2010 Report to Clients*

About this report…

In this space last year we made a pledge to you, our clients, that we would be here for you in the future. In 2010 we took effective steps to make this pledge a reality.

For a little history, you helped Sam start the firm in 1994 as a FeeOnly® Investment Adviser. This created the platform that allows us to charge you for our advice as opposed to receiving commissions for investment “products” you “buy” (or are sold). For Tom and me, the assets-under-management (AUM) model is a great way to do business. We don’t lose sleep worrying about what we can “sell” you next month to generate some commission income. When we come to work in the morning, we spend our time (and other resources) looking for investments that fit your objectives and needs.

This doesn’t mean we always sleep well! The AUM model puts us squarely on your side of the table, both short term and long term. We remember 2008-2009; in a word, it was horrible. Of course, it is not possible to prove that charging for assets under management versus commissions delivers better investment returns over the years. Our hope is that any value we can add with our judgment, combined with low transaction costs and minimum turnover, will generate pleasing investment returns over time. In any event, your side is the only side of the table we want to work on.

Back to the present, there is a limit to how much fun one can have. At some point, Sam (the old-timer) will have to stop, or slow down, even if the only reason is the law of large numbers. As with any small firm, such an eventuality can be disruptive. One way to address this uncertainty would be to sell the business, and we investigated this option with at least two interested parties. In both instances, we soon realized that the firm would not be operated in the same fashion if it were sold. Whereas Tom and I enjoy operating with a small number of clients and working hard to invest your money according to what is right for each of you, any buyer of the business would operate on a larger scale. You would receive less individual attention and more one-size-fits-all investment “solutions.”

Tom and I both believe there is value in our services and how they are delivered. So we rejected the possibility of selling in favor of a solution we hope will preserve the firm’s operating model. Namely, ownership was transferred to Tom. We spent the first six months of 2010 negotiating and discussing with each other what each of us wanted and what was the best way to serve your interests. When we were able to identify these precepts, we hired an attorney to “make it legal.” By the middle of September, you fulfilled your role in the process by signing and returning documents required by the regulatory authorities. (Once again, it comes to our attention that we exist because of our wonderful clients. Thank you again.)

As a result of this transition, when the time does come for Sam to stop or slow down, for whatever reason, it should be a non-event for you and the firm. Meanwhile, he enjoys a robust employment contract which duties include writing this report. At the risk of being repetitive, we both think the transition steps we took in 2010—with your help—will enable the firm to continue giving investment advice we believe in.

For more detail about Sam’s employment contract, one of the firm’s goals is to improve our communication initiatives, especially with regard to the internet and our website. And in a continuing response to the crash of 2008-2009, which tested investors’ investment strategies, we are beginning a process to review your individual Investment Strategies. Do they continue to match the risk you are willing to assume for the investment returns you seek and need? (See LEVEL I, Long-Term Interest Rates, Outlook and Portfolio Construction.) Sam is looking forward to being involved in both of these endeavors; additionally, he remains the firm’s Chief Compliance Officer and has portfolio management and research responsibilities.


Sam Dreher


INSIDE THE MARKETS                                         Introduction

At H.S. Dreher Capital Management, LLC we use four broad investment classifications to help us diversify your portfolios. We believe investments in each of these categories are necessary to receive what we call a “Complete Investment Experience.”  Within these four broad categories, it is possible to identify an infinite number of sub-categories to provide even more diversification and exposure to various investment choices.

Specifically, we have identified seven investment sub-categories that we believe are necessary to construct a properly diversified investment portfolio. Three of these are income oriented; four are growth oriented.  We call these seven sub-categories the “Essential Elements for an Effective, Diversified Allocation Strategy.” The amount of your funds allocated to each of these markets depends on your individual Investment Strategies and the opportunities we think we discover in each market.


For the most part, these seven investment categories added year number two to their impressive rallies begun after the 2008-2009 wipeout. Thus, on the surface the most important characteristic of 2010 was total participation on the upside. Delving a little deeper into these results reveals some—possibly important—observations for investors.

One, the annual returns were more varied in 2010. The REIT, mid-cap and small-cap categories continued to exhibit 20%-plus returns, outpacing utility, foreign and large-cap stocks. In 2009, large-cap equities did a better job of keeping pace.

Two, even though bonds were last for two years in a row, they have the best return for the most recent three-year period (that includes the 2008 crash), turning $1.00 into $1.18.

Three, despite the financial press’s love affair with investing abroad, it produced the worst record of our seven elements over the past three years. One dollar has declined to only $0.81, as the segment experienced one of the worst declines in 2008, and its recovery lost its trajectory in 2010.

Four, average returns continue to deceive. As reported by mutual funds, mid-cap stocks averaged a 9.3 % return for the past three years; bonds averaged only 5.8%. (Which would you rather own for the period?) In fact, $1.00 invested in bonds turned into $1.18 versus only $1.11 for mid-caps, once again demonstrating the importance of using compound annual rates to accurately measure investment returns. Looking at average returns only, one might conclude that five of our seven elements have recouped their 2008-2009 losses, since they exhibit positive average returns. As the value-of-$1.00 column shows, however, almost the opposite is true: only three out of the seven categories have managed to hold onto, or grow, the value of the $1.00 with which they started.

Are these observations trends that investors should follow, or do they represent opportunities for investors to take a contrary investment position? In the pages that follow, we peel back the onion to examine the conditions of the markets as we find them. Below, we have ranked the seven elements by their annual returns over the past ten years. The only thing we know for certain about how the next decade will unfold is that it will contain surprises!



*Complete reports available to clients and subscribers in Client Area.