PCM | Investment Reports

Polaris Capital Management, LLC

A leading global & international money manager

Portfolio Analysis

AUGUST 2011 ANALYSIS: Expect Negative Events - Volatility Leads To Opportunity
As reiterated since early 2010, we believe the economic recovery will be slow, steady and mixed, resulting in periods of market volatility. Last year and in early 2011, we forecasted that certain economic issues could develop into headline events and send security markets into negative territory from time to time. The categories of events included the following:

The public sector's implementation of budget cuts, higher taxes and similar measures to mitigate rising debt levels in Europe and the United States

Deflation in developed markets, due to slower government spending, housing concerns and decreased fiscal stimulus

Inflation in emerging markets, courtesy of a strong economic rebound and rising standards of living and labor rates

The imbalances due to surpluses in resource-rich and trade surplus countries vs. countries on the other
side of the trading relationship

Market bubbles in hard and soft commodities, alternative energy stocks, bonds and emerging market real
estate

Persistence of trade barriers, ranging from tax/accounting structures to political environments

And any number of unpredictable and unexpected occurrences. Examples of such events that actually occurred include the Middle East unrest and the Japanese earthquake/tsunami/nuclear events

Many of these events we “forecast” have in fact come to pass. Importantly, we encouraged fellow investors to change their thinking and anticipate and expect such negative events. In our investment strategy this year, the portfolio has managed to sell fully valued positions during the positive months and hold cash to reinvest and capitalize during negative months. This strategy has worked well in 2011 as the portfolio was “de-risked” by adding lower risk investments after selling more cyclical firms. We are never pleased to see the value of our investments decline as our personal portfolios are invested right alongside your funds. Our thinking is to prepare for such normal market fluctuations even though high downside volatility never quite seems normal emotionally. Statistically speaking, 2011 has seen 3 down months and three up months to June, followed by declines in July and August to date. Reflecting back to the disastrous March earthquake in Japan, the events proved both impactful and emotional, as the world reached out to help a nation in turmoil. Although markets fell in sympathy with the Japanese plight, the ensuing four months saw a strong market recovery. Other events today or tomorrow will likely follow a similar pattern.

The Polaris June investment screens showed a near record number of companies at great values. We have a steady hand on the investment strategy and encourage fellow investors to use these “predictable” downturns to occasionally add to investments at low prices. These are our kind of markets, where volatility and subsequent irrational market behavior present excellent investment opportunities.