Quarter Ended 30 September 2008

For Q3, corporate and economic newsflow was extremely negative.  There were a few notable exceptions, i.e. newsflow related to oil and inflation.  However, volatility in the securities markets had increased significantly.  The process of the bursting of the credit bubble has been well and truly initiated

There has been a crisis of confidence with regard to the financial sector.  Investors have lost belief in the credibility of management of financial companies.  Continued asset writedowns on their balance sheets are expected.  Not only are investors lacking trust in the strength of financials’ balance sheets, but banks continue not to trust what their peers are suggesting regarding their credit worthiness.  This is reflected in the inter-bank lending market, which continues to remain at elevated levels.  The easing of the inter-bank lending market is of the utmost importance to global Governments.

There is some relief to be found in that monetary and Government authorities are aware of the risks associated with the tightening of the credit markets and have begun the process to ensure that liquidity in credit exists.  The unfortunate aspect from an investor’s perspective is that the woes of the financial sector and the bursting of the credit bubble seem to be preceding a severe economic cyclical slowdown.  Consumer confidence and retail sales figures have shown significant signs of weakness and forecasters are suggesting a year of sub-par growth on a global basis.

Investment Banks

The catalyst for the recent significant fall in the global equity markets has been the collapse and bankruptcy of Lehmans.  Lehmans at the beginning of 2008 was one of the big five US investment banks.  An investment bank by its very nature tends to have significant leverage on its balance sheet.  Once it became clear that Federal authorities were unwilling to bail out Lehmans as they had Bear Stearns and AIG, the risks associated with holding financial stocks extrapolated significantly.  The landscape for the US investment bank sector has significantly changed.  Bear Stearns was taken over by JP Morgan in the second quarter, Lehmans was allowed to enter bankruptcy, Merrill Lynch found a willing acquirer in Bank of America and Morgan Stanley and Goldman Sachs applied for banking licences, thus enabling them to take on retail deposits.

Within the global financial sector, there are some areas which are unregulated, such as hedge funds and credit default swaps.  More than anything else, it is the fear of the unknown and unregulated that is causing a collapse in share price of financial stocks.

Reduced leverage, greater regulation and lower return on equity should now be considered as the future characteristics of the financial sector.

Appian

Appian, through its 5½ year existence, has emphasised its ethos of value investing and evaluating risk.  The risks associated with the global economy and the corresponding securities markets have been reflected in our cautious and defensive stance.  We have held significant cash holdings, despite the occasional protestation from our clients which, unlike our peer group, has ensured that not only have we grown clients’ wealth over the long-term but we have also, at the appropriate time, preserved their wealth.

Despite the global credit boom, as exemplified by the Irish property market, Appian has not participated in leveraging of their investments.  This was reflected in having no CFD accounts but also in having no property assets within the Appian investment portfolio.  Property, as an asset class, can be a suitable investment vehicle at the opportune moment, but Appian’s argument has been that property on a global basis has not been appropriately priced over the last five years (this author outlined his concerns as far back as July 2004 in the Sunday Tribune).

Appian’s ethos has been to grow our clients’ wealth via reasonable returns over the long-term, to preserve their wealth and taking appropriate evaluation of the risk associated with any investment.  There continues to remain significant structural risks within the global economy.  Of particular concern remains the troubles and woes of the financial sector.  The financial sector’s role will permeate every other sector within the global economy and hence, an appropriate and diligent evaluation of risk with any future investment is required.  Value will undoubtedly appear and Appian will remain diligent with any possible opportunistic investments that may arise.

As always, we welcome the opportunity to meet with you, review your portfolio and outline our investment thoughts to you in further detail.

Pat Kilduff
September 2008