Sie sind auf Seite 1von 14

Matterhorn Capital Management Investor Update 3Q2011

Economic and Market Outlook The debt crises on both sides of the Atlantic, but particularly in Europe will steer the direction markets take for the remainder of this year. P2

Market Review A lack of European leadership to stem the sovereign debt predicament was front and center of market concerns for most of last quarter. P3

Portfolio Review Our strategy to dampen downturns and participate in upturns performed as designed with our global composite declining 4.6% for the year versus a 12.2% decline for its benchmark. P4

Europe in Crisis We explain the importance of the European crisis to the global financial markets, and how we are responding to these unprecedented events. P4

Fixed Income Strategy Our credit concerns have diminished; we expect interest rates to stay at current levels or trend even lower. P10

P2 3Q2011


Matterhorn Capital Management

Economic and Market Outlook

The debt crises on both sides of the Atlantic, but particularly in Europe, will steer the direction markets take for the remainder of this year. The crises impact sentiment and economic growth, the two levers that drive equity markets. Since the crisis in Europe is so influential, we devote all of our theme section to it to inform clients and derive a tactical investment plan from our understanding of it. In our Europe in Crisis theme section, we conclude that the economic crisis is likely to get worse before it gets better, exacerbated by a string of inadequate, short-term solutions aimed at buying time until a more permanent solution to Europe's structural issues can be agreed upon. Time is running out and we believe Greece will ultimately default on its debt obligations. In the interim, lack of confidence is weighing down the economy, while austerity measures do not lessen the short-term impact on growth. The lack of confidence is founded in the fear that the Euro sovereign debt crisis morphs into a banking crisis, pushing the Euro area into recession. While the probability of that occurring has certainly increased over the past few weeks, the probability of a sustained global credit contraction (and resulting market meltdown) like we experienced in 2008 is low for three reasons: first, the Euro crisis has been well telegraphed, with the total debt and derivative exposure well known (i.e., increased transparency). This has given not only European financial institutions, but U.S. and Asian banks, time to limit their exposure to the troubled countries within the Euro region; second, the U.S. banking sector is better capitalized than in 2008, which should help limit the contagion effects from weakened Euro banks; and third, the European Central Bank has the power to limit the severity and duration of the current crisis by providing a much-needed backstop for troubled Euro banks, as well as serving as a buyer of last resort for government bonds. We forecast an inevitable snap-back in confidence and market sentiment when a clear European plan is resolved. The parallel snap-back in market appreciation will overwhelm any negative influence that possible declining earnings growth may have on markets. In our opinion, the influence of sentiment is larger than the influence of company earnings on market appreciation. Therefore, although the cyclically adjusted market valuation is above the long-term mean (Exhibit 1), we anticipate that a rising valuation will overwhelm downward earnings revisions as financial risk containment is achieved in Europe and long-term sovereign debt reduction plans become clearer in the developed world. We have responded to the unfolding crisis by decreasing our exposure to All-Cap Equity Composite Performance (Net of Fees) As of 9/30/11
QTD MCM Global Core2 Core Equity Blend Index3 MCM International MSCI World ex U.S. Index S&P 500 Index (11.34) YTD (4.55) Ann ITD1 4.90 2.54 3.38 (1.56) 1.67

(16.79) (12.20) (12.37) (7.96)

(19.85) (16.80) (13.86) (8.67)

1 2

Inception date 4/14/05 for Global Core and 9/30/2006 for International. Returns are annualized. Composite contains U.S. Growth, U.S. Value, International and Global Core accounts. 3 Blended index consists of two-thirds Russell 3000 Index and one-third MSCI World ex U.S. Indices.

economically sensitive sectors as stocks have moved down through the 20% from high watermark levels (a key sell discipline for us). Taking risk off the table and increasing our cash levels gives the remaining portfolio a decidedly defensive posture. We currently do not own any stocks in the affected countries,
(continued next page)

Exhibit 1: Cyclically Adjusted Long-Term Valuation of U.S. Equity Markets

50 45 40

Price-Earnings Ratio

35 30 25 20

Long-Term Average=16
15 10 5

P/E = 19

Source: Robert J. Shiller, Yale University 0 1960 1970 1980 1990 2000 2010 2020

Matterhorn Capital Management


3Q2011 PG 3

Economic and Market Outlook (continued from 2) nor do we own any European banks in the portfolio. The portfolio is geared to outperform in the current, volatile market environment, by protecting to the downside and participating on the upside when those swings do occur. We contain the upside risk by remaining at least two thirds invested since timing the return of market confidence is most difficult to predict. As in 2009, we will follow a disciplined approach to redeploying capital into quality companies, once we feel the macroeconomic issues have been adequately addressed in Europe, as well as in the U.S. For the time being, we will continue to monitor the situation and make any necessary changes to the portfolio should the macroeconomic conditions worsen.

We forecast an inevitable snap-back in confidence and market sentiment when a clear European plan is resolved.

Market Review
In the third quarter, we experienced one of the most challenging quarters in our firms history, a period that required vigilant monitoring of global events and nimble portfolio action. After an extremely volatile quarter that resembled the financial crisis of 2008, our global equity benchmark index1 declined 11.3%, while our blended bond index2 reflected the flight-to-safety, increasing 2.4%. Exhibit 2 reflects the flight-to-safety and, interestingly, indicates that the bond market signaled the downturn earlier in the year. At the start of the quarter, U.S. congressional debt and deficit debates pushed market fears to the limit before the legislature once more postponed conclusively addressing the problem. Although the process was poorly received, markets eventually discounted the idea that the nation has until 2014 to distill a tactical plan. Even a downgrading of U.S. sovereign credit by Standard & Poor's had a muted impact on short-term market action during July. Waiting in the wings however, was the familiar and more urgent European debt crisis. A symmetrical lack of leadership in Europe to stem the sovereign debt predicament was front and center of market concerns for most of the quarter. It became increasingly clear that Europe does not have years to muddle through political wrangling to find a solution. In August and then amplified in September, markets reflected the uncertainty caused by the lack of coordinated intervention, sending equities plummeting and European credit spreads soaring. A lack of confidence in an economic zone that constitutes almost half of global GDP (U.S. and Europe) had a measurable impact on economic growth expectations and caused economists to raise the probability of another recession in Europe and consider the possibility of a recession in the U.S. Unfortunately, reduced growth expectations and inflation fears in developing markets caused these recent pillars of optimism to appear less stable during a time that they were most needed.

Exhibit 2 - Bond Market Signals Equity Downturn

1,400 1,300 1,200 1,100 1,000 900 800 700 600 500 400 Mar-09
S&P 500 Index Barclays Aggregate Bond Index / Barclays 7-10 Year Treasury Bond Index

3Q 2011











1 2

Blended index consists of two-thirds Russell 3000 Index and one-third MSCI AC World ex U.S. Index Blended index consists of half Barclays 1-10 Year Municipal Bond Index and half Barclays Intermediate Gov't Credit Index

P4 3Q2011


Matterhorn Capital Management

Portfolio Review
Our equity composites recorded losses during the ruthless volatility last quarter, but performed as they were designed to perform by protecting the downside and participating in the upside. In this manner our clients built a significant lead through active management on investors that were boldly exposed to index returns in passive investment vehicles such as ETFs and indexed mutual funds. As an illustration, we limited the decline in our global core portfolios3 for the quarter to 11.3% versus a benchmark index4 decline of 16.8%. Similarly, the same composite of client portfolios is down 4.6% for the year (January to September) versus an index decline of 12.2%. While writing our last quarterly letter, we were optimistically anticipating a strong investment market for the second half of the year. As happens sometimes in the dynamic world in which we operate, we realized soon after publication that we were wrong and swiftly adjusted our outlook and portfolio positioning. We communicated the change to clients in a letter on August 4, explaining that the contentious U.S. political debate surrounding the federal debt and deficit had created a prolonged and increased period of uncertainty. Our tactical response to the increased vagueness in leadership was to immediately position the already conservative equity portfolio even more defensively by selling five stocks and purchasing one. Small changes at the margin to reduce our exposure to economically sensitive industries made a significant impact on the portfolio and dampened losses in the unexpectedly severe downturn. As usually happens in periods of crisis, losses were widespread across asset classes, investment styles, economic sectors, geographies and company sizes. Our heightened exposure to cash in equity portfolios contributed a large portion of the outperformance, but stock selection, country exposure allocation and currency exposure assisted equally in protecting from outsized losses. For the quarter, U.S. Utilities was the only sector that showed positive returns in the market and in our client portfolios, driven by Duke Energy (DUK) and Public Service Enterprise (PEG). Traditionally defensive sectors such as Consumer Staples and Healthcare also dampened declines, while our portfolio names in Consumer Discretionary and Telecommunications stocks performed better than indices.
3 3

Matterhorn Global All-Cap Core Equity Composite Blended index consists of two-thirds Russell 3000 Index and one-third MSCI AC World ex U.S. Index

Europe in Crisis
Current Situation Time is running out. The set of policy choices that are both economically viable and politically feasible is shrinking as the crisis shifts into a new, more political phase. ~IMF Global Financial Stability Report Given the fluid nature of the unfolding European financial crisis, it is nearly impossible to predict with any certainty what is likely to happen next week, let alone next quarter. That said, given the importance of these issues to the global financial markets, we felt it necessary to explain what is going on in Europe and how we are responding to these unprecedented events. We begin our discussion with an overview of the current debt situation, providing some context where needed. We then discuss what issues need to be addressed, as well as the different options available to address those issues, including some of the impediments to those proposed solutions. We conclude our discussion with an examination of what we believe to be the most likely outcome and what that means for your portfolio. One caveat before we proceed the data and conclusions presented below are reflective of the information available to us at the time of the writing of this letter (early October). By drowning out the media-amplified noise and focusing on a few key issues, we aim to provide some insight and, in the process, communicate our strategic thinking as it relates to the crisis and, more importantly, to your portfolio.
(continued next page)

Matterhorn Capital Management


3Q2011 PG 5

Europe in Crisis (continued from 4) this year agreed to provide Greece with 109 billion to help it meet its short-term debt obligations. However, the disbursement of those funds is tied to Greece meeting certain budget deficit targets, none of which have been met.6 The greater fear is that the 109 billion is insufficient to handle Greeces increasingly perilous fiscal dilemma and that the political impediments to providing additional bail out funds are such that Greece will ultimately be forced to default on its obligations. Depending on how it is handled, a Greek default can be potentially dangerous for several reasons. First, it could spur additional sovereign debt defaults, most likely in Portugal and Ireland (two countries already receiving bail out funds), but also in Italy and Spain, particularly if interest rates spike up in those countries on fears of default, making them effectively insolvent (i.e., fear of default becoming a self-fulfilling prophecy). Second, a default could lead to a banking crisis as many European banks would have to write down the value of their Greek debt to levels that would make the banks themselves insolvent (highlighted in Exhibit 3 below). While much attention has been focused on Dexia, it is clear that sovereign debt exposure is fairly widespread throughout the European banking system. What is particularly troublesome is that Europe's interlocking sovereign debt and banking crises are starting to feed into one another, in what market analysts refer to as a negative feedback loop. Worries that the Greek government will default on its debts is triggering concern that the region's other weak economies may also default. This in turn increases the risk
(continued next page)

Greeces increasingly perilous fiscal dilemma and that the political impediments to providing additional bail out funds are such that Greece will ultimately be forced to default on its obligations.

While Greece is at the heart of the current crisis, the fear is that these debt issues will quickly spiral out of control, spreading to other high debt/weak economy countries in Europe, notably Portugal and Ireland. There is also a risk, if left unchecked, that this contagion could spread to larger, more stable countries, like Italy and Spain. The financial markets are justifiably skeptical of European politicians, who up to this point have done just enough to stave off catastrophe without dealing with the underlying problem too much debt and not enough economic growth to deal with the debt burden. The most pressing concern is Greece, a country mired in recession and grappling with severe (structural) budget deficit issues. These issues are in turn complicating Greek efforts to receive much needed bail out funds from the troika, a group of European and international institutions5 that earlier

Exhibit 3: European Bank Exposure to Troubled Debt (

Bank Credit Agricole Dexia RBS Danske Bank Santander Lloyds BG Barclays Intesa SPI Societe General BNP Paribas Sovereign Periphery Exposure (SPIE) 3,261 6,713 3,533 89 5,173 169 1,838 794 5,093 8,090 Periphery Loan Exposure (PLE) 31,825 3,894 73,857 11,086 33,342 31,451 20,728 9,362 4,830 3,500 Periphery Total (PT) 35,086 10,607 77,390 11,175 38,515 31,620 22,566 10,156 9,923 11,590 TNAV* 28,612 8,905 68,752 12,103 51,530 52,223 53,781 29,866 34,149 59,675

PT/TNAV 123% 119% 113% 92% 75% 61% 42% 34% 29% 19% Domicile France Belgium UK Denmark Spain UK UK Italy France France

SPIE/TNAV 11% 75% 5% 1% 10% 0% 3% 3% 15% 14%

*Tangible Net Asset Value 2011 (TNAV): seen as the true loss absorbing part of the capital base; strips out goodwill.

Source: CEBS Morgan Stanley Research

5 6

Includes the European Commission (EC), the European Central Bank (ECB), and the International Monetary Fund (IMF). At the time of this writing, the troika is currently withholding a much-needed 8 billion disbursement, which Greece needs to make it through the end of the year.

P6 3Q2011


Matterhorn Capital Management

Europe in Crisis (continued from 5) that the region's banks, many of which hold these sovereign bonds, will need to be rescued/recapitalized by their governments, many of which are already struggling with heavy debt burdens themselves. Issues to be Addressed Over the short term, the risk of contagion will ultimately depend on the ability of European leaders to ring-fence Greece. In order for any grand bargain response to be perceived as effective, it must address all of the following issues in some form: 1. Restructuring of Greek Debt. On July 21, an agreement was struck among European leaders for a private sector involvement (PSI) scheme in which bondholders would exchange their short-term (3-year) bonds for long-dated bonds (10-year), effectively taking a 21% loss on the value of their bonds. With Greek bonds trading at 40 cents on the dollar on the open market, a more realistic PSI haircut would be 50%, given the deteriorating Greek fiscal situation. While this would help ameliorate the Greek funding crisis, it would mean instant insolvency for certain European banks. 2. Recapitalization of Euro Banks. Euro leaders need to make available substantial amounts of capital with which to bolster bank equity to reassure markets that a Greek or Portuguese default would not precipitate a systemic financial crisis. Any recapitalization plan should go much further than the 2.5 billion required by regulators after the Euro bank stress tests in July. JP Morgan estimates that banks will need 75 to 100 billion, while the IMF estimates banks will need 200 billion, with a further 100 billion at risk from interbank exposures. In response to increased pressure on Euro banks, the European Central Bank (ECB) is expected to increase the emergency credit available to banks in need of financing.7 3. Enlargement of EFSF. At that same meeting in July, Euro leaders agreed to increase the capacity of the European Financial Stability Facility (EFSF) to 440 billion, 140 billion of which has already been committed to the bailouts of Portugal, Ireland and Greece. In addition, the facility was granted rescue fund powers to recapitalize banks, as well as the ability to buy sovereign debt. Given the new functions/ responsibilities being levied on this facility, its fund would need to be enlarged to 1 to 2 trillion to be able to adequately handle any contagion spreading from the periphery countries to Italy and Spain. Building an effective firewall around these two countries is vital to containing the contagion within Europe. European leaders aim to have a plan in place by the next G20 summit in Cannes in early November, though it is unclear
7 8

Euro leaders need to make available substantial amounts of capital with which to bolster bank equity to reassure markets that a Greek or Portuguese default would not precipitate a systemic financial crisis.

whether Greece can hold out until then. Longer term, European leaders will need a credible plan to deal with the massive debt overhang and restore growth to the region, if the Euro is to survive. That will most likely include tighter economic, fiscal and political integration among Euro countries, which is dubious at this juncture. Possible Solutions Leverage the EFSF. The only way to increase the capacity of the facility to the required 2 trillion level to cover Italy and Spain without having to get approval from 17 different national parliaments is to either turn the EFSF into a bank or link it to the ECB. Turn EFSF into a Credit Institution. Turning the facility into a bank opens it up to outside sources of capital through the issuance of bonds or through direct loans with outside credit institutions. EFSF/ECB Combination. Link the EFSF to the ECB by allowing the EFSF to borrow money from the ECB's unlimited lending operations, which it could use to inject money into troubled government bonds or banks. Under the Geithner version8 of this plan, the facility would assume an equity stake of 20% in holdings of Euro debt (i.e., take the first 20% of losses), supported by loans of 80% from the ECB. Impediment: The ECB is fighting against pressure to use the bank to supercharge the EFSF. Klaus Regling, chief executive of the EFSF, recently said, there are serious concerns that such a scheme wouldnt be allowed under the EU Treaty, which forbids the ECB from financing governments directly. In fact, the ECBs controversial bondbuying program has already caused German conservatives to decry its actions as undermining German independence by straying into fiscal policy. (continued next page)

The last time it was forced to do so was in 2008 in the aftermath of the Lehman collapse. Proposed by U.S. Treasury Secretary Timothy Geithner at the last G20 meeting to his European counterparts; plan based loosely on the U.S.'s TALF program in 2008.

Matterhorn Capital Management


3Q2011 PG 7

Europe in Crisis (continued from 6) Move up Euro Stabilization Mechanism. One plan is to move up the start date for the ESM to 2012 from 2013 as a permanent replacement for the EFSF. The ESM will ensure that countries with difficulties borrowing in the markets will have rapid access to loans in conjunction with adjustment programs until they are able to roll over their debts. Impediment: Euro leaders are still hammering out the details of the ESM and any acceleration in implementation would likely require approval by all 17 national parliaments. The funding of the ESM would most likely mirror the contributions to the EFSF, which are already problematic. Issuance of Euro Bonds. The issuance of a Euro Bond, backed by all of the Euro nations, has been hailed as a possible solution to the funding crisis. Another version of this plan calls for the separation of insolvent banks from solvent institutions in order to prevent the zombie banks from infecting the financial system, similar to what the U.S. was able to accomplish with its Resolution Trust Corporation to deal with the losses from the S&L crisis in the 80s. Impediment: Higher contributions would strain the public finances for several European countries. As highlighted in Exhibit 4 below, any future contributions would be made pro-rata, which given the inability of Greece, Portugal, Ireland, and perhaps Italy and Spain to contribute, would mean an increased load for Germany and France, which is in danger of losing its AAA rating if forced to commit additional funds, according to Standard and Poor's. Bank Recapitalization Funds. Germany has proposed a system of backstops, requiring bank shareholders to put up more equity first, then national governments and, finally, the EFSF rescue fund as a last-ditch lender if national governments do not have the means. In Germany, there is talk of reopening the Soffin bank rescue fund, founded in 2008 with a total of 480 billion in federal guarantees and cash available for bank recapitalization. Impediment: Few countries would be able to backstop their banks alone, without help from the EFSF. Germany would shoulder most of the liability here and it is not clear German voters are willing to bail out non-German banks. Delay Default. Postponing a default gives the French and German financial institutions time to build up their capital, reduce their exposure to Greek banks by not renewing credit when loans come due, and sell Greek bonds to the Europea Central Bank. Impediment: Buying time requires additional bail out funds, since Greece is highly dependent on these funds. Not politically feasible in Germany. Most Likely Outcome Perhaps what is most striking when examining the possible short-term solutions is that the largest impediments are oftentimes not economic, but social. As the quote below attests, this is the first true stress test of the Euro experiment. "In the end, Germans are Germans and Greeks are Greeks. Germany and Greece are different countries in different places with different value systems and interests. The idea of sacrificing for the European Union is a meaningless concept. The EU has no moral claim on Europe beyond promising prosperity and offering a path to avoid conflict. When prosperity stops, a large part of the justification evaporates and the aversion to conflict begins to dissolve." ~ George Friedman, Stratfor, The Crisis Europe and European Nationalism, September 13, 2011. Trying to predict which plans are politically feasible is easier said than done because decisions will be based on social and political factors in addition to economic and fiscal factors. That said, as we have seen in recent economic history, crisis affords politicians the opportunity to enact policies that may not be politically expedient in non-crisis times. This crisis may well give politicians the cover to move toward a unified Europe that is more economically, politically and fiscally integrated. Whether Greece, Portugal and Ireland will be part of that stronger union remains to be seen, but it is clear neither the
Source: EFSF, Thomson Reuters Datastream
(continued next page)

Exhibit 4: EFSF Contributions

PG 8 3Q2011


Matterhorn Capital Management

Europe in Crisis (continued from 7) Germans nor the French have any incentive to kick these countries out of the Euro, at least while their banks are exposed to Greek and Portuguese debt. The timing, duration and ultimate secondary effects of a Greek default are difficult to quantify given all of the considerations listed above. In our opinion, the most likely outcome is that Greece defaults and some combination of the EFSF/ECB steps in to provide temporary relief to Euro area banks to contain the damage. Given the U.S. bank exposure to European banks, it would not be surprising to see the U.S. Treasury or Fed play a role in building a firewall around Italy and Greece, similar to the coordinated central bank moves after the Lehman collapse in 2008. Whether this coordinated action is successful will determine both the severity and duration of any resulting crisis. Our Response We have responded to the unfolding crisis by decreasing our exposure to the economically sensitive sectors in the portfolio. This not only takes some risk off the table, but increases our cash levels (more than 25% cash in the global core portfolio), giving the remaining portfolio a decidedly defensive posture. In addition, we don't currently own any stocks in the affected countries, nor do we own any European banks in the portfolio. The portfolio is geared to outperform in the current, volatile market environment by protecting to the downside and participating on the upside when those swings occur. We have plenty of cash and, as in 2009, will follow a disciplined approach to redeploying that capital into quality companies once we feel the macroeconomic issues have been adequately addressed in Europe as well as in the U.S.

U.S. Growth Portfolio Transactions

Portfolio Sales American Science & Engineering, Inc. (ASEI) Small-Cap, Industrials As part of our investment process, once a stock is added to the portfolio, we monitor short-term revenue and profit margin trends closely, as they oftentimes act as early warning systems for future revenue/earnings misses. In the case of ASEI, the company's increasing inability to control the timing of preparatory work done at large project sites has led to numerous delays and project cost overruns in recent months, exacerbating the volatility in quarter-to-quarter revenue trends. In our view, the expectations for continued project/order delays, as well as an unexplained spike in recent insider selling (CEO sold 60% of his stake over the past 12 months) and decreased demand from the company's high growth Middle East division, all pointed to potential earnings misses in upcoming quarters. Although ASEI remains an attractive acquisition candidate, an over reliance on site preparatory work done by outside third parties (resulting in ongoing delays), has made us increasingly uncomfortable with the company's ability to meet its consensus earnings target for the year. With the risk of an earnings miss and a corresponding valuation contraction increasing, we decided to sell out of the stock. Cliffs Natural Resources Inc. (CLF) Mid-Cap, Basic Materials A drop in spot iron ore prices in China, coupled with short-term operational shutdowns in the company's Oak Grove (severe weather) and Pinnacle (high carbon monoxide levels) mines combined to drive the stock lower before our sale. Despite the short-term weakness, our long- term thesis (transformation from a North American iron ore player to a global iron ore and metalurgical coal play) remained intact. That said, our decision to sell out of the stock was driven more by short-term portfolio risk considerations than by any long-term, company-specific issues. In light of the tenuous global macroeconomic environment, we felt it was prudent to decrease our exposure to commodity-linked stocks in the portfolio, including Cliffs Natural (iron ore) and Peabody (coal), given their heightened (price) sensitivity to changing economic conditions and negative market sentiment. We will continue to monitor the stock and may re-establish a position in the future, assuming some of the macroeconomic issues have been properly addressed and the fundamental thesis remains intact. Flir Systems, Inc. (FLIR) Mid-Cap, Industrials This maker of infrared cameras and surveillance equipment was hit hard by the unwinding of the Defense Department's BETSS-C program in 20102011. The company's fast growing commercial vision systems division, was ultimately unable to make up for the loss of this particular contract, reversing what had been a stellar, industry-leading, longterm revenue and earnings growth track
(continued next page)

In light of the tenuous global macroeconomic environment, we felt it was prudent to decrease our exposure to commodity-linked stocks in the portfolio.

Matterhorn Capital Management


3Q2011 PG 9

U.S. Growth Portfolio Transactions (continued from 8) record. With a slowing revenue base, an unjustified premium valuation, and relatively high exposure (57% of revenue) to defense spending, we could no longer justify holding on to the stock. Peabody Energy Corp. (BTU) Mid-Cap, Basic Materials The bullish case for coal remains, and owning BTU, the largest private sector coal company with operations in the U.S. and Australia, is still the best way to play long-term domestic and Chinese/Indian demand for metalurgical and thermal coal. However, the industry has been beset by negative announcements from some of BTU's largest competitors, warning of decreased demand for coal and decreased pricing over the short-term. As with Cliffs Natural, our decision to sell out of the stock was driven by short-term portfolio risk considerations, and not by a change to our longer term thesis (increased Asian demand). We will continue to monitor the situation and may re-establish a position in the name assuming the macro economic environment improves and we are able to do so at a compelling valuation.

U.S. Value Portfolio Transactions

Portfolio Sales Amedysis Inc. (AMED) Small-Cap, Healthcare We sold our position in Amedysis inc. (AMED) after the company reported earnings on August 2, missing estimates by $0.01, but reducing 2011 guidance by 27%. Although the motivation to own this stock remained in place (growing industry, consolidator in a fragmented market place and reduced investigative overhang), regulatory and reimbursement risks materialized and overwhelmed the investment thesis, particularly in the light of our changed economic and market outlook. Three specific risks impacted our investment thesis: 1) regulation requiring face-to-face time with a physician before a treatment regimen could be initiated created a bottleneck, and 2) the Centers for Medicare and Medicaid Services (CMS) announced on August 1 that it would reduce nursing home reimbursements by 11% in the next fiscal year. Although this reduction did not affect AMED directly, it foreshadowed the result of the ongoing home healthcare compensation regimen review at CMS and 3) although homecare has proven to be more cost effective than facility-care, profitability of private companies in this area presents an attractive industry to target for government budget cuts.

International Portfolio Transactions

Portfolio Purchases America Movil, S.A.B. de C.V. (AMX) Large-Cap, Telecommunications, Mexico America Movil is the largest wireless company in Latin America with operations in 16 countries and a wireless subscriber base of 236 million, 28.9 million land line customers, 14.0 million fixed broadband subscribers and 11.6 million PayTV units across the region. America Movil generates 45% of sales in Mexico, where it is the dominant provider with a 70% market share in mobile and 90% share in fixed. The company's extensive scale and distribution network have helped it lower its operating costs significantly, both through the avoidance of high interconnection costs (they own the network), as well as through lower negotiated prices on equipment. As a result, Telcel (the company's Mexican subsidiary) remains one of the most profitable wireless operators in the world, the proceeds of which are used to fund the company's investments and expansion into high growth markets in the region. In terms of future plans for growth, the company expects its subscriber base to increase by one-third to 300 million by the end of 2014, driven by massive investments in network upgrades (3G and 4G LTE), as well as by expansion of its prepaid usage model and increased consumer adoption of new (data intensive) devices like tablets and netbooks. Low wireless penetration rates throughout Latin America, as well as expansion of spectrum licenses in Mexico should provide additional opportunities for growth over the medium term. Autoliv, Inc. (ALV) Mid-Cap, Industrials, Sweden Autoliv AB is a Swedish supplier of automotive safety systems, including airbags (65% of sales) and seatbelts (33%), as well as other safety products (2%), including safety electronics, infrared night vision systems, steering wheels, antiwhiplash systems, seat components and child seats. Autoliv generates 35% of its sales in Europe, 30% from North America and 10% from emerging markets. We view
(continued next page)

America Movil is the largest wireless company in Latin America. Its extensive scale and distribution network have helped it lower its operating costs significantly, both through the avoidance of high interconnection costs, as well as through lower negotiated prices on equipment.

PG 10 3Q2011


Matterhorn Capital Management

International Portfolio Transactions (continued from 9) Autoliv as a play on the growth in auto safety, driven primarily by consumer demand (as disposable incomes increase, consumers demand more safety products in their vehicles) and government regulations (new safety requirements and state/federal consumer laws). Innovations drive revenue growth and pricing in the industry, which is why Autoliv allocates an industry-leading 6% of sales to R&D. The company holds over 7% of all automotive safety patents worldwide, having pioneered seatbelt technology in 1956 and introduced the first commercially viable airbag system in 1980. Today, it holds a commanding 40% market share in side Portfolio Sales Aixtron SE (AIXG) Small-Cap, Information Technology, Germany The stock of this German manufacturer of MOCVD (Metal Organic Chemical Vapor Deposition) machines used to make LED lights tends to be quite volatile, with shortterm trading dictated by ever-changing LED headlines. Since the beginning of the year, these stocks have come under selling pressure due to rumors that the Chinese government was planning to cut subsidies for MOCVD machines purchased by Chinese LED manufacturers. While a formal announcement was never made, a report put out by VantagePoint Capital Partners, a respected industry investor, forecast LED prices to fall 90% by 2015 impact airbags, the fastest growing segment in the auto safety market. Given the concentrated nature of the company's customer base (its top ten customers generate 74% of revenue), cost pressures are ever present. Management has responded to these pressures by moving a significant amount of their research and production to lowcost labor markets. Roughly 62% of their workforce is now in low-cost countries, up from 29% in 2002. This lean cost structure has enabled the company to generate industry-leading profit margins (22% gross margins versus 16% industry) and sent LED related shares lower. Given our desire to lower the risk profile of the portfolio in the current market environment, we used this as an opportunity to sell out of AIXG. Barclays Plc (BCS) Large-Cap, Financials, UK Barclays Plc (BCS) vacillated around 20% down from its high watermark since first reaching that level in September 2009. Through numerous reviews of the investment thesis, we resisted selling the stock because the weakness was not predominantly a company-specific problem, and the stock provided some exposure to the large financial sector. Early in the third quarter we decided to sell the stock when, to us, the market

Autoliv is a worldwide leader in automotive safety, a pioneer in both seatbelts and airbags, and a technology leader with the widest product offering for automotive safety.

and strong free cash flow (expected to average $700 million or $7 per share/9% yield) over the next five years. reached a tipping point in the European debt crisis. Our fears were that BCS would be dragged down even if it had no direct debt exposure to defaulting sovereign bonds. Risk management disclosures in BCS' 2010 annual report indicated that it had little exposure to direct investments in Greece, Portugal, Ireland or Spain; however, the possibility of BCS having issued opaque CDS or other credit derivatives on at-risk European debt could not be counted out. Also, proposed regulatory changes required BCS to impede an increasing amount of its capital, decreasing profitability and making the bank more and more reliant on its debt-focused capital markets group. In combination, we could not justify these risks.

Fixed Income Strategy

Our fixed income investment process emphasizes credit quality. We use three filters to sift through the municipal bond universe to find appropriate, conservative bonds for our portfolios. First, we filter geographically to eliminate states and regions with weaker economies and budget challenges. Second, we filter across types of issuances and narrow our focus to general obligation bonds and essential service revenue bonds. We prefer obligations of states, counties, cities, school districts, and universities, while eliminating hospital, nursing home, MUD districts, pension obligations, stadium, convention center, tobacco settlements, and special district bonds. Third, our credit focus is on the underlying issuer rating, with only a secondary emphasis on any credit enhancement via bond insurance. Currently, our three-stage filtering leads us to Texas, one of the better state economies in the country. As far as issuance type, we look for university revenue bonds, water and sewer revenue bonds, and general obligation bonds with a specific focus on school district bonds guaranteed by the Permanent School Fund
(continued next page)

Matterhorn Capital Management


3Q2011 PG 11

Fixed Income Strategy (continued from 10) of Texas. Lastly, our credit strategy is for 75% of the portfolio to have bonds with an underlying credit rating of AA or better by one of the credit rating agencies, and no more than 25% of the portfolio having bonds rated A or better by at least one agency. In our view, the credit and default concerns that we have expressed during the past several years has diminished dramatically. Last quarter, we discussed the bond market valuation concerns amid a strong rally in prices during the first half of 2011. Our concerns proved unfounded as the bond market rallied even further. Longer dated Treasuries rallied 100 to 125 basis points during 3Q2011, and municipal bonds saw yields fall from 25 to 75 basis points across the curve. With the European sovereign debt situation unfolding and the lackluster U.S. economy, we now predict interest rates to either stay at current record low levels or gradually trend downward to even lower levels. The only factor on the horizon that could potentially cause municipal bonds to increase in rates would be the unlikely approval of proposed legislation in the current jobs bill that calls for a reduction in the tax exemption treatment of municipal bonds. Our municipal focus will remain on general obligation with increased use of essential service revenue bonds. Our geographic focus will be almost exclusively Texas with an underlying credit quality of AA and AAA for the majority of the portfolio. As we discussed last quarter, a shift in our strategy has emerged as we continued to see municipalities' budget situations improve and have become less concerned about defaults and credit downgrades going forward. We now will look to incorporate a portion of the portfolio in uninsured single A-rated bonds within appropriate concentration constraints. We continue to regard municipal bond insurance as a secondary credit support and do not rely on it in the same manner as the bond issuer's credit ratings. Our strategy remains market neutral on duration. Portfolio Review Matterhorn's municipal bond composite continues to show a strong tax-free yield on cost basis of 3.38%, down only 4 basis points from the previous quarter despite the rapid decline in rates. Matterhorn's muni composite had a tax-free yield to worst (YTW) basis of 1.56% compared to the composite's tax free YTW of 1.86%. Using a marginal tax rate of 35%, these

With the European sovereign debt situation unfolding and the lackluster U.S. economy, we now predict interest rates to either stay at current record low levels or gradually trend downward to even lower levels.

yields are 5.20% and 2.4% for Matterhorn respectively, and 2.86% for the composite. The portfolio's duration to worst calculation is 3.59, which is lower than the benchmark's 3.94. While the yield on cost level is higher than the benchmark's yield to worst calculation, the municipal bond composite slightly underperformed its benchmark on a total return basis for the quarter. The composite had a strong positive total return of 1.79% compared to 2.38% for the Barclays 1-10 year Municipal Bond Index. As we have demonstrated in previous quarters, yield is our primary focus with a market neutral maturity structure. We believe this strategy produces more income to our clients rather than a total return focus.

Compliance Corner
Clients are advised to notify their MCM representative of any changes to their financial status, including changes in income needs, account restrictions and/or risk tolerance. Clients are reminded to review their custodial statements with those received from Matterhorn Capital Management, LLC. Please contact us if you do not receive a statement from your custodian. Please note that we are now offering to e-mail your statements and Investor Update. If you would like to receive these electronically, please contact Neala Moore at Disclosures As always, the latest copy of our firm's Privacy Policy and ADV Part II can be found on our Web site at If you have questions or concerns or would like a hard copy of the Privacy Policy or ADV Part II, please contact Neala Moore at (210) 694-4329 or Matterhorn Capital Management, LLC, 16410 Blanco Rd., Suite 2, San Antonio, TX 78232.

PG 12 3Q2011


Matterhorn Capital Management

Disclaimers (continued from 11) Disclaimers Matterhorn Capital Management, LLC is an independent investment management firm that invests client portfolios predominantly in U.S. traded equities and bonds creating either a large to small-capitalization equity portfolio in the growth, value or core investment styles or an investment grade domestic fixed income portfolio of taxable, tax-free or a blend of taxable and tax-free securities. Returns are calculated net of fees, including advisory fees, custody fees, brokerage commissions, and include reinvestment of all income. Returns are presented net of nonreclaimable withholding taxes. Past performance is not indicative of future results. There is a possibility of loss. Returns are calculated by Advent Axys and reflect the total account return, inclusive of securities, cash and accrued income. The portfolio characteristics shown relate to the investment strategy as indicated by the composite title. Not every client's account will have these exact characteristics. The actual characteristics with respect to any particular client account will vary based on a number of factors including but not limited to: 1) the size of the account; 2) investment restrictions applicable to the account, if any and 3) market exigencies at the time of investment. Net of fees performance returns are calculated by deducting the fee from the individual accounts. The annual management fee schedule for equities is as follows: 1% on first $0-$2MM; 0.90% on next $3MM; 0.80% on next $5MM; and 0.70% above $10MM. The annual management fee schedule for fixed income is as follows: 0.40% on first $0-$5MM; 0.35% on next $5MM; 0.30% above $10MM. Be advised that fees are negotiable and that clients receiving the same service may be paying different fees based upon various factors including but not limited to: account size, number of accounts, complexity, relationship and nature of the account (direct vs. sub-advised). This material is not financial advice and it should not be considered a recommendation to purchase or sell any particular security. There is no assurance that any securities discussed herein will remain in an account's portfolio at the time you receive this report or that securities sold have not been repurchased. The securities discussed may not represent an account's entire portfolio and in the aggregate may represent only a small percentage of an account's portfolio holdings. It should not be assumed that any of the securities transactions, holdings or sectors discussed were or will prove to be profitable, or that the investment recommendations or decisions that we make in the future will be profitable or will equal the investment performance of the securities discussed herein. MCM calculates performance by following the Global Investment Performance Presentation Standards (GIPS ). The listed composites contain all fee-paying accounts with an investment strategy as indicated by the composite title. These portfolios are managed in a tax-aware manner. Non-fee paying or non-discretionary portfolios are excluded from the composites but are included in the definition of total firm assets. Neither leverage nor derivatives are used in the composite portfolios. Performance results are expressed in U.S. dollars. Performance returns are considered PRELIMINARY numbers until verified according to GIPS for the reporting period. To receive a complete list and description of MCM composites and a presentation that adheres to the GIPS standards, contact Stefan Gr ter at (210) 694-4329 or write Matterhorn Capital Management, LLC, 16410 Blanco Road. Suite 2, San Antonio, TX 78323 or

Matterhorn Capital Management


3Q2011 PG 13

Value Portfolio
CONSUMER DISCRETIONARY Omnicom Group 4.1% 10,296

Growth Portfolio
CONSUMER DISCRETIONARY Nike Steve Madden Starbucks CONSUMER STAPLES Colgate Palmolive Herbalife 21.8% 39,931 22,370 1,288 27,822 13.3% 43,142 6,344 0.0%

International Portfolio


4.4% 97,963

CONSUMER STAPLES AmBev Coca Cola FEMSA Unilever ENERGY BG Group Canadian Oil Sands Royal Dutch Shell Sasol FINANCIALS Franklin Resources EZ Corp 9.0% 21,092 1,425 FINANCIALS Bank of Nova Scotia

13.8% 84,753 16,384 95,398 14.4% 64,679 9,346 198,035 26,110 4.0% 54,451

ENERGY ConocoPhillips

5.2% 86,940


FINANCIALS Aflac Arch Capital Group Cullen/Frost Bankers Discover Financial Services HEALTHCARE Becton Dickinson Eli Lilly Humana

19.7% 16,327 4,354 2,809 12,609 14.9% 15,943 42,800 12,134


5.3% 28,405

HEALTHCARE Fresenius Med Care Novartis Teva Pharmaceuticals

11.7% 20,380 153,123 35,008


4.7% 14,452




3.1% 39,536

INFORMATION TECHNOLOGY Accenture Micron Technology Microsoft

14.0% 40,537 5,060 208,535


21.2% 353,518 166,075 144,982 81,686 0.0%


4.8% 10,928




3.7% 36,990





8.1% 85,646 37,329

UTILITIES Duke Energy Public Service Enterprise CASH HOLDINGS

10.4% 26,623 16,882 22.6%



3.8% 10,657





Percentages = portfolio weightings per sector. Dollar amounts = market capitalization per compay in $ million.

PG 14 3Q2011


Matterhorn Capital Management

Equity Portfolio Performance

(Net of Fees)

Global All-Cap Core Equity Composite (as of 9/30/11)


Matterhorn Capital Global Core Core Equity Blend Index S&P 500 Index

(11.34) (16.79) (13.86)

(4.55) (12.20) (8.67)

3.30 (3.29) 1.15

4.66 1.23 1.22

3.09 (1.04) (1.18)

4.90 2.54 1.67

Inception to date (4/14/2005), 3- and 5-year returns annualized. Composite contains U.S. Growth, U.S. Value, International and Global Core accounts. Blended index consists of two-thirds Russell 3000 Index and one-third MSCI World ex U.S. indices.

International Equity Composite (as of 9/30/11)


Matterhorn Capital International MSCI World ex U.S. Index

Inception to date (9/30/2006), 3-year and 5-year returns annualized.

(12.37) (19.85)

(7.96) (16.80)

0.90 (10.81)

7.45 0.53

3.38 (1.56)

3.38 (1.56)

Fixed Income Portfolio Performance

Municipal Bond Composite (as of 9/30/11)

(Net of Fees)



Matterhorn Capital Municipal Bond Barclays 1-10 Year Municipal Bond

Inception to date (9/30/2006), 3-year and 5-year returns annualized.

1.79 2.38

4.56 5.69

2.72 3.66

5.38 6.37

4.15 5.15

4.14 5.14

Muni Bond Composite Portfolio Characteristics

As of 9/30/11 MCM Barclays 1-10 Muni Blend

Weighted Average Coupon Duration to Worst Yield to Worst TE Yield to Worst Yield on Cost TE Yield on Cost

4.65% 3.59 1.56% 2.40% 3.38% 5.20%

4.87% 3.94 1.86% 2.86% N/A N/A