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Funds Eye Asia, Fed Hikes, Volatility: Analysis of Shareholder Reports Indicates Concerns

What are portfolio managers, chief investment officers and fund executives telling their fund shareholders these days?

A review of the annual and semi-annual mutual fund reports to shareholders that were recently filed by firms for the six or 12-month period ended March 31 show that an assortment of topics are on managers' minds, but the most prevalent concerns are opportunities in Asia and continued market volatility.

The burning question appears to be whether the Federal Reserve will continue on its rate raising regime or hold the line at the 16th rate increase since June 2004. In fact, the name Ben Bernanke, new chairman of the Federal Reserve Board, was almost as prevalent in fund shareholder reports as the name "Brangelina" has been in the Hollywood press.

A Yen for Japan

Specifically, global or international fund managers almost universally agree that Japan is back on track, experiencing a sustained recovery worthy of closer attention.

"For years, Japan's economy was the weakest of any developed nation. Today it is among the strongest, with domestic wages and salaries growing 3-1/2% annually," said Charles I. Clough, Jr., chairman and chief executive officer of Clough Capital Partners of Boston, investment advisor to the Clough Global Allocation Fund. The fund has current positions in Japan.

"Corporate profits are strong, and corporate debt in Japan is now below the pre-bubble period," he added. Japanese companies' high cash flows and strong balance sheets will prove helpful. Moreover, domestic investors in Japan are beginning to shift their sizeable savings into stocks, and the yen appears seriously devalued, he noted. All of these factors bode well for the Japanese market, he summed up.

Optimism for China

And fund managers see yet another Asian market as ripe with investment opportunities.

According to managers at Baring Asset Management (Asia) in Hong Kong, which sub-advises the Asia Pacific Fund sponsored by Prudential Investments of Newark, N.J., China is poised for continued growth.

"The secular growth trend of China will continue for at least the next five years," predicted the fund managers in their recent shareholder report. Although Asian markets were generally "trapped in a gently rising and volatile trading range" from April through October last year, more recently, from November 2005 through this past March, the market saw a "full-blown bull market period," the managers commented. Now underway is an ambitious plan to modernize rural areas of Central and Western Asia, they added.

Focus on the Fed

Whether or not the Federal Reserve will continue raising interest rates or take a breather is also up for discussion in recent shareholder letters. Most managers are taking a wait-and-see approach, while others aren't shy in voicing their apprehensions.

"Interest rates are likely to remain the market's biggest bugaboo," said Bob Turner, chairman and chief investment officer of Turner Investment Partners of Berwyn, Pa., investment advisor to the 11 Turner Funds.

The Fed "used low interest rates to spur the economy after the speculative excesses were adjusted in the stock market and the terrorist attacks of Sept. 11, 2001 slowed economic activity dramatically," reminded Blake T. Todd, senior vice president of Seidler Investment Advisors, which sub-advises The Montecito Fund, a $7.3 million series of The Santa Barbara Group of Mutual Funds in Pasadena, Calif.

"It is our opinion that the Fed has completed the removal of the accommodative low interest rate environment and [has] moved on to focus on different market forces - providing enough money to keep the consumption-based economy afloat without having inflation become a major concern," Todd said. That, however, is a "very tricky tightrope to walk indeed," he added.

Several shareholder reports hinted that inflation was once again creeping into the picture, although managers disagreed as to whether the Fed's actions are helping or hindering efforts to head off inflation.

"The Federal Reserve hasn't done diddly' in terms of slowing inflationary pressures," commented Mark Travis, president and chief executive officer of the $27.8 million Intrepid Capital Fund, run by Intrepid Capital Management of Jacksonville Beach, Fla.

"The steady pilgrimage that the Fed has been on since June 2004, with consistent 25 basis-point booster shots, is almost laughable at this point as the price of gold is soaring and the dollar is rapidly depreciating against the currencies of our major trading partners," Travis added.

Whether the Fed may raise interest rates once or even twice more before stopping, is a "guessing game [that] will likely drive much of the day-to-day volatility over the next few months," predicted Mark A. Coffelt, chief investment officer and co-portfolio manager of the $101 million Texas Capital Value & Growth Fund, along with co-portfolio manager and vice president Eric Barden. Both are employed by First Austin Capital Management of Austin, Texas, investment advisor to the fund. "Unfortunately, the U.S. market will probably end up sloshing around a bit until this uncertainty is cleared up," Coffelt added.