BakerEllisLLC_Commentary

INVESTOR UPDATE
APRIL 2005

The market pulled back in the first quarter as investors worried about rising oil prices and inflation, and the Fed nudged interest rates higher. The S&P fell 2.6% for the quarter, the Russell 2000 index of smaller stocks lost 5.6% and the NASDAQ dropped 8.1%, the worst quarterly showing for all three indices in two years. Investors found nowhere to hide as foreign currencies, bonds and REITs all lost ground.

Baker Ellis accounts held up relatively well, with our main composite gaining 1.6%.* With the close of the quarter we also completed our third year at Baker Ellis. Our main composite has now gained 45.5% compared to 8.5% for the S&P 500. This gives us a three-year average annual return of 13.3%, compared to 2.8% for the S&P.

During the quarter, we benefited from our substantial position in energy stocks, which bucked the market trend as crude oil hit a record $56.72 a barrel. Our recent decision to reduce exposure to REITs and high-yield debt (“Investor Update January 2005”) turned out to be timely. And we finally were rewarded for holding some cash; with the yield on six-month Treasury bills rising from 1% a year ago to nearly 3%, cash is beginning to offer a viable alternative to stocks and bonds for conservative investors.

During the quarter, we sold Toys “R” Us (TOY) on news that the company will be acquired for $6.6 billion by a consortium of private firms. We had bought shares in the struggling retailer starting in 2003, attracted primarily by the value in its real estate. The sale price equated to roughly a double.

Among new buys, we began accumulating shares of Deutsche Post (DPSTF.PK). The company is best known as the operator of the German postal service, a stable, cash-generating business. However, it also runs a retail bank through its postal offices, and has intriguing growth prospects in its DHL delivery service. If DHL can gain market share or Germany’s long-dragging economy improves, we think the shares have good upside.

Our Asian investment thesis was reaffirmed recently by a two-week tour of Vietnam by Barnes. Like other countries in the region, Vietnam is embracing market reforms after years of central-government control. New factories and housing developments are springing up, and the country is full of young, highly motivated workers.

Barnes visited Vietnam’s stock market, which opened in July 2000 and now lists shares of 28 companies. The combined market value of these shares is a mere $250 million. Theoretically, the clients of Baker Ellis could own nearly one-half of the publicly traded stock in Vietnam – a country of 80 million people with the second-fastest economic growth in Asia. While a growing economy does not always mean a rising stock market (as investors in China have learned recently) our quest for value continues to lead us to areas of the world that are undergoing rapid transformation.

Looking ahead, we remain somewhat cautious. The run-up in prices of all asset classes over the past two years leads us to expect more modest future returns. We are taking profits in stocks that appear ahead of themselves, committing capital gradually to new ideas and maintaining a healthy cash position, knowing that the market sometimes presents us with unexpected opportunities.

Sincerely,

Barnes C. Ellis, RIA
Brian C. Baker, CFA

*Composite represents discretionary accounts over $100,000 held at Fidelity Investments. Performance is size-weighted, and will vary significantly based on risk tolerance, timing of investment and other factors. Composite return is weighted monthly. Size-weighted dispersion for the quarter was 1.34%. Performance is presented net of fees. S&P index data includes gross dividends. Investors cannot own an index, which is always fully invested and does not include management fees or other expenses. Data is believed to be accurate but is not audited or guaranteed. Past performance is no guarantee of future results.