As We See It, the Current Equity Outlook ...                     Second Quarter 2007

We are generally cautious on the outlook for equity markets over the next six months. Negative factors affecting our view include housing, where we think more weakness is coming, and energy, which remains at very high levels. It is hard to make a case for consumer spending as a driver of the economy. Business spending has been strong, but if long rates increase so does the cost of capital, which in turn should slow spending growth. In other words, we don’t expect a strong economy to drive the stock market.

Where we could be wrong: The economy may accelerate in early 2008 and the market is usually pretty good at discounting GDP growth 6-9 months ahead. There is still a great deal of liquidity globally, and US equities may be seen as the most attractive alternative given global geo-political risks, relative valuation, and potential inflation.

Stock Focus - Quest Diagnostics (DGX): We have been gradually adding stock in clinical laboratory chain Quest Diagnostics to the portfolios. Quest has a valuable franchise (number one market share) in a growing market (US healthcare/diagnostics) and has had its stock price correct to an attractive valuation because of a near term disruption in their business (a large HMO has dropped them as a laboratory services provider). We see an opportunity in the stock as we believe the company will resume a growth path after "anniversarying" the contract loss. Part of Quest’s competitive advantage is their access to diagnostic technologies from their own internal development or from preferential arrangements with outside partners who prefer to work with the biggest and best player in clinical diagnostic services. Physicians and caregivers in turn recognize this powerful, valuable, and frequently lifesaving combination and are more inclined to refer their patients to Quest.

Bill Fissell: We are heartbroken to inform you of the death of Bill Fissell on July 7. Bill served his country as a line officer in the US Navy during the Korean Conflict, and then, after earning his MBA at Columbia started an illustrious career in investment management. All we hear about today are hedge funds. Bill worked at the original hedge fund, A.W. Jones. He then went on to manage portfolios at various firms including Eberstadt and Bessemer Trust before founding Fissell Laidlaw in 1985. He joined Johnston Asset in 2000, where he was active until late last year. Bill believed in innovation and growth in his investments, but his guiding principle in business was the pre-eminence of the client. He was a fastidious steward of the client’s assets, eschewing securities that he felt were too risky or whose management he felt lacked integrity. He was patient and caring, and understood that investment management was as much about the relationship between the client and the manager as it was about investment performance. Most of all, he was a great colleague. He questioned everything, but always without judgment. His sense of humor as well as responsibility were infectious and could not help but rub off on us. We will miss his advice, his investment acumen, and his friendship.

Solid Economy, Liquidity Squeeze & Unusual Volatility...

Subprime mortgage lending and Alt A mortgage lending are now well-known terms in the investor’s lexicon. During the recent housing boom, many subprime mortgages were made with incredibly lax lending standards, and it is impossible to see, in retrospect, how many of these loans could have passed even the most cursory level of scrutiny. The lenders were simply supplying the volume to a market where the mortgages could be structured into Collateralized Debt Obligations (CDOs) and sold to hedge funds and other eager buyers of mortgage debt. The investment banks that created the CDOs carved then into tranches, which corresponded to assumed levels of risk, that is, the risk of non-payment of the mortgages or foreclosure. The risk assumptions used by the CDO creators were old and overly optimistic, but the rating agencies used the same assumptions in assigning ratings to the various tranches. The lower rated tranches provide protection for the higher rated portion of the pool, meaning all the BBB rated owners will be wiped out if defaults are large enough, and if payments are slow, all payments are diverted to the higher rated portion until they are satisifed. With high default rates the lower rated pieces will receive no principal or interest, and it seems likely that some of the higher rated pieces will be hurt as well.

These tranches were then sold to hedge funds who believed they could capture extra yield without additional risk. It was not just hedge funds who participated, but some short-term investment vehicles bought these securities as well. The hedge funds then borrowed against these securities many times. This leveraged borrowing made better returns possible, until the defaults on the underlying collateral started to show up at levels that the models had not anticipated, and the value of many of the tranches declined.

Problems deepened as lenders discovered that the collection of collateral supporting leveraged loans to hedge funds was not sufficient. They asked for more collateral, and when there was not enough, hedge funds were forced to sell and de-leverage. "Short-term" funds needed to borrow to protect the return on their funds from dipping into negative territory, which could occur if they were forced to sell these now difficult holdings. Fund managers learned once again the meaning of "no bid". At this point, no one could value these securities, and because of the uncertainty, the lenders demanded additional collateral.

This is where the Federal Reserve entered the picture and told the banks that it was okay to lend against that collateral, because the banks will be able to borrow against it at the Federal Reserve window. In fact, it was not just okay, the Fed wanted the banks to do it. This will provide temporary liquidity for all, and allow the market sufficient time to sort out who has the good paper and who has the bad. We think the Federal Reserve will continue to provide liquidity but not cut the Federal Funds rate. We expect rates will edge back a bit higher, to the July levels, as the market adjusts to that reality. The Federal Reserve will look to the strength of the economy for its decision to cut rates.