January 6, 2012

Dear Investor,

Stocks ended 2011 about where they began but the journey was more like a roller coaster than a stroll through the park. The most notable feature of the market was also its most exasperating – volatility. More about that later. Excluding dividends, the Dow gained 5.5%, the S&P 500 was unchanged, the Nasdaq lost about 2% and the smaller cap Russell 2000 slumped 5.5%. Other markets around the world fared worse with many, including China, Japan, Germany and Brazil, losing more than 15% for the year. Here at FIM there were a handful of exceptions, but overall our portfolio returns were solidly in positive territory. I am quite proud of the results that our team was able to achieve in a very challenging environment.

When 2011 began there was a feeling of optimism in the air regarding the economy and the financial markets. Indeed, by springtime US markets sported gains of approximately 10%. Spirits turned sour when negotiations over the debt ceiling revealed how dysfunctional our government had become. The downgrade of the US credit rating didn't help. Interest rates in certain European countries rose sharply as it became painfully clear that they would likely not be able to service their debt. Many of the large European banks, financiers for much of the world beyond Europe, found themselves with too much of this sovereign European debt and therefore gaping holes in their balance sheets. As we enter 2012, there surely will be a contraction of credit, a continuation of austerity, and a moderate recession in much of Europe. European leaders are still struggling to prevent an even worse outcome which would have negative ramifications for economies around the globe.

It would be nice if our only problem was Europe. Unfortunately, that's not the case. Asian countries will likely see their growth rates slow as they attempt to suppress inflation. We also have serious problems in the US, though they are not as pressing. Our federal debt is large and deficits are out of control. However, as long as interest rates remain very low this is not an immediate concern as the debt can be refinanced cheaply. The US economy will probably continue to plod forward, albeit in only 1 st or 2 nd gear.

A brief comment is in order regarding the volatility permeating market action these days. I and many others think it's shameful that the authorities allow this to occur. Fast money trading firms using computers programmed with sophisticated algorithms make thousands of trades in a second to exploit small market anomalies or to front-run institutional trades. The result is exaggerated moves of large baskets of stocks, striking fear into the hearts of investors on big down days. This has driven many investors, particularly those in or near retirement, out of the stock market. And the markets have become less like the conduit for investment flow, which is their basic function, and more like a casino for the high frequency traders. Assuming these traders make money in a zero-sum market, whom do you suppose is suffering losses? Like it or not, we must learn to live with volatility.

So we enter 2012 with investors justifiably on edge. Governments are struggling with serious problems in Europe, Asia and the US. That said, it is companies in which we invest, not governments, and American companies are generally in excellent shape. They have become very efficient by upgrading technology, implementing leaner operating systems and reducing their dependence on our own weakened banking system. Well-managed companies continue to exploit opportunities for growth in technology, healthcare, aerospace, mobile computing, energy production, energy conservation and many other fields. This is where we focus our investments and this is where we have achieved success in the past.

Some predictions I made year ago seem as appropriate today as they were then –

* Washington will try to reduce the deficit while stimulating the economy. They won’t succeed at either, but the economy will find a way to grow nonetheless.

* Growth in China will moderate as they struggle to contain inflation.

* Despite the rapid growth of the US money supply, inflation will remain subdued due to relatively low factory utilization and an excess supply of labor.

* The cyclical component of unemployment will fall as the economy recovers, but the structural component, due to wider use of the internet, will be with us for some time.

* Most important to us, corporate earnings will continue to rise.

Back at the office, I’m happy to report that our team is continuing to perform at a very high level. One issue that we would like to improve upon however, concerns management fees. It has become very time consuming to determine a fair fee when there are multiple portfolios with varying objectives for a single family. We are therefore about to implement a more simplified management fee structure. Beginning at the end of January there will be a single fee rate dependent on portfolio objective and independent of the size of the account. Since a fee structure like this cannot be implemented fairly for all investors, we will, where necessary, apply an adjustment to each investor's fee calculation such that the net change from the old fee structure to the new one will be very close to neutral. It will make life much easier for us with little or no consequence for each of you. If you have any questions about this, please contact our office.

Looking ahead, I expect 2012 will be another challenging year for investing. Europe remains a powder keg. Though the most likely outcome is a moderate recession, there is a risk of a break-up of the Eurozone with unknowable consequences. Our own government seems incapable of addressing our nation’s debt and deficit problems. Austerity and deleveraging in Europe and the US continue to constrain economic growth. In addition, there is no reason to expect volatility to magically subside. So it looks like we are in for another bumpy ride, at least in the early part of the year.

On the positive side, corporate profits should continue to grow, though at a more modest pace than in 2011. Deficit problems in the US may be disconcerting but they are not critical. As the year progresses, we should expect better news out of Europe, clarity in the outcome of the US election (clarity is good whomever wins) and we will continue to chip away at the overhang of debt that has been hampering our economic progress. Most importantly, stocks are cheap by historical standards and interest rates are attractively low. So, despite near term risks, I think stocks will ultimately perform reasonably well. It is just the timing that is unclear. We continue to be optimistic for the long term and our target for the Dow remains 15,000 by 2015.

Wishing each of you all the best in the new year.

For the team at FIM,

Jeff Friedberg