One Northfield Plaza, Suite 470 Northfield, IL 60093 (847) 282-3800 www.dlscapital.net DLS Global Equity Composite 2013-Q2 Commentary The DLS Global Equity Composite produced a net loss of 0.4% for the quarter ending June 30, 2013 versus the S&P 500 Total Return Index which was up 2.9%. Our gross and net performance over multiple time frames is shown in the following table. Returns for Periods Ending June 30, 2013 Absolute Return Annualized Compounded Return Quarter YTD 3 Years 5 Years Since Inception* DLS Global Equity Gross -0.2% 1.1% 2.3% -0.8% 12.2% DLS Global Equity Net* -0.4% 0.6% 1.3% -1.8% 11.1% S&P 500 Total Return 2.9% 13.8% 18.4% 7.0% 8.6% * Net returns are proforma and assume a 1% management fee (applied 1/12 th per month). Since inception represents performance from March 2003. In previous quarters we have tried to explain this underperformance using a chart of the valuation differences between Staples (overvalued) and Cyclicals (undervalued). Recently we received a chart from JP Morgan s chief strategist that shows this relationship in a new way. We thought we would share it with you. We believe this chart explains a lot about recent performance but it also quantifies a significant multi-decade opportunity in the Cyclical sectors. This is an example of a tail valuation metric that we have profited from in the past. This chart also illustrates risk aversion. We see similar illustrations of risk aversion in emerging markets equity indices (e.g. EEM) which are also at 30-plus percent discounts to developed market indices (e.g. SPX) valuations. 190% S&P 500 Cyclical / Defensive Sectors LTM P/E 170% 150% 130% 110% 90% March 2011 peak DLS performance relative to market 70% 50% 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012 Source: J.P. Morgan and DataStream. Note: Cyclical = Industrials, Discretionary, Technology, Materials. Defensive = Healthcare, Staples, Utilities, Telecom. Data as of 5/13/2013. One critical difference in this chart versus the ones we have shown in the past is the time frame. JPM includes data from 1973 and shows that the valuation of Cyclicals versus Staples is at the lowest levels in 40 years. Our underperformance since our March 2011 peak (both absolute and relative to market) corresponds with this rapid decline in Cyclical valuations from norms to extremes.
Page 2 of 6 Typically, these periods of extreme undervaluation are short in duration and are followed by good returns. The past four periods where this Cyclical PE/Defensive PE Ratio dipped below 75%, the Cyclical index responded with 3-year returns that generated 8% to 30% annualized. We will discuss sector performance and some specific securities in more detail below: Technology Our investments in technology were significant outperformers during the quarter. 45% 44% DLS Global Equity Composite Technology Holdings 2013 Q2 Performance 17% 14% 11% 5% 4% 1% 3% IMOS MU CLS FLEX INTC AMKR HPQ R3000 Tech Indx UIS Despite the strong recent performance of these shares, they remain undervalued relative to their historic norms. ChipMos (IMOS) still trades at less than 4x EV/EBITDA with improving fundamentals and some compelling catalysts on the horizon. Micron (MU) trades at 4.4x EV/EBITDA and industry consolidation has led to strong underlying prices for their core products. Energy Broad energy indices declined mid-single digits during the quarter. Our Oil & Gas holdings performed in-line with larger integrated producers outperforming and smaller producers underperforming. The price of oil remains near $100 as global demand continues to grow steadily and supply becomes more expensive or less stable. Even the tremendous growth from American shale plays are showing signs of slowing down. Our coal companies performed horribly. Despite continuing capacity reductions and price stabilization in thermal coal markets since the spring of last year, coal companies have simply been liquidated. The goal of conservationists and the Obama Administration to eliminate coal cannot be achieved in the short-term due to limitations in plant and equipment and natural gas pipeline capacity. What continues to be ignored by investors is global expansion in thermal powered electric plants planned for the next two decades. Coal companies are now selling at EV/Sales of 0.7x to 1.2x. We turn to EV/Sales metrics during times of extreme margin compression. These valuation levels have only been reached before during the 2008 financial crisis and in 1999 when basic material stocks were discarded to chase the technology bubble.
Page 3 of 6 Gold Miners The Gold Mining stocks also performed abysmally during this quarter. The relevant indices were down 33% (GDX large miners) to 45% (GDXJ junior miners). Our gold mining stocks have been primarily comprised of the largest in the industry were in this range with our best down 26% (Goldcorp) and our worst down 46% (Barrick). The spot price of actual Gold fell 22% during the quarter. Gold miners have been plagued not only with the falling price of gold but also a shift in sentiment regarding Gold as an asset class. We have included gold miners in our portfolio for two reasons. 1) gold miners were absolutely undervalued given their cash flow and reserves, and 2) the price of the underlying commodity is correlated with global currency creation. Neither of these conditions has changed. Miners are even cheaper now. In fact, they are as undervalued as they have been in 40 years (see chart below). Currency creation continues at a historic pace with Japan and the United States leading the way. Our specific gold miner holdings are extremely undervalued compared to the price of gold. The table to the right shows Enterprise Value per Ounce of Reserves for each of our securities. Each of these companies is trading below $300 per ounce while gold is selling for greater than $1,200 per ounce. Interestingly, physical buyers of gold (central banks, individuals buying actual gold coins) remain strong. Paper investors (ETFs) have liquidated according to data from the Gold Council. Enterprise Value Proved & Probable Reserves (000s oz.) Enterprise Value per Oz. of Reserves Barrick 29,290 159,400 184 New Gold 3,442 12,432 277 Goldcorp 21,434 84,926 252 Kinross 6,045 62,500 97 Yamana 7,490 27,100 276 Newmont 21,694 102,500 212
Page 4 of 6 Comments on General Investing Climate The love affair with bonds may finally be broken. The Benchmark ETF for Government Bonds (TLT ishares 20+ Year Treasury Bond ETF) is down 9% during 2013 and 6% for the 2 nd quarter. These price declines along with recent large outflows from bond funds (chart below) indicate that investors may finally be shifting their allocations away from fixed income. 60,000 Inflows/Outflows to/from Fixed Income Mutual Funds and ETFs 40,000 20,000 (20,000) (40,000) (60,000) (80,000) 1/1/2007 3/1/2007 5/1/2007 7/1/2007 9/1/2007 11/1/2007 1/1/2008 3/1/2008 5/1/2008 7/1/2008 9/1/2008 11/1/2008 1/1/2009 3/1/2009 5/1/2009 7/1/2009 9/1/2009 11/1/2009 1/1/2010 3/1/2010 5/1/2010 7/1/2010 9/1/2010 11/1/2010 1/1/2011 3/1/2011 5/1/2011 7/1/2011 9/1/2011 11/1/2011 1/1/2012 3/1/2012 5/1/2012 7/1/2012 9/1/2012 11/1/2012 1/1/2013 3/1/2013 5/1/2013 7/1/2013 Source: Investment Company Institute, Index Universe, DLS analysis This is how we currently see things. 1) Bonds remain overvalued. Still not a great place to be. Overowned and finally starting to be liquidated. 2) U.S. equity markets are reasonably priced. Within the broader indices, staples and defensive companies are fully valued or overvalued while cyclicals and materials are inexpensive. 3) Emerging market equities are likely the best values relative to all markets but are currently out of favor. 4) Our overall portfolio remains at valuation levels lower than we have ever seen them and significantly below the historical norms (see charts below) DLS Capital - Portfolio EBITDA and EV/EBITDA Total Portfolio 120 Aggregate Portfolio EV/EBITDA 10.0 5.0 - (5.0) (10.0) 30.0 28.6 27.4 25.3 21.4 22.5 19.520.3 20.8 31.4 29.1 29.1 24.3 42.6 40.1 37.8 29.1 48.0 44.8 43.6 36.4 51.650.6 36.6 28.8 25.7 23.7 7.4x = 20-Year Historical Mean 5.6x = 20-Year Historical 1st Quartile 3.7 3.7 53.5 54.5 54.5 50.0 48.8 49.6 47.7 46.7 47.9 46.2 43.0 40.4 36.9 33.6 31.0 100 80 60 40 20 - Aggregate Portfolio EBITDA Series2 Series1 Source: CapitalIQ, Bloomberg, DLS Capital analysis
Page 5 of 6 18 Historic Valuation Ranges (EV/EBITDA) - S&P500 vs DLS Capital 16 23 23.0 High 14 12 10 75th Percentile = 13.4 Average = 11.4 9.1 Current 25th Percentile = 9.0 10.0 High 8 6 75th Percentile = 8.8 Average = 7.4 25th Percentile = 5.6 4 3.7 Current 2 - S&P500 Note: S&P500 statistics sourced from Bloomberg and Ned Davis, actual EV/EBITDA used from 2006-2011, EV/EBITDA from 1980-2006 estimated using available price/earnings data, DLS valuations from internal sources DLS We cannot nor have we ever predicted when mean reversion could occur. We can say based on our fundamentally-based and factually-supported analytics we are currently invested in the areas that are most undervalued. Our holding in miners, manufacturers, technology companies, and industrials cannot be reproduced physically for anywhere near where the businesses are priced. With global capacity in these industries being reduced, simple economic forces should eventually align the values of these businesses. It has been a difficult couple of years. However, this may prove to be a short period of aberration on a historical timeline. We believe the fundamental mathematics of our portfolio will ultimately drive the portfolio. As always we thank you for your confidence. We remain available to answer any questions. Regards, Dave Steinberg
Page 6 of 6 Global Equity Composite DLS Capital Management LLC ( DLS ) is an investment manager who manages assets for ultra high net worth investors and private investment funds utilizing a global value strategy. DLS investment strategy is to invest in securities of companies that are selling at significant discounts to their intrinsic value based upon historical multiples of cash flows, normalized cash flow (where there is an expectation that historical levels of cash flow will return), or where the assets are being valued below their asset liquidation value. The returns identified in this communication represent the composite performance for the Global Equity Composite for periods ending June 30, 2013. Returns are presented in U.S dollars and are gross and net of management fees. Net of fee performance was calculated using a 1% management fee and include the reinvestment of all income and capital gains. Minimum account size for portfolio management purposes and composite inclusion is $100,000 although DLS requires a minimum portfolio size of $500,000. Prior to January 1, 2010, the DLS Global Equity Composite was known as DLS Deep Value Opportunities Composite. Additional information regarding the policies for valuing portfolios, calculating performance, and preparing compliant presentations is available upon request. DLS Capital Management, LLC claims compliance with the Global Investment Performance Standards (GIPS ). DLS Capital Management, LLC's compliance with the GIPS standards has been independently verified for the periods January 1, 2006 through December 31, 2011. Verification assesses whether (1) the firm has complied with all the composite construction requirements of the GIPS standards on a firm-wide basis and (2) the firm s policies and procedures are designed to calculate and present performance in compliance with the GIPS standards. The DLS Global Equity Composite has been examined for the periods January 1 2006 through December 31, 2011. The verification and performance examination reports are available upon request. The Global Equity Composite contains fully discretionary global equity accounts and for comparison purposes is measured against the S&P 500 Index which is an index of 500 stocks chosen for market size, liquidity and industry grouping, among other factors. The S&P 500 is designed to be a leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of the large capitalization universe. Companies included in the index are selected by the S&P Index Committee, a team of analysts and economists at Standard & Poor's. The S&P 500 is a market value weighted index - each stock's weight is proportionate to its market value. The composite was created in March 2003 under a predecessor company named D2 Capital Management, LLC ( D2 ). The performance returns from March 1, 2003 through December 31, 2005 were attributed to D2, a DLS predecessor company. Performance returns from January 1, 2006 through June 30, 2013 are attributed to DLS. The current DLS portfolio management team is substantively the same team that managed the portfolio at D2. A complete list of composites, their descriptions, and compliant presentations is available by sending a written request addressed to Tami Maurer, Administrative Manager, DLS Capital Management LLC, One Northfield Plaza, Suite 470, Northfield, IL 60093 or by telephoning Ms. Maurer at 847-282-3800. All dividends and capital gains are re-invested. The portfolio is valued on a daily basis. The returns include trading costs and are presented both net and gross of investment management fees. Past performance is no guarantee of future performance. Investors have the ability to impose reasonable restrictions on he management of their accounts. The Firm s standard fee for separately managed portfolios is one percent (1%). A copy of DLS disclosure document, Form ADV Part II, is available upon written request.