fever is running pretty high here in Boston (hope springs eternal!), so that inspired the baseball analogy theme in this month’s report (my apologies in advance). But it is an apt one. Something you quickly learn about managing other people’s money is that some clients think we should be more active and make more frequent portfolio decisions, equating activity with effort, and inactivity with taking our "eye off the ball." Of course there are others who think we "swing" too often, equating activity with lack of "patience at the plate." The reality is that we do as much or as little as our disciplined investment process dictates, based on what the markets give us. To return to baseball parlance again, "we go with the pitch."

This year our over-all trading activity has been below average, for a couple of key reasons. First and foremost, the over-all volatility in the stock market has been less than two-thirds of typical levels, so relative valuations have not fluctuated as dramatically as they typically do. With valuations between sectors more in line with each other, there have been fewer "mistake pitches" in the market for us to hit.

Second, most of the mutual funds that we own in client portfolios are having a pretty good years on a relative basis. While there are a few exceptions of course (there almost always are), our typical fund holding is solidly above average within its respective peer group year-to-date. In the case of taxable accounts, another reason why we have made a few less trades than normal this year is that we haven’t had many opportunities to harvest tax credits by taking losses on existing positions. (Unlike many other money managers, we actively pursue tax harvesting all year long, not just in the fourth quarter or December.)

How Much Do We Want Our Underlying Managers To Swing?
In the financial press, portfolio turnover (a measure of activity within a portfolio; a rate of 100% would mean that the entire portfolio would be turned over each year) is often equated with lower total returns for mutual funds. That assessment is mostly correct, but this topic is very rich and deserves a fuller comment at a later date. In short though, higher turnover does mean higher transaction costs (trading commissions and market impact costs). The actual dollar cost of transactions in a fund depends on a variety of factors: the size of the fund; the style of investing that the fund follows; the size of the companies it invests in; the asset class it focuses on; and more. In general though, for funds with similar investment mandates, those with higher turnover have higher transaction costs. I often refer to transaction costs as "hidden" fund expenses, because they don’t show up in the fund’s stated expense ratio, but simply come right out of returns.

Please note that this analysis doesn’t apply to the transactions we make in your portfolio. When we buy or sell a fund, we don’t pay commissions like money managers who buy individual stocks. We don’t have to worry about market impact costs (when the size of a trade in a security affects its price) either, since we buy funds at the 4 pm fixed net asset value like all other fund investors.

In summary, all else being equal, funds with lower transaction costs should have higher returns over time. That’s why our typical fund holding in client portfolios has a below-average turnover ratio. We make exceptions, of course, because all else isn’t equal (some managers are more astute traders than others), but in the aggregate that statement holds true. We believe that this is one of our many edges that we bake into your portfolio.

That said, you can’t simply focus on low-turnover funds. One of the biggest myths in the industry is that higher portfolio turnover means lower tax efficiency and lower after-tax returns. This is not necessarily so. If a manager is tax-aware (if she or he cares about the portfolio’s after-tax return), then a higher turnover rate could mean that they more actively took tax losses to enhance the fund’s tax position. You won’t find out about a manager’s tax-awareness (or lack of it) in the fund’s prospectus or in the standard fund literature. It is something that we ask of all our managers.

October The Scariest Month?
October has a reputation as a very dangerous month for the stock market. To a degree, the reputation is deserved since the two biggest market crashes we have experienced (October 28, 1929 and October 19, 1987) began in this first full month of fall. But as the chart below demonstrates, the month just past, September, actually has a far worse track record, with an average loss of 1.2%, and only a 40% chance of a positive market. In fact, over the past 100+ years, the chance that October would be a positive month for the market is just about average at 56%.

Enhanced Service to You
Hopefully, many of you had the chance to listen to our recent quarterly conference call where we briefly commented on our investment process and market outlook and answered your questions. If not, you can listen to it on our newly enhanced website. Or you can contact your account manager for a copy on compact disc.

On the enhanced website, you’ll find many new features, including these Portfolio Manager Reports, our Five-Factor Equity Model which many of you have seen, an additional monthly commentary from our Director of Research and co-Portfolio Manager Rusty Vanneman, CFA (this month’s article: "How to Not Pick A Mutual Fund") as well as a monthly article from one of our research analysts (this month John Manley, CFA talks about a unique investment "alternative," Pimco All Asset fund). As always, please let us know what you think -- what you like and what you don’t like.

Once again, thank you again for your confidence. If you have any questions, please feel free to contact us.