TO:                    CLIENT MEMORANDUM
DATE:               JANUARY 2, 2023
FROM:             CHRISTOPHER WARGAS
SUBJECT:        2022 PRESIDENTS' LETTER

     2022 has been a year full of surprises, with supply chain disruptions and Federal Reserve stimulus sending inflation soaring to levels not seen in decades. The tech-related equities sector has also taken a hit due to its high valuations and reliance on low-cost debt.

     One of the biggest surprises to many has been the losses investors have taken in bond funds. As interest rates have risen substantially, many are awakening to how volatile long-duration bonds can be. We've tried our best (and very successfully) to keep our clients away from long-term bonds when interest rates were low. Unsurprisingly, those owning long-term bond funds are now sitting on hefty losses.

     The risk of owning low-yielding long-term debt is too high unless one can secure adequate rates. It seems absurd that many owned these bonds when yields were below 1.5%. Low-rate 30-year bonds should mainly be used for pension managers who match their investment funds with future long-term liabilities. We think it's silly for individual retirees to own these bonds within their investment accounts with rates so low. Long-duration bonds like 30-year treasuries can get extremely volatile when rates rise. It's the reason why we owned no long-duration bonds for our clients in 2022. While many investors took large losses in 2022, our clients were spared.

     The next forty years will radically differ from the previous forty, yet, our investment philosophy will not change. It's time for investors to get back to basics. Over the past decades, many have been sold the illusion of shiny new products like leveraged ETFs, commodity ETFs, speculative option plays, and direct indexing. Thousands of mutual funds charge high fees while hugging the benchmark, adding no value for investors.

     Many firms have placed client money into speculative crypto entities that gamble with their assets. Unsurprisingly, one of the largest crypto exchanges, FTX, recently imploded, causing many hedge funds with client money to suffer large losses. We wrote a memo to clients earlier in the year stating to avoid this space because more blowups would occur. While many advisors wanted to get their clients crypto exposure while Bitcoin was "hot," we steered clear. Our client funds will never be placed into speculative products. When we value securities, we discount the future cash flows to the present value. Bitcoin has no cash flow, so valuation becomes a problem. Highly speculative products need not apply in our portfolios.

     Customer funds across the crypto ecosystem are now either vaporized or locked away with a bankruptcy trustee in many cases. As Warren Buffett has stated, "It's not until the tide goes out that you see who is swimming naked." Enduring portfolios owning high-quality individual bonds and high return on capital businesses will continue to deliver investment returns for long-term holders. For a successful lifetime of investing, one need not play along the edges.

     Our positive view on individual bonds (not bond funds) permeates this firm for a reason - they work. Most investors don't buy individual bonds because they lack an understanding of this terrain. This is quite understandable, as there can be many moving parts. Our bond-heavy portfolios for clients serve multiple purposes. Let me explain.

     First, bonds fix the emotional mistake. What may that be? We would classify this as buying high and selling low. Emotional selling occurs because most individual investors don't know the value of what they own. Bonds fix this. When you own a bond (not a bond fund or ETF), you receive your original investment back at maturity while collecting the coupon payments during the year. Investors know what they own, what they will earn, and when the investment matures. Details like this help investors stick around when the investment landscape becomes uncertain.

     The second and very overlooked reason that bonds excel is optionality. When holding cash, one must consider the decline in purchasing power as an option payment on the ability to use your liquidity when others don't have any. With shorter-duration bonds, we get a leveraged bet on this optionality because we are not holding stagnant cash but instead, a bond that pays interest. Therefore, if stock prices experience a significant decline, a portion of a client's maturing bond assets can be allocated to stocks now trading at much lower valuations. Does this mean an individual will not experience losses on these new equity purchases? Not at all. Volatility is inherent in markets. Bond optionality gives us a call option on the stock market's future margin of safety.

     The basic concepts of investing have been lost over the years. Instead, speculation runs unchecked, even at the professional level. First Shelbourne aims to build client portfolios in the most logical and sensible way while preserving their capital. Our time-tested approach to investing will help individuals and their families for generations to come. 

Respectfully,
/s/ Christopher Wargas
President, First Shelbourne