Members Present:  John Hammond, Howard Brown, William Brown, Dennis Callahan, Hunter Calloway, Jay Cuccia, Andrea Fulton, Jennifer Gilbert-Duran, Frank Marzucco, Jay Middleton,  LeRoy Wilkison.

Members Excused:   Douglas Willis

Members Absent:   M. Kathleen Sulick

Staff Present:   John Peterson

Guests:   Brian O. Casey, Gwin Griesbeck, Lee Harper, Rhett Humphreys, David S. Spika, Frank Stanley   

Recorder:  Laura C. Jackson, Audio Associates

MINUTES

Mr. William Brown moved to approve the minutes for the June 12, 2008, Board of Trustees meeting. The motion was seconded by Dennis Callahan and approved unanimously.

Investment Committee

Southeastern

Southeastern has been one of Anne Arundel County’s longest-standing investment managers. The employee-owned firm is based in Memphis with research offices in London, Tokyo and Singapore. Southeastern recently hired Ms. Griesbeck, who soon will be working out of the London office.

Southeastern looks for good businesses run by good people, and seeks to get those businesses at a good price.  The firm maintains a target return of inflation plus 10 percent.      

Its U.S. large cap separate accounts has been closed to new business since 2004. The Longleaf Partners small-cap fund, a mutual fund that mimics the county’s account, also has been closed since 2004. The firm temporarily reopened it this year, said Ms. Harper, because new cash flow coming into the fund would allow the firm to purchase new opportunities that benefit shareholders.     

Mr. Callahan asked if Southeastern can open or close its funds at any time.  Ms. Harper said yes, depending upon approval from the funds’ board of trustees. Opening a fund depends largely on opportunities. The Partners Fund, for example, has been closed three times to new business in the past, she said, typically at points when companies have been sold but there were no new opportunities, which caused cash to build up.  New cash coming in at that point does nothing for shareholders, said Ms. Harper.   

As a concentrated manager, Southeastern maintains 20 names in its portfolio so it doesn’t get too big.  Despite the turbulence in the market, Southeastern sees a lot of opportunities, said Ms. Harper.  The only constraint is not having as much cash to take advantage of every opportunity and not having names in the portfolio that are selling at enough of a full price that managers want to sell them.  

The portfolio’s value as of June 30, 2008, was $92,953,513. Portfolio returns for the period between December 31^st, 2007, and June 30^th, 2008, were -3.54 percent. The firm’s benchmark, S&P 500, showed returns of -11.95 percent for the same period. 

Although the fund’s target is inflation plus 10 percent, since inception it has been a little over 14 percent, said Ms. Griesbeck. The portfolio’s return for the current period isn’t great, Ms. Griesbeck said, but lower prices allow the firm to buy more, so Southeastern is in a great position for the future. 

Since July 2007, Southeastern has sold Liberty Capital, Discovery, Comcast and Sprint. The firm also trimmed other names that had done well, such as Aon and Chesapeake. With the proceeds from those sales, Southeastern bought Ebay and Sun Microsystems.  Neither of those are full positions yet. Southeastern also added UBS to its portfolio.

Mr. Middleton asked if the firm ever thinks about selling a more expensive stock to get a cheaper one.  Southeastern thinks about that all the time, said Ms. Harper, but managers also must consider quality.  Some businesses are cheap statistically but have very little growth potential.

Ms. Harper explained the reasons for some of the names in Southeastern’s portfolio.    

Mr. Hammond noted, for example, that he didn’t consider Ebay a value stock. Ms. Harper said Ebay is historically a growth company. Although sales have slowed, it is still growing. Southeastern chose to purchase Ebay because of its price to free cash flow. Further, Ebay has been buying its shares at a huge pace. The company benefits from scale and competitive advantage, and the five-year outlook is exciting.

Mr. Hammond asked about GM. Ms. Harper said GM is the cheapest thing Southeastern owns. It has been a mistake in the portfolio but the firm has received a good dividend. It has less than a 2 percent position in the portfolio. Because the stock is so cheap, Southeastern isn’t willing to sell it for less than 30 cents on the dollar.  It is not Southeastern’s most-loved stock, but changes in the next few years could improve GM’s outlook. If the price gets to 85 cents on the dollar, she said, Southeastern would probably sell it.

Next, Mr. Hammond asked about UBS. Ms. Harper said UBS has been a mistake in a sense because its value has come down. Southeastern bought it, she said, because UBS has a strong brand name overseas as a wealth management company. UBS, she said, has more than 50 percent market share and is the dominant private wealth manager for multimillionaires and billionaires in Europe, Asia and the Middle East. 

However, UBS had investment bank exposure to credit that had to be written down. Southeastern estimated that exposure to be about $20 billion when the actual cost was more like $38 billion. Southeastern paid in the low $40 range for the stock, but the stock is trading in the $20 range. Even so, the wealth management business continues to grow.

Mr. Middleton asked when Southeastern would consider throwing in the towel on the  fallen angels in its portfolio.  Ms. Harper said that would happen if the value of a company declined or if a company won’t grow and Southeastern would prefer to focus on other opportunities. Mr. Stanley added that it is the value of a business that serves as an anchor when fund managers must make those decisions.    

Westwood

Founded in 1983, Westwood focuses on downside protection. It has more than 60 professionals, and employees and directors own 36 percent of the firm. Westwood has more than $8 billion in assets under management.

Westwood looks for companies that are performing well but aren’t getting enough notice or credit from the market. Mr. Casey said the market represents pure risk, so managers try to add value by controlling risk at every level. They also look for companies that have multiple income streams and more than one way to succeed.

Mr. Spika said Mastercard had been a major success for the county’s portfolio.  Westwood owned the stock for about two years, and the stock was trading at 25 times its 2009 earnings estimate and had reached its price target when Westwood sold it in June 2008.

Home Depot, which the firm bought in December 2006, suffered from changes in the housing market and an inability to sell its contractor business at a good price due to the tightening of the credit markets. Mr. Spika said Westwood quickly cuts its losses, so even though it had the stock for three quarters, fund managers protected the county’s capital. United Technologies, which still has growth opportunities, is a victim of negativity in the market, said Mr. Spika. Westwood’s downside price target is $55 a share, and the company is currently trading at $61. 

The county’s portfolio had a good year in 2007, with returns of 13.6 percent versus a benchmark of -0.2 percent. Mr. Spika said the returns were due to Westwood’s focus on risk and underweight position in financials. Year to date, Westwood is down 7.9 percent and the benchmark is down 13.6 percent because of the volatile market.  From its inception date of January 5, 2006, to June 30, 2008, the portfolio has posted returns of 8.6 percent versus benchmark returns of 1.5 percent.

Mr. Spika said the most positive contributor to performance has been financial services because fund managers have done such a good job of avoiding the toxic parts of the market. Westwood also has a significantly greater weight in the technology sector than the benchmark. Energy and consumer staples have been very strong, and Disney has been a great holding for the portfolio. Westwood sold a number of stocks during the year, including Macy’s, Bank of America and Phizer. Fund managers purchased Wells Fargo, EMC Corp. and XTO Energy.   

New England Pension Consultants

The Investment Committee recommended that the board put $5 million with Siguler & Guff Distressed Opportunities Fund III, L.P., a fund of funds that invests across the spectrum of distressed and special opportunities strategies.  Mr. Hammond said the investment would involve an eight-year timeframe.

Action: Mr. Wilkison moved to accept the investment committee’s recommendation.    

Mr. William Brown seconded the motion. The board unanimously approved the motion.

Mr. Humphreys reported that June was another volatile month, noting that the county was down 4.7 percent on the June 30, 2008, flash report.  For the quarter, the composite is 1.1 percent.  The county’s total equity composite was 1.8 percent for the quarter, in comparison to the benchmark’s -1.5 percent.

Mr. Humphreys said only two managers underperformed the benchmark during the quarter, Chartwell and ING Equity.  However, when taken together with other funds in the asset classes,  the composites still outperformed the benchmarks.

On the bonds side, the county was down 20 basis points, said Mr. Humphreys.  Western Asset Management and ING FI showed quarterly returns of -0.9 and -0.8, respectively. The benchmark was down 1.0.

Under the alternative composite, Bridgewater’s returns were -0.7 percent for the quarter, while Wellington was up 3.2 percent.  Last year, Wellington was up 4.5 percent against a benchmark of -3.2, and Bridgewater reported returns of 16.8 percent against the benchmark’s 7.6 percent.

Action: The next meeting of the investment committee is August 7.

Mr. Peterson reported that benefits statements went out. Twenty-six errors were reported, and corrected statements were sent immediately. Most of the corrections were address changes. Cost-of-living adjustment letters also went out for July. 

Mr. Peterson also addressed a question from LeRoy Wilkison, who reported last month that he received benefits payments from his credit union on May 30 instead of June 1. Mr. Peterson said that was a one-time issue related to the credit union’s maintenance work.

Pending August retirements are 19 compared to 28 last year, Mr. Peterson said, a change that could be due to the economy.

The next board meeting will take place September 11.

The meeting adjourned 1:50 p.m.