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December 2007
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.
(Click here for most recent and complete performance information)
(Click here for the most recent portfolio holdings)
Dear Fellow Shareholders,
We are pleased to report that for the one-year period ended December 31, 2007, the Kinetics Paradigm Fund (No-Load Class) achieved 21.15% compared to the S&P 500 Index and NASDAQ Composite, which returned 5.49% and 9.81%, respectively.
The Paradigm Fund is run using the now unconventional view that stocks represent a fractional interest in a business, and the key determinant of a portfolio’s long-terms returns are driven by returns on capital (ROC) of the business operations of companies held in the portfolio. Risk is evaluated primarily by considering the potential for permanent loss of capital, rather than volatility.
Consequently, Kinetics’ methodology focuses on finding good businesses with high returns on capital, discounted at high rates. In our view, this process reveals securities with asymmetric return potential – those for which reward potential exceeds downside risk, both in magnitude and probability. Such a process yields what we believe is a margin-of-safety approach to investing.
Our research efforts are designed to identify securities that have unique risk and return characteristics. Our research, unlike that of most buy and sell side firms, is organized around pervasively inefficient segments of the marketplace such as tax-free spinoffs, contrarian investments, distressed equities, capital structure arbitrages, large passive holdings, etc. Our research methodology and structure unearths companies that have the potential to thrive irrespective of sector or industry performance.
In analyzing a company, we focus as much on the qualitative elements of an investment as on quantitative factors, seeking out unique qualities that might give companies an edge or distinctive quality (e.g. brand names, monopolies, etc.).
The first quality we look for in a company is to determine the longevity of its products and services. The highest risk any company faces is that its products and services are no longer desired by the marketplace, and that its existence is made obsolete by technological progress or innovation. The next criteria is to find companies that lend themselves to operating with predictability and transparency. In other words, we must understand the company’s operations and the way that they generate their revenues and profits. By focusing on these two factors, we believe that we reduce long-term risk by selecting investments where the “cone of uncertainty” of a company’s cash flows is markedly superior to alternatives.
Focusing on the long-term returns on capital associated with the business operations of the companies held in the portfolio and ignoring day to day price volatility allows us to purchase what we believe are excellent businesses at steep discounts. This is due to the investment management industry’s focus on short-term returns and a desire for investments with near term catalysts that are aligned with their compensation. Extending our time horizon allows us to cast a wide net in a pool of discounted assets with significant potential returns.
Our diversification strategy is based on the avoidance of financial risk, defined as the permanent erosion of capital caused by events and issues that might affect the business operations of portfolio companies simultaneously. We refer to this form of risk mitigation as the Principal of Non-Codependence – ensuring that companies within the portfolio don’t have significant or material inter-linkages in their business dealings. In periods of real financial distress, a portfolio with such diversification ensures that analytical errors are not transmitted through the portfolio in a domino-like fashion.
Our sell decisions are not dictated by price volatility, but by our evaluations of business returns and discount rates. For example, a security will be sold if its business thesis is invalidated by new information. Another sell criterion is triggered if the market calculation discounts in full the long-term business prospects of the company such that an investment is unlikely to provide a prospective satisfactory return. Finally, sell decisions may be dictated by the discovery of new opportunities with superior risk/return characteristics compared to existing investments.
We thank you for your confidence and believe you will be rewarded for it.
The Kinetics Investment Team
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Portfolio Commentaries for Other Funds:
The Internet Fund
The Global Fund
The Paradigm Fund
The Medical Fund
The Small Cap Opportunities Fund
The Market Opportunities Fund
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Disclosure
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 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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