On Risk

We feel that the primary skill needed to manage money is Risk Management.  It is a mathematical fact that it is harder to make up losses than to make money. Therefore, we try not to lose any.  

Mathematics of Declines And Advances
Decline Amount	Advances Required to Breakeven
7%	8%
25%	33%
33%	50%
50%	100%
75%	300%
90%	900%

Look at the time it has taken Buy and Hold investors to make up Bear Market losses.

Bear Market Break-Even Analysis
Bear Market	Duration	% Decline	To Breakeven
Sept. '29 - June '32	33 months	-86.7	25.2 years
July '33 - Mar. '35	20 months	-33.9	2.3 years
Mar. '37 - Mar. '38	12 months	-54.5	8.8 years
Nov. '38 - Apr. '42	41 months	-45.8	6.4 years
May '46 - Mar. '48	22 months	-28.1	4.1 years
Aug. '56 - Oct. '57	14 months	-21.6	2.1 years
Dec. '61 - June '62	6 months	-28	1.8 years
Feb. '66 - Oct. '66	8 months	-22.2	1.4 years
Nov. '68 - May '70	18 months	-36.1	3.3 years
Jan. '73 - Oct. '74	21 months	-48.2	7.6 years
Nov. '80 - Aug. '82	21 months	-27.1	2.1 years
Aug. '87 - Dec. '87	4 months	-33.5	1.9 years
July '90 - Oct. '90	3 months	-19.9	0.6 years
Mar. '00 - Oct. '02	31 months	-50.2	????

Consider these three Scenarios:

NASDAQ 100 Break Even Analysis
Date	NASDAQ 100 Buy & Hold	NASDAQ 100 Actively Managed No Losing Years	NASDAQ 100 Actively Managed 50% of losing years
1990	-10.41%	0.00%	-5.21%
1991	64.99%	24.91%	41.19%
1992	8.86%	3.40%	5.62%
1993	10.58%	4.05%	6.70%
1994	1.51%	0.58%	0.96%
1995	42.54%	16.30%	26.96%
1996	42.54%	16.31%	26.96%
1997	20.63%	7.91%	13.08%
1998	85.31%	32.70%	54.06%
1999	101.95%	39.08%	64.61%
2000	-37.65%	0.00%	-18.83%
2001	-32.64%	0.00%	-16.32%
2002 9/30/02	-47.66%	0.00%	-23.83%
Average Rate of Return	19.27%	11.17%	13.53%
Actual Compound Rate of Return	10.45%	10.45%	10.45%
Percentage of Gains Necessary to Equal Buy & Hold Return	100.00%	38.33%	63.67%

If risk can be controlled to avoid any losing years, a portfolio would have only needed to capture 38.33% of the gains!  If the losses could be limited to only half the NASDAQ 100 losses, a portfolio would only need to capture 63.67% of its gains to achieve the same return!

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On Risk Control

We use the following methods to control risk:

1.	We use mutual funds rather than individual stocks and bonds to gain better diversification.  Risk analysis of individual bond issues is highly technical and time consuming and most investors do not have portfolios large enough to purchase a sufficient number of different bond issues to properly diversify.  The same is true with stocks.   We feel we add value by getting the big picture right.  That is the hard part.  We can then hire the best stock and bond pickers in the world (leading mutual fund managers) for about +/- 1% per year.
2.	We pick mutual funds that have low volatility compared to their recent performance.  This type of fund tends to hold its value better on those inevitable days and weeks when the market trades sideways to down.
3.	We try to pick investments that are not closely correlated.  In other words, we like investments that are in an uptrend but are not necessarily affected by the same market forces. In that way, when one goes down the others may go up.
4.	We use stop-losses.  For example, we are not willing to give back all of our gains so we sell or hedge if the price declines to a certain point - usually 3-8% - or to some technical support level.
5.	We use a market-neutral hedging strategy.  If we feel that we hold very strong investments but the market is in a short-term correction, we will hold the investments but add a hedge.  A hedge in our case would be a mutual fund that goes in the opposite direction that the market is going.  For example, if we are invested primarily in small company stocks or funds, we might buy a fund that moves in the opposite direction of the small company index.  In this way, we do not have to liquidate our holdings and incur trading fees or taxes to protect the portfolio from losses. If it turns out that the market correction is not short-term and is the beginning of something worse (see Bear Market Break-Even Analysis above) then we have protected your money.  If we get it wrong and the market does not go down, we just miss some initial gains.  Remember, we only need to capture about 40% of the gains to be ahead, if we miss the losses (see NASDAQ 100 Break Even Analysis).

These methods have allowed us to reduce our draw-downs and volatility to less than half that of the S&P 500 and to less than a third that of the NASDAQ over the last two years.  Because of this, for the two year period ending 12/31/02, our four accounts out-performed the S&P 500 from 27.41% to 35.70% and the NASDAQ from 39.99% to 48.28% respectively!

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On Compensation

We are a Fee-Only investment advisor.  We take no commissions or subsidies from anyone.  We do not make anything when we trade your account.  We do not get paid to sell you anything.  We only increase our income by growing your portfolio.  If your portfolio decreases, our income goes down.  We have the same interest in your money that you do.  Therefore, when we make a trade, you never have to wonder whose interests we have at heart.  With a commissioned broker, if your account is down and you are concerned, they might try to get you to change investments just to make another commission. They get rewarded for trading your account or selling you something when you have lost money.

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On Our Money

Ninety-five percent of the investment manager's money is invested in the accounts our client's money is invested in.

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On Performance

We combine risk management with our momentum capturing ranking systems which move us to higher performing investments as the market starts to move up. For the five year period ending 7/31/03, the date of this posting, our three equity accounts have from 36% to 47% more money than if you had bought Vanguard S&P 500 Index Fund. Who says active managers can't beat the market? Even more important - you have more than you started with - positive return, not losses. That was after subtracting all expenses and our management fee. We feel that we have added value far in excess of our management expense.

As of 6/30/03, all four of our accounts have outperformed more than 90% of the 15,000 mutual funds in the Morningstar database on a risk-adjusted basis over the last five years.

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Summary

MLK Capital Management was originally founded in 1994 to help companies establishing 401(k) and employee retirement plans pick appropriate investments for those plans.

From the very beginning we received requests from individuals and plan participants to help manage their personal money in addition to their retirement plan accounts. After our initial few years in business, we began to ask why - with no marketing or sales program - our client base and assets under management kept growing.

After talking with many of our clients, we found that most of our clients came to us because of two reasons:.

1.	They thought we knew more than they did about investing because we worked at it every day, and
2.	they trusted us.

We have added value because we have given our clients significantly better returns than the market with less risk.  Our personal money is invested in the same model accounts and traded the same way as all of our client's money.

We are a "fee only investment advisory firm".  This means that the only way we can increase our income is to grow your money or keep you from losing any.  We do not get paid to sell products or make trades.  You may have the finest broker in the world, but every time they make a trade in your account do you wonder; Whose problem are they solving?  Yours or theirs?  We do not get paid when we make trades!

We have a proven track record for managing risk effectively in down markets, have proven that we can capture up-market performance and have no interests that are not consistent with those of our client's interests.  Let us help preserve and grow your wealth.

Lane Kerns
Kerns Capital Management, Inc.

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