Jones Villalta Opportunity Fund Semi-Annual Report Commentary
– April 30, 2009

This abbreviated period (just over four months) started on a good note, with the S&P 500® index moving 1.19% higher from December 23, 2008 (JVOFX’s inception) to April 30, 2009. After a very tumultuous start to the year, JVOFX ended April with a since inception return of 8.90%.

This start however, masks the volatility that remains inherent in the present market. In the first quarter of 2009, the S&P 500® index moved lower by 11.01%, with all sectors save information technology moving lower. It’s fair to conclude that much of the market’s gain (and JVOFX’s gain) was based upon robust returns in March and April. This leads one to question whether the market has moved too high in too short of a period of time. Are investors (professional or otherwise) becoming too euphoric? Is this irrational optimism?

Our sense is that it is not. While the market has indeed moved higher over the past two months, it
remains down significantly over the past year or more. To say that the market has moved too high too quickly is to presume that the market is a remarkably efficient determinant of value. In other words, it presumes that the prices that prevailed in early March were an efficient (or reasonably efficient) estimate of the prospects for the individual companies. Indeed, it presumes that the short-term prospects should lead estimates for value. While there is much to fault with classical valuation techniques, and the formulas that guide assessment of “value”; they are a good baseline, or starting place, for establishing a company’s worth. But, what is remarkable, in examining such formulas, is how little an impact any given quarter can have on a company’s value. Most of the value in a company is derived from long-term estimates or assessments of a company’s earning power – these estimates, while subject to current events are much slower to change, than is generally implied by interim movements in stock prices.

We are further encouraged by the nature of the present volatility. The dynamic that contributed to the recent downward volatility in 2008 and early 2009 works in both directions. With housing prices already down significantly in 2007 and 2008, the global stock and credit market losses contributed to an environment that had already made most individuals and companies feel “poor”. We believe this feeling reinforced and fed the downward movements, as consumers cutback purchases and companies cut costs and employees. This paradigm, however, can reverse course as well. When the market gains, investors (professional and non-professional alike) feel better and less “poor”; typically they spend more money and take more risks, reinforcing an upward movement that feeds on itself.

Most stocks in the portfolio contributed to our positive performance; however, Corning Inc. (GLW), Ford Motor Company (F), Goldman Sachs Group, Inc. (GS), J.P. Morgan Chase & Company (JPM), Liberty Media Holding Corp. – Interactive (LINTA), MGM Mirage Inc. (MGM), and Royal Caribbean Cruises Ltd. (RCL) all performed particularly well. Each of these holdings, which collectively represent 26.74% of the portfolio, was up more than 35% from its average cost in the quarter, significantly out-performing the portfolio as a whole and the S&P 500® index.

An acquaintance of mine recently remarked that we were certainly courageous to purchase more of MGM in early March at $1.86 per share. This was after our initial purchase of MGM in January for $15.55. We do not believe this is to be true. If one is being objective, it took courage to purchase MGM at $90 per share in late December of 2007.

However, given MGM’s assets and long-term prospects, it does not take courage to purchase this issue in January at $15.55, after it has fallen more than 80% in less than a year, and it certainly doesn’t take courage to add to this position at $1.86. Retrospect allows me to say this, of course, but the tenor of this argument would be unchanged, even if MGM traded at $1 today. In short, generally one should be more concerned when prices are high and less concerned when prices are low. While this sounds intuitive, in practice perception of risk is reversed when emotion takes hold – both in bull markets and bear markets.

Our biggest performance detractors this period were American International Group, Inc. (which we sold in February for a loss), Citigroup Inc. (C), Lear Corporation (LEA), Pfizer Inc. (PFE), Time Warner Inc. (TWX) and UTStarcom Inc. (UTSI), which together only represent 5.11% of the portfolio. C has been exhaustively covered in the press, and fits neatly within the confines of our contrarian mindset. While we believe it will be years before C’s share price moves back to its highs of 2007, we do think that there is an inordinate amount of pessimism with regard to this issue, and that there remains significant value in C’s global franchise. LEA supplies components to the automobile industry, and given the performance of automobile manufacturers and consumer trends, it is easy to see why this issue has been volatile in recent months. While we don’t think prior high automobile sales rates will prevail for a number of years, we also don’t believe that current sales rates are sustainable either (and will move higher). As with C, we think an inordinate amount of pessimism has created an investment opportunity that will bear fruit over
the long-term. PFE and TWX valuations were affected by transactions proposed (PFE’s proposed acquisition of Wyeth) or undertaken (TWX distributed shares in Time Warner Cable Inc.) in the quarter.

UTSI, a telecommunications equipment provider, has been affected by the recession and remains a volatile issue. Obviously, at some point the recession should come to an end, and we expect that UTSI will prosper over the long-term. In the interim, we expect that this issue will remain volatile, as it is one of the smaller companies in the portfolio, and most of the company’s demand comes from emerging countries – which have been severely impacted by the economic downturn.

While market volatility is impossible to predict, we believe that the market is cheap. Unfortunately, this is not to say that the market can’t get cheaper. As a consequence, we are not making significant changes at the present time, but rather we are adding incrementally, and paring positions that we view as have done relatively well. Still, we continue to feel that the current environment presents an opportunity. While we will take comfort in the stock market’s upward movement when it is accompanied by an improving economic backdrop, it’s worth noting that the stock market is a leading indicator and not a lagging one. Moving in and out of the market has proven to be a futile effort, as the market has generally moved significantly higher before the economic data has turned positive.

Moreover, one can spot an under-valued opportunity, but it is impossible to know whether such a cheap stock will not become cheaper. This has been the hallmark of the current environment, as many savvy value investors have been early in recent investments. In short, opportunities created by short-term volatility do not instantly become immune from the environment. Consequently, while we can’t predict when the market might turn, or when the volatility might subside, we can say that in our opinion, an awful lot of stocks look cheap at the present time.

Thomas Villalta, CFA
Chief Investment Officer and Portfolio Manager
Jones Villalta Asset Management, LLC

Updated 12/30/09