With the onset of the Great Recession, investors fled equity markets seeking safety in cash and fixed income investments. A great many of these investors, in the interest of preserving capital, have remained sidelined even though equity markets have rebounded strongly from the lows of 2008 and 2009. In fact, from its March 9, 2009 low through December 31, 2012, the benchmark S&P 500® Index has posted a total return of more than 100%, with many value funds increasing by an even larger percentage. Yet, despite this strong performance, a significant number of investors remain on the sidelines immobilized by doom-filled headlines and afraid of a repeat of 2008.

From our perspective, the primary driver of equity market growth since the global financial crisis and market lows of 2008 and 2009 has been an aggressive easy monetary policy in order to jump start the economy and reduce unemployment. It has been the government’s stated objective to keep interest rates as low as possible for as long as possible. In our opinion, the current approach to monetary policy holds real risk for investors who are “in the now” and out of the market, that is, those investors who have sharply increased their holdings in bonds and cash and have decreased their holdings of common stocks. At some point, the aggressive monetary policy of the past four years is likely to trigger an increase in inflation that could negatively impact the value of fixed income and cash holdings. In fact, we believe that counter to past market cycles, an increase in interest rates from these abnormally low levels would be indicative of an increase in economic growth and be bullish for equity returns and bearish for bond returns.

At this stage of the economic recovery, we believe investors should prepare for the long-term effects of the current low-interest rate monetary policy and seek ways to improve investment returns in a low-growth environment. The real possibility of increased inflation combined with the realities of investing in a low-growth economic environment should compel investors to find ways to benefit from both productivity growth and capital appreciation in their portfolios. While many investors are nervous about equity markets or remain sidelined waiting for robust improvement in the economy, we believe there is a strong case for investing in the equity securities of companies whose real economic value is unrecognized by the market, obscured by market uncertainty or overshadowed by temporary problems. We believe our free cash flow accounting-based investment discipline of looking behind the numbers of individual companies to identify undervalued securities has a decided advantage in the current market environment.

While we attribute much of the current under-exposure in equities to macro- economic concerns and doom and gloom scenarios by most investors and the press, we prefer to focus on the undervalued securities of good companies with strong balance sheets and unique business models that generate (or have significant potential to generate) sustainable free cash flow. In addition, we prefer management teams that are deploying their cash balances to either grow through value-added capital expenditures or return excess cash to shareholders through dividends or stock buybacks.

We also believe it is important to identify those companies that not only have correctly focused their priorities in the face of a fragile economic recovery but have also identified options that have created a substantial strategic advantage for what we believe is an eventual inevitable acceleration of economic growth. As we have stated many times, the Fund focuses on a company’s ability to generate normalized free cash flow as the primary determinant of value. In particular, companies that continue to thrive in a challenging or stagnant economic environment eventually draw the favorable attention of investors.

Above-average long-term returns are generated by paying attention to the cash return an investor can expect from owning a share of a business and whether or not the potential return has enough of a premium (to the risk free rate) to compensate an investor for the risks of the company’s business model and to correctly predict its ability to produce normalized free cash flow. Assessing the adequacy of the cash flow return is of greater importance during an uneven economic recovery especially during a time when investors are being told, often quite loudly, to avoid equities and seek safer opportunities. We believe such times have the potential to set up significant above-average long-term investment returns.