This quarter we’re removing nine funds from our recommended list and adding six.. In our opinion the best opportunities are likely to be found in the U.S. small and mid-cap growth sectors, natural resources/energy, Africa/Middle East region of the emerging markets – each of which has shown resiliency in the market turbulence to date.  We suggest remaining overweight “growth” funds relative to “value” at this juncture as well.

For those who believe the bear market has further to run, we continue to recommend modest positions in the Grizzly Short and Prudent Bear funds - maybe 15-30% stakes in aggregate. Even without “alpha”, or risk-adjusted excess return, the reduced day-to-day portfolio volatility afforded by these funds make them prudent investments.   We continue to advise against owning real estate investment trusts (REITs), high yield bonds, and other instruments heavily dependent on issuing securities to fund their operations – typically financial service companies.

Opportunities are developing in the preferred stock and fixed income arenas as credit conditions continue to deteriorate.  Municipal bonds look extremely timely from a strategic perspective, especially for investors nearing retirement in higher-tax states such as California. Though it wouldn’t surprise us to see spreads widen out further (relative to treasuries) over coming months, the combination of historically wide tax-adjusted yield spreads and the high probability of tax rate increases after the election really shift the decision from “if” to “when” investors should make purchases.

Over the next quarter we will also be looking at opportunities in the convertible preferred, trust preferred, exchange-traded debt, convertible debt and closed-end fund spaces.  While often illiquid, these securities trade on the major stock exchanges and can be purchased through most brokers for commissions similar to those paid for common stock.  As is often the case when markets collapse, these less liquid sectors have been abandoned by underwriters, market-makers and investors alike, leaving solid long-term potential for those willing to conduct the research, step in to buy and hold for years to come. 

For those interested in researching indenture provisions and company capital structures themselves, we recommend a great free resource – QuantumOnline.com.

Changes in Fund Recommendations

We’re not going to elaborate on every change we made this quarter but will provide a bit of color for what we consider to be the more interesting edits to the list.

Hennessy Focus 30 (HFTFX): this is a “swing for the fences type fund”; it’ll likely leave you either jumping for joy (homerun), or crying in yourself to sleep (strike out).  The fund’s extremely concentrated with investments in just 30 companies and a handful of industries so it’s likely to see some drastic moves from time-to-time.  Yet the long-term performance is pretty impressive, assets haven’t ballooned to levels that hinder manager Neil Hennessy’s ability to be nimble, the expense ratio is fair and it’s available as a no-transaction fee fund through Fidelity, Schwab and TD Waterhouse.  Only buy in small amounts (maybe 5-10% of your portfolio value) with a plan to hold it for years to come and you’ll likely be well rewarded.

Loomis Sayles Mid Cap Growth (LAGRX):  Momentum investments have been working since late last year and this fund has capitalized.  With investments like MasterCard and First Solar it’s easy to see that the main risk to performance is a change in investor bias from growth, back to value.  Like Hennessy, this is a reasonably priced offering in sector being favored by the market presently but vulnerable – don’t load up too heavily on it.

PIMCO Commodity Real Return (PCRAX) - A: Returns have been stellar in 2008 after a trying first four years in which the fund trailed the natural resource sector by nearly 60% cumulatively.  Unlike most natural resource funds, the PIMCO offering uses a derivative-based strategy for implementing its views.  Specifically it buys and sells contracts tied to commodity prices which could expose fund shareholders to counter-party credit risk that we would vet prior to investing.

Janus Contrarian (JSVAX):  Fund’s value-oriented style is now out of favor – time to move on.

Most of our selected funds continue to turn in solid relative performance in a down market, and that’s great.  With our current downturn showing a bounce early in Q2, now is a good time to review your portfolio.  This quarter we’re taking five funds off our selected list and recommending selling four of them.

We’d recommend looking at the following sectors for inclusion in portfolios at this time: bear market funds (small positions only), Africa/Middle East (low correlation w/ U.S.), Mortgage & Municipal Bonds.

Changes in Fund Recommendations

Deletions

Kinetics Paradigm (WWNPX) – Great fund, wrong time in our opinion.  While the fund’s bias towards global financial exchanges has added real value over the past few years, it’s likely the sector will come under increasing pressure as the slowdown builds.  We’re moving elsewhere in managed accounts and the Pariveda Wealth Advisor models.

Delafield (DEFIX) – relative out-performance has decelerated.  While the fund may continue to be a worthwhile hold over the coming quarters we’re taking it off our recommended list.

Bridgeway Small Cap Growth - N (BRSGX) – it’s extraordinary growth bias makes it susceptible to further losses in a bear market.  Will be a solid choice when the economy bottoms.

Alpine International Real Estate (EGLRX) – faced with a severe credit crunch, nothing good will come of the global real estate sectors for the next few years in our opinion.  Yields are still too low to make the sectors, at home or abroad, attractive.

Cambiar Conquistador (CAMSX) – the team here has shown they’re not savvy at investing for a down market.  As such, there’s no compelling reason to continue holding, so move on.

Additions

Jordan Opportunity (JORDX) – Concentrated, but management looks adept at searching out opportunities in both up and down markets.  While it’s probably worth the transaction fee needed to enter, plan to hold for the long-term and don’t place more than 10% of your investible assets here.

Janus Mid Cap Value Inv. (JMCVX) – Another timely offering from Janus (this time from the value side of the shop).  This is a solid long-term offering that seems to be positioned well for the downturn.  We like many of the individual stock names that currently make up the portfolio.

Royce Dividend Value Service (RYDVX) – Royce has long been a quality small cap value shop and, while the fund is relatively unknown, the management team isn’t.  We like the prospects for this offering.  Given the 50% weighting in financial service companies and the fund’s ability to hold up quite well so far this year, we think it’s got good prospects for solid capital appreciation as the current storm lifts.

Grizzly Short Fund (GRZZX) – a complement to BEARX, the Grizzly Short fund has been turning in far superior risk-adjusted returns over the past quarter and a half.  While the fund focuses more on the small cap sectors of the market, and performance relative to BEARX may trail off, it’s a good diversifier.  There’s nothing more frustrating for an investor than to get the macro call wrong and stumble on the implementation.  Diversifying among even bear market funds provides this.  Recognize that the market sensitivity of BEARX is roughly -0.80 while GRZZX sports a more volatile -1.10 beta.

We’re quite pleased with the recent performance of most of the funds on our opportunities list.  For the most part, they far exceeded the U.S. stock market’s 5.14% increase in 2007 and continue to be adding value relative to their respective benchmarks.

For all the market volatility during the fourth quarter, the impact on the relative attractiveness of most funds we track was quite minimal.  Those that had been doing well going into Q4, continued to do so. We are removing only three funds this quarter, and adding three more.

Changes in Fund Recommendations

Deletions

Janus Overseas (JAOSX) – fund closed to new investors during the fourth quarter.  We still find it quite attractive and will continue to hold in our managed accounts. We recommend individual investors do the same.  What many may not realize is that this is not a traditional large-cap overseas fund.  Instead, the Janus fund has generated quite a bit of recent excess performance through its exposure to emerging markets.

Forward International Equity (FFINX) – fund is just not performing well enough on a risk-adjusted basis for us to continue recommending it.  In all likelihood performance has been negatively impacted by the fund’s significant weighting in financial service stocks – a sector that’s come under intense pressure over the last few quarter and is likely to face difficulties going forward.  Time to move on.

SSgA Emerging Markets (SSEMX) – due to the fund’s recent becoming closed to new investors, we need to SSgA Emerging Markets from our opportunities list. SSgA’s offering has put up a marginally better record than most competitors in the sector, yet we’d continue advising investors to consider our primary recommendation in the sector, Quant Emerging Markets (QFFOX) which has slightly greater exposure to the Asian markets – a region we continue to find attractive.

Additions

Artisan International (ARTIX) – While we’d like to find a more compelling opportunity in this space, Artisan International has a long-term record of moderately out-performing the large cap international sector and with growth now strongly preferred by investors should have the wind at its back for awhile now.

Harbor International Value – Inv. (HIINX)  – Unlike Artisan, Harbor International has relatively large positions within the natural resource and industrial materials sectors, areas we continue to find attractive late into the stock market cycle due to supply/demand imbalances which remain.  Like Artisan, Harbor has had long-term success in modestly out-performing the broad international markets.  It’s a solid long-term holding in our opinion.

T. Rowe Price Africa & Middle East (TRAMX) – to start off, this fund is new, likely prone to incredible volatility and definitely not for all investors.  The regions in which it invests are growing rapidly but are the center of geo-political turmoil and notable human rights tragedies – neither of which caring human-beings are insensitive to.  So, there are a lot of issues investors need to deal with before asking the question on whether the fund is right for you.  

If you’re still with us, here are a couple of quick points.  The Africa and Middle East regions are some of the fastest growing in the world and are relatively under-owned by investors.  The fund invests in many of the largest companies in these regions.  T. Rowe Price is a well-respected investment management company, having invested in the emerging markets sector for years.  The fund does have a transaction fee, and a 90-day short-term redemption fee of 2%.  The fund will likely close when they’ve reached a modest amount of assets (say $1-2 billion).

Besides the potential for strong returns, we likely have a real diversifier here – something that isn’t as closely tied or highly correlated to U.S. growth as many other emerging markets.  Give it some thought.

Our opportunity list, shown below, is comprised solely of actively managed mutual funds that should be available through the Fidelity, Charles Schwab and TD Ameritrade fund platforms as “no-transaction fee” options.  However, if you find an error in availability, let us know and we’ll be sure to correct it next quarter.

Investors continued to rotate towards large cap growth funds and away from small/mid-cap value in Q3.  These macro trends typically tend to last for a year or more, so by our analysis we’re still early in the growth stock cycle with plenty of opportunity for readers to benefit.

This quarter we’re making only a few changes to our recommended fund lineup as most of our recommendations have been faring quite well.

Changes in Fund Recommendations

Deletions

Fidelity Real Estate Income (FRIFX) – we liked the low-risk strategy this fund had been managed to over the past few years, specifically emphasizing REIT preferred stocks for income.  However, over the past few quarters the fund’s manager has taken on more risk, veering into standard REIT shares.  The change has been both untimely and unprofitable and calls into question the overall fund strategy.  It’s not being managed in a way we had expected and it just doesn’t stack up against traditional real estate investment trust funds, so out it goes.

Diamond Hill Long-Short A (DIAMX) – Time to move on from this fund as it’s just not performing well, especially given its long-side bias towards energy which has been a strong performing sector throughout 2007.  What’s happening here?  The short-side of the portfolio has been under-performing, dominated by growth names such as Google, Panera Bread and other high-octane growth stocks which have been coming back in favor.  Given our expectation for continued out-performance for growth over value, Diamond Hill Long-Short is likely in for spell of under-performance. 

Perhaps paradoxically, we continue to recommend that investors remain invested in TFS Market Neutral.  While the fund under-performed significantly during the third quarter, during a period when many quant-based strategies came under fire, it’s our opinion that this is likely to reverse itself over the coming quarters.  Specifically, TFS invests in small and micro-cap stocks where liquidity events, such as that which occurred in August, can have a greater impact on short-term performance.  We’re comfortable with the fund’s strategy.

Forward International Small Company Inv (PISRX) – The fund’s risk-adjusted performance has really fallen off these past six months, again a likely victim of sector rotation.  Moreover the international small cap growth sector, where we’d be pre-disposed to invest funds, is rife with closed offerings.  A better alternative in our opinion would be to allocate this money to an international large cap growth offering, preferably Janus Overseas.

PIMCO Diversified Income – D (PDVDX) – at the present time, the fund is taking on a bit too much risk for comfort in our opinion, and has been spanked pretty much every time the financial markets get into trouble.  That’s not what we’re looking for at this stage in a fixed income offering, especially as the economy slows.  We’d advise moving fund to Franklin Strategic Income – A, or perhaps an international offering to take advantage of the prospects for further depreciation in the dollar.

PIMCO Emerging Markets Bond – Admin (PEBAX) – Given the tightness in spreads and the costs associated with most emerging markets bond funds we’d advise moving out of the sector at this time –the opportunities don’t justify the costs, or risks.  Instead we’d recommend either developed international bonds (Templeton Global Bond – A or Oppenheimer International Bond), or Franklin Strategic Income.

Additions

Janus Overseas (JAOSX) – Janus’ funds are on the upswing again as growth comes back into favor.  Janus Overseas is a perfect example.  It’s a hybrid fund, mixing developed and emerging markets stocks in a single portfolio – but the risk-adjusted returns are compelling.  More importantly, the fund’s performance held up well during the summer sell-off.

Oppenheimer International Bond – A (OIBAX) – a second fund in the international fixed-income space, we’d pick it over Templeton Global Bond A.  We are somewhat reluctant to recommend it if you have to pay either a load or a transaction fee (as we don’t), but for investments of $10,000 or more we think it still makes sense in light of our expectations for further weakening in the dollar.  Moreover you’re getting an excellent management team that has shown a great ability at out-performing their competitors.

Our opportunity list, shown below, is comprised solely of actively managed mutual funds that should be available through the Fidelity, Charles Schwab and TD Ameritrade fund platforms as “no-transaction fee” options.  However, if you find an error in availability, let us know and we’ll be sure to correct it next quarter.

With investors now more aggressively seeking out opportunities in the growth sectors of the market, we’ve added a few funds that you may find attractive.  Not surprisingly, Janus Capital funds are faring very well again.  The fund complex has long had a growth bias and through the first half of 2007, Janus funds have been faring quite well.  Of course we’re partial to Janus Contrarian as we hold it in our Wealth Advisor model portfolios. Its current large cap, growth bias is arguably the right place at the right time, and the fund’s performance has been quite strong for the past four years, yet Janus Orion – a mid-cap growth offering is also looking very attractive.  We’d caution against holding both in an investor’s account as the returns to both funds will likely be highly correlated.

Changes in Fund Recommendations

Deletions

Allianz NFJ Dividend Value – D (PEIDX) – while performance has been strong, and we’d continue to recommend holding for those who have already purchased, the fund closed to new investors during the second quarter.  In its place we’d recommend new investors focus their attention on FMI Large Cap (FMIHX) or Excelsior Value & Restructuring (UMBIX).

Permanent Portfolio (PRPFX) – Risk adjusted returns have fallen off for this conservative asset allocation fund over the past six months.  While Morningstar continues to rate it “5 stars”, and it may remain a sound choice for more conservative investors, we believe there are better opportunties in funds like Oakmark Equity Income (OAKBX).

Baron Partners (BPTRX) – concentrated holdings make this a difficult fund to hold when it goes out of favor, which seems to be happening now.  We’d exchange for Janus Orion (JORNX), or Kinetics Paradigm (WWNPX).

Quant Foreign Value (QFVOX) – a solid fund we’ve owned for quite awhile in our models.  As value continues to rotate out of favor, we’d suggest exchanging for Forward International Equity (FFINX).  It’s unlikely that Quant can continue to deliver market-beating performance in the face of a strong headwind against its sector biases.

Additions

 Amana Trust Income (AMANX) – solid long-term performance, reasonable diversification, and a relatively small asset base ($250 million or so) make this fund a nice addition to an investor’s large-cap allocations. 

FMI Large Cap (FMIHX) – surprisingly this large-cap fund has remained relatively undiscovered by investors, yet its performance on a risk-adjusted basis is commendable – especially considering its concentration (roughly 20 assets). With only a bit over $500 million in assets, FMI retains the flexibility to move but turnover has been only modest, pointing to solid stock-picking ability. 

Excelsior Value & Restructuring (UMBIX) – with a tilt towards large-cap value, Excelsior Value & Restructuring is an attractive complimentary fund to Janus Contrarian.  Again, performance has been solid, if a bit volatile.  Our concern is that at close to $10 billion in assets, the opportunity for adding value may be reduced marginally going forward.

Janus Orion (JORNX) & Heartland Select Value (HRSVX) – while Heartland Select has added value over time, of the two Janus Orion looks the more timely option at this time.  Combine the two for coverage of the mid-cap value and growth sectors.

Forward International Equity (FFINX) – This is a nice growth-oriented, international investment option with a very small asset base (less than $60 million).  The fund should provide solid performance in a growth-led environment.

SSgA Emerging Markets (SSEMX) – there aren’t a lot of options in no-load, no-transaction fee emerging markets funds available through Fidelity, Schwab or TD Ameritrade, but the State Street Global Advisor Emerging Markets fund will provide robust coverage of the sector, and has shown an ability to generate “alpha” over time.  That said, we’d remain partial to Quant Emerging Markets (QFFOX) if its available to you on a no-transaction fee basis.

Matthews Korea (MAKOX) – Korea has been one of the cheaper Asian emerging markets for the past four or five years.  In fact, the Matthews Korea fund sports an overall P/E ratio of just 12.3x prospective earnings.  While performance has been erratic over the recent past, the diversification benefits shouldn’t be overlooked. We’d recommend tucking a small position (2-5%) away in investor accounts, as a contrarian long-term investment.

With the economy slowing and sector leadership waning, investor interests may be best served by considering funds, and management teams, that have shown a knack for good, old-fashioned stock-picking.  Here’s an updated list of what we find attractive at present and a few thoughts as to why these funds might make sense in your portfolio.

If you recall, we added “bear market” and “market neutral” investment options to our list at the beginning of July 2006.  Not the most auspicious time to do so, but we’re not just looking for funds that “zig when the market zags”.  In order to make the list, these funds have to provide not only downside protection to a portfolio, but also a modest level of risk-adjusted excess return, or alpha.  So, even if we get the ensuing market direction wrong, our market neutral and bear market funds have a good probability of mitigating directional bias. 

As it turns out, a good example of a fund with these characteristics is the Prudent Bear fund we mentioned in July.  From our work, the fund’s beta relative to the U.S. market was roughly -0.75 over the past year (through March 31, 2007).  Given the broad U.S. stock market returned positive 11.28% over the last 12-months, one would expect Prudent Bear to have lost roughly 8.4%.  Yet the fund generated positive returns of 7.4%.  This difference of 15.9% would have allowed one to both insulate an investment portfolio to short-term moves on the downside while capturing a good deal of the market’s upside.  We like that.

We present all three of the market neutral and bear market funds we recommended last July in the table below along with two funds we’d be unlikely to hold in either model portfolios, or client accounts, namely the Rydex Inverse S&P 500 and ProFunds Bear funds.  The column marked “Beta Implied 1-year Return” is an estimate of the return an investor should have expected from just fund’s beta exposure to the broad market.  The fund’s “Excess Return” is simply the difference between the fund’s total return and its Beta Implied 1-year Return.

A logical question that might arise – why do both the Rydex and ProFunds offerings show any positive “Excess Return”, given that they both attempt to mirror the overall market in the opposite direction?  The answer stems from two sources.  First, part of this benefit is due to the strategy that each employs - investing the proceeds from shorting futures in risk-free short-term obligations.  This accounts for maybe 5% of each fund’s total returns and, given that Prudent Bear is roughly 75% short, about 3.75% of the excess return generated by this fund as well.  The remainder of the excess return generated by Rydex and ProFunds can be attributed to the mis-match between the S&P 500 Index and the Russell 3000 index.

We’d be unlikely to recommend, much less hold, either the Rydex or ProFunds offerings simply because we don’t place much faith in our abilities at accurately calling the direction of the overall market over the short term  – and that’s what benefiting from these funds requires. Yet in cases where an active market neutral or bear fund manager shows an adept ability to add modestly consistent excess return we’re more interested, as that excess return (assuming it persists) actually mitigates the risk if our directional biases are wrong.

Our opportunity list, shown below, is comprised solely of actively managed mutual funds that should be available through the Fidelity, Charles Schwab and TD Ameritrade fund platforms as “no-transaction fee” options.  However, if you find an error in availability, let us know and we’ll be sure to correct it next quarter.

Changes in Fund Recommendations

Deletions

Chase Growth, Hillman Focused Advantage (CHASX & HCMAX) – both fund’s risk-adjusted returns have fallen off markedly since last July.  We recommend swapping out of each into Janus Contrarian (JSVAX) and/or Allianz NFJ Dividend Value – D (PEIDX).

Fidelity Value Discovery (FVDFX) – still producing solid returns, we recommend continuing to hold in taxable accounts, but we’d rather dedicate new money to either Kinetics Paradigm (WWNPX), Kinetics Small Cap Opportunities (KSCOX), or Delafield (DEFIX).  Realize the overlap between Kinetics Paradigm and Small Cap Opportunities is sizeable, so we’d select either one or the other.

James Equity & James Small Cap (JALCX, JASCX) – deterioration in both funds merit a move to greener pastures.  We suggest Delafied (DEFIX) for owners of James Equity and Cambiar Conquistador Inv. (CAMSX) for James Small Cap holders.

Touchstone Small Cap Value Opportunities (TSVOX) – Shorter term prospects might be brighter with Cambiar Conquistador Inv. (CAMSX) or Royce Value Plus Service (RYVPX).

Fidelity International Discovery (FIGRX) – fund has closed.  We’d recommend continuing to hold but new money is advised to look to Quant Foreign Value (QFVOX).

Additions

Janus Contrarian (JSVAX) – it looks like Janus is getting its groove back, and Contrarian is one of the timeliest of their offerings.  Solid risk-adjusted returns for the past few years add to its attractiveness.

Allianz NFJ Dividend Value – D (PEIDX) – steady, consistent performance along with a modest expense ratio make this fund attractive in the large-cap value sector.

Delafield (DEFIX) – a solid way to get mid-cap value exposure.  Much more cyclically positioned than either Kinetics Paradigm (WWNPX) or Kinetics Small Cap Opportunities (KSCOX) and hence a likely complement to either.

Royce Value Plus Service (RYVPX) – a nice small cap opportunity, Royce has done a great job with many of their small cap offerings and Value Plus Service is both well diversified and most timely.

Cambiar Conquistador Inv (CAMSX) – a relatively unknown fund with only $63MM under management, he performance has been solid since inception. This looks like a good opportunity to get in on the ground floor though the ride may be bumpy at times.

Fidelity Real Estate Income (FRIFX) – a nice conservative offering that seems to be completely misunderstood by Morningstar, who give it a one-star rating.  The fund invests in preferred shares of real estate companies (REITs and operating companies) and is much more comparable to fixed income offerings than other REIT funds.  A good fund for those seeking retirement income with some upside.

Alpine International Real Estate (EGRLX) – in our opinion the U.S. REIT sector is both picked-over and over-priced relative to the risk inherent in the sector.  However, international REITs are in their infancy and, as the market develops, we’d expect a lot of opportunities for early investors.  The yields are currently low, but expected to rise over the next few years as the REIT structure matures overseas.  Funds in this sector are not without risk, but tuck this fund away for five years and we think you’ll be well rewarded.

Waning investor enthusiasm merits a re-assessment of the risks one is willing to take in their portfolios.  While we continue to like the sectors, we’d recommend investors consider scaling back exposure to emerging markets, international small caps and dedicated natural resource funds to an aggregate 15% or less in total portfolio weight.

This quarter we’re adding coverage of a few additional alternative sectors, namely “bear market” and “market neutral” funds.  Bear market funds are portfolios positioned to benefit from the downturn of an entire market, specific sectors, or individual companies.  Market neutral funds combine long and short positions so that the portfolio’s total return is less dependent on overall market conditions and driven more by the manager’s ability to ferret out relative attractiveness amongst companies.  Both types of funds can play instrumental roles in safeguarding portfolios during market downturns.

Changes in Fund Recommendations

Deletions

Neuberger Berman Partners (NPRTX) – relative performance has been lagging of late.  Recent increase in cyclical exposure has shown to be untimely.  Probably a good longer-term holding however.

Fidelity Focused Stock (FTQGX) – while performance remains solid, we’re swapping for what we consider to be a slightly better option, Fidelity Value Discovery.

Additions

Permanent Portfolio (PRPFX) – this is a really nicely diversified, moderate risk portfolio.  Manager Michael Cuggino manages to pack a lot of punch into a portfolio that holds cash, bonds, stocks and precious metals.  We find the consistency of returns extremely compelling at this juncture.

Fidelity Value Discovery (FVDFX) – this is a large-cap growth fund that works in this environment.  Specifically the fund looks for big companies with valuations that have faltered owing to (hopefully) short-term, and correctable, setbacks.   Names recently in the portfolio included AIG, Altria, Pfizer, and AT&T.  While the fund is relatively new, having been launched at the beginning of 2003, we’re pretty comfortable with the manager’s style and effectiveness.

TFS Market Neutral (TFSMX) – small, undiscovered market-neutral fund, offered through Fidelity, Charles Schwab & TD Waterhouse platforms.  The fund is a nice complement to many of the cyclically biased funds we’ve been fond of as TFS Market Neutral is currently positioned with very limited “net” exposure to cyclicals. The fund emphasizes small-cap offerings, both long and short, and has put up an excellent track record.

The negatives - the fund has a very limited history, having first been offered in late 2004, there is a minimum initial purchase of $5,000, a relatively high management fee (2.49%), and a transaction fee for purchasing shares through the aforementioned platforms.  Furthermore, those holding for less than 180 days will incur a 2% redemption fee.

Diamond Hill Long-Short A (DIAMX) – if we had to pick one market neutral fund for inclusion in our portfolio, it would likely be Diamond Hill.  The track record is excellent, the philosophy clear, and the fees reasonable.  Additionally, Diamond Hill’s large cap focus should complement the small-cap focus of the TFS Market Neutral portfolio.  Minimum purchase of $10,000 may make Diamond Hill Long-Short prohibitive to some, but we like it.

Prudent Bear (BEARX) – Perhaps the best known of the short-only funds, Prudent Bear has turned in an enviable track record over the past four years  While the short-sale bias of the fund may be of concern to investors, the management team has generated returns over and above what would be expected had they just shorted the general market.  They’re good at what they do.  Paradoxically, adding such a fund to a portfolio holding predominantly long-only positions can both lower market sensitivity and increase returns in a relatively static market environment.

Previously Recommended Closed Funds

The table below presents our current thoughts on funds previously presented in our recommendation table that were removed due to closing.  Though closed to new investors we suggested that existing investors continue to hold each as we still found them attractive.  Here we update our thoughts on these offerings. Once we recommend swapping out of the funds in our list below, they will be removed from record the following quarter.

If you have any questions on the broad markets or individual sectors, please feel free to e-mail us at InvOutlook@pariveda.com. Until next quarter, best wishes for continued investing success.

We’re making only modest changes to our sector and fund recommendations this quarter.  A few shifts in sector outlooks brought about by relative performance and fund changes precipitated primarily by recent fund closings.

Changes in Sector Recommendations

Our sector recommendations reverse course this quarter, as investor willingness to take risk translated once again into strength in small and mid-caps versus their large cap counterparts. 

Large Cap Growth (downgrade) – we’re nudging down our rating for the large cap growth sector this quarter.  Valuations are moderately attractive here, but investor interest has been limited.  In our opinion, it’s tough for investors to get overly excited about the modest growth expectations for many of the market’s leading growth bellwethers.

Small Cap Growth/Small Cap Value (upgrade) – after a few quarters rest investor enthusiasm for small cap stocks re-emerged in the first quarter of 2006.  Expectations for large earnings increases seem to be the driver, though in our opinion these earnings expectations are becoming increasingly fraught with uncertainty.  Still, market action dictates that we remain overweight small caps with a bias towards the growth side.

Emerging Markets – Asia/Far East (upgrade) - this quarter we’ve broken out our emerging markets coverage to include three regional sub-categories. In our view, the Asia/Far East region presents the greatest opportunity for investors at present owing to a lackluster 2005, strong secular growth trends and modest valuations.

Changes in Fund Recommendations

Deletions

Rainier Small/Mid Cap Equity (RIMSX) – fund closed to new investors, so we’re swapping out of it for one that is open.  If you hold this fund, continue to do so, as it’s a well diversified offering with performance that has been exceptional.

Oppenheimer International Small Company A (OSMAX) – another closed fund.  Again, performance continues to impress with astute sector positioning so we’d recommend continuing to hold.

Oppenheimer Developing Markets A (ODMAX) – shut out again!  Same story, different fund.  If you own this diversified emerging markets offering, continue to do so as the managers have shown a real knack for identifying profitable opportunities globally.

Additions

Baron Partners (BPTRX) – Ron Baron and crew have done an excellent job with this fund over the past few years and their streak continues into 2006.  While the fund lacks diversification in terms of sector exposure and individual names, we’re comfortable recommending it as a “supporting fund” in reader portfolios.  Try to keep exposure limited to under 15% of your entire portfolio however, perhaps supplementing it with Kinetics Paradigm for mid-cap exposure.

James Equity (JALCX) – we’re supplementing our top recommendation in the mid-cap value space with James Equity this quarter.  In our opinion it’s a second tier fund behind either Kinetics Paradigm or Baron Partners, yet worthy of mention due to its eclectic, value-oriented mix.

Constellation Small Cap Value Opp (TSVOX) – we’ve owned this fund in client portfolios for the past six months or so and have been impressed with the manager’s ability to buffer downside risk over that time period.  Constellation Small Cap’s recent out-performance can be primarily attributed to adept sector selection, as the fund is heavily weighted in financial services and industrial materials, both of which have performed well over the past year.

Forward International Small Company (PISRX) – as a replacement for Oppenheimer International Small Company we suggest readers consider this fund.  Performance has been solid, but perhaps not quite as good as Oppenheimer’s over the past few years, yet the attractiveness of the sector more than makes up for holding this arguably second-tier offering.

Quant Emerging Markets (QFFOX) – from the family that brought you Quant Foreign Value, we offer readers their emerging markets fund as a replacement for Oppenheimer Developing Markets (closed this quarter).  Like Forward International Small Company, our interest in Quant Emerging Markets has more to do with gaining sector exposure than the merits of this particular fund.  Still you’ll be hard pressed to find better qualified diversified emerging markets offering that remains open at this time.

Previously Recommended Closed Funds

The table below presents our current thoughts on funds previously presented in our recommendation table that were removed due to closing.  Though closed to new investors we suggested that existing investors continue to hold each as we still found them attractive.  Here we update our thoughts on these offerings. Once we recommend swapping out of the funds in our list below, they will be removed from record the following quarter.

If you have any questions on the broad markets or individual sectors, please feel free to e-mail us at InvOutlook@Pariveda.com. Until next quarter, best wishes for continued investing success.

Our apologies for failing to update this section with the end of the year update.  Happily, there are only a few changes to report at the time of this writing (March 3, 2006).  We’ll be updating more extensively at the end of this quarter. 

Times change and we’re here to stay on top of the latest trends in the financial markets.  This quarter we’re downgrading three U.S. market sectors and upgrading two.  We’re also making quite a few changes to our recommended funds, both additions and deletions, so have at it!

Changes in Sector Recommendations

Large Cap Growth (downgrade) – in our opinion large cap growth share valuations remain stretched relative to the prospects for growth for the companies that make up the sector.  Declining earnings estimates and poor relative strength over the past year only support our fundamental assessment.

Large Cap Value (downgrade) – the large cap value sector has performed admirably over the past few years, but the relative strength of the group has been deteriorating over the past six months.  We’re taking this opportunity to downgrade the sector to neutral from attractive.

Mid Cap Growth (upgrade) – mid cap growth stocks, including technology, have had a good run over the past six months and momentum remains positive at this time.  While we’ll look for opportunities outside of the technology sector due to continuing lackluster growth prospects, we’re upgrading the overall sector to very attractive from attractive.

Small Cap Growth (upgrade) – it looks to us like the small cap value run over the past few years may be rotating to favor growth. Though the market continues to favor mid over small cap growth stocks, we’re upgrading the small cap growth sector from attractive from neutral.

Small Cap Value (downgrade) – relative strength of small cap value stocks has been deteriorating over the past six months.  While we remain biased towards smaller companies over large-caps on a fundamental basis, a downgrade of the sector from attractive to neutral is prudent at this time.

Changes in Fund Recommendations

Deletions

Baron Asset (BARAX) – better opportunities in Fidelity Focused stock at this time (FTQGX).

Artisan Mid-Cap Value (ARTQX) – fund closed to new investors so we’ll look for opportunities elsewhere.  If you hold the fund, we’d recommend continuing to hold it at this time.

Schroder U.S. Opportunities  Inv. (SCUIX) – better opportunities to be found in micro-cap growth stocks.  Both Bridgeway Small-Cap Growth N and Perritt Micro Cap Opportunities fit this bill better.  If you currently hold Schroder, we’d recommend continuing to do so as it’s a solid fund.

Wells Fargo Advantage Small Cap Discipline Inv. (SCOVX) – name is simply too long for our liking.  Actually while it may be hard to find, we believe our new addition (PVFAX) to be a far better offering.

Artisan International Value (ARTKX) – better prospects elsewhere.

Excelsior Emerging Markets (UMEMX) – while we just added this fund to our recommended list last quarter, we recommend exchanging it this quarter for Oppenheimer Developing Opportunities A.

Loomis Sayles Bond (LSBDX) – great fund.  If you own it, it should continue to serve you well.  We’re removing it from our recommended list due to its changing from an “no transaction fee” fund to a “transaction fee” fund with a higher minimum purchase.  TD Waterhouse investors may still have access to Loomis Sayles Bond without a transaction fee.

Additions

Fidelity Focused Stock (FTQGX) – this looks like a long-term winner.  Manager Robert Haber took over the fund in February 2004 and has simply turned it around.  Fidelity Focused holds concentrated positions in Haber’s best ideas, meaning that it can volatile over short periods.  Yet with only a bit more than $100MM in assets, it has something most other Fidelity funds don’t – the agility to move in and out of positions quickly.  Turnover has been high, so this fund is best suited for tax-deferred accounts.  While Morningstar rates this fund only 2 stars due to the longer-term track record, we’d be a buyer at this time.

Perritt Micro Cap Opportunities (PRCGX) – No household names here! As the name implies this fund holds shares in the smallest companies traded on the U.S. stock exchanges.  Companies with small profiles, but high P/E’s and big prospects.  We like the micro-cap sector of the market at this stage of the business cycle because the economy is growing, yet skilled labor remains available and affordable.  Additionally, in environments where investors are willing to take risk, which is the case today, micro caps can really soar while adding some level of diversification. 

Paradigm Value Fund (PVFAX) – we’ll state upfront that we have no idea if this fund is available to individuals through any of the leading brokerages mutual fund supermarkets yet…so you’ll have to research this yourself.  What we do know is that the fund has turned in excellent results in its first 2 ½ years in existence. If you have to buy it directly from the company, that may not be a bad option since strong performing small cap value funds open to new investors are extremely hard to find.  Paradigm Value is well diversified with moderate turnover and a current emphasis on business services, industrial materials and consumer service companies.

Fidelity International Discovery (FIGRX) – Nothing flashy here, but the performance has been consistent and, over time, that’s tough to beat.  We’ve recommended holding this fund in both the Cisco and Oracle 401(k) plans for some time now and, though large, the fund’s managers have been adept at generating better-than-market returns with lower-than-market risk.  International Discovery focuses its efforts on large cap international stock and sports a value bias.

Oppenheimer International Small Company A (OSMAX) – a keeper.  Oppenheimer has really done a good job with its international funds and we’re recommending not one, but two this quarter.  The first, International Small Company has turned in a fabulous record over the years out-performing the sector by a wide-margin.  But we recommend buying only if you can get it, or another class of the fund, without a load. (As advisors we’ve been able to purchase this without a load to date.)  If you can’t buy without a load we’d recommend Driehaus International Discovery (DRIDX) in its place. 

Oppenheimer Developing Markets - A (ODMAX) – again, a keeper. Similar to Oppeheimer International Small Company but instead with a bigger emphasis on emerging markets. Again, we’d recommend purchase if you can pick it up without a load.  If not, stick with Excelsior Emerging Markets (UMEMX).

PIMCO Diversified Income – D (PDVDX) – as our replacement for Loomis Sayles bond which we took off the recommended list this quarter, we’d advise investors to look to the PIMCO Diversified Income fund.  In a rising interest rate environment, what we like best about this fund is its flexibility in seeking out opportunities globally in whatever sector the manager’s see fit.  PIMCO is the biggest bond shop in the country and it expends a lot of efforts in ferreting out fixed income opportunities to both protect principal and provide upside.  This fund has done both over its short lifespan.

If you have any questions on the broad markets or individual sectors, please feel free to e-mail us at InvOutlook@Pariveda.com. Until next quarter, best wishes for continued investing success.