Client Letter - 8/30/07

To our clients,

Here is a general update on our thinking regarding current market volatility and the impact on your portfolio.

Rapid deterioration in the housing/sub-prime mortgage and low-grade corporate debt markets has created a large amount of uncertainty in the stock market, as well as forecasts for growth in the U.S. economy. In February and again in June of this year, there were indications of problems surfacing, which created small and short-lived stock market corrections. In both cases the markets recovered within days and resumed the upward trend toward new highs. As managers, this process has been frustrating, as the opportunity to find values was short-lived; not the sign of a healthy market. Just as risk was not accurately priced into inherently risky debt securities, the stock market has also been mispricing risk. While not yet a bear market, this correction is starting to bring risk premiums back in line.

As you know, we have designed portfolios that are conservative and diversified to include only companies that meet our stringent Return on Capital and Valuation parameters. We have always used appropriate risk premiums when evaluating our holdings and consistently focused on preservation of capital in the post stock market bubble-9/11 environment. Economic expansion and global growth has encouraged us to stay fully invested, even though troubles in housing and mortgage markets have been brewing for some time. While we remain conservative, we believe there is opportunity in this market for both buying and selling. We have identified several companies we would like to own and, when appropriate, are using current cash, plus proceeds from sales, to fund purchases.

Almost all of the holdings in the portfolio at the time the market peaked on July 19th have outperformed the S&P500 during this decline, with several of our stocks moving higher. Our bank holdings, US Bank and TCF Financial, while remaining volatile, have managed to outperform the market since this correction began. TCB and USB are both very conservative banks with good balance sheets and very little exposure to sub-prime lending. When considering bank stocks over the last several years, we have intentionally avoided anything with significant residential mortgage exposure. Even so, all bank stocks have been affected due to the volatility of credit markets. Declines this year have enhanced the dividend yields on TCB to 4% and USB to 5%, which may tempt us to add to one or both of these positions at the appropriate moment. Moody’s continues to be our most volatile holding, but still appears significantly undervalued. We are keeping our options open given the “headline risk” associated with rating agencies over the sub-prime fallout. It will continue to be highly volatile as long as credit concerns remain in focus.

In summary, our portfolios are performing as expected in this environment. We think the housing and credit markets have further trouble ahead and believe that uncertainty will continue to plague the markets into 2008. This necessary (and long overdue) process will correct an inflated real estate market and eliminate dangerous consumer lending practices. While we see opportunities developing, we will continue to be careful with our investment decisions in an effort to protect capital.

Please feel free to call us with any questions.