2007 Quarter 1 Update

April 26, 2007

The first quarter of 2007 was relatively quiet despite a sharp pullback in late February as a result of a one day “collapse” in the Chinese stock market. Global market participants panicked following China’s overnight decline of roughly 9%, fearing that it might trigger, or at least signify, the end of what has been a nice global stock market run beginning last summer. In hindsight this fear was unwarranted and most likely represented a good profit taking opportunity for those looking for such an occasion. We simply viewed this brief correction in the Chinese, and to a lesser extent other markets as a much needed “pause that refreshes.” Upon hearing of the drop in the Chinese market the media immediately began stoking the fires of panic by proclaiming that such a large move in such a short period of time had to portend something frightening in the offing. If looked at in a broader context, however, one would have seen that following the late February correction the Chinese market was still up for the month! Not exactly the stuff of nightmares in our opinion.

Needless to say we maintained our longer term view of the markets and the macro economy and our clients were better for it as a result. The world’s markets have returned to their highs since late February and continue their ascension as of this writing. While it can be useful to evaluate the past, it is our preference, as well as our job, to focus on the future and what it holds for our clients. It is this “future” that has us especially excited and below we will discuss one reason for that excitement, something new we’ve been adding to our client portfolios.

“Opportunity is missed by most people because it is dressed in overalls and looks like work." Thomas Edison said that and we believe it remains very applicable in today’s investment landscape. We’re certainly not patting ourselves on the back for working hard for our clients. That’s what we are paid to do and quite frankly we enjoy the work. Fortunately not everyone in our business sees it quite this way and that reality provides great opportunity. This brings us to what has excited us the most in recent months: reverse convertibles. As many of you may have noticed, there is a new type of asset present in your accounts. This is an asset that we are extremely excited about as it has everything an investor typically looks for: high yields with less risk than owning equities outright. In our opinion these reverse convertibles add a fantastic piece of diversification to our client portfolios and act as an excellent tool to lower risk while maintaining high returns.

So what are reverse convertibles? In the simplest terms possible they are “bond-like” securities offered by investment banks that are linked to the price of an underlying stock. Each one of these securities has a downside component, a guaranteed coupon, a “put” price for the underlying stock and a maturity. An example will illustrate this best:

A particular reverse convertible security might be based on Apple Computer’s stock. The security has a maturity of three months, a yield of 20% annualized and downside protection of 20%. When this security is priced the stock might be trading at $100/share (for the sake of explanation in this instance). As a result of the 20% downside protection inherent in the security, the put price on the Apple stock is $80 (20% below the trade date price of $100). During the three month term the coupon of 5% is paid (20% annually) regardless of what Apple’s stock does. If the stock never trades below the $80 put price during the three month term the owner receives his/her principal and has earned the 5% coupon. Should the stock trade below the put price during the period the stock itself can be put to the owner of the security in lieu of the principal, resulting in a loss dependent upon where the stock happens to be trading at the time of maturity. The coupon is earned regardless however, thereby mitigating the loss in such an instance. Said another way, should we have owned the stock outright rather than the reverse convertible associated with it the loss should the stock fall by 20% or more would not be mitigated by the coupon received, therefore the loss would be larger.

As can be determined from the example above, the ability to effectively price each security is key, as is a necessary understanding and knowledge of the underlying stock and a certain comfort level with that stock. Through our custodian Fidelity Investments, we have the ability to approach multiple investment banks when pricing a reverse convertible, thereby allowing us to achieve competitive pricing when it comes to the coupon and the amount of downside protection we are able to negotiate in each situation. As one might imagine, the fact that these banks must compete for the reverse convertible in question provides us the ability to garner the most attractive terms possible for our clients. In the example above, we would already have a certain amount of comfort with Apple as a stock/company, therefore our ability to negotiate an attractive coupon for the amount of downside protection we are provided is significant, as is our comfort level with the fact that we would be at ease owning the stock should it fall as much as 20% during the period in question. This comfort level would be aided by the fact that we would feel confident that the stock had fallen too much and would therefore return to a much higher price in the not too distant future.

There is a large amount of effort involved when putting together these securities for our clients, however the ability to remove some risk from our client portfolios while not giving up returns is hugely important in our minds and worth every minute. We wanted to share this information with all of our clients to not only remove any confusion that might be created but to express our excitement about such an effective security that is available to us, allowing us to further diversify our client portfolios. Should you have any questions regarding the above described security please do not hesitate to call. We would be happy to further discuss these assets with you should you choose to do so.

As always, we appreciate the confidence and trust you have shown in us by hiring our firm as your investment manager and we look forward to the remainder of 2007.

Cordially,

Paul R. Ray III Brian M. Phillips