Quarterly Newsletter: December 2006

Click here to view the Index Returns for 4th Quarter 2006
 (PDF, 237kb)

Looking Back, Looking Ahead
There's nothing magic about the calendar year for measuring investment returns. We regularly monitor returns by month, quarter and by other 12-month periods. But since the calendar drives our non-financial lives, it tends to be our primary yardstick for looking at investment performance.

No doubt, 2006 was an excellent year for stock returns as all classes of equities delivered significant gains.

Real Estate Investment Trusts (REITs) continued to amaze. Though residential housing markets have softened, stocks in companies that invest in and manage commercial properties (apartment, office, retail, industrial, hotel, etc.) have performed exceptionally well. Indeed, REITs were the best performing asset class in domestic equities for the past one, three, five and ten years running.

Fixed income returns were modest as measured by the Lehman Brothers Aggregate Bond Index. Intermediate term bond yields trended higher through mid-year and subsequently declined as the Federal Reserve suspended its string of rate increases this summer. With yields remaining stubbornly low and the curve slightly inverted (short-term yields are higher than long-term yields), it is a challenging time for fixed income investors. Floating Rate Securities (non-investment grade bank loans) have been a compelling alternative.

Unfortunately for investors, there is no crystal ball to know what lies ahead for the coming year. Importantly, we do not make investment decisions on the basis of an annual forecast—the price of being wrong is simply too great. Our investment philosophy is centered on capital market forecasts over the long term—10 years or more—which are much more stable and predictable.

But we do read and monitor the annual predictions of others. It appears that there is always a bell curve of predicted outcomes in the newspapers and financial journals this time of year. These are usually centered around high single digits for stocks. This is probably because these are the historic average stock returns by single year and the most obvious choice.

Some optimistic forecasters always come up with a rosy outlook and, of course, there are always the doom and gloom folks with their negative scenarios. But regardless of geopolitical events or economic cycles, the annual forecast ranges are roughly the same—minus 20% to positive 25% with a consensus of around 8 to 9%.

The Downside of Diversification
We believe deeply in our Investment Philosophy: Building portfolios to match the long term risk/reward goals of our clients, implementing the program with low-cost, tax-efficient investment vehicles, then maintaining an investment discipline of rebalancing to those goals.

Extreme shifts in asset allocation do not pay, especially after you tally the known costs of taxes and trading. But we're always surprised at how many investors do try to time the markets—only to eventually experience the disappointment and financial cost of being wrong.

Sticking to a discipline isn't easy. There is always the hope of beating the averages, beating the odds. And over time, there is always regret—at not having invested in the best performers and holding onto assets that underperformed.

In years like 2006, it's natural to regret having not been allocated 100% in stocks but we have to remind ourselves that our low-return bonds have an important strategic role in the portfolio—to provide a stable foundation and diversify against our more volatile stock holdings. Had equity markets been down 20% last year (which has occurred and will happen again), we would be appreciative of those 4% fixed rate securities.

Business Notes
To date, we have provided clients a notebook at the beginning of each year to store Arbor reports, Fidelity statements, tax reports and other important information. Clients have shared with us that the notebooks are helpful organization aids but create a storage challenge when received annually. Also, many clients discard stale information and don't want a new one each year. Based on this valuable feedback, we will not provide annual notebooks going forward. Instead, you can expect to receive in the coming months a new, more durable notebook that will meet your needs through the years ahead.

Arbor Growth in 2006
2006 was a year of growth on all fronts. Arbor's assets under management grew by 27% as shown in the chart below. Thank you for your business and referrals.

And in other growing news, our young children under care increased by 75%. Congratulations to the Beason, Jones and Birchfield families!

Tyler David Beason July 4th	Ethan Aubrey Jones August 31st	Lane Patricia Birchfield November 13th

Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this newsletter, will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio. Due to various factors, including changing market conditions, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from Arbor Investment Advisors, LLC. Please remember to contact Arbor Investment Advisors, LLC if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services. Please also advise us if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. A copy of our current written disclosure statement discussing our advisory services and fees remains available for your review upon request.

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