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Wescott Trust Services

What We Do

A History of Our Advice

Our process combines both passive and active management to capture both the rational and irrational facets of the market.

Wescott’s Investment Results and Recommendations

The early 1990s were filled with concerns about the recession, Persian Gulf War, rising unemployment and global risks (the Mexican peso crisis of 1994 shocked global markets). In 1995, investors had no clue that the most extraordinary period in stock market history was about to begin. By late 1999, investors could not see that they were about to confront one of the most severe equity market declines in history. Our clients were well prepared by our adherence to asset allocation and rebalancing strategies.

We have since endured September 11, 2001, the recession and market decline of 2002, uncertainty of conditions in the Middle East, the war in Iraq, the subprime mortgage fallout and credit crisis that unfolded in 2007, and gas prices that broke the $4 per gallon barrier in 2008.

We were timely in our concerns about creative accounting, auditors, fraud and threats to earnings and avoided the severe losses as the technology bubble burst. Our emphasis on diversified portfolios has dampened the impact of bubbles in real estate, the financial sector and commodities. We were cautious about the instability of the bond market, focused on short term high quality bonds rather than stretching for yield, and this protected portfolios from losses from subprime mortgages and junk bonds.

Our global perspective has prepared portfolios for a lower return environment for U.S. businesses and a time of unprecedented opportunity in non-U.S. markets. Of particular note is our Global Asset Allocation Policy which was implemented during 2005 through 2006.

We are grateful for and very proud of the confidence that our clients placed in us and in our process during this series of market cycles and periodic extremes. We think you might enjoy reading how our conviction to stay the course dramatically helped returns.

For your consideration, we have assembled a collection of excerpts from past Wescott Investment Commentary. We share the following so that you may place in context the thoughts underpinning Wescott’s investment results and recommendations.  We also invite you to read our complete History of Our Advice.

Timeline of Events

As we climbed to the market peak in March 2000, we shared the following recommendations:

“The fear of loss, or awareness of the risk incurred, has seemed frighteningly absent as it concerns the most popular and speculative “New Economy Companies.”

April 2000

“We have yet to be convinced that a New Paradigm makes the principles of asset allocation obsolete.”

January 2000

“As more volatile stocks are added to the indices there are more opportunities for market manipulation. If you develop a yen for investing in stocks which are prone to whipsawing prices, limit orders should be employed.”

January 2000

“Is the market ready to shift away from the popular growth stocks? We believe that even new paradigms must contend with the business cycle and investor behavior.”

April 1999

“We consider it time for another “lifeboat drill” and are recommending that most aggregate equity positions be no more than 70%....In times of raging speculation, it is prudent to take some money off the table to have the liquidity to buy into times of weakness.”

January 1999

We wrote about our concerns with auditors and creative accounting rules before Enron, WorldCom and others disclosed the depth of their problems starting late in 2001 and throughout 2002:

“Earnings management strategies are undermining the integrity of the process used by investors to make well informed investment decisions...we are troubled by the frequency of pro-forma earnings announcements which exclude expenses just because management doesn’t like the way the numbers look with the costs accurately reflected....All is not as it seems when it comes to earnings reports.”

July 2001

“The market bubble has many contributors, and the greed of investors was among them...many are the indicators that investors were manipulated and that investment bankers played a part in creating the supply of what now appears to be “damaged goods.” Unfortunately, Wall Street underwriters have a “no returns” policy in dealing with investor losses.”

April 2001

“Even a reputable accounting firm listed as auditor is no assurance that the financial statements are accurate.”

April 2000

“The drive to provide investors with “better numbers” has encouraged companies to be even more aggressive in their accounting and financial reporting. We urge skepticism of management’s promises and caution in reviewing the rosy outlook of analysts. Peel behind the forecasts and you often find unreasonable expectations for growth.”

January 2000

We shared our perspective and actions in response to September 11, 2001:

“We have been in contact with our managers and/or have reviewed material which they have provided. All are safe; none were headquartered in the World Trade Towers. None are given to panic or wholesale sales and continue to marshal their resources to understand the events and manage your investments accordingly...It is true that this event will impact an already difficult 3rd quarter, as well as the 4th quarter. There is no escape from this. We have weathered these difficult economic times before and we will this one, too.”

September 2001

We shared our outlook during the bear market that followed the technology bust:

“We now believe that stocks have returned to favorable valuations and that it is an opportune time to return some of the proceeds we rebalanced to defensive bonds in 1999 and 2000.” (2002 4th Quarter return of the Wilshire 5000 was 7.8%.)

October 2002

“We do not expect a sudden rebound for equities but do believe that the market bottom is getting much nearer.” (The market bottom occurred October 2002.)

July 2002

“The pension gains which helped major corporations in the 1990s have become pension liabilities that will likely detract from earnings for the next several years.”

January 2002

“During each of the craziest periods in U.S. market history, the investor best positioned is the one with cash to invest after the bubble bursts and who does not rush in to buy just because companies look cheap in relation to what they were. Cheap stocks can become cheaper.”

January 2002

We were poised for the market cycle and return of the bull market that stalled in 2007:

“We may look fondly back at 2007 as the year that interest rates, inflation and unemployment rates were all low at the same time. The global economy has shown its resilience and ability to adapt. Short term turbulence should be expected and may come from any source. Long term investors, however, use periods of uncertainty to position portfolios for the future.”

October 2007

“We are experiencing conditions for which history provides no guidance except to remind us that all extreme conditions eventually revert back to more normalized levels, but often after great pain has been inflicted. We are not market timers, and we are not pessimists. We are cautious and thoughtful in our asset allocations and are monitoring equity allocation ranges and liquidity levels to ensure that our portfolios are buffered against the turbulence we expect during the second half of this year.”

July 2007

“For equities we continue to anticipate highly positive trends from globalization. Sectors that are struggling in the United States are doing well elsewhere, making it more critical that stock analysts have a global perspective and understanding of the companies within each sector and industry group. Non-U.S. customers have become more significant to American and foreign companies. We remain committed to a global asset allocation policy.”

April 2007

“Many investors continue to wait for large companies to outperform smaller companies. As we discussed in our Third Quarter 2006 Investment Commentary (available at www.Wescott.com), small companies have growth patterns and attributes that make them attractive investments during all market cycles. We believe an investor should have allocations to companies of all sizes as trying to time the next surge for large companies can be detrimental to one’s wealth.”

April 2007

“We have three themes for the coming year. First, follow the pessimism to find investment opportunities. Use the fears of others to your advantage as an investor.....Second, think small....we believe that more opportunities exist among small and mid-sized companies which have less coverage by analysts. They are the companies in which innovation often incubates behind the scenes for many years....Third, think globally.... If investors limit their investments to companies headquartered in the United States, they may need to skip industries or settle for the weakest companies. Consider the auto industry.....”

January 2006

“We expect that the pace of business expansion will accelerate as 2005 progresses, which will result in jobs growth and strategic acquisitions. Our outlook is most optimistic for global companies; we are maintaining full target weights to international investments....We never know what group is ready to take the lead, nor do we know which will stumble. We will always have distractions in the form of commodity prices, currency valuations and geopolitical events. Yet even in the bleakest of times, there are companies and sectors that do well.”

January 2005

“Regardless of the outcome of the November 2nd election, the equity market appears ready for an enthusiastic response. Political campaigns, even ugly ones, end in a spirit of cooperation. The economy will move forward, as it has always done. Businesses will assess the environment in which they will exist for the next several years, and most are likely to discover that little is expected to affect bottom line decision making. Good business decisions, and good investment decisions, consider, but are not dictated by, tax related decisions or politics.”

October 2004

“A topic of current interest is the fear that we are entering a period of low equity returns, which would suggest a change to asset allocation policy. Looking forward to a period during which interest rates and inflation are coming off extremely low levels, it is our perspective that the key question should be ‘which asset class best protects investors in the projected environment?’....We remain convinced that over the long term, equities will outperform cash and bonds on a real (after inflation) return basis.....A low return environment for the S&P 500 does not mean that companies of all sizes will do poorly.”

July 2004

“While headlines will likely blame any stock market pullback on rising interest rates, it will also be a sign that the U.S. economy is on solid footing when the Federal Reserve brings interest rates back to more normalized levels.....As we explained at year-end 2003, we believe that large American companies will be most challenged by competitive pressures on a global basis. For small and mid- sized companies, the cost to expand their reach globally continues to decline.”

April 2004

“Our optimism for the U.S. market is tempered by a concern that Fourth Quarter gains had so much momentum, and valuations may have become too high in some areas......We believe the U.S. economy is strengthening, that labor trends, while in transition, will improve, and that we will look back upon this period as “one of the best of times”.....For the bond market, we expect an ambush that may come from any single or combined effect of the above factors (discussion pertained to economic growth, foreign ownership of U.S. debt, government deficits, etc.), as soon as mid-year.”

January 2004

“We see positive signs that the economy is stabilizing and setting the foundation for another period of growth....Decisions based upon fear are always ill-timed. Consider the market swings experienced during the quarter as investors speculated about the implications of war....We continue to expect that equity returns will be positive in 2003.” (The 2003 return for the Wilshire 5000 was +31.65%.)

April 2003

“We do believe that the next bull market is in its earliest phase and want our clients to be rebalancing during periods of market uncertainty, as these are the times of greatest bargains for those with discipline.”

January 2003

We developed a Global Asset Allocation Policy to be prepared for a changing world:

“We see a tsunami-like change looming for global market leadership, which will blindside those so rooted in the belief that the health of the global economy depends on economic conditions in the United States. With a rise of the middle class in the emerging markets, regional markets for goods and services are growing. As an example, China’s population alone suggests that there will be extraordinary demand for products made in China and other markets, which will lessen the impact of any reduction in demand from Wal-Mart or U.S. consumers.”

January 2008

“You might recall that several years ago we increased our allocation to Non-U.S. equities to be 40% of our clients' equity allocation. This was done in anticipation of the time when the U.S. economy would slow, and in consideration of the changing (and diminishing) role that the U.S. will have in the global equity market and economy going forward. The U.S. equity market represented 47.7% of the MSCI All Country World Index at year-end 2006, and only 42% of the Index at year-end 2007.”

January 2008

“Our revised Asset Allocation Models reflect an allocation of 40% to Non-U.S. companies, well diversified by managers, company size and geography.....Our Global Asset Allocation Policy has been motivated by our observations of global opportunities, and what we believe will be a dynamic environment for investors in the years and decades ahead....We no longer believe it defensive to invest primarily in a country that represents approximately 48% of the world’s equity market capitalization, 20% of global GDP and only 5% of the world’s population.”

July 2006

“It is our intention to increase the Non-U.S. allocation further in 2006...From our focus on diversification has evolved a belief that to be defensive in a changing global environment, one must diversify globally....Regardless of the outcome of the events that make headlines and influence our outlook about the world, businesses will be reporting their results and looking for ways to grow their revenues and profits. We expect the second half of the year to be rewarding for equity investors.”

July 2005

“During 2005 we will be raising the non-U.S. allocation to 30% of the equity allocation in all our models....Our pending allocation changes are not being made because we feel that the U.S. economy is on the brink of disaster. Quite the contrary.....There is a huge market developing, as citizens of other countries experience rising standards of living....As other areas of the world develop and benefit from the advances in technology, health care and sanitation, there will be new global leaders
emerging.”

April 2005

We addressed varied risks:

Inflation
“Ironically, the renewed interest in alternative energy sources, including bio-fuels, has caused escalating prices for corn and agricultural products, which in turn results in higher food prices.

We do not expect overall inflation to be problematic for the foreseeable future, due to technology and productivity gains that trace back to innovations developed since the late 1990s. Competitive pricing and negotiation by giant retailers, led by Wal-Mart, also counter normal inflationary forces. However, supply and demand for energy, commodities and health care can create volatile conditions and cause short term spikes in prices that offset the cost controls in other areas. It takes higher prices to curb demand and to spur investments in alternatives.”

January 2007

“It surprises many who do not know of our discipline when we seem calm in the midst of volatility. Sharply down days for the stock market are the times when we feel that the risk has been lowered by cheaper prices, and we are investors for our clients. It is when the market is euphoric that we perceive the market risk to be greatest, and take advantage of the higher share prices to rebalance clients’ portfolios. We invest with managers who share this discipline and conviction.”

July 2006

Market Volatility
“Risk and volatility are often confused. Admittedly, periods of high volatility are the most unsettling for investors....The recent turmoil in the global markets prompted fear-based selling and investment opportunities for those who know how to discern values....Our conviction to invest in areas of the market that are underperforming, and to invest in Non-U.S. companies, helped to reduce our clients’ overall portfolio volatility during the extreme swings of the past tenyears.....Riskscannotbeeliminated,butmanyriskscanbemanaged.”

July 2006

Bird Flu
“Frequent articles about the Avian Flu, also known as ‘Bird Flu’ and ‘H5N1’ virus, have caused feelings of alarm that a resultant pandemic could cripple the world’s economy. We do not share these fears.....The global economy has survived a series of pandemics, including HIV/AIDS which remains a global threat. From an investment perspective, the risk of a pandemic is only one of the potential reasons that Wescott has a Disaster Recovery & Contingency Plan, as do our custodians.”

January 2006

Risks of Aggressive Debt Financing
With the proliferation of esoteric mortgages (interest only, adjustable rate mortgages, “hybrid” mortgages and numerous other arrangements) property owners may be vulnerable if property values soften. Higher interest rates will reveal the aggressive loan-to-value strategies. Owners of highly leveraged residential and commercial properties are more likely to default if the value of the property, net of all selling expenses, becomes less than the outstanding debt.

October 2005

Real Estate
“For those who are looking to real estate because they believe that the returns for real estate will be greater than what will be able to generate from investing in equities, they are hoping that ‘it will be different this time.’....Even if a property has no debt, does not rely on rental income and has the cash flow to cover all costs, real estate has a high level of liquidity risk as prices soften and decline. There is the risk that you could be ‘trapped’ owning the property for far longer than you intended.”

October 2005

We wrote about our concerns with the bond market and derivatives before the subprime mortgage crisis captured headlines beginning in 2007, with increased momentum during 2008:

“For the bond market, we need to see a return of the risk premium. It is a dangerous web that was woven by mortgage companies, investment banks, brokerage firms, ratings agencies and others. Investors in bonds have relied on ratings companies, and ratings companies have relied upon models which understated the risk of putting together a pool of risky bonds. In 2008 there will be much loss taking by those who should have known better.”

January 2008

“We are in the midst of addressing a mess that has its origins in a loosening of credit standards and a lack of regard for the consequences of being paid too little for taking too much risk. It is not the first time. The market tends to overreact to both good and bad news, hurting those who respond to short term news on impulse. There are investors willing to buy pools of distressed mortgages at attractive prices. We also expect a portion of the vulnerable mortgages to be refinanced, yet for some foreclosure will be the only option.”

October 2007

“Peak periods for private equity investments have coincided with those periods during which investors are willing to accept only a modest credit spread (the spread is the amount by which the yield on the bond exceeds the yield on a 10 year Treasury Note). We appear to be in the most extreme period for credit spreads and private equity activity that the market has ever experienced.

Record low spreads have led to extraordinary amounts of debt issued in the past several years, much of it to finance private equity mergers and acquisitions. With much at stake when the market shifts gears are those who may have unwittingly invested in “bridge loans” extended by banks as an interim source of financing for LBOs until long term loans can be arranged. The banks “syndicate” these loans by selling them to institutional investors and to special purpose vehicles called “collateralized debt obligations” (“CDOs”). However, if deals begin to sour before the loans can be packaged and sold, the bank could end up holding the loans longer than expected.”

July 2007

“The subprime mortgage market will survive. Subprime lending is typically very profitable for companies who offer these loans, as long as they are priced appropriately. The dangers today arise from lax underwriting standards and predatory lending practices. Lenders deserve to be held accountable for issuing or selling bad loans. Companies including Washington Mutual, Wells Fargo and Countrywide are setting aside reserves for potential losses; it’s hard to feel sorry for an industry coming off record earnings because they issued these loans to begin with.”

April 2007

“In our due diligence and research of bond managers, we emphasize experience and an understanding of what can go wrong with the securities in which they invest. We reject portfolios that focus on getting the maximum yield out of our belief that preserving capital is much more important. This applies to subprime mortgages, and all other high yield bonds (referred to as “junk bonds” for their greater default risk).”

April 2007

“We continue to believe that the bond market has poor fundamentals, with prices higher than they deserve to be, and market interest rates lower than they should be. The market has priced in everything good that can happen for bonds, and has ignored the hazards, much like equity investors did with technology stocks in late 1999. We maintain allocations to short term bonds as a source of liquidity reserves and are focused on protecting principal. Our focus is on maintaining the target levels of cash flow desired by our clients, which we are able to accomplish without yield-motivated strategies that involve hidden risks.”

January 2007

“If global interest rates rise as we expect, there will be more alternatives for bond investors and greater pressure on the prices of bonds to keep yields attractive. Market volatility is not limited to the stock markets around the world; the bond markets can make the volatility of stocks look tame. We continue to be concerned about the risks inherent in the bond market, and the additional risks attributable to leveraged hedge funds and traders in derivatives. It is dangerous to become complacent after a period of extended calm.”

July 2006

“It is noteworthy that the group formed in 1999, following the Long Term Capital Management bond market scare of September 1998 (which we discussed in our Third Quarter 1998 article, “Hedge Funds Meltdown: Risks Revealed”), reconvened this year. In the July 27, 2005 Wall Street Journal article, “Changing Face of Market Risk,” journalist Henry Sender explored the work of the Counterparty Risk Management Group II, in response to concerns about widespread risk-taking and increasingly complex strategies that could result in a liquidity crisis in the bond market.

We continue to believe that investors in longer term and high yield bonds are not being fairly paid for the risks of their investment. And, these risks grow. The Federal Reserve is expected to continue to raise the federal funds rate through year-end 2005. In early 2006 Federal Reserve Chairman Alan Greenspan retires. It has been a remarkable period of relative stability since Greenspan took office in 1987, and he will be missed. While Greenspan guided the country during a period in which both interest rates and inflation were declining, his successor will take the helm as both inflation and interest rates trend higher.”

October 2005

“In our view, it is only a matter of time before investors in longer term bonds will experience the loss of principal least expected in a portfolio.”

October 2005

“In our view, it is only a matter of time before investors in longer term bonds will experience the loss of principal least expected in a portfolio.”

July 2003

As we prepare for the next phase of the market cycle during 2008, against the headwinds of a presidential election year, and negative headlines, we shared the following in March 2008:

"As you know, our portfolios are very broadly diversified. Sometimes the market sentiment is so negative that it clouds the bright spots within our economy. Several of our managers have exposure to agriculture, materials and metals; many of their holdings were bought when these companies were out of favor. Our non-U.S. holdings include mining companies and commodity producers; these resources tend to be located in the emerging markets to which we also have exposure.”

March 2008

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