January 11, Dear Investment Partner:

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1 January 11, 2016 Dear Investment Partner: During 2015, the S&P 500 Total Return Index increased +1.4% (including dividends), its worst year since Excluding its best performing eight stocks which include FANG: Facebook, Amazon, Netflix, and Google, the S&P 500 would have been down over -4%. On a sector basis, energy (-21.1%) and materials (-8.4%) stocks performed worst, while consumer discretionary (+10.1%) and health care (+6.9%) stocks performed best. There was nowhere to hide amongst risk assets; the Bloomberg commodities index returned -24.7%, emerging markets equities %, small cap U.S. stocks -4.4%, high-yield bonds -2.7%, and developed market equities - 0.4%. On December 16 th the Federal Reserve raised interest rates for the first time in nearly a decade, actualizing the most anticipated rate hike ever. Anticipation of the hike led to a rising U.S. dollar (USD), which ended the year up +9.3% versus a basket of major currencies. The commodities price rout deepened, with oil ending the year at $38 per barrel, down over 66% from its June 2014 peak. The sharp decline in commodities prices has hit producing nations particularly hard; countries as diverse as Brazil, Russia and Saudi Arabia are facing dire economic times. Global investors have renewed their focus on credit risk, particularly for indebted corporates and sovereigns most exposed to commodities and/or USD-denominated debt. The result has been a sell-off in the riskiest credit sectors, including emerging market and high-yield debt. Rising U.S. interest rates have also depressed equity values for small cap companies, which generally rely on more debt financing for growth. Even as financial markets faltered, U.S. economic data remained robust. U.S. real gross domestic product (GDP) expanded at a 2.0% in annualized pace during the quarter, slowing from 3.9% during the second quarter. Jobs growth accelerated sharply, with the economy adding ~850K jobs in the fourth quarter, up from ~500K in the third quarter. The unemployment rate fell to 5.0%, a seven-year low. Consumer confidence remained robust as jobs growth and lower gas prices enabled optimistic consumers to make bigger purchases. Auto sales had their best year ever in The Institute for Supply Management s (ISM) non-manufacturing Index which measures services sector business activity logged its 71 st consecutive month of expansion in December. According to the ISM Manufacturing Index, manufacturing activity has slowed, contracting in November and December. Housing starts remained robust at 1.15 million annualized in November, while existing home sales declined, in part due to delayed closings resulting from the implementation of new consumer protection rules related to mortgage disclosures. According to the S&P/Case-Schiller nationwide home price index, home prices grew at an annualized 5.2% through October. On a nationwide basis, housing affordability remained high, with the average mortgage payment making up just 13.6% of household income in November, well below the 40-year average of 19.6%. Consumer balance sheets are strong, with the average U.S. household net worth at record highs and the average household debt This presentation is intended for description purposes only. It does not constitute an offer to sell or the solicitation of an offer to buy any securities, nor will any sale of a security occur in any jurisdiction where such an offer, solicitation or sale would be unlawful. Past performance is not necessarily indicative of future results. Form ADV Part II is available upon request.

2 service ratio at 10%, near 35-year lows. While GDP growth remains subdued for an economic recovery, the U.S. economy is in the best shape amongst developed economies. According to the International Monetary Fund (IMF), world economic growth slipped to its slowest pace since 2009 last year. China is the nexus of global financial and economic worries. The economic slowdown, combined with policy unpredictability and high debt levels, are weighing on global investor sentiment. The People s Bank of China s (PBOC) unexpected yuan devaluation in August wrecked so much havoc on global financial markets as well as accelerated capital outflows that the Chinese government stepped in to reassure markets about its commitment to a stable currency. However, similar to its rhetoric regarding liberalizing financial markets while intervening heavy-handedly in the stock market, its commitment to a stable currency is being questioned. The yuan trades at its lowest level versus the USD in five years and continues to slide. While this makes exports more competitive, it has led to a decline in other emerging markets currencies versus the USD, as well as accelerated capital outflows by investors shunning yuan-denominated assets. Over the past twelve months, an estimated $500 billion has left China. An increasingly concerned government cracked down on China s biggest underground banking network in November, sending a clear message to rich Chinese that circumventing currency controls would not be tolerated. While the services sector continues to expand, manufacturing continues to suffer from overcapacity. After five interest rate cuts and the loosening of lending requirements, home prices have slowed their decline or stabilized in most major cities. While domestic consumption expands, renewed business spending and investment requires greater policy certainty. The government s seemingly erratic interventions in the financial markets and economy are hurting confidence. Even China s vast economic and financial resources cannot compensate for the vital role of investor confidence in a market economy. The Eurozone continues to muddle through. In an effort to boost inflation and economic growth, on December 3 rd, the European Central Bank (ECB) extended its 60 billion euro a month bondbuying program by six months, at least through March Prolonged Eurozone monetary easing coupled with monetary tightening in the U.S. will continue to pressure the USD/Euro exchange rate, currently at $1.07, with some strategists expecting parity later this year. Eurozone unemployment continued to improve, reaching 10.7%, down from its 12.3% peak in May The Eurozone Purchasing Managers Index for manufacturing and services indicated the fastest growth in the four-plus years during the fourth quarter. Bank lending is improving and economic confidence has reached four-year highs. The ECB s monetary stimulus seems to be working its way to firms and households, which bodes well for economic activity going forward. However, China is Europe s second largest export market (after the U.S.), so an economic slowdown there will inevitably impact European exports, although a cheaper Euro will offset some demand decline. Venture capital funding reached a record $100 billion in the first nine months of the year. While private market valuations continue to reach new records, the initial public offering (IPO) market slowed sharply as companies pulled their filings amidst equity market volatility. Proceeds from global IPOs totaled $156 billion in 2015, down 35% from At the same time, global mergers and acquisition (M&A) activity topped $5 trillion for the first time ever in 2015, up +37% from As fewer companies choose to go public and a greater number of 2

3 public companies are acquired, the number of U.S.-listed publicly traded companies has fallen from 8,823 in 1997 to 5,297 today. Buyout multiples on average have exceeded 10x EBITDA, the highest since before In the past twelve months, S&P 500 companies spent more on buybacks than they generated in free cash flow. The pace of share buybacks is not sustainable; there are growing concerns that widespread stock buybacks are propping up stock markets. The S&P 500 forward price-to-earnings ratio is at 16.1x, near its 25-year average. Stocks are fairly valued, and undervalued when compared to other asset classes, particularly when taking into account risks to bonds from rising interest rates. While the rising USD and uncertainty in emerging markets will weigh on earnings for U.S. corporations, these factors are priced in to current stock prices. According to Investment Company Institute (ICI) data, investors withdrew $170 billion from domestic equity mutual funds and $34 billion from taxable bond funds during Over the same period, investors added nearly $100 billion to global equity mutual funds. U.S. corporations and individuals continue to hold record levels of cash. When volatility abates and/or risk appetite returns, equities should fare well. While downside risks to global economic growth and financial markets remain, the U.S. economy is on good footing, even with signs of bubbles forming in certain pockets of the economy. A great rotation out of bonds into other risk assets, such as equities, is yet to occur. At the end of 2015, investors started liquidating bonds at an accelerated pace, moving proceeds into cash. We continue to believe that, for patient long-term investors able to tolerate short-term price volatility, select domestic equities are compelling investments, in part due to overly depressed valuations. Business Update "Everything should be made as simple as possible, but not simpler" Albert Einstein I could improve your ultimate financial welfare by giving you a ticket with only twenty slots in it so that you had twenty punches representing all the investments that you got to make in a lifetime. And once you d punched through the card, you couldn t make any more investments at all. Under those rules, you d really think carefully about what you did and you d be forced to load up on what you d really thought about. So you would do so much better. Warren Buffett Recently we marked our fifth year in business. We took this milestone as an opportunity to question everything about the way we do business. It is natural to be pulled in multiple directions by day-to-day business operations. While most firms in our industry are shaped by the day-to-day, we launched this business with the goal of doing things differently. We wanted to offer investors an alternative approach to building long-term wealth. We must admit that the day-to-day including demands from clients and potential clients as well as suggestions from service providers and product salespeople has inadvertently impacted the way we do business. And we don t like this. It has pulled our focus away from the things that truly matter our individual investments and our individual clients to running a firm that meets everybody s needs. We have decided to take a step back to analyze the 3

4 shape and trajectory of our business during the past 5 years in order to move forward. Our explicit aim is to make things as simple as possible, but not simpler while keeping our fiduciary responsibility to our clients. To this end, we have made major changes over the past several months. We are confident that the changes outlined below by streamlining our business and focusing more of our attention on research and investing will allow us to better serve existing and future clients. First, we have eliminated our office space. We had thought clients would like a place to visit and meet, while in reality, clients and prospects prefer that we come to them. Additionally, we are no more productive with research and trading in a solo office than we are at home or on the road. Second, we have reduced our investment strategies to two a concentrated taxable strategy and a concentrated retirement strategy. These concentrated long-term investment strategies reflect our contrarian value-oriented investment approach. As Warren Buffett s quotation above implies, limiting one s focus to fewer investment opportunities is a better albeit more volatile long-term approach. We will always be focused on business fundamentals and estimating the intrinsic value of our investments. We plan to be less harried by minute-by-minute market moves in the future. While macro developments will inevitably feed into our investment decisions, they will never drive our investment philosophy. Third, this will be our final public investor letter. We will continue to provide clients with a detailed quarterly client memo that discusses portfolio developments. Even though we will no longer opine on short-term macroeconomic developments, we will always be reading about and analyzing financial markets. While the research and knowledge is useful for us, we believe the letter adds little value for our clients. Fourth, we have reduced our business offerings to two. The first is investment management in our concentrated taxable or concentrated retirement strategy which is only appropriate for long-term clients with tolerance for volatility. The second is consulting services which vary based on client needs but are increasingly focused on individuals with complex finances and investments or businesses seeking strategic or financial advice. Fifth, we plan to maintain RIA registration in California and New York. We are eliminating our registration in Texas at the end of We have clients in other jurisdictions; however, we are not currently required to register in these states. We will continue to consider taking on clients in other jurisdictions, as permitted by regulations. We will soon be updating our website to reflect changes to our firm ( More than ever, we will be relying on word of mouth and referrals to generate new business, and appreciate you keeping us in mind for your or your acquaintances financial needs. As always, please feel free to get in touch if you have any questions or would like more information. Wishing you a prosperous New Year! Sincerely, 4

5 Amil A. Bera Founder, Chief Investment Officer Advaya Investment Management 55 Page Street #612 San Francisco, CA (415) Tel (415) Fax 5