This shareholder letter is part of the Bretton Fund 2011 Annual Report (pdf).

February 27, 2012

Dear Fellow Shareholders:

The Bretton Fund’s net asset value per share (NAV) as of December 31, 2011, was $16.98. For the quarter ended December 31, 2011, the fund’s total return was 16.39%, compared to 11.82% for the S&P 500 and 12.02% for the Wilshire 5000. For the full year, the fund’s total return was 7.90%, while the S&P 500 and Wilshire 5000 returned 2.11% and 0.98%, respectively.

The year’s performance put the fund in the top 2% of all mutual funds classified by Lipper as having a value strategy investing in companies of all sizes (“multi-cap value”), the average of which returned -3.00%. While I’m relatively pleased with the fund’s performance, the goal of the fund is not to outperform benchmarks in every calendar year; the goal is to compound value over many years at an attractive rate. There will be years the Bretton Fund lags materially behind its peers.

Total Returns as of December 31, 2011

4th Quarter1 YearSince Inception -
Annualized (A)
Bretton Fund16.39%7.90%11.44%
S&P 500 Index (B)11.82%2.11%10.33%
Wilshire 5000 Total Market Index (C)12.02%0.98%10.00%

Calendar Year Total Returns

Bretton FundS&P 500 Index (B)Wilshire 5000
Total Market Index (C)
9/30/10 – 12/31/106.13%10.76%11.59%
Cumulative Since Inception (A)14.52%13.10%12.68%

(A) Since Inception returns include change in share prices, and in each case, include reinvestment of any dividends and capital gain distributions. The inception date of the Bretton Fund was September 30, 2010.

(B) The S&P 500 is a broad, market-weighted average dominated by blue-chip stocks and is an unmanaged group of stocks whose composition is different from the Fund.

(C)The Wilshire 5000 Total Market Index is a market-capitalization-weighted index of the market value of all stocks actively traded in the United States.

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%. An investment in the fund is subject to investment risks, including the possible loss of the principal amount invested. The fund’s distributor is Rafferty Capital Markets, LLC.

4th Quarter

For the quarter, the largest contributor to the fund’s performance was Apollo Group, increasing the NAV by 48¢, followed by the three railroad investments, which together contributed 40¢. The fund added Wells Fargo to its portfolio during the quarter and did not sell any securities.

Contributors to Performance

For the year, the biggest positive contributors were Ross Stores, Apollo Group, and Carter’s, adding to the NAV by 65¢, 47¢, and 26¢, respectively. The main detractor was Aflac, which had a negative impact of 40¢.


Security% of Net Assets
Ross Stores, Inc.11.4%
Apollo Group, Inc.10.8%
The Gap, Inc.9.4%
Aflac, Inc.9.4%
Carteru2019s, Inc.5.8%
New Resource Bank4.7%
Union Pacific Corp.4.6%
CSX Corp.4.6%
JP Morgan Chase & Co.4.6%
Wells Fargo & Company4.5%
CapitalSource, Inc.4.4%
Norfolk Southern Corp.4.2%
American Express Co.4.1%
Peoples Federal Bancshares, Inc.3.4%
Standard Financial Corp.3.3%
SI Financial Group, Inc.3.1%

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

How the fund’s companies fared during the year:

  • Ross Stores: By opening new stores, increasing each stores’ sales, reducing relative costs, and buying back stock, Ross increased its earnings per share by about 22% over the past year. Its stores have great economics, and it has plenty of room to expand. Investors have caught on a bit to Ross’s success: Its share price increased 50% during the year.
  • Apollo Group: Regulatory changes and negative news muted demand for Apollo Group’s universities. Excluding certain one-time items, earnings per share declined 8%, but its share price increased 38% since things didn’t turn out to be as bad as investors thought they would.
  • The Gap: As discussed in the semiannual report, Gap’s earnings are being hindered by abnormally high cotton prices, which peaked close to four times its historical average before receding. In recent years, Gap has used its excess cash to purchase enormous amounts of its own stock, reducing its total shares outstanding by 50%. Think of it as buying out your business partner at a low price. The compounding effect of a company buying back a lot of stock can be significant: In 2010, during the days of normal cotton prices, Gap made $1.2 billion, which resulted in earnings per average outstanding share at the time of $1.88. If Gap earned the same $1.2 billion today, it would be spread over much fewer shares, resulting in earnings of about $2.50 per share. This dynamic will continue as Gap plans to keep using its excess cash flow for share repurchases, and I expect earnings to at least come close to 2010 levels when cotton costs normalize. While its eponymous brand is struggling sartorially, revenue is flat due to international expansion and the relative health of its other brands. Gap’s shares ended the year around the same price for which the fund acquired its shares.
  • Aflac: Aflac’s underlying business continues to perform well, but this was obscured by losses on its investments in European bank debt. Net of currency fluctuations and investment losses, its core earnings per share increased 8%. While not immaterial, its European investments remain manageable and a declining portion of assets. The key is that Aflac’s earnings stream—its business of selling supplemental health insurance in Japan and the US—remains unimpaired by anything happening in Europe and will accrue to investors over time. Its stock price declined 24% during the year.
  • Carter’s: Similar to Gap, high cotton prices dragged down Carter’s earnings per share by 29% over the first nine months of the year, while revenue increased 20% from opening new stores, improving sales per store, and a successful launch of its new website, which now allows it to sell directly to customers. Its stock price increased 31% during the year.
  • American Express: As fewer cardholders became delinquent and the affluent consumers that tend to make up American Express’s customers spent more, earnings per share increased 22%. American Express has many elements I look for in an investment: a long runway (cards are replacing cash and checks worldwide), a defensible business, management that thoughtfully pays out its earnings to shareholders, and a reasonable valuation. Its share price increased 10% during the year.
  • Small Banks: Peoples Federal Bancshares, SI Financial Group, and Standard Financial Corp. are small community banks that recently converted from mutual savings banks, a corporate structure in which the depositors technically own the bank. The conversion process left them with excess cash that they’re now returning to shareholders through buybacks and dividends, and they trade below their liquidation value despite having virtually no bad loans. New Resource Bank is a tiny, relatively new bank focused on environmentally sustainable loans. After running into problems years ago, the bank has since turned around under the guidance of a new management team, who improved loan quality and made it profitable. Its shares sell for only slightly more than half its liquidation value. As CapitalSource continued to reduce its problem loans and build up excess cash, it began to return capital to shareholders through share repurchases, which reduced total shares outstanding by 15% in the third quarter alone. The stock prices of these banks were relatively flat during the year.
  • Railroads: CSX, Norfolk Southern, and Union Pacific continued to experience outstanding economics: Rail volumes increased only 3–5%, but earnings per share increased 20–35% through price increases, operating leverage, and large share buybacks. I expect greater increases in volumes over the next few years and the same attractive economics. The stock prices of Union Pacific and Norfolk Southern increased about 16% during the year, while CSX was flat.
  • Large Banks: JP Morgan and Wells Fargo are the two newest companies in the fund, acquired last fall when stock prices of large banks fell precipitously. Banks, and especially large banks, are opaque, and it’s difficult for an outside investor—or even the bank’s CEO—to know with precision if loans are being accurately valued. No one knows for sure who’s going to pay back their loans and who won’t. Yet there are solid indicators that JP Morgan and Wells Fargo will be able to earn through bumps in the road: Loan metrics like delinquencies have steadily improved the past two years and capital levels, the cushion against losses, are close to all-time highs. Both companies have highly competent management teams who have worked their way through downturns before, and both have the structural ability to make profitable loans across wide portions of the US economy while funding those loans with low-cost deposits. This is inherently a sound business model, and their shares are priced so low that the return potential is attractive even if a lot goes wrong. Wells Fargo’s share price ended the year 14% higher than the fund’s average cost, while JP Morgan’s was lower by 4%. I expect their stock prices to be volatile over the near term.

The Difference Between Knowing and Doing

I’m always struck by how often I’ll notice a young investor reading a copy of The Intelligent Investor by Benjamin Graham on a plane or a subway. It’s not surprising that it’s widely read; it is, after all, the original manifesto for value investing and referred to with near-biblical reverence by well-known investors. What strikes me is the disconnect between how many people have read the book and how few seem to implement its principles. The main premise is simple enough: The price of a stock is eventually determined by its value. Yet funds that invest with this simple truism form only a minority of all funds. I suspect the majority of mutual fund managers would readily agree Warren Buffett is one of the greatest investors of all time, but despite how well publicized and documented his strategy is, only a few dozen out of the thousands of mutual funds operating today invest with the same long-term, concentrated, value approach. It’s basically a secret hiding in plain sight.

There’s a significant disconnect between what investors say is the right approach and how they invest in reality. Many funds claim to be long-term, but the average holding period for the average stock mutual fund is only 10 months. Part of the reason for this dissonance is the incentive for fund managers to invest a particular way to attract institutions, who often want low variances to market movements, not necessarily maximum returns. The desire to collect assets can cause a divergence of interests between fund shareholders and fund managers. This often leads funds to take on restrictions that, while now commonplace, are major disadvantages to performance: limiting investments to a certain asset class or within a narrow mandate, matching sector weightings to a specified index, or being fully invested at all times.

But I think the bigger reason for the disconnect between knowing and doing is human nature. This disparity exists in all areas of human activity. Weight-loss books need only three lines: “Eat better food. Less of it. Exercise more.” That there are thousands of books in the genre, and certain to be thousands more written, is because this knowledge-action gap exists. This is exacerbated by our tendency to justify our actions. It’s easy to forget the investor maxim “Be greedy when others are fearful” when things do indeed become scary and instead justify it with something like, “It seems prudent to reduce our equity exposure given increased market volatility.” Investors don’t like to admit, even to themselves, “There are loads of great investments around, but we are too scared to do anything about it.”

People tend to see what they want to see. And they often seem more motivated to be proven right than to understand reality. Bridging the gap between knowledge and action means doing things that are uncomfortable, like changing one’s mind and admitting mistakes. No one is right about everything the first time around. It means analyzing past mistakes, thinking about personal shortcomings. In a 1999 New Yorker article, Malcolm Gladwell interviews Charles Bosk, a sociologist who developed a system to evaluate the differences between unsuccessful surgeons and successful ones. It boiled down to one thing: “He [Bosk] concluded that, far more than technical skills or intelligence, what was necessary for success was… a practical-minded obsession with the possibility and the consequences of failure.” Bosk elaborates:

In my interviewing, I began to develop what I thought was an indicator of whether someone was going to be a good surgeon or not. It was a couple of simple questions: Have you ever made a mistake? And, if so, what was your worst mistake? The people who said, “Gee, I haven’t really had one,” or “I’ve had a couple of bad outcomes, but they were due to things outside my control”—invariably those were the worst candidates. And the residents who said, “I make mistakes all the time. There was this horrible thing that happened just yesterday and here’s what it was.” They were the best. They had the ability to rethink everything that they’d done and imagine how they might have done it differently.

This type of introspection isn’t fun to do; that’s why few people do it. The difference between great investors and average investors is often behavioral, not informational. Buffett doesn’t have a team of 200 analysts who cover the entire investment universe, attending conferences and flying to management meetings. He attributes much of his success to just being more patient than the next guy. It’s an enormous advantage to be able to do nothing when the current opportunity set is meager, and there were years when Buffett made only minor changes to his portfolio. Many large fund firms are structurally incapable of doing this simply because it is extremely difficult for any group of 200 highly motivated, high-IQ people to do nothing for long periods of time, even when it’s the best course of action.

The vagaries of human nature is one of the main reasons investment opportunities exist. Informationally, markets are trending toward greater efficiency, but behaviorally, I believe they’re becoming less so. Technology and cultural changes have enabled the more schizophrenic elements of our nature and make it harder to have a long attention span. Patience is a major competitive advantage, possibly one of increasing value.

2011 Reading

One of my favorite business/economics books I read this past year was the The Rational Optimist by Matt Ridley, which was excellent. He illustrates, in an economically attuned and wonderfully conversational manner, how human ingenuity and the ability for people to exchange goods, as well as ideas, has led to exponential increases in well-being over tens of thousands of years. Ridley also picks apart the Malthusian tendency for current generations to believe that process will suddenly stop with them. On the dramatic improvements in our world:

Today, of Americans officially designated as “poor,” 99% have electricity, running water, flush toilets, and a refrigerator; 95% have a television, 88% a telephone, 71% a car, and 70% air conditioning. Cornelius Vanderbilt had none of these….

This is what prosperity is: the increase in the amount of goods or services you can earn with the same amount of work. As late as the mid-1800s, a stagecoach journey from Paris to Bordeaux cost the equivalent of a clerk’s monthly wages; today the journey costs a day or so and is 50 times as fast. A half-gallon of milk cost the the average American 10 minutes of work in 1970, but only seven minutes in 1997. A three-minute phone call from New York to Los Angeles cost 90 hours of work at the average wage in 1920; today it costs less than two minutes.

 How we got here:

The cumulative accretion of knowledge by specialists that allows us each to consume more and more different things by each producing fewer and fewer is, I submit, the central story of humanity. Innovation changes the world but only because it aids the elaboration of the division of labor and encourages the division of time.

Another favorite of mine was Where Good Ideas Come From by Steven Johnson. Inventors and great thinkers, often contrary to their own explanations, develop their best ideas slowly over time, in semiconscious “slow hunches,” and in environments where diverse ideas are able to bounce around with and borrow from each other.

Keeping a slow hunch alive poses challenges on multiple scales…. Most slow hunches never last long enough to turn into something useful, because they pass in and out of our memory too quickly, precisely because they possess a certain murkiness…. So part of the secret of hunch cultivation is simple: Write everything down…. Darwin was constantly rereading his notes, discovering new implications.

Thank You

Feel free to e-mail me at if you have questions about the fund.

As always, thank you for being an investor.

Stephen J. Dodson
Bretton Capital Management