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Dear Shareholder:
Analysts and Brokers and Conflicts of Interest: The $100 million settlement to which Merrill Lynch has just agreed, concerning the firm's analyst's recommendations has stirred up a lot of surprised indignation among investors (and former investors). There are similar reactions to the Arthur Anderson criminal trial and the many Enron revelations.
Frankly, the level of shocked surprise startles me. What did investors expect? A stock analyst's recommendation is never going to be "independent" if his firm is in the investment banking business underwriting IPO's, and it doesn't matter whether or not he/she is paid from underwriting fees if that activity is a big part of his employer's business. An auditor's opinion is never going to be "independent" if that firm can be hired or fired by management, or if they are doing other consulting work with the company audited.
Even brokers have a built-in conflict of interest with a client if they are paid by commission or sales load instead of being paid by a negotiated flat fee for advice. Most brokers handle this conflict honestly, but some don't.
All that is required to protect an investor from biased advice is for him to ask, "What is your source of income?"; "How will you be compensated if I take this advice?" Then, act accordingly.
While nobody condones conflicted advice, I do think investors could use a little more caution and common sense in their own behalf. So, I would summarize my reaction as follows:
When a skeptic advises, "follow the money,"
He isn't merely being funny.
Market advice is never free,
Somebody pays for that, you see.
So, if it's the market you are playing,
Always find out just who is paying.
State Budgets and Municipal Bond Ratings: There is a lot of current news about state budgets, which are under pressure, and the threat of rating agencies lowering current bond ratings in some states. We are watching all of this closely, but have yet to get seriously concerned about the situation. Budget problems always seem to engender political fights and that, in turn, gets the problem a lot more media attention than it would normally get.
The facts on Tennessee are that Moody's changed the rating last year from AA1 to AA2, such a small reduction that the market for the bonds changed imperceptibly, if at all. AA2 is still a very high rating.
Now Kentucky is having a budget fight as well, and so are North Carolina and Alabama. All will be watched by the rating agencies. We don't expect rating changes in any of them which are any more severe than the small change in Tennessee, indeed if that. But finally, we have very little exposure to state general obligation bonds in any of our single state funds.
In addition, most states have various state agencies and authorities that are directly or indirectly supported by state appropriations. Again, we see little risk that these budget problems could affect appropriations which have moral and sometimes legal precedence over many other state appropriations. No politician can survive letting one of these bond issues default.
All in all, the risk of downgrades and subsequent down-pricing is minimal. I would guess the risk to our funds might be measured in two or three pennies per share of price, at most, and virtually no risk of default at all.
Finally, when the politics of reducing budgets finally gets all worked out, I think you will see these bonds return to their previous ratings in a short time.
Time to add one more Trustee: Our total assets have now grown to exceed $725 million and our Trustees voted at the last meeting to start the process of adding one more independent Trustee. The SEC wants a majority of public trustees over inside trustees (meaning trustees who work for or are related to the fund manager). Since, for estate purposes I may want to add a family member as an inside trustee at some future point in time, it makes sense to get another independent trustee in place and well trained now. The four existing public Trustees are in the process of choosing this nominee.
Stock Market Blues: The stock market has performed poorly for long enough that, for the first time in years we are seeing people simply losing interest and turn to other forms of investment. This reminds me of a public relations jingle we used years ago, long before tax-exempt funds were permissible. It is even more appropriate today. "Don't lose interest, see Dupree!"
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