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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,
For the fourth quarter 2009, the Kinetics Water Infrastructure Fund (No-Load Class) produced returns of 3.05%, compared to 6.04% for the S&P 500 Index and 5.06% for the S&P Global Water Index. Year-to-date, the Fund appreciated by 16.46% as of December 31, 2009, compared to returns of 26.46% for the S&P 500 Index and 32.67% for the S&P Global Water Index.
Water stocks, when evaluating the three main sectors - water treatment, water industrials & services and water utilities – varied in their returns during 2009 with utilities lagging in performance. As such, we increased our portfolio holdings in utilities during the year to obtain what we believe will be favorable valuations relative to the rest of the water sector.. Water utilities may not grow very fast, but we feel they are remarkably consistent—delivering solid but not spectacular returns every year. This enables these stocks to deliver impressive compounded returns over time. While U.S. water utilities only returned approximately 5.0% as a group in 2009, valuation sensitivity and appropriate weighting allowed us to establish positions and add to existing positions at multi year low prices. Investing in water is not as simple and straightforward as investing in other commodity groups, but this is likely to change in short order. As a value fund, water utilities continue to be our favorite subsector and our "Anchor" stocks, defined as cheap, high quality companies with solid dividends that have a lower beta relative to the broader market, prospects for continued earnings growth, and the possibility for valuation multiple expansions based on increased cost for water treatment and delivery.. The recent upward trend is providing a clear snapshot that a rebound in 2010 is clearly occurring. With that in mind, we anticipate that pipe manufactures, pump companies, meter manufacturers and integrated water treatment solution providers will benefit from 1.) Stimulus money earmarked for water projects that is finally freeing up in 2010 coupled with 2.) Annual maintenance and upgrades that were postponed during the last 15 months, but which are now underway. In the context of what many professional investors are calling he “new normal” - diminished growth, deleveraging, and increased government involvement that will reduce profits, we believe that water utilities could experience significant investor interest in 2010 and beyond. Our rationale can be summed by the recent words of Bill Gross, PIMCO’s bond guru, who said “why not just buy utilities if that’s what the future American capitalistic model is likely to resemble.” In a low growth environment, it seems that a company’s stock should yield more than its less risky debt, and many utilities, especially water utilities bought at the proper valuation metrics, provide just that opportunity.
Water investing is not a direct investment based on some arbitrary value per gallon of water, but a strategic investment in the many sub-sectors that are involved in its extraction, treatment, regulation, metering, conveyance and resource management on both the domestic and global stage. Many investors look at water in varying capacities: commodity, natural resource, alternative, and utility are just a few of the boxes that water is placed into by the investment community. Although water is continually referred to as the next oil, our approach has always been that the consistent growth of the global water business would provide investors exposure to a solid growth commodity that remains a necessity in everyday life.
One area of the global water sector that we believe will become high profile is the water energy nexus. Most investors have failed to realize that large amounts of water are needed to produce energy at power plants, and significant energy is used to treat and transport water to consumers. More now than ever, the American West is realizing the binary nature of energy production and water delivery. Moving water from source to sink takes a significant amount of power. And power plants, especially nuclear and hydroelectric sites, require water to cool and create energy. Thermoelectric cooling, hydropower, minerals extraction and mining, fuel production in the form of non-fossil and biofuels, and emission controls all require significant amounts of water for processing. Water collection, processing, distribution, and end-use require power for pumping, transporting, treatment and desalination of water. For desalination, the more salt in the water, the more energy is required to remove it due to the need to extract the salt ion through the breaking of the ionic bond. The drive for low-carbon energy alternatives in the form of solar power plants is further compromising already limited water resources in the Southwest United States. Solar power plants use a system of mirrors to heat water into vapor. We are constantly evaluating how the water sector will evolve based on regional issues, country specific availability, and industry specific uses of water, and we will continue searching for mispriced or misunderstood investment opportunities.
In summary, we believe the Fund accomplished its stated goals in 2009, to invest with a value approach, thereby minimizing volatility while emphasizing risk management. We will continue to use cash as a hedge when we feel the market valuations are fully or over-priced. We believe the economic underpinnings of today's markets are less than stable while valuation multiples have expanded in certain sub sectors beyond what would be our normal investment comfort level. However, we remain confident in our ability to identify good companies at reasonable valuations. Looking at 2010, we will remain optimistic but cautious as a host of unresolved issues brought on by the structural hangover of governmental intervention will likely be longer and more painful then we anticipate. With a market that could possibly remain flat, the active selection of water equities may be in a position to outperform water benchmarks in 2010.
We thank you for your confidence and believe you will be rewarded for it.
Brennan Investment Partners, LLC
Sub-adviser to the Kinetics Water Infrastructure Fund
The above commentary was prepared exclusively by Brennan Investment Partners, LLC ("BIP"), the sub-advisor to Kinetics Water Infrastructure Fund. As a result, neither Kinetics Asset Management, Inc. nor any of its affiliates can guarantee the accuracy or completeness of any statements in this commentary. Accordingly, the views expressed are solely those of BIP and do not necessarily reflect the views or opinions of Kinetics, or its affiliates and should not be construed as an investment recommendation.
Disclosure
Past performance 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 in the fund can lose money.
Because the Funds [other than The Paradigm Fund and The Small Cap Opportunities Fund] invest in a single industry, their shares do not represent a complete investment program. Internet, biotechnology and water related stocks are subject to a rate of change in technology, obsolescence, regulation 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. The Fund's share price is expected to be more volatile than that of a U.S.-only fund. Because smaller companies [for The Global Fund 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 [for all Funds], 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. Small and medium-size companies often have narrower markets and more limited managerial and financial resources than do larger, more established companies. As a result, their performance can be more volatile and they may face a greater risk of business failure.
As non-diversified and single industry funds, the value of their shares may fluctuate more than shares invested in a broader range of industries and companies.
Unlike other investment companies that directly acquire and manage their own portfolios of securities, the Funds pursue their investment objectives by investing all of their investable assets in a corresponding portfolio series of Kinetics Portfolios Trust.
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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