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December 2009
You should consider the investment objectives, risks, charges and
expenses of the fund carefully before investing. For a free copy of a
prospectus, which contains this and other information, visit our website at
www.kineticsfunds.com or call 1-800-930-3828. You should read the
prospectus carefully before you invest. Please read the important
disclosure at the end of this portfolio commentary.
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Dear Fellow Shareholders,
The Kinetics Small Cap Opportunities Fund (No-Load Class) achieved returns of 5.95% for the three-month period ended December 31, 2009, compared to gains of 6.04% and 2.18% for the S&P 500 Index and MSCI EAFE, respectively. Year-to-date, the Fund appreciated by 58.16%, as of December 31, 2009, compared to the S&P 500 Index and MSCI EAFE, which returned 26.46% and 31.78%, respectively, for the same period.
We believe the last three quarters of 2009 have unfolded as a mirror image of 2008. Financial asset prices of all types rebounded, helped by extraordinary and innovative measures implemented by the Federal Reserve, U.S. Treasury and Government, resulting in a supply of liquidity to otherwise frozen markets. In periods of panic and during a liquidity crisis, we believe it is the role of the Federal Reserve and U.S. Government to act as the lender of last resort. With the crisis receding into the background, investors are slowly emerging out of their defensive shells and looking to cautiously allocate capital, with a renewed focus on liquidity, leverage and transparency, each of which was sorely lacking during the crisis. Despite the significant rally in financial asset prices most financial investors continue to be cautious, as evidenced by mutual fund inflows. According to the Investment Company Institute, investors withdrew $61 billion from developed market oriented mutual funds in 2009 while investing $70 billion into emerging market funds and $292 billion into fixed income funds.
The one-sided asset allocation tendencies of investors have historically represented a notable contrarian indicator as to where future returns lie. The contrarian asset allocation, in our opinion, would overweight equities over fixed income and developed markets over emerging markets. Small cap assets then can be seen as that much more contrarian, being that most investors tend to underweight asset classes due to their perceived riskiness.
The field of economics, finance and risk management has been thrown into chaos as a result of the crisis. Many long- held notions that until recently were accepted as fact are now under attack, including the efficient market theory, which we believe failed miserably in every aspect during the crisis. Diversification and risk techniques built on efficient market theory's shaky foundation, such as value at risk, beta, alpha, and the Sharpe ratio, however, are still widely used despite having evidenced no demonstrable utility during the crisis. While the implementation of new diversification and risk mitigation techniques are not rapidly forthcoming, there are two lines of thought that could represent the basis for more useful tools in the future. One of these is the rapidly emerging field of behavioral finance, which claims to have systematized various investors’ irrational behaviors (relative to the efficient market theory) that cause large deviations from efficiency for long periods. The other thought line, moving less rapidly, perhaps due to its mathematical orientation, is the use of power laws and fractal mathematics to derive price behavior. Both concepts, in our opinion, would represent a vast improvement over efficient market theory and may provide future investors with real tools to gauge the risks associated with financial markets.
The rise of these new schools of thought is a reminder that financial markets are organic mechanisms that are periodically captured by invalid theories, which, in a crisis, reveal their futility. Ultimately, no theory or tool is likely to stop the markets from periodically expressing what the behavioral finance theorists posit are the real fundamentals: fear and greed.
This time of year is often used for generating predictions and prognostications for the year ahead. With few exceptions, the predictions are tinged with fear, a remnant of the crisis. In our opinion, fear continues to keep asset prices cheap even after the rally that occurred in 2009. For investors, the environment of fear provides a psychological margin of safety against the likelihood that the financial markets will reprise the problems of last year. We are hopeful that the coming year will continue to provide an environment that will allow our companies’ values to rise, due to their ability to create wealth through their underlying business operations.
We thank you for your confidence and believe you will be rewarded for it.
The Kinetics Investment Team
Disclosure
You should consider the investment objectives, risks, charges and expenses of the Funds before investing. For a free copy of the Funds' prospectus, which contains this and other information, visit our website at www.kineticsfunds.com or call 1-800-930-3828. You should read the prospectus carefully before you invest.
The opinions expressed are not intended to be a forecast of future events, or a guarantee of future results, or investment advice. Additionally, the views expressed herein may change at any time subsequent to the date of issue hereof.
Past performance and does not guarantee future results. Due to market volatility, current performance may be more or less than for the rankings shown. Investment return and principal value will vary, and an investment can lose money.
Because the Funds [other than The Paradigm Fund, The Tactical Paradigm Fund and The Small Cap Opportunities Fund] invest in a single industry, their shares do not represent a complete investment program. Internet and biotechnology stocks are subject to a rate of change in technology, obsolescence and competition that is generally higher than that of other industries, and have experienced extreme price and volume fluctuations. International investing presents special risks including currency exchange fluctuation, government regulations, and the potential for political and economic instability. Because smaller companies [for The Global and Small Cap Opportunities Fund] often have narrower markets and limited financial resources, they present more risk than larger, more well established companies.
Non-investment grade debt securities (i.e., junk bonds) are subject to greater credit risk, price volatility and risk of loss than investment grade securities. Further, options contain special risks including the imperfect correlation between the value of the option and the value of the underlying asset.
Unlike other investment companies that directly acquire and manage their own portfolios of securities, the Funds (except the Tactical Paradigm Fund) pursue their investment objectives by investing all of their investable assets in a corresponding portfolio series of Kinetics Portfolios Trust.
You will be charged a redemption fee of 2.0% of the net amount of the redemption if you redeem or exchange your shares 30 days or less after you purchase them.
Distributor: Kinetics Funds Distributor, Inc. is an affiliate of Kinetics Asset Management, Inc., and is not an affiliate of Kinetics Mutual Funds, Inc.
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