“In recent years, holding cash is so completely out of favor that it has become the ultimate contrarian investment.” —Seth Klarman

“There is nothing so disturbing to one’s well-being and judgment as to see a friend get rich.” —Charles Kindleberger

“It’s as if people used the invention of seatbelts as an opportunity to take up drunk driving. Psychologists call this ‘risk compensation.’ The entire point of the CDS was to create a margin of safety that would let banks take more risks. As with safety belts and dangerous drivers, innocent bystanders were among the casualties.” —Tim Harford

 “… With notably rare exceptions, Germany remained largely at peace with its neighbors during the 20th century … With notably rare exceptions, Alan Greenspan has been right about everything … With notably rare exceptions, Russian roulette is a fun, safe game for all the family to play.” —Comments on Crooked Timber blog

2013

ANNUAL REPORT

_______________________________________________________

For further information, contact Gary Sieber at (574) 293-2077(574) 293-2077 or via email at [email protected]

MARTIN CAPITAL MANAGEMENT, LLC

2013 ANNUAL REPORT

TABLE OF CONTENTS

Total Account Composite Performance……………………………………………………… 2 S&P 500 Index and MCM Asset Allocation/Performance ..………………………………… 3 Letter to MCM Client

Performance Commentary …………………………………………………………. . 3 The ‘Unavoidables’: Death, Taxes … and Succession………………………….……. 4

Essential Traits of a Successor……………………………………………………….. 5

It Takes More Than Intelligence and a Good Track Record…….……………. 6

The Hard Truth About ‘Soft’ Traits……………………………………………6

A Preview: Recognizing and Avoiding Serious Risks…………………………. 7

Behavioral Economics and the Prerequisite of Fierce Independence………………….. 8

Market Prices Are More Volatile Than Intrinsic Values………………………. 8

The Folly of Forecasting…………………………………………………….. 10

 

The Hidden Motives Behind Profit Margins, Earnings, and Dividends………..………12

The Valuation Debate: Should Long-Term Investors Rely on Short-Term Earnings? ..16

Are ‘Fat Tails’ Yesterday’s Risk? ……………………………………………………. 17

Decision Making Without Forecasts and the Role of Optionality …………………… 21

A Foreordained Conclusion ………………………………………………………….23

Final Thoughts ……………………………………………………………………….. 24

Endnotes …………………………………………………………………………………… 25

Copyright©2013 Martin Capital Management, LLC. This report is provided for clients; it is not for further distribution. It is protected by U.S. copyright law and may not be reproduced, distributed, transmitted, displayed or published in any form without the prior written permission of Martin Capital Management, LLC.

Total Account Composite Performance

In 2013, the annual return on MCM’s total account composite1 was 9.8% after fees. Since we began documenting performance history at the end of 1999, coinciding with the peak of the greatest bull market in financial assets in history, our compounded annual performance has been 5.3% compared with the S&P 500 Index’s 3.6%.

Annualized Growth Rate

MCM

MCM vs S&P 500:

MCM

Total

S&P

Relative

Compounded

Year

Equities *

Account *

500

Performance

Outperformance **

(1)

(2)

(1)-(2)

2000

30.4%

16.3%

-9.1%

25.4%

27.9%

2001

22.5%

14.8%

-11.9%

26.7%

66.7%

2002

-14.2%

-8.0%

-22.1%

14.1%

96.9%

2003

33.4%

22.3%

28.7%

-6.4%

87.2%

2004

4.3%

3.5%

10.9%

-7.4%

74.7%

2005

-0.3%

-0.3%

4.9%

-5.2%

66.1%

2006

4.8%

2.0%

15.8%

-13.8%

46.3%

2007

1.5%

2.9%

5.5%

-2.6%

42.7%

2008

-20.2%

-7.0%

-37.0%

30.0%

110.7%

2009

57.6%

20.9%

26.5%

-5.6%

101.4%

2010

18.1%

1.3%

15.1%

-13.7%

77.4%

2011

-2.4%

-0.3%

2.1%

-2.4%

73.3%

2012

15.9%

1.0%

16.0%

-15.0%

50.8%

2013

46.7%

9.8%

32.4%

-22.6%

25.1%

 

* Net of fees

** Invested dollar with MCM relative to invested dollar in the S&P 500 since 12/31/99

Disclosures: The MCM Total Account composite includes consolidated portfolios greater than $1 million where MCM has been given full investment authority. The strategy seeks long-term growth through a combination of capital appreciation and income. The reported return includes interest and dividends but does not factor in taxes. Returns are net of fees. The S&P 500 is a market value weighted index consisting of 500 stocks chosen for market size, liquidity and industry group representation. The reported return is inclusive of dividends but exclusive of taxes and management fees.

PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS.

Copyright©2013 Martin Capital Management, LLC. This report is provided for clients; it is not for further distribution. It is protected by U.S. copyright law and may not be reproduced, distributed, transmitted, displayed or published in any form without the prior written permission of Martin Capital Management, LLC.

Martin Capital MCM

Letter to MCM Clients

Performance Commentary

To the Clients of Martin Capital Management:

The crux of our investment strategy over the last several years has been to serve as prudent stewards of your portfolios of marketable securities. We’ve tiptoed through a field of dreams under which we believe a few random landmines await the unwary. At great peril to career and business but little to your capital, we’ve invested to try to minimize wealth-threatening risks while most managers are attempting to maximize return. Proactive and precautionary investing, however, has come at a price in the short term.

Our equities rose 46% in 2013 compared with 32% for the S&P 500 Index. The MCM total account composite gain of 9.8% reveals the opportunity cost of forgoing equity investments for lack of an adequate margin of safety. That left us holding an average of 73.4% of the portfolio invested predominantly in short-term U.S. Treasury securities, which yielded 0.2%. The net cost of

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