April 19, 2011

Dear Fellow Shareholders:

The Bretton Fund’s net asset value per share (NAV) as of March 31, 2011, was $16.45, and the total return for the fund for the quarter was 3.33%. Over the same period of time, the total return for the S&P 500 Index was 5.92%, and the total return for the Wilshire 5000 Total Market Index was 6.18%.

Total Return as of March 31, 2011

Since 1/1/2011Since 9/30/2010 Inception
Bretton Fund3.33%9.67%
S&P 500 Index5.92%17.31%
Wilshire 5000 Total Market Index6.18%18.48%

Performance data quoted represents past performance. Past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. All returns include change in share prices and reinvestment of any dividends and capital gains distributions. Current performance may be lower or higher than the performance data quoted. Indices shown are broad-based, unmanaged indices commonly used to measure performance of US stocks. These indices do not incur expenses and are not available for investment. You may obtain performance data current to the most recent month-end here or by calling 800.231.2901. The fund’s expense ratio is 1.50%.

Contributors to Performance

The most significant contributor to the fund’s NAV was Ross Stores, which increased the NAV by 19¢ as Ross’s stock price rose 12% since the start of the year.

Additionally, the rise in CSX’s share price increased the NAV by 13¢. Including the other two railroads in the fund’s portfolio (Norfolk Southern and Union Pacific), the group as a whole had a positive effect of 25¢ on NAV.

The main detractor from the fund’s performance was Aflac, whose stock price declined 6% in the quarter, bringing down the fund’s NAV by 11¢.


Security% of Net Assets
Aflac Inc.14.0%
CapitalSource, Inc.10.9%
Ross Stores, Inc.10.3%
Apollo Group, Inc.10.1%
Norfolk Southern Corp.4.9%
American Express Co.4.8%
Carteru2019s Inc.4.5%
CSX Corp.4.2%
SI Financial Group, Inc.3.8%
New Resource Bank3.8%
Federated Investors, Inc.3.5%
Peoples Federal Bancshares, Inc.3.5%
Standard Financial Corp.3.5%
Kaiser Federal Financial Group3.3%
Union Pacific Corp.3.0%

*Cash represents cash equivalents less liabilities in excess of other assets.

The fund’s largest holding is now Aflac. If you’re like the majority of adult Americans, you recognize the brand and might even know that Aflac sells some type of insurance using a tenacious and vocal (and maybe occasionally grating) duck. What you may not know about Aflac: They’re big in Japan.

Despite being a Columbus, Georgia–based company, roughly 75% of Aflac’s business comes from Japan. The fund bought more shares of Aflac when investors panicked about the March earthquake and the resulting nuclear disaster, neither of which will materially impact the company’s long-term earnings ability. This is a scenario where a long time horizon is a wonderful competitive advantage.

The structure of the Japanese healthcare system makes Aflac’s products particularly compelling. Essentially, the Japanese government provides healthcare for its citizens, but only pays for 70% of the costs, leaving individuals to pay for the remaining 30%. There’s no Japanese equivalent of the US-style, employer-sponsored, comprehensive health plan, where the employee pays only a nominal co-payment for everything from simple doctor visits to major surgery and the insurance company pays the rest. If you come down with cancer in Japan, you’re not going to “slip through the cracks,” but you’re going to have to pay 30% of all your medical costs, which can be onerous with major diseases like cancer, potentially costing you tens of thousands of dollars. Aflac fills that gap by selling supplemental health insurance: When policyholders come down with certain major illnesses, Aflac pays out a fixed amount to cover the extra medical costs. It’s an attractive product for anyone who doesn’t have the deep pockets to afford a significant medical incident.

Aflac has been selling insurance in Japan since the ’70s. As the portion of health costs that the government covers has gone down from 90% in 1984 to 70% today, Aflac’s services have become increasingly relevant and are now the go-to choice for supplemental health insurance. It has over 94% brand-name recognition (the Japanese duck is more reserved than the American version). Due to the rigid distribution channels for selling insurance in Japan, Aflac’s strong brand and reputation for fast payouts make it difficult for new entrants to compete. The company has branched into other types of insurance and now sells one out of every four insurance policies sold in Japan. In short, Aflac is a highly defensible and growing business.

(Supplemental health insurance makes less sense in the US, given our health system’s tendency toward either employer-paid, nuts-to-bolts coverage or individual-paid, high-deductible plans. Aflac manages to find a decent market in the US providing coverage for individuals in the event that they aren’t able to work due to an accident or certain types of medical events.)

The investment community’s main concern with Aflac has been the quality of its investment assets. When Aflac receives premium payments from its customers, it invests that money in fixed-income securities that pay back interest and principal over time, which Aflac uses to pay out future claims. Unfortunately, Aflac made some poor investments in European banks and the debt of European countries, including such notoriously profligate places as Portugal, Ireland, Italy, Greece, and Spain. Aflac has recognized losses on some of these investments and will lose additional amounts, but all its investments in these countries combined is less than what Aflac earns before taxes in a single year. In other words, if all of its investments in these countries become worthless (an unlikely scenario since there’s typically some recovery in corporate and sovereign defaults), the company will be fine and continue to be a great business. Throughout the recession, Aflac has continued to add customers and grow its operating earnings impressively. Aflac’s earnings power is about $6 per share, which is about 11% of its $53 share price, and I believe those earnings will continue to grow robustly for years.

There were three new additions to the fund this past quarter: SI Financial Group, New Resource Bank, and Peoples Federal Bancshares. All three are small, regional banks that have 1) high levels of equity capital, which is the cushion against potential losses, 2) healthy, performing loan books, and 3) share prices that trade significantly below their book values, the theoretical liquidation value of the bank.

There have been no sales in the portfolio since the fund’s inception.

Institutional Investing
Institutions like pension funds tend to take their fiduciary roles seriously and, in their pursuit of managing their capital responsibly, the investment committees at such institutions take the well-intentioned step of hiring various consultants to help select investment managers. This can work perfectly well theoretically, but it often creates significant distortions on what sound investment management should be.

Not surprisingly, when institutions hire institutional consultants to tell them how to invest in institutional managers, an institutional mindset kicks in. Funny things start happening. Risk is no longer the possibility of losing money; it is redefined as deviating from a market index in a finite time period. Investment managers act less like investors and more like self-justifying entities. The multiple layers of institutions create a bureaucracy with strong incentives for investment managers to roughly match the fluctuations of a particular index, hoping to edge it out by a percentage point or two, in set calendar years. The raison d’être of the Bretton Fund is to manage capital without these constraints. The goal of the fund is to compound value over a long time period and to preserve our shareholders’ investments by avoiding permanent losses of capital.

In practice, this means a few things: 1) The fund will not look like the overall market indices, either in composition or performance, particularly over a short period of time. 2) The fund will not participate in speculative bubbles, even if it means missing out on a good party with great music. These tend to end suddenly with high-stakes games of musical chairs. 3) While the values of the fund’s holdings will tend to fluctuate with the rest of the market, the fund seeks returns irrespective of the market indices. I will not gloat if the market is down 35% over five years and the fund is down “only” 30%. Some funds would consider this a successful outcome. The Bretton Fund is not one of those funds. 4) The fund will hold a moderate level of cash if I cannot find enough high-return investments with satisfactory margins of safety. These are all attributes that are intended to maximize shareholder wealth over the long run, but very few mutual funds will invest like this for fear of looking too different from the market or appearing unconventional.

Thank You
You will continue to receive by mail our required semiannual and annual reports for the periods ending June 30 and December 31. For the interim periods (the quarters ending March 31 and September 30), we will post updates like these online at www.brettonfund.com.

Thank you for being a shareholder in the Bretton Fund,

Stephen J. Dodson
Bretton Capital Management