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September 2008
You should consider the investment objectives, risks, charges and
expenses of the fund carefully before investing. For a free copy of a
prospectus, which contains this and other information, visit our website at
www.kineticsfunds.com or call 1-800-930-3828. You should read the
prospectus carefully before you invest. Please read the important
disclosure at the end of this portfolio commentary.
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Dear Fellow Shareholders,
In the third fiscal quarter of 2008, we have witnessed events of unimaginable proportions that, quite possibly, will not occur again within our lifetime. Within a matter of weeks, which given the rapidity felt like days, a number of venerable financial services firms either expired or came uncomfortably close to expiring were it not for the intervention of the U.S. Government. The list of companies should not be a surprise given the attendant media attention, and comprises companies such as Lehman Brothers, American International Group, Washington Mutual, Wachovia, Fannie Mae, Freddie Mac, and IndyMac Bank. Even firms that had originally been anointed as having deftly avoided the subprime mortgage debacle, such as Goldman Sachs and Morgan Stanley, have suffered mightily, as indicated by their falling share prices.
While it is the collapse of the subprime residential mortgage-backed securities market that was the spark, it is the virtual stoppage of the overall credit market that is propagating the financial wildfire. Moreover, much like the proverbial mob running for the exits of a burning building, investors are selling stocks virtually simultaneously at an unrelenting pace. Panic selling is occurring irrespective of the fundamentals of the underlying companies and is based on the mindset: “I don’t want to be the last one out, so I’ll get out now, no matter what the price.” The clamor for safety is evident by the prices of U.S. Treasury securities. The one-month U.S. Treasury Bill, considered to be the paragon of a safe and liquid investment, has increased in price due to overwhelming demand, such that the interest rate is now 14 basis points. In other words, investors are willing to receive an annual rate of 0.14%, or less than one-quarter of one percent, for the privilege of owning U.S. Treasury Bills. Historically, the one-month U.S. T-Bill rate has more or less tracked the Federal Funds rate set by the Federal Reserve. Presently, the Federal Funds rate is 1.5%. Meanwhile, banks are unwilling to lend to each other for more than a day. If loans are (reluctantly) made, they are at onerous rates for fear that they may not be repaid. Three month LIBOR, which is the reference rate banks charge each other, was reported to be 4.8% as of this writing.
This is, bluntly speaking, the current reality. It is not surprising, for this reason, that the Fund (No-Load Class) has declined 20.5% during the third quarter of this year, compared to the S&P 500 Index and Nasdaq Composite, both of which declined by 8.37% and 9.19%, respectively. This is not radically different from the performance of various Asian indices for the same period. For example, the Hang Seng Index declined 18.4%; the Shanghai Stock Exchange Composite Index was down 16.1%; the Shenzhen Composite Index was negative 22.5%; and the Hang Seng China Enterprises Index depreciated by 23.8%.
What, you may ask, are we doing in the portfolio? The short answer is: not much. When the price of equities are divorced from their underlying economic reality (as it seems to be quite clear to us), making rash decisions is, we believe, to the ultimate detriment of our investors. For example, does one really believe that foreclosures in Las Vegas or California have any real, direct effect on the driving habits of China’s citizens? Of course not, yet Shenzhen Expressway, a toll road operator in China, has declined over 65% to date, trading at a price-earnings multiple of less than 9x earnings. This is an incredibly cheap valuation, in our view.
To be sure, even though shares in China appear to be inexpensive, it is certainly possible that they may decline further. Such is the case in a panicked market. Yet, even if the United States enters (or perhaps has already entered) a recession, it will not prevent the continued expansion of the Chinese middle class, which is currently estimated at 80-150 million people out of a total population of 1.3 billion. As this segment increases in size, certain secular trends will continue to develop. For example, a larger middle class will likely lead to an increase in auto ownership, which should benefit the Fund’s investment in the aforementioned Shenzhen Expressway, as well as the other toll roads within the portfolio. We believe, travel, whether for business or pleasure, will continue to flourish, due to domestic economic activity, regardless of the economic climate in the U.S. We believe this should have a positive effect on the value of companies such as Beijing Capital International Airport, which is the 9th busiest airport in the world, based on 2007 figures.
In short, the rapid decline in the Chinese equity market is, in our opinion, not a reason to sell. Rather, it represents an opportunity to buy. While the crisis that has gripped the world will not be resolved for some time, we are confident that our long-term prospects remain bright.
We thank you for your confidence and believe you will be rewarded for it.
The Kinetics Investment Team
Disclosure
Past performance does not guarantee future results. Due to market volatility, current performance may be more or less than for the rankings shown. Investment return and principal value will vary, and an investment in the fund can lose money.
Because the Funds [other than The Paradigm Fund and The Small Cap Opportunities Fund] invest in a single industry, their shares do not represent a complete investment program. Internet, biotechnology and water related stocks are subject to a rate of change in technology, obsolescence, regulation and competition that is generally higher than that of other industries, and have experienced extreme price and volume fluctuations.
International investing presents special risks including currency exchange fluctuation, government regulations, and the potential for political and economic instability. The Fund's share price is expected to be more volatile than that of a U.S.-only fund. Because smaller companies [for The Global Fund and Small Cap Opportunities Fund] often have narrower markets and limited financial resources, they present more risk than larger, more well established companies.
Non-investment grade debt securities [for all Funds], i.e., junk bonds, are subject to greater credit risk, price volatility and risk of loss than investment grade securities. Further, options contain special risks including the imperfect correlation between the value of the option and the value of the underlying asset. Small and medium-size companies often have narrower markets and more limited managerial and financial resources than do larger, more established companies. As a result, their performance can be more volatile and they may face a greater risk of business failure.
As non-diversified and single industry funds, the value of their shares may fluctuate more than shares invested in a broader range of industries and companies.
Unlike other investment companies that directly acquire and manage their own portfolios of securities, the Funds pursue their investment objectives by investing all of their investable assets in a corresponding portfolio series of Kinetics Portfolios Trust.
Distributor: Kinetics Funds Distributor, Inc. is an affiliate of Kinetics Asset Management, Inc., and is not an affiliate of Kinetics Mutual Funds, Inc.
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