minutemen equity fund q3 2008 annual report

MINUTEMEN EQUITY FUND FOURTH QUARTER REPORT 2008

TABLE OF CONTENTS

1. Letter to Stakeholders ……………………….. 2

2. Investment Philosophy ……………………….. 3

3. Economic Outlook ……………………….. 5

4. Portfolio Allocation ……………………….. 18

5. Portfolio Performance ……………………….. 19

6. Sector Analysis ……………………….. 20

a. Energy ……………………….. 20

b. Capital Goods ……………………….. 21

c. Consumer Staples ……………………….. 22

d. Financials ……………………….. 23

e. Consumer Discretionary ……………………….. 26

f. Basic Materials ……………………….. 29

g. Technology ……………………….. 30

7. Fund Operations ……………………….. 31

a. Building Alumni Relations ……………………….. 31

b. Fundraising ……………………….. 31

c. SOM497SA: Securities Analysis Course ……………………….. 32

8. Closing Note ……………………….. 33

LETTER TO STAKEHOLDERS

Dear Stakeholder, Since our first trade on January 3rd, 2007, the Minuteman Equity Fund (MEF) has made great strides in enhancing the educational opportunity of real world portfolio management investing. The Fund has grown in size to over 65 members, made a substantial effort to have University alumni involvement, established a portfolio management class, and has also made a strong fund raising effort. The year-to-date value of the Fund stands at $21,000, and is down 13%, while beating the S&P 500 benchmark by 15%. The Fund’s organizational accomplishments and portfolio performance can be attributed to the tireless effort and collaboration between students, faculty, alumni, the UMass Foundation, and the Fund’s Advisory Board.

Originally we invested in exchange traded funds (ETF’s) to diversify from non-market risk, while also exposing ourselves to various equity positions with our limited capital. Recently, we adjusted our investment strategy emphasizing more capital into individual stocks using a two tiered time horizon approach. This would entail long term (five or more years), medium (one to five years), or short term(less than one year) time periods. In the long-term, the Fund will invest in individual stocks. In the medium and/or short term, the Fund will invest in ETF’s in addition to individual stocks. The reason for this strategy is to take advantage of larger returns from individual companies, which we strongly believe will outperform their sector average performance, but not pass over profiting from the current macroeconomic environment.

The individual stocks making up the portfolio were researched by our sector lead analysts. The companies that were selected for investment, all had strong cash positions and equally strong cash generating ability. In addition to our securities, we have allotted cash position of 23% in the portfolio, to decrease our volatility to the market, and to also allow for the option to invest in potentially outperforming company that fits our investment strategy.

The management team has improved the organization and structure of the Fund to ensure that real world investing knowledge and skills will be applied into the future. In doing so, we contacted University alumni, faculty and administrators. This fall, we had conference calls, networking trips, and boot camps to meet with alumni to be educated on their area of expertise. To provide a sound curriculum for the Fund, management has worked with faculty to create a Portfolio Management Class starting in Spring 2009. We have spent endless hours creating a syllabus and recruiting various professors to help teach the class. The MEF and Development Office have worked together to raise capital so that the Fund can have an improved opportunity of real world investing, while competing with fellow universities in the Northeast.

In the third and fourth quarter of 2008, the Fund has made much progress which will help the MEF become a more effective portfolio management investing experience going forward. As the Fund continues to beat the S&P 500 benchmark and develops strong relationships with alumni, faculty, and administration, the MEF looks to constantly improve itself by opening new opportunities to all students of the University of Massachusetts-Amherst.

Sincerely,

MEF Senior Management Board

INVESTMENT PHILOSOPHY

Strategy

The Minuteman Equity Fund invests using a two tiered time horizon strategy. In the long-term, defined as five or more years, the Minuteman Equity Fund invests in individual stocks. Those stocks will be purchased only if the intrinsic value of the company is greater than what is reflected in the stock price according to Minuteman Equity Funds internal research. In the short term, defined as a year or less, or medium term, defined as one to five years, if there seems to be a transparent economic outlook for that duration. There will be a focus on investing, according to the current to near future economic environment, in exchange traded funds in addition to individual stocks whose return drivers are reflected in our short term economic outlook.

Criteria Overview

Economic Based Investments

Economic based investments will be based on our domestic and international economic outlook. The outlook will be representative of present economic indicators, both domestic and international, and trends found in present and past economic indicator data. As well as through reputable publications and news sources. Investments will be purchased based on their correlation and high R2’s with economic factors which are drivers or weaknesses in our economic outlook for the foreseeable future. Technical analysis will be employed, when necessary, to determine buy points and sell points, to assist in profit maximization in the short term. In addition, it should be noted that the Amherst Minuteman Equity Fund aims to be slightly ahead of the growth in the sector and/or industry in which we invest.

Value Based Investments

Value based investments will be purchased by examining their financial situation and their competitive situation and environment. The financial situation of the company will be analyzed paying attention to capitalization, net current assets, cash flow, insider purchases, book value, dividend yield, price to free cash flow, and price to earnings. The competitive situation will be analyzed using a framework like or similar to Michael Porter’s five forces, threat of substitute products, threat of the entry of new competitors, the intensity of competitive rivalry, the bargaining power of customers, and the bargaining power of suppliers.

Basis for Criteria Adaptation

Adaptation, defined as any alternation including amending, to the criteria is put forward evidence as to why such a rule is required to be put forward, and the majority of the senior management board of the Minuteman Equity Fund must approve of the adjustment. The evidence must include a logical, defined as a claim followed by proof, explanation of why the alteration should be included and success, as defined as statistically stocks with this pending criterion have had stock price appreciation over a five to ten year time frame, with a preference to those pending criterion that demonstrate a positive relationship with time and stock appreciation Adaptation to a thought process or framework is put forward evidence as to why such a rule is required to be put forward and the majority of the senior management board of the Minuteman Equity Fund must approve of the adjustment. The evidence must include a logical explanation of why the alteration should be included and some trend of usefulness, defined as enabling a profitable decision.

Trading Rules

If positions are liquidated, without immediate, defined as less than or equal to four weeks, investment, then that cash will be placed in short term U.S. Government Treasury Bills until the Amherst Minuteman Equity Fund foresees it being able to allocate such funds profitably.

Short term, economic environment driven, positions will have good till canceled stop loss orders with a target liquidation based on volatility of the equities markets and the appreciation of the position. In high volatility, defined as a VIX greater than 25 for two weeks, markets the target liquidation will be closer to the current price, than in low volatility markets, defined as a VIX less than or equal to 25 for one month. The good till canceled stop loss orders will be moved up as appreciation occurs. In high volatility markets for every 5% appreciation the stop loss order will be moved in relation to the current equity price. In low volatility markets for every 10% appreciation the stop loss order will be moved in relation to the current equity price.

Long term, value driven, positions will be re-evaluated, researched to determine if the intrinsic value is still greater than market value, if the position decreases by 10%. If the intrinsic value is still greater than the market value, the position will be held. If the intrinsic value is less than the market value, the position will be liquidated.

Any position that has appreciated 50% will be liquidated and re-evaluated. Economic environment driven positions will be examined based on the economic environment in the foreseeable future and the return drivers of the equities to reflect the economic environment. Value driven positions, will be examined to determine if the intrinsic value is still greater than the market value.

Whenever possible the Amherst Minuteman Equity Fund will rebalance, or adjust with minimum transactions, in order to reflect current views on all outlooks.

At the beginning of each semester each position will be examined. Value driven positions will be researched to determine if the intrinsic value is still greater than market value. If the intrinsic value is still greater than the market value, the position will be held. If the intrinsic value is less than the market value, the position will be liquidated. Economic environment driven positions will be examined based on the economic environment in the foreseeable future and the return drivers of the equities to reflect the economic environment.

At the end of the spring semester all economic positions must be revaluated to determine if those positions reflect the Amherst Minuteman Equity Fund’s economic outlook for the summer session. If the positions do reflect the outlook, then the fund maintains their positions. If the positions do not reflect the outlook then a re-balancing must occur to reflect the outlook.

If an investment opportunity arises in which the Amherst Minuteman Equity Fund would like to take advantage of, but lack the capital to support such a position, then a review of the current positions must be undertaken. The review will consist of a comparison between the integrity of the investment and the investment opportunity. If any economic environment driven position does not reflect the fund’s economic outlook for the foreseeable future, it will be replaced by the opportunity. If any value driven position does not have a higher intrinsic value than market value, it will be replaced by the opportunity. Otherwise, it must be considered what diverse risk profile the opportunity can provide to the portfolio, what the expected future return of such investment is over a current position, and the feasibility of allocating a section of the portfolio to the opportunity. In such a case, where it is deemed the portfolio should undertake the position, it shall only be allocated out of like investments, such as economic driven investments would be adjusted to allocate an economic driven opportunity.

The portfolio’s return volatility will be within the portfolio tracking error from the benchmark, the S&P 500.

The portfolio will be allocated with regard to the foreseeable future’s economic environment with at least one long term or value driven position and one short term or economic driven position. Risk will be the primary concern of the portfolio allocation. It is imperative that the portfolio receive the maximum return possible for the risk taken.

At all times the Minuteman Equity fund will attempt to limit transaction costs and other fees.

ECONOMIC OUTLOOK

IS WALL STREET TO BLAME?

Much of the focus of the current financial crisis has been on the men and women of Wall Street, but they are not solely at fault. Along with the housing market boom and bust, consumers spending over their means, overleveraging and lack of regulation among financial institutions, the people over in Washington have played a key role in the creation of this mess.

The Federal National Mortgage Association, nicknamed Fannie Mae is a government sponsored enterprise (GSE) that was created by President Franklin D. Roosevelt and Congress in 1938 in order to buy mortgages from lenders with the intent of freeing up capital that could go to other borrowers. This was a reaction to the collapse of the housing market during the Great Depression, which discouraged private lenders from investing in home loans. Fannie Mae’s creation was an attempt to provide availability of affordable housing and thus raise levels of home ownership in the United States; directed mostly towards low- and middle-income buyers who otherwise might not have been considered creditworthy. Since it operated as a GSE, it meant that although it was privately owned and operated by shareholders, it was protected financially by the Federal Government- including access to a line of credit through the U.S. Treasury, exemption from state and local income taxes and exemption from SEC oversight. With Fannie Mae’s extraordinary growth and the Vietnam War’s strain on the national budget, President Lyndon Johnson removed Fannie Mae’s debt portfolio from the government balance sheet and it was converted into a public traded company in 1968. Two years later, the Federal Home Loan Mortgage Corporation, nicknamed Freddie Mac, was launched, primarily to keep Fannie Mae from functioning as a monopoly and it too went public in 1989. Today, Fannie and Freddie have become America’s two largest mortgage companies, together holding or guaranteeing roughly $5 trillion in debt. Their substantial growth was partly due to the belief that the companies were so large that the government would never allow them to fail. “Fannie and Freddie raise cash to buy mortgages from a variety of sources, including pension funds, mutual funds and foreign governments. Their influence on economies at home and abroad is pervasive enough that the Federal Reserve and the U.S. Treasury felt they had little choice but to offer assurances that the companies will not be permitted to collapse from reverberations of the sub-prime- mortgage-debacle.” (http://www.time.com/time/business/article/0,8599,1822766,00.html) Foreign investors began to sell off existing paper holdings in Fannie and Freddie and resisted purchasing new paper. In addition, their inaccurate accounting practices made them appear to have more capital than was actually the case. Furthermore, the recent decline in the value of Fannie and Freddie’s mortgage loans caused a significant loss in capital. Since there was no help to be seen from Private investors, on September 7th the U.S. Treasury

announced that it would take control of Fannie Mae and Freddie Mac- the largest acquisition in decades. This bailout was estimated to cost anywhere between $0 and $100 billion. Their actions were a sign of their fear of massive collateral damage to the U.S. financial system, which would potentially lead to failures among banks heavily invested in mortgage-backed securities. The Federal Government’s rationale in nationalizing both of these banks was to strengthen the guarantee of GSE debt and thus prevent an emergency “run on the bank” situation by foreign central banks as well as to stabilize the flow of guaranteed mortgage issues through GSEs, which would sequentially help to prevent further declining house prices by reducing the surplus of homes.

$700 BILLION BAILOUT PLAN TO RESTORE TRUST

The Federal Reserve Chairman Ben Bernanke, Treasury Secretary Henry Paulson and President George Bush have continued to stress that all will be done in their power to stabilize the U.S. economy. Paulson’s previously rejected $700 billion bailout plan was quickly passed on October 3rd after the massive 777 point fall in the Dow Jones industrial average on the day of its rejection four days prior. The plan was originally to use the entire $700 billion to buy up troubled assets from financial institutions, but on October 14th a twist in the original plan surfaced. The Treasury announced that it was going to invest up to $250 billion of the $700 billion directly into the banks. Under this plan the U.S. is also expected to guarantee new debt issued by banks for three years with a goal to resume lending from banks to one another and their customers. “Of the $250 billion… half is to be injected into nine big banks, including Citigroup, Bank of America, Wells Fargo, Goldman Sachs and JPMorgan Chase, officials said. The other half is to go to smaller banks and thrifts.” (http://www.nytimes.com/2008/10/14/ business/economy/14treasury.html?hp) The Dow Jones industrial average rocketed up 936 points on news of this new plan. After the G8 meeting earlier this month, other central banks around the world have also began to act against the crisis with massive injections of liquidity into their economies.

UPDATE: $4.2 TRILLION INJECTION

There has been a great deal of action going on “behind the scenes” as far as the Fed and Treasury’s bailouts go. The focus has managed to remain on the TARP lending facility (Troubled Asset Relief Program, also known as the $700 billion bailout plan), however, that accounts for just a fraction of the liquidity that has been injected into the markets during the last few months. This data (see chart on next page) includes the Automakers Bailout plan of $25 billion, but this plan has not been confirmed yet. Nonetheless, the numbers are unprecedented and one has to question where the limit is. In any other economic environment, this sort of spending from the Fed and Treasury would be causing massive inflationary pressure and a collapsing dollar value, but the current deflationary pressure has proven strong enough to mask this. The dollar has been holding its value over the past few months for multiple reasons, which are discussed later, but when the environment begins to change in the future, the consequences from this enormous increase in the national debt should begin to surface and may overbear the factors that have been keeping the dollar strong. However, these factors are currently still predominant forces and will continue to act on a stronger dollar, at least in the short run.

Note: Figures as of Nov. 13, 2008

*References includ US National Archive, US Dept of Defense, US Bureau of Reclamation, Library of Congress, NASA, Panama Canal Authority, FDIC, Brittanica, WSJ, Time, CNN.com, and a number of other websites. (http://www.cnbc.com/id/27719011)

LIBOR RATES SHOW ZERO TRUST

(http://www.economagic.com/em-cgi/PW_MChartOmni.exe/save:economagic!Liborus1m3m6m12m)

The London Interbank Offer Rate (LIBOR) has been extremely volatile recently with extreme moves to the upside. The LIBOR is a financial index that represents the interest rate at which banks offer to lend money to one another in the wholesale money markets in London. It is used in the U.S. capital markets as a tool to judge the levels of trust banks have in one another- will be higher if banks fear that other banks will default on the loans they offer them. Since the LIBOR indexes have shown increasing volatility and moves toward the upside, this represents low levels of trust between the banks due to transparency issues and fear of defaults.

Judging by the market’s reaction to the promises of the newly announced bailout plan, there may be signs of a significant turning point in the Financial Sector as confidence returns. It remains uncertain how the results of this bailout will continue to unfold, but the Federal Government continues to show its willingness to take action against the financial crisis, which may prove to be positive for investors.

UPDATE: LIBOR RATES DOWN

(http://www.economagic.com/em-cgi/PW_MChartOmni.exe/save:economagic!Liborus1m3m6m12m) On a positive note, LIBOR Rates have been declining since mid-October, which may be showing some success from the Fed and Treasury’s lending facilities. The lower rates display some trust being restored amongst banks in lending to one another and some thawing of the frozen credit. However, there still remains a great deal of uncertainty in the financial industry as fear continues to play a major role in controlling the markets.

CRUDE PRICES BACK TO SANITY

(http://www.livecharts.co.uk/daily_charts/daily_charts.php) “Rattled by the swift price drop and evidence of plunging demand, members of the Organization of Petroleum Exporting Countries hastily agreed Thursday to meet next week in Vienna to weigh a production cut, in a bid to firm up prices. The cartel, supplier of nearly 40% of the world's oil, had planned to hold an emergency session in mid-November, but the plunge in prices has spread alarm among countries like Nigeria and Venezuela that have grown heavily dependent on rising crude revenues.” (http://online.wsj.com/article/ SB122418052416641331.html?mod=googlenews_wsj)

OPEC has scheduled a meeting for next week to discuss a possible output cut as the price of crude oil dropped below $70 a barrel on October 16th. During their previous meeting in September they agreed on an output cut of 520,000 barrels a day and acted upon this agreement quickly. The markets did not show a lasting reaction to this previous output cut as we have witnessed crude oil reaching continuously new lows since its peak of $147.27 a barrel on July 11th, 2008. Prices are at the lowest in 14 months and have dropped more than 50 percent since the all time high on July 11th. This dramatic decline in prices has continued due to lower demand caused by stocks plunging on a global scale and concerns of the effectiveness of the central banks bailout plans in preventing a global recession.

These decreasing energy costs have been hitting the energy sector hard and should continue to do so as the demand outlook for oil looks to continue to the down side, unless of course OPEC is successful in stabilizing oil prices in the long-term. It is unlikely for a significant increase in crude oil prices by the end of 2008 because of the uncertainty that still remains in the markets as there is no end in sight to the turmoil at this point.

Besides being a relief to consumers at the pump, the lower fuel costs are a benefit to the transportation industry. However, this may not be true in all cases. Southwest Airlines posted its first quarterly loss in 17 years on October 16th with the causal factor being costs tied to fuel hedges. They, like many other companies, use the futures market and other forms of derivatives to hedge against higher fuel costs.

Although hedging did not benefit Southwest this quarter, it proved to be beneficial in the previous quarter: “Southwest's spending for fuel, its largest expense, rose 52 percent in the quarter. It paid an average $2.60 a gallon for jet fuel, which sold for an average $3.53 on the spot market in New York. The airline had $448 million in favorable cash settlements on its hedges in the quarter…“Falling energy prices are a great thing for Southwest Airlines," Kelly said. "We simply have to manage our hedges as a component of our overall fuel costs."” (http://seattletimes.nwsource. com/html/businesstechnology/2008276589_southwest17.html) We are keeping an eye on companies that have exposure to unsuccessful hedges against higher oil prices. The consumer staples sector should also benefit from this decline in crude oil prices and other raw materials- especially companies producing rubber and plastic products since their production processes call for an intensive use of crude oil and other raw materials. Also, we are looking out for OPEC’s meeting next week to see if any significant decisions on output cuts have an effect on the markets.

UPDATE: OPEC CONTINUES TO FIGHT

Late October, OPEC agreed to cut oil production by 1.5 million barrels per day, in addition to the previous reduction of 520,000 barrels per day. This cut took effect on November 1st. On the release of this news the market reacted with a $4 (-5%) drop in the price of crude oil. This may have set the tone for how successful OPEC was going to be in propping up oil prices in the short term. Nevertheless, this massive cut in supply may need time to effectively prevent further declines in oil prices. Although crude has closed below the $50 mark, OPEC has made it clear with their actions that they will do what it takes to put a stop to the declining oil prices; we may witness further action by OPEC if the market continues its downtrend. If they are successful, we may begin to see better earnings from the energy sector in the future.

UPDATE: OIL DEPLETION, THE FORGOTTEN TRUTH

As crude prices dropped below $50 per barrel this week, the lacking demand from slowing global growth still remains to be evident. However, it is not to be forgotten that crude oil is not a renewable resource and it is very much in the process of being heavily depleted. The International Energy Agency recently released their annual report, which included the World Energy Outlook. In this outlook they stated, “Without extra investment to raise production, the natural annual rate of output decline is 9.1 percent… The IEA, the oil watchdog, forecasts that China, India and other developing countries’ demand will require investments of $360bn each year until 2030… The agency says even with investment, the annual rate of output decline is 6.4 per cent… The decline will not necessarily be felt in the next few years because demand is slowing down, but with the expected slowdown in investment the eventual effect will be magnified, oil executives say.” (http://www.ft.com/cms/s/0/e5e78778-a53f-11dd-b4f5-000077b07658.html?nclick_check=1) Although China and other developing countries are experiencing slowing growth through the global economic turmoil, there is still the major factor of exponential population growth that may prove to have a huge effect on oil demand in the future. This is a reality that will play its role in the global outlook unless every country decides to adapt China’s one-child-per-family policy. In addition to this, the extraction of oil is becoming increasingly energy dependent since the quality crude (easier to extract) has been highly depleted already, which results in less output per input. These factors, although not prevalent right now, should play a massive role in the price of crude in the future as supply is inevitably squeezed. This also may play a positive role in earnings for the energy sector in the future.

INVESTOR FEAR AND THE REACH FOR “SAFE-HAVEN” ASSETS

(http://moneycentral.msn.com/investor/charts/chartdl.aspx?Symbol=%24vix.x&CP=0&PT=11)

The Chicago Board Options Exchange Volatility Index (CBOE- VIX) spiked to its all time high on October 16th, peaking just above the 80 mark. The VIX is a symbol that represents a popular measure of the implied volatility of S&P 500 index options. To put this new high into perspective, around the time of the catastrophic events of 9/11 it peaked at just below 45. As fear and uncertainty spreads amongst investors, they are beginning to focus more on less risky asset classes. There has been a popular shift towards Treasury Bills, Notes, and Bonds. This shift has caused demand for these assets to increase, thus raising their prices. As their prices increase, their yields decrease, which we have been witnessing on the CBOE 10-year Treasury Note Yield Index (TNX) since mid June. However, since the Treasury first announced their $700 billion bailout plan towards the end of September, yields have shown increases. The bailout plan that was passed during the first week of October came with a promise from Henry Paulson, Ben Bernanke and President Bush to continue injecting liquidity into the financial system as necessary. The Treasury funds these billions of U.S. dollars by issuing T-bills, T-notes, and T-bonds, thus increasing their supply. With this massive increase in supply, their yields increase as their prices drop. Keep in mind that the full $700 billion is not used in a onetime spending spree; Treasuries are issued in increments over a period of time. This means that the yields on T-bills, T-notes, and T-bonds should continue to increase for quite some time.

With rising uncertainty and risk in the financial sector, Treasury yield indexes have greater upside potential, while Treasury ETF funds such as iSHARES Lehman 20+ Year Tsy Bond Fund (TLT) and iShares JPMorgan USD Emerging Markets Bond Index Fund (EMB) have stronger potential to the down side.

UPDATE: GLOBAL FLIGHT TO U.S. TREASURIES

“Foreigners were big buyers of U.S. securities in September as credit seized up and global stocks tumbled, sparking the biggest U.S. capital inflow in nearly three years, the Treasury Department said on Tuesday. Overseas investors in September snapped up a net of $143.4 billion in U.S. securities including short-term instruments such as Treasury bills, the biggest inflow since January 2006… Demand for long-maturity securities such as bonds, notes and equities also rose to $66.2 billion, compared with an upwardly revised $21 billion in August… Indeed, Treasury debt was the most highly demanded U.S. asset, with international investors buying a net $20.7 billion, with $4.9 billion coming from foreign central banks.”

(http://www.fxstreet.com/news/forex-news/article.aspx?StoryId=5761a564-38b7-4aed-8996-0f9f0ba2030f)

This increasing trend of foreign investment in U.S. treasuries comes as no surprise as investors from around the world continue to search for the safest investments possible during these times of high risk and uncertainty. T-bill, note, and bond yields continued to consolidate over the past month, but over the last few days the demand for these securities has sent yields to historic lows- with the 10 year Treasury note yield (TNX) reaching 3.1%. This strong demand for U.S. government dept should continue to hold the dollar’s value, but as the yields on these safe-havens decline, they become less attractive to buyers, which may play a big role in the future of the Treasuries market and the dollar.

THE ALMIGHTY DOLLAR

(http://quotes.ino.com/chart/?s=NYBOT_dx)

On the flip side of the financial crisis, the dollar crisis has seen a massive turnaround in recent months. After hitting double-digit-year lows and, in some cases, all time lows against a basket of foreign currencies around the end of 2007 to July 2008, there has recently been a substantial move to the upside for the U.S. dollar. To give an example of how extraordinary the U.S. dollar’s strengthening has been, simply take a look at the chart below which shows its value relative to that of the Australian dollar. As you can see, it has taken 3 months for the U.S. dollar to gain back its losses against the Australian dollar over the past 5 years.

AUS/USD

(www.metaquotes.net)

Keep in mind, the United States economy is fundamentally at one of the worst levels it has ever seen, as will be discussed later on in this report. This gives a key perspective that displays how massive the effect of this crisis is on a global scale.

This dramatic shift into the U.S. dollar has been caused by multiple factors. Although the United States was responsible for the core trigger in setting off the current financial crisis, many foreign nations around the world are witnessing issues with freezing credit and slowing economic growth because of it. Foreign nations are turning to the U.S. dollar as a safer currency because of the structure of the U.S. Federal Government and its ability to act fast in times like these. Since the European Union is made up of 27 sovereign member states, the European Central Bank is not structured in such a way where it can take action as fast as the Federal Reserve Bank due to the individual governments of each member state having to agree with the proposed plans and policies before action is taken. A recent example of this barrier of authorization in the ECB occurred last week when they tried to pass a bailout plan of their own, but not all of the members agreed with it and was thus declined. Another factor includes the rising Treasury Bills, Notes and Bonds yields as they become more appealing to foreign countries that need to convert their money into U.S. dollars to purchase such assets, thus increasing the demand for U.S. dollars. In addition to all of this, the global monetary policy environment plays a role in determining where the currency markets have been and will be heading to in the future. Since the Federal Funds rate in the U.S. is currently at 1.5% after the recent global coordinated rate cuts it has only so much room for easing whereas the interest rates in other major industrialized nations such as the European Union, Australia and Great Britain remain at reasonably high levels, which provides their central banks with ample room for easing. This creates an environment in which it is much more realistic for interest rate spreads to shrink in favor of the U.S. dollar. Controversially, the Japanese yen has recently been strengthening against the U.S. dollar due to an unwinding of carry-trades, in which the investor sells a certain currency with a relatively low interest rate (Japanese yen) and uses the funds to purchase a different currency yielding a higher interest rate (U.S. dollar in this case). The investor attempts to capture the difference between the rates, which can often be substantial when using high amounts of leverage. (http://www.investopedia.com/terms/c/ currencycarrytrade.asp)

Therefore, as the interest rate spread between these currencies continues to become smaller, the yields on the carry-trades decline equivalently. Also, as there has been increased volatility and uncertainty in the markets, investors unwind their carry-trade positions as they face a risk of losing more money than they are earning through the interest rate spread yield if the low interest rate currency begins to rise relative to the high interest rate currency.

The dollar should either continue to strengthen in the short-run or consolidate at its current levels unless there is significant intervention by the G8 or a major increase in oil and commodity prices. Since some countries, such as Canada, are major exporters of oil, their currency is strongly positively correlated with oil prices. The same goes for Australia and gold prices, with one of their major exports being gold. In addition, this higher exchange rate for U.S. dollars will have a negative effect on major exporting companies in the U.S.

Nevertheless, there are some companies who have used the foreign exchange market to hedge against this increasing dollar value such as the well known tech company, Google. Google’s 3rd quarter earnings came out much higher than expected on October 16th at 3% growth q/q, 31% y/y, which they account for some due to their successful hedges in the currency market. (http://news.cnet.com/8301-1023_3-10068654-93.html)

There are also companies who have hedged on the wrong side of the move (betting against the U.S. dollar). Look out for companies that have hedged against the strengthening U.S. dollar.

FUNDAMENTALS:

[1] RETAIL SALES ABYSMAL

September retail sales fell 1.2%, the largest drop since August 2005 and the third consecutive month to see a decline. The previous releases for August and July came out at -0.3% and -0.1% respectively.

“Auto and auto parts dealers saw sales fall by 3.8%, after gaining 1.7% in August. In the first nine months of 2008, auto and parts sales are down 8.4% compared with the first nine months of 2007. September auto sales are down 18.5% compared with the sales level in September 2007, a record decline in any month compared to the same month a year earlier… Sales were down in every major retail category except health and personal care stores and gas stations, which both saw small gains… and sales excluding autos and gas fell 0.7%, the largest decline in nearly a year and a half… Sales at furniture stores fell 2.3%, the largest monthly decline since February 2003. Sales fell 2.3% at clothing stores, 0.4% at general merchandise stores, 0.5% at food and beverage stores, and 0.6% at building material and supply stores.”(http://www.forbes.com/afxnewslimited/feeds/afx/2008/10/15/afx5557091.html)

This extraordinary drop in retail sales in September represents a shift in the mentality of the U.S. consumer. They are moving away from their consumption-centered ways into a new mentality of saving. Although this will hurt growth in the U.S. economy as well as the global economy, some economists believe it is necessary since over-consumption was one of the root causes of the financial crisis. As the holiday season approaches the retail sales numbers are usually cyclically higher during the month of November, but the likeliness of seeing the 1.2% increase in retail sales we saw last November is slim to none. Look out for aching profits for retail companies.

[2] INFLATIONARY PRESSURE DECLINING?

The Producer Price Index (PPI) fell for the second consecutive month, down 0.4% in September. The PPI release measures the change in the price of finished goods and services sold by producers from the previous month and is a leading indicator of consumer inflation because when producers charge more for goods and services, the higher costs are usually passed on to the consumer.

“Within the energy sector, home heating oil prices fell 13.9%, the largest decline since September 2006. Liquefied petroleum gas prices fell 11.1%, while residential natural gas prices dropped a record 8.2%. Gasoline prices fell 0.5% in the month. A 0.2% gain in food prices was the seventh straight month without a decline. Fresh and dry vegetable prices soared 28.4% in September. Intermediate goods prices fell 1.2%, the largest decline since October 2006, while crude goods prices fell 7.9% in September.”(http://www.fxstreet.com/news/forex-news/article.aspx?StoryId=43b9584b-2bfe-4b7f-bcac-7abf5a04e91b) On the other hand core PPI (PPI excluding food and energy costs) rose 0.4% for the month of September. That meant core PPI was up 4.0% in the past twelve months, which was the fastest unadjusted annual pace since February 1991. Overall wholesale inflation has risen 8.7% in the past year. (http://www.fxstreet.com/news/forex-news/article.aspx?StoryId=43b9584b-2bfe-4b7f-bcac7abf5a04e91b)

Without the recent major decline in food and energy prices, we are still seeing some increasing inflation. If food and energy prices are to gain back some of their losses, there will be added pressure on the Federal Reserve to avoid lowering interest rates.

[3] HOUSING MARKET BUST CONTINUES

September housing permits reached its lowest level since November, 1981 – annual rate of 748,000 units, down 8.3%. This was the fourth consecutive decline in housing permits since June, where it was at 1.09 million units. Housing permits data is an excellent gauge of future construction activity because obtaining a permit is among the first steps in constructing a new building. It is tightly correlated with housing starts data and a permit must be issued before the house can begin construction. The effects of the declining housing permits can be seen in housing starts data, which fell 6.3% to an annual rate of 817,000 units in September – the lowest rate since January 1991. Housing starts are down 31.1% from September 2007. The decline in home values across the U.S. and the oversupply of houses has been fueled by the credit crunch, which has squeezed potential buyers and negatively affected borrowers, lenders and builders. Also, mortgage rates remain high and the end of the housing crisis is still nowhere in sight at the moment. There will be a continued devaluation of home prices in the U.S. at least until the end of 2008.

[4] UNEMPLOYMENT RATE AND NON-FARM PAYROLL

“US employers shed more jobs last month than in any month in more than five years, led by a sharp drop in service sector jobs and continuing losses in the construction, manufacturing and retail sectors, the Labor Department said today. The economy lost 159,000 jobs in September... September's decline is the largest seen since March 2003, when the economy lost 212,000 jobs.

The economy has now lost 760,000 jobs since January. Economists have said the economy needs to create about 100,000 jobs each month to keep up with new workers, but with September's numbers, the economy has now averaged a monthly loss of about 43,000 jobs over the last 12 months.” (http://www.fxstreet.com/NEWS/forex-news/article.aspx?StoryId=e856db3b-d50d-428a-9082 371af7aa8555)

The unemployment rate remained at 6.1% in September, up from 4.7% in September, 2007. This level of unemployment has not been seen since September, 2003. As of now, there is nothing to offset this growing unemployment as the reasons for its increasing are still in full force. It should continue to grow, possibly surpassing 7% by mid 2009.

UPDATE: EMPLOYMENT DATA SHOW MAJOR JOB LOSSES The Non-Farm Employment Change number, provided by the Bureau of Labor Statistics, was released on Friday, November 7th. “Earlier, government data showed that U.S. employers slashed 240,000 non-farm jobs in October after eliminating 284,000 positions in September, pushing the unemployment rate to 6.5 percent, the highest since March 1994.” (Thomson Reuters) In addition to this release, last month’s release of 159,000 jobs lost in September was revised down to a loss of 284,000 jobs. All this has caused the unemployment rate to jolt up 0.4% to 6.5% from last month’s release at 6.1%. Major job losses have a negative effect on the overall economic health of the United States, but primarily will cause declining consumption and continued distress in the housing market. In addition to this, the fear of losing a large number of workers in the auto industry is haunting the U.S. economy in its already uneasy state. “The Center for Automotive Research, an Ann Arbor, Mich., think tank pushing for a bailout, estimates a loss of nearly 2.5 million jobs if just half of the Big Three manufacturing capacity were shuttered - a possible scenario if GM files for protection. About 240,000 of those job losses would be at the automakers, while 800,000 would be at various suppliers and dealerships. The other 1.4 million job losses would be at businesses that rely on automaker spending.” (http://money.cnn.com/2008/11/17/ news/companies/gm_showdown/ index.htm) This will play a major role in the government’s decision in whether or not to bail out the auto industry. UPDATE: GLOBAL INTEREST RATE CUTS • Federal Reserve Bank cut their Federal Funds rate to 1.00% from 1.50% • Swiss National Bank cut their Libor Rate down to 1.00% from 2.00% • Bank of England cut their Official Bank Rate to 3.00% from 4.50% (massive cut) • European Central Bank cut their Minimum Bid Rate to 3.25% from 3.75% • Bank of Canada cut their Overnight Rate to 2.25% from 2.50% • Reserve Bank of New Zealand cut their Official Cash Rate to 6.5% from 7.5% • Reserve Bank of Australia cut their rates to 5.25% from 6.00% • Bank of Japan cut their Overnight Call Rate to 0.30% from 0.50%

Look for more rate cuts to come from the central banks around the world. GROWTH OUTLOOK There are few reasons, given the worsening economic and financial conditions, to believe that the United States will be able to avoid a recession. Many economists and investors believe we are and have already been in a recession. Since the U.S.’s toxic financial crisis has spread across the world, we are starting to see strong signals that we will be entering a global recession before the end of the year (some believe we already are in one). Many major stock indexes around the world have plummeted to levels that make the Dow Jones and S&P 500 look appealing. In addition, since the currencies of these nations around the world have been losing value rapidly to the U.S. dollar, they are also experiencing a major loss in buying power. As far as economic expansion, this is invisible in the short-term picture since the first step of stabilizing the economy is still at its beginning stages. Chairman Bernanke has hinted towards further necessary rate cuts to come soon, but with a current Fed Funds rate at 1.5% there is little room to stimulate economic activity. Although the U.S. may not be in a recession by definition, the fundamentals are pointing towards it becoming a reality very soon. UPDATE: RECESSION SPREADS ACROSS THE GLOBE

China has shown their exposure to the global financial and economic crises with the announcement of a new hefty stimulus package. Although they have stated the stimulus package to be a preventative procedure, with a value of $586 billion one has to wonder if it really is a pro-active measure or a reaction to what is currently being experienced by them. As a major exporter China has experienced major losses due to slowing demand from importing countries, such as the United States, due to their contracting growth. Nonetheless, China has taken a longer-term approach to fixing the mess as their stimulus package focuses on building the country’s infrastructure rather than strictly stimulating spending (keep in mind overspending is the reason why we are in this mess). “…the government unveiled a two-year stimulus package it valued at around four trillion yuan, or $586 billion. The government said it would build infrastructure, fund housing, cut business taxes and encourage banks to lend money, all in a bid to offset slowing global growth by boosting the spending power of its people.” (http://online.wsj.com/article/SB122634126983014381. html?mod=googlenews_wsj) With more focused spending on education, they are setting the stage for long-term growth by taking advantage of the multiplier effect where higher education leads to higher wages, which in-turn, leads to greater spending and growth. The Eurozone has declared its economy to be in recession and they have been joined this week by Japan, whose economy has not seen contraction to this extent since 2001. In the coming months, The United Kingdom and United States are expected to confirm economic recession.

PORTFOLIO ALLOCATION

MEF’s strategy was to deliver a portfolio of outperforming stocks at an acceptable risk level. To achieve this end, the portfolio was allocated to include all stocks with strong recommendations from our investment team but at a mix that controlled the overall portfolio’s volatility. For example, MEF’s research of Techwell Inc. uncovered strong growth potential which led the investment team to consider it a strong buy. However, the stock is fluctuating wildly, at 59% volatility, which is an unacceptable level for the portfolio as a whole. Therefore, we allocated a minor portion (7%) of fund assets to Techwell which will allow the fund to realize future gains in Techwell without putting the fund as a whole in jeopardy. High risk of stocks like Techwell and Chipotle, were counterbalanced by heavy weightings in large-cap low-volatility stocks like Johnson & Johnson and Wal-mart, as well as holding a sizeable portion of the portfolio in cash (23%). This balancing allowed the MEF to hold a portfolio which it estimates to trade at 10.3% volatility per annum in the long run.

The allocation process was facilitated through a quantitative model which evaluated the stocks based on their historical data, but also allowed the investment team to insert information it believed was not incorporated into past performance. Specifically, the model tried to maximize the portfolio’s overall Sharpe ratio, while satisfying the following constraints:

• No one stock should compose more than 40% of equity holdings • All stocks strongly recommended by investment team receive at least 5% weighting • Hold at least 20% in cash

Results of this model were slightly adjusted to reflect the bias of the investment team: Techwell was weighted slightly heavier (7%) than the model recommended (the 5% minimum). The model under-weighting Techwell based on its short-term losses and volatility and our adjustment reflects our research’s favorable outlook. One of the main challenges of using a quantitative model is to establish long term trends in stock price, in the face of the current crash. To distill long term trends from short term fluctuations caused by the crash, we used two different samples of data: 1) A short-term sample based on data from one year ago to present and 2) A long-term sample based on data from six years ago to one year ago. Removing this current year’s data from the long-term sample offered a better estimate of return and volatility in the long-run, when the financial conditions improve. Based on these different samples, we calculated a long-run and short-run overall Sharpe ratio for the portfolio. The short-term data sample featured mostly large losses and high volatilities. For this reason, maximizing the Sharpe ratio in the short term was really trying to achieve the least negative. The long-term data sample featured much lower volatility levels, and wide range of positive returns from Chipotle gaining 40.6% per annum to Johnson & Johnson gaining 5.9% per annum. To define a single metric which we could maximize, we created a weighted average of the two Sharpe Ratios. Increasing the short-term weighting caused the model to allocate more into defensive positions like Wal-mart. Increasing long-term weighting favored high-growth companies like Chipotle. Ultimately, the investment team agreed on a 35% weighting to the short-term and 65% weighting to the long-term. This weighting reflects the fund’s emphasis on the a long-run buy and hold strategy, yet still has enough weighting on the short-term to assure enough of the portfolio is allocated in stocks that have demonstrated stability during this past year.

PORTFOLIO PERFORMANCE

Initial Holdings

Symbol Name Shares Price Returns($) Stop-loss

VCR Vanguard Consumer Discretionary 25 52.43 -192.26 6/30/08

KXI iShares S&P Global Consumer Staples 60 62.38 -1007.25

PBW PowerShares WilderHill Clean Energy 30 27.78 -239.41 6/27/08

VDE Vanguard Energy 30 113.71 -27.32 7/16/08

RYU Rydex S&P Equal Weight 30 60.85 -655.35

KRE SPDR KBW Regional Banking 20 36.37 -154.51 6/13/08

IXG iShare S&P Global Financials 35 78.64 -583.82 6/24/08

VHT Vanguard Health Care 45 60.56 -807.60

XLI Industrial SPDR 50 38.69 -252.51 6/27/08

VGT Vanguard Information Technology 70 58.94 -564.22 7/10/08

S&P 500 SMF

Initial Value – Jan. 2, 2008 $1,468.36 $25,000

Ending Value – December 1, 2008 $835.78 $20,693.76

Holding Period Return -42.25% -17.33%

This quarter has seen some of the most volatile weeks to ever hit the stock market. We have witnessed records for both single day losses and gains and are faced with the worst recession since the Great Depression. Academically this has been a great opportunity to study the movements and reactions of the market, practically however, this has been a rough time to be invested in the stock market.

Our initial investment strategy was to take a more defensive position that mirrored our benchmark, the S&P 500. We created a portfolio of ten exchange traded funds (ETFs) that covered the various market sectors, but weighted differently to take advantage of sectors we deemed particularly bearish or bullish. The portfolio itself had a beta of .8177 and an r-squared of .9433, therefore a lot of the movement in the benchmark was reflected through the performance of the fund. By the end of Q2 our fund was outperforming the S&P 500 by 1.76%.

As the market continued to drop our stop losses came into play. It is no success to have stocks hit their stop losses but, having the majority of our portfolio in cash led to us missing the worst of the market drop, leaving the majority of our fund still intact. The effect of the stop losses is most easily seen when looking at how our portfolio has outperformed the S&P in the third quarter. Our fund was down 11.41% YTD, a 2.61% quarterly drop; while the S&P dropped 19.41% YTD a 7.76% drop in the third quarter. By this point all but three of our ETFs saw their stop losses hit, leaving us invested in the Vanguard Healthcare ETF

(VHT), the Rydex Utilities ETF (RYU) and the iShares Global Staples ETF (KXI). Since the end of the third quarter the stock market has seen record losses that the fund avoided by holding mainly cash. As of December 2nd, the fund is down 17.33% YTD while the S&P is down 42.25%.

Being in cash has put our fund in a strong position to reinvest into the market. With that in mind, we have spent the majority of the semester looking for companies that have high liquidity and a strong business models. We feel that a combination of these attributes is necessary in the current market, where consumer spending and lending looks to be tighter than in past quarters. The liquidity of our fund has allowed us to get back into the market with companies, despite the economic environment, poised for growth and strong returns in the coming quarters.

SECTOR ANALYSIS

Energy

The Energy sector has witnessed one of its more volatile years in 2008 as performance has been mixed across industries and throughout quarters. Energy use over 2008 has grown slower than has been projected, but there is still an overwhelming reliance on fossil fuels including oil, natural gas and coal. Oil is the dominant source of energy, but the demand for coal has been rising more than any other fuel.

The price of oil increased to record highs of $147/barrel over the summer and has recently come down to a three-year low of $48/barrel, a 67% drop in price. The decrease in the price of oil has been largely due to a reduction in oil demand as a result of the recent financial crisis. The market has been oversupplied with oil

and the Organization of Petroleum Exporting Countries (OPEC) cut output by 1.5 million barrels per day on October 31st in an attempt to halt the decline in price. On November 13th, the International Energy Agency slashed its demand forecast and claimed that demand for energy in developing countries will continue to rise, but slower than was previously forecasted.

The news of demand decline has trumped OPEC’s output cut in influence and oil prices continued to decline. Factors such as declining reserve discoveries, high oil field depletion rates, political tensions in the Middle East and South America and growth of emerging countries have had a diminished impact on driving the price of oil.

With oil prices as low as they currently are, new oil projects and related capital investments have been either cancelled or delayed by many firms. The predicted consequence of the absence of said projects is a production shortage in the medium to long-term. When demand begins to rise once again as the economy pulls itself out of a recession, the market will be undersupplied and there may be a sharp rise in oil prices.

When the price of oil peaked over the summer, there was great incentive for companies across all sectors to implement or investigate alternative sources of energy. Consumer dissatisfaction with expensive fuel prices prompted policy makers and corporate heads to promote various alternatives such as solar, wind, hydrogen and bio-fuel initiatives. One of the major policy platforms for President-Elect Barack Obama was his “New Energy for America Plan” that outlined short, medium and long term directives to work toward energy independence. However, due to severe issues in the housing and credit markets as well as the rapid decline in the price of oil and gasoline, attention has shifted and incentive to promote and invest in alternative energies has been reduced. Without government assistance and without easy access to credit, many alternative energy companies will find it difficult to increase earnings due to high capital costs associated with advanced technology utilized in production.

Short-term investments in the energy sector are fairly risky, as more economic problems threaten to further deteriorate demand. Industries such as Oil and Gas Drilling and Exploration are especially risky as the credit crisis and falling oil prices will likely continue to suppress capital spending by firms involved in drilling and exploration for the short to medium term. More sound investments might be found in companies within the Major Integrated Oil Services and Independent Oil and Gas providers. Firms that have lower levels of debt, substantial cash, and the ability to remain profitable with current oil prices will be most successful in the near term.

Capital Goods

The Capital Goods sector was hit extremely hard over the past three months where it lost approximately 38% of its value as compared to a loss of approximately 35% by the S&P 500. All industries in the sector seemed to perform similarly except for Construction-Raw Materials which gained 51%. With a bleak outlook on the credit markets and some degree of uncertainty regarding commodities, a major goal for the quarter was to find an investment that would be insulated from the liquidity freeze and have low exposure to drastic changes in commodity prices. Other investment criteria included potential for growth and low risk.

We decided to allocate approximately 15% of the fund to a hardware manufacturer and distributor called Fastenal. Fastenal has an above average P/E ratio as compared to its sector and the S&P 500 and its sales figures have seemingly transcended the economic contraction and posted increases. The company is

insulated from the frozen liquidity markets because of its lack of long term debt and extremely high current ratio of 5.703. Fastenal also recognizes the impending recession and has adjusted its business practices accordingly. The new strategy calls for a decrease in the rate of store openings which should help individual stores meet their sales numbers.

When looking at a long term horizon, the capital goods sector becomes much more appealing. There has been an obvious economic contraction over the past year or so, but we see capital goods being one of the first sectors to rebound. This is simply because all of the other sectors rely on capital goods to conduct their own businesses. When the other sectors begin to stabilize, they will need capital expenditures to start growing again and thus, capital goods will flourish. It is important to note that these capital expenditures often must be financed because of the nature of their size. This turnaround for capital goods will not occur until the liquidity freeze loosens up and companies will be able to secure loans at reasonable rates.

Fortunately, there are some brighter aspects of the sector in the short term too. For example, many of the companies in capital goods are massive in size and they are seen as rock solid in terms of credit ratings. This ability to borrow money helps hugely during the credit crunch where loans are becoming scarcer and scarcer by the day. Furthermore, we expect the plummeting price of crude oil to grossly affect the performance of the capital goods sector in a positive manner. This prediction is based on the fact that nearly all of the industries in the capital goods sector rely heavily on fuels like gasoline, diesel and aviation fuel. Another positive aspect of the sector is the relatively low volatility of most of the companies. This sector seems to be more predictable than some of the others which can be helpful in the volatile market conditions we are currently experiencing. Over the coming months, we expect to see a slower rate of decline in the capital goods sector and we also expect to gain stability and some growth from our investment in Fastenal.

Consumer Staples

The Consumer Staples sector is historically known as a defensive sector. It has maintained its defensive reputation throughout this economic cycle. The Consumer Staples market is made up of mature industries with well established global companies. Because of the defensive nature of the companies, as well as their size and global footprint, Staples, despite having been hurt by the down economy, has still outperformed the rest of the market.

We feel that Consumer Staples is poised to be one of the top performing sectors in the short term due to the current, prolonged recession. Consumer Staples has always been considered to be one of the more recession proof sectors. This protection is due in part to the economies of scales that the larger companies within this sector enjoy, which helps to control their cost structures. More importantly Consumer Staples companies produce the basic need products for consumers, so we expect demand to remain stable.

A concern for this sector is that people may begin to purchase generic goods shying away from the more expensive name brands. High commodity prices will have a negative effect on many industries within the Consumer Staples sector. Also a strengthening dollar will negatively impact foreign sales, while strengthening the competition from imports.

Regardless of the severity of this current recession, people will continue to buy their basic necessities. However, to combat these recession fears we have invested in more established companies that provide low cost goods while maintaining high market share and strong brand recognition. We feel that the combination of these attributes will keep consumers buying their products no matter how badly the economy is hurting.

Financials

Eleven months ago, no one would have envisioned the Street and the market to be in the state that it is in today. In the past eleven weeks, the Financial sector has weathered historical changes and is still unwinding itself in these tumultuous conditions:

September 7, 2008: The housing market financial problems hit a pinnacle point when Fannie Mae and Freddie Mac, the two largest mortgage finance companies in the country, faced government intervention. The government shored up $100 billion to each mortgage provider to backstop any capital shortfalls.

September 14, 2008: A week before, Lehman Brothers was struggling to find a buyer. While they shopped around for potential acquirers, Lehman Brothers lost half its market value. Many feared that the bank was running out of options and it was unlikely the government was going to repeat a rescue like Bear Sterns for Lehman. On this day, Lehman filed for bankruptcy and face possible liquidation. Merrill Lynch agreed to be sold for $50 billion to Bank of America.

September 15, 2008: After the announcement of Lehman Brothers’ bankruptcy and sale of Merrill Lynch, the Dow Jones Industrial Average (DJIA) plunged 504 points, the worst loss since 9/11/2001.

September 16, 2008: A.I.G. has been fishing for federal rescue for the past week and the Federal Reserve agreed to aid A.I.G. in a $85 billion deal, giving control of the insurance company to the government. A.I.G.’s financial suffering stemmed from complicated debt securities such as collateralize debt obligation (CDOs) and collateralized mortgage obligations (CMOs). These securities were advertised as safe investments on the basis of diversification. In hindsight, the underlying assets were much riskier than they were once considered.

September 21, 2008: Goldman Sachs and Morgan Stanley, the last investment banks on Wall Street, became bank holding companies. They will be under more of a microscope regulated by the government. This changed the world of finance as we once knew it.

September 25, 2008: Washington Mutual, nation’s largest savings and loan company, “became the largest bank failure in American history, as regulators engineered an emergency sale to JPMorgan Chase.” (http://www.nytimes.com/interactive/2008/09/27/business/economy/20080927_WEEKS_TIMELINE.html)

October 1, 2008: After a week of inconclusive debates, the Senate approved the $700 million financial bailout plan presented by the Federal Reserve and the Treasury.

http://projects.nytimes.com/creditcrisis/recipients/table

October 3, 2008: Wells Fargo won the bid to buy Wachovia over Citigroup.

October 5, 2008: The crisis is evident in Europe as major European leaders have agreed to back all private savings accounts.

October 22, 2008: In the past week, world leaders gathered to conclude on possible financial bailout plans to aid the ailing international markets. The stock market has also experienced drastic upward and downward movements due to federal announcements regarding government interventions or poor economic outlooks.

October 29, 2008: The Federal Reserve cut key interest rates to 1% to counteract the down spiral of the economy.

November 4, 2008: Senator Barack Obama won the presidency. Upon his succession in the White House, the imminent top priority for President-elect Obama is an economic stimulus plan.

Many of the major players in the Financial sector have seen unimaginable downturn in their market value. Two years ago, they were at historical highs and many of them are now valued below $10 per share.

Valuation of these stocks in Financials has been reinvented and reevaluated. Despite the immense volatility in this sector, there has been a trend in the market to move towards regional banks to provide exposure into Financials in ones portfolio. With current economic conditions, the outlook is not optimistic since many analysts have lowered their ratings on many holding and regional banks. Regional banks increased their offerings of loans since many of the larger banks ceased after credit tightened. In the long run, it is estimated that loan defaults will ripple out to the regional banks and industry specialists are not optimistic about their future performance.

With credit stretched as tight as it could go, it is taking a very long time for the credit crunch to loosen. Lacking available credit in the markets, mergers and acquisitions (M&A) and leveraged buyouts (LBOs) have been halted by the investment banks and private equity firms. With the $700 billion bailout for the financial giants, much of that money has been used to acquire other banks or regional banks. Lazard Ltd. (LAZ) has

been a company of interest in this area. They specialize in the financial sector and have been sought after by many troubled investment houses for advice, such as restructuring for Lehman Brothers after they filed for bankruptcy. Lazard has two main focuses: Financial Advisory (M&A, strategic advisory, restructuring, corporate finance and others) and Asset Management with $113 billion AUM. When compared to its two biggest competitors, Goldman Sachs and Morgan Stanley, Lazard’s Advisory revenue has changed by -9% compared to Goldman Sach’s -30% and Morgan Stanley’s -31%. Lazard’s operating revenue in the first nine months of 2008 is 5.2% less than the 2007 period. The biggest portion of their operating revenue comes from their M&A and strategic advisory business. With credit frozen in 2008, Lazard still has a healthy inflow of business comparable to the peak times of M&A transactions. Since most of their revenue is fee based, many of their pending deals are ones with the biggest price tag: inBev’s acquisition of Anheuser-Busch ($52 billion), BHP Billiton’s offer for Rio Tinto ($147.4 billion), and Nationwide Financials merger with Nationwide Mutual Insurance ($2.4 billion). In their restructuring practice, they have been advisors to some of the largest deals, such as Parmalat, Northwest Airlines, Daewoo Corporation, and WorldCom. Of the top 20 bankruptcy filings of 2008, Lazard is involved with 8 of these public and private companies in the financial services, homebuilders, real estate development, gaming/leisure, automotive supplier, advertising, and chemicals industries. Lazard’s financial performance has been affected by the current market conditions, but compared to the other big players in financial advisory, they have suffered fewer losses and are positioned well in time for an upswing.

We approach Financials with hesitation because of the volatility in the market in recent months. There are pending regulations after Senator Obama steps into his role in January. We are waiting on the FDIC rulings on the banking industry and believe that many people will be trying to wipe clean their financial holdings at the end of the calendar year. It would be more prudent to be patient anticipating new regulation. The financial sector will never be what we once knew it to be.

Consumer Discretionary

Performance:

1 Month 3 Month YTD P/E Price Per Sale

-12.93% -21.50% -33.55% 30.1x 0.6x

Current Outlook:

The year of 2008 has been grim for the Consumer Discretionary sector as a whole, with only financials performing worse in terms of YTD decrease. I hold the belief that while 2009 will be slightly better for the sector in terms of performance, the sector will not thrive, and many of the companies will face an uphill battle to regain their profit levels from before the recession began. The main reason the sector will struggle can be broken down into the three factors which are most critical to its success:

The unemployment rate is most important to the sector’s health, and the most recent job reports indicate that not only is unemployment high, but it could be getting higher. At the moment, 478,000 people in the work force are unemployed, up about 15,000 from the prior week, and is steadily rising at 6.1%. Not helping unemployment is the fact that even beyond the current unemployment; average payroll has dropped

to a 5 year low in the country, giving Americans less cash to spend during the next few months, which includes the holiday seasons which are the most important to this sector’s success.

Consumer Confidence fell to 38 from 61.4, signaling that a huge number of consumers do not want to spend their extra cash, and are probably going to start saving rather than consuming. Consumer confidence at its current levels could indicated that not only is the sector, experiencing a rough year, but that the sector could be facing a total crisis at these lifetime lows.

Earnings are repressed due to the above mentioned indicators, and internal obstacles within each company’s respective industry. I expected earnings to be decreasing significantly in the next few quarters. While this is no shock and should already be factored in the stock price, the sector of consumer discretionary has a P/E ratio of over 30. If these stocks are still expensive after all the negative reports, and the months of poor earnings to come, one has to wonder how much longer it will be before the industry as a whole adjusts to the current situation.

Where there is fear and pain in the market there is opportunity. While the investment landscape seems to be a desert, there may be a lush rainforest over the on the horizon. Corporate investing is lagging, but an efficient company could produce an excellent return. The plan for the sector is to hunt companies with steady earnings growth and a low price to earnings ratio, that happens to be not deeply affected by the economic turmoil such as multi-line retailers and apparel companies for a company. By targeting those companies the fund will be able to recognize a growth in price with the expansion of earnings in an economic recovery.

Industries Retail Textile, Apparel and Luxury Goods (38 Companies)

0.00% +7.30% -6.56% 19.6x 0.8x Specialty Retail (106 Companies)

0.00% +2.90% -9.58% 17.5x 0.6x Multi-line Retail (17 Companies)

0.00% +7.01% -7.55% 14.5x 0.6x Retail, the largest industry of the sector has had a down year, but has been hit much less hard then other industries in the consumer cyclical sector. Although it seems to be more resilient towards the tough economy than the other industries, tough times may lie ahead. With consumer credit harder to get, less money going to Americans via payroll and a high unemployment rate, retail is projected to have one of its worse holiday seasons ever. Beyond that it will take an economic turnaround to bring back consumer confidence and revitalize the retail industry.

There are, however, some bright spots in the industry. Multi-line stores like Wal-Mart and Target which have lost some of their share price recently are great shopping alternative for struggling consumers. They may pick up business from other stores that offer similar products at higher prices.

Also, some higher end apparel stores have continued to enjoy moderate successes despite the fact that their stock price is trading lower because of a fear in the market. Cherokee and American Eagle are too companies that have had a letdown in stock price this year despite outperforming a majority of their peers. These are the types of companies in this sector that will enjoy the largest returns, once the economy turns

around and/or investors once again feel confident about the market. Possible Investments: Wal-Mart, Cherokee, American Eagle

Media (94) companies 0.00% -5.89% -17.13% 40.3x 1.4x

Media is an incredibly diverse industry and many of the companies have different business models and streams of revenue. One thing is certain, however; trading at 40.3x P/E media is by far the most expensive industry this sector has to offer. At such expensive prices, most media companies do not look too attractive. Companies with a ticket based revenue stream (such as WWE) could find a lack of turnout due to their high prices selling less seats in the turbulent economy. Also, about half of the companies in this industry rely on some kid of advertising based model. Advertising has remained flat this year, and spending is only estimated to increase by 1.5% in 2009. Facing competition from new forms of media that fall into tech categories, such as internet and mobile software, it does not look like traditional media with these business models (newspapers, radio, television), will experience too much growth in earnings. With such expensive stocks, I would estimate that these stocks will decrease in value over the coming six months.

One media company I like is Dreamorks SKG Animation. The company has achieved an excellent return on investments through its movies. With advanced animation more popular than ever (see Pixar), Dreamworks has been able to make great, high grossing movie and manage costs better than ever, due to great management and a board full of some of the smartest minds in the industry. Also the P/E ratio of 14.7 is extremely low for the industry, especially with a company that has been successful even in a down year. Possible Investment: Dreamworks SKG

Hotel, Restaurant, Travel and Leisure (470 companies) 0.00% -5.01% -23.54% 18.8x 1.7x

This is perhaps the industry within the sector that has taken the most beating due to the downturn. Both the travel and hotel businesses have taken a dive not only because of the consumer downturn, but also the fact that businesses are traveling less while trying to cut costs.

The restaurant is experiencing much difficulty, not only because of consumer difficulty, but because of inflation which increased prices and cut into profits. With inflation somewhat tame now, restaurants, especially full service, are struggling due to less disposable income. Another problem within the restaurant industry has been mismanagement. Recent reports have shown that things like mistaken orders and poor service are higher than ever, turning people away from paying extra to eat out. To fix these problems restaurants will have to spend more to either hire consultants or new managers, both costly and lengthy procedures. Another thing that scares me about the restaurant industry, is that once the economy does turn around, inflation will likely reach a level not seen in years. With restaurants already struggling a large increase in the price of food could mean the end for several of them. This could also negatively affect hotels which make a large amount of revenue from their bar and restaurant business.

A bright spot in this industry could be the ultra risky airline industry. Southwest Airlines, although making some bad energy bets in recent months, has excellent management and a loyal customer base due to its low prices. While commoditization of the industry has hurt it as a whole, Southwest could do great business this year if oil prices stay low. Also, the Delta/ Northwest merger could prove a great investment opportunity as both businesses could streamline costs and have a higher net income if inflation remains tame. I am a bit

hesitant to suggest investing in airlines, however, because of their history of poor performance and troubles in dealing with their labor union.

The safe choice for this industry would be McDonalds, and as a pessimist of the economy in the near future, I would say McDonalds is best positioned to weather the storm. Great management, excellent relationship with suppliers and a loyal customer base are exactly the traits needed in this kind of situation. The one problem with McDonalds is that it does not provide too much of an opportunity for growth, and its stock price has no dropped much year to date, suggesting that it will not produce a great gain if the economy recovers. Possible Investments: McDonalds, Southwest Airlines, Choice Hotels

Basic Materials

Aluminum is an industry within Basic Materials that is on the increase. Projected GDP growth to 2013 is 1.9% in a $46.8 billion (2008 forecast) industry; this is a dramatic revenue growth compared to last year’s $31.9 billion.

Aluminum companies such as Alcoa, Inc. (36% market share) have had slowly diminishing stock prices. Alcoa is now down to $11.78 per share, and in the past couple weeks has started to increase in stock price. Now would be a great time to invest in Alcoa and ride the wave as they begin to improve. Their 52-week low was $9.00 on October 27th, and has since been increasing steadily.

A more productive industry within basic materials is Plastics, Resins, and Rubbers. This $87 billion industry has positive forecasted numbers when it comes to revenue growth (2.3%), GDP growth (1.9%), and average profit margin (5%--not projected). Another great thing about this industry is that the power within the industry is very spread out, as the top three companies only have 8% market share. Exports have also been rapidly increasing over the past five years, from just above $20 billion in 2004 to approximately $35 billion in 2008. This industry is also expected to contribute nearly $321.5 billion to the U.S. economy. With the constant government bailouts, it is fortunate that the industry does not mainly rely on the government for assistance with the industry. In fact, the only way the government mainly interacts with this industry is in the form of tariffs when international residents purchase the items.

With the ever-increasing bankruptcy of airline companies, aluminum is not going to be needed for the construction of airplanes as much as it used to be, so aluminum will lose a majority of an entire branch of its uses. Approximately 30% of the use of aluminum is for transportation; therefore, aluminum is subject to the changes in this industry and others. Like the aluminum industry, the sector of Basic Materials as a whole is subject to others as well, since the Basic Materials are used to create other industries from the bottom up. Stock prices for companies in the sector are just coming out of their 52-week lows. While they have been increasing for the past couple weeks, it is not certain that the trend will continue; this is due to the high volatility rates of the industries under Basic Materials as an effect of the recent instability of crude oil prices.

Now that gas prices are starting to go down, hopefully the economy will rebound back to a form that at least somewhat simulates what it should be. Two words: Barack Obama— How long it takes for Obama to “change” America and its economy cannot be predicted, but for the sake of the economy, hopefully it comes soon. With the rebounding of gas prices, hopefully transportation costs will decrease; this would bring a higher demand for Basic Materials to make more airplanes, trains, etc.

There may be much opportunity in the economy, the economy can also be a drastic threat. With all of the changes facing the country over the next couple months, one cannot be sure how the economy is going to

react. I think the largest threats to the Basic Materials sector are time and insecurity. The volatility of the industries within the sector along with the drastic changes on the political and economic fronts make predicting what is going to happen in the sector (even though it is understood that predicting the stock market is not easy already).

After looking through several industry reports and stock outlooks under the Basic Materials sector, we are hesitant to invest in any of the aforementioned industries or companies until the market picked up enough to ensure financial security. Though the majorities of the companies have been on an incline in the past couple weeks, their 52-week lows have been experienced not too long ago. Thus, the short-term analysis is skeptical at best, and investing into a highly volatile market would not be advisable.

Once the economy bounces back from this recent recession, the long term brings growth for the Basic Materials industry. As our world becomes “flattened” (in the words of Thomas Friedman) and international exporting becomes more popular, basic materials such as aluminum, plastics, and steel will be more demanded by economies abroad. It is also crucial to keep an open mind when it comes to investing in basics in the future. After the official change of commanders-in-chief, many changes are to come. Whether these will be positive or negative is still not determined, but with the international support for President-elect Obama, one can foresee more open doors abroad come January. This in turn will positively affect the American economy and a growth in the overall market.

Technology

Following the greater trend of the S&P 500, the Technology sector has similarly experienced a significant decline in value since the beginning of the fiscal year, down approximately 36% compared to the S&P’s 35% loss. The relatively volatile nature of the Technology sector has been further compounded by the bleak overall macroeconomic forecast and unpredictable market behavior, resulting in greater than normal instability. Year to date economic performances and future outlooks vary from subsector to subsector, however, which means that the MEF should be able to find viable options for both the short and long term investment through diligent analysis and qualitative screening.

Semiconductors – Despite promising signs of growth in the first half of 2008, the semiconductor market will likely see significant volatility and consolidation in the next few years as ASPs continue to trend downwards due to product commoditization and general macroeconomic weakness. Larger companies such as Intel and AMD are poised to pick up the pieces of the PC chip market, while smaller companies will either survive on ingenuity and critical restructuring or by virtue of pre-existing competitive advantages and niche-market dominance. Overall outlook is neutral, but given the large number of advances in technology still ongoing within the sector, as well as the increasing number of goods using semiconductor products, opportunities certainly exist.

Software – The software sector, which includes Software as a Service (SaaS) companies, has traditionally depended on the economic strength of North America and Europe, where high levels of corporate spending drives licensing revenue. Given the economic weakness of both of these regions, the software sector will likely underperform in the near future until either a) developing markets, specifically Asia, can pick up the slack, or b) corporate and consumer confidence is restored in developed markets. Meanwhile, significant consolidation is expected due to below-normal valuations, as are strategic shifts in revenue models. The SaaS model in particular is seen as a highly practical approach in the world of business software, offering lower overall costs to end users and providing a more stable recurring revenue stream to software

distributors. Consequently we expect that some companies will thrive in the down market, while other companies will either be acquired or go under due to corporate belt-tightening and shifts in market dynamics.

Computer Hardware and Peripherals – Computer sales growth was strong early in 2008 but has failed to perform similarly through the third quarter. Market instability, decreased consumer confidence, and a lack of liquidity in equity markets mean that individuals and businesses have cut down on PC purchases in developed markets. Asia and other developing economies are prime candidates to continue sector growth in years to come, however, especially as WiFi and other technologies become more available and affordable. Mobile devices and laptops in particular are beginning to replace desktop PCs, meaning that a shift in power among the top manufacturers may not be far off. MEF is currently neutral on Computer Hardware, pending further macroeconomic and subsector developments.

FUND OPERATIONS Building Alumni Relationships Before leaving for the summer session, outreach to alumni was the MEF’s main goal. As a result of our efforts, the Fund met with UMass graduates to organize networking trips to Boston, Springfield, and New York during this fall 2008 semester. Our mission was to enhance our portfolio management and securities analysis strategies, in addition to, gaining advice from alumni’s professional expertise. We have also organized conference calls and guest speakers on campus on topics such as career advice, asset management, and the research process. The MEF has continued our partnership with the Isenberg Development Office. We have further engaged the University Advancement Office under the Vice Chancellor to establish alumni relations. The Minutemen Equity Fund has had the opportunity to meet and communicate with alumni contacts that have not been involved with the University in the past. There are many alumni who work at investment houses who have an underdeveloped relationship with the University. The MEF has been an opportune platform to attract alumni involvement with the University as well as give the students involved face time with possible employers. Fundraising The MEF has made great strides in fundraising this Fall. Our goal this academic year was to grow the Fund’s size to $100,000. In collaboration with the Isenberg Development and University Advancement office, we have met with alumni to help meet this fundraising objective. For the students to fully apply the theories we have learned in the classroom to real world investing, we need more capital to be properly diversified, make optimal investment allocations, and to minimize cannibalism in our portfolio. Through our fundraising efforts, we gained the support of alumni who have become very invested in the success of the MEF. Two alumni in particular have spearheaded a fundraising campaign to help us reach our goal of $100,000. They feel, as strongly as we do, about this endeavor as a positive influence on campus. They believe, as

much as we do, that we should be on the same playing field with other student managed funds such as Northeastern University, Georgetown University, and Carnegie Mellon University who have more than $100,000 asset under management (AUM). These alumni have together pledged $25,000. When we have cash-in-hand, potentially by the end of this calendar year ending December 31, 2007, the UMass Foundation will also match every dollar raised by $0.50, up to $25,000. This month, the Advancement Office and the Fund will be sending out letters on behalf of these two distinguished alumni to solicit donations. They have been the biggest advocates of our efforts and have received very positive feedback and enthusiasm from other UMass alumni for this project. We are currently planning a pitch meeting in Boston to potential investors for a date in February. SOM 497SA: Securities Analysis Course A year in the making, we are officially en route to incorporate a course into the structure of the Fund. The senior management board and the lead analysts will be using the deliverables we have compiled into a structured classroom setting. The management board has been working tirelessly in developing a curriculum and syllabus, as well as engaging professors to teach in a lecture series styled forum. With the course operating at full speed, we feel this would be added incentive for students to take part in the Fund. They will be receiving credit for the research and analysis. This course is also a tool that will ensure the longevity and continuity of the MEF.

Left to Right: William Sutton (Portfolio Manager), Andrew Dunham (Portfolio Manager), Andrew Nolan (Lead Capital Goods Analyst), Daniel Levine (Lead Basic Materials Analyst), Ryan Flynn-Kasuba (Chief Investment Officer), Michael Harper (Chairman), Brenton

Thornicroft (Chief Economist), Candice Lo (Head of Fund Development), Jonathan Mauro (Chief Investment Officer), Tristan Cecala (Lead Energy Analyst), Scott Munro (Lead Technology Analyst), Ian Murphy (Lead Consumer Discretionary Analyst)

Not pictured: James Xu Zhang (Chief Marketing Officer) and William DiJohnson (Equity Analyst)

CLOSING NOTE Dear Alumnus,

We are excited to inform you that through the hard work of many UMass students and dedicated alumni, the first ever student managed investment fund has been formed at UMass. The Student Managed Fund (SMF) has been fortunate to receive generous support from alumni and other supporters. We really appreciate the active role many of you have taken in the past and will truly value your support, guidance and advice in the future.

After a year in operation, this venture has already been a great opportunity to expose students to the world of asset management before they enter the work force. It is a unique breeding ground for many budding analysts and portfolio managers to combine the skills they’ve learned in class with professional experience and accountability that comes with managing a real money fund. The real world experienced gained in the fund has already helped students gain jobs at many prestigious financial firms.

The Student Managed Fund is currently investing a $25,000 portion of the University of Massachusetts Foundation’s Endowment in equity securities. A major fundraising effort has been created to build the fund to the level of many other business schools around the state and country. The current goal is to increase asset under management to $100,000. This additional funding will allow students to run a properly diversified portfolio and truly apply the theories learned from faculty and industry professionals. Additionally, as the fund grows to an endowed status of $200,000, gains from the fund will be dispersed through scholarships to the students, making this a perfect opportunity to make education more affordable for students. The enhanced fund also gives students the experience needed to succeed in the job market and in the end build the overall reputation of the Isenberg School of Management.

Not only is monetary support key in the perpetual growth of the Fund, your time and knowledge is a precious commodity to the group. We have been fortunate to have alumni return to the Amherst campus to teach us investment strategies, how to evaluate the economic landscape, and the nature of different investment vehicles. Members have also visited distinguished industry leaders in Boston and New York in our “Boot Camp” initiative where we have day-long seminars with fund managers, economists and strategists, security analysts, etc. We view this as an excellent opportunity for participating students to enhance the performance of our portfolio and our experience of real world investing. As students, we would enjoy having you, involved as much as possible. This is an extremely exciting opportunity that other schools across the Northeast have had for years. After working so hard to achieve this, we want to make the most of this opportunity. Our group has the desire and the drive to learn and is looking for professionals to aid in our learning process.

The Minutemen Equity Fund wants to continue to build and foster relationships with our alumni and supporters. Thank you for your consideration and always standing by us. We will be hosting an investors meeting in Boston at the UMass Club in February 2009.

If you are interested in contributing to the Fund, attending the investors meeting, or learn about how you can get involved, please email Candice Lo at [email protected].

Yours Truly,

The Minutemen Equity Fund

minutemen equity fund q3 2008 annual report

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