As We See It ...                                                                 Second Quarter 2008

Our last two letters dealt with the uncertainty of the economic environment, and six months down the road things have not become much clearer. We have a bit more information, but nothing that has not been obvious to most observers.

First, we are officially in a bear market. As of this writing the S&P 500 is down more than 20% from the October highs. The financial crisis is not curing itself, and the contagion has spread as far as Fannie Mae and Freddie Mac, the for profit yet congressionally chartered clearing houses of mortgage debt. Offsetting our concerns about these developments, however, is the fact that financial institutions have had access to the capital markets, albeit at higher rates. They have been able to issue debt and preferred stock, and every offering we have seen has been oversubscribed, speaking to the continued appetite of professional investors for high quality income producing securities.

Second, inflation is no longer a secondary concern, but has been brought right to the front of our consciousness by the parabolic trajectory of energy prices and the floods in the Midwest that ruined crops and disrupted transportation networks for weeks if not months. These are unquestionably inflationary shocks. Producers of goods and services cannot absorb the related decrease in their profit margins indefinitely. Eventually they will seek to pass these price increases on to the consumer. On the other hand, consumers will treat the increase in prices they pay for direct energy consumption (gasoline, electricity, and fuel oil, for example) as they would a tax increase, and simply reduce their discretionary spending to fill the void. This will have a deflationary effect as demand decreases.

Where then does one invest? Look for companies that have underlying recession resistant secular growth and a degree of pricing power. Healthcare supply companies generally fit this category, as do some areas of the information technology sector. For example, banks, retailers, and governments will continue to gather data, and will need to store that valuable digital intelligence somewhere. We believe that bodes well for EMC and NetApp’s ability to grow even in a slowdown. We also check to make sure that management teams of all of our portfolio companies are experienced enough to husband resources in a slowdown without sacrificing investment in future growth opportunities. Finally, if things do turn south, high price/earnings multiples are usually not rewarded, so we maintain our discipline of adding new companies to the portfolios only when the downside risk is low.

We are generally comfortable with the portfolio’s position and its ability to weather a further downturn in the market. Performance in the quarter outpaced the relevant indices, but that only meant we fell less. Nonetheless, we welcome your questions and comments, and hope you enjoy the rest of your summer.

ADR's...

American Depositary Receipts (ADRs) are negotiable US securities that represent a non-US company’s publicly traded equity. They are denominated in US dollars and trade on US exchanges, so they can be an easy and efficient way for US investors to put money to work internationally.

While ADR-only mandates have attractive characteristics, they also have a number of drawbacks. The ADR universe includes only a portion of the non-US universe of securities. While many large non-US companies have an ADR, some well-known global companies such as Samsung Electronics, do not. In addition, many interesting mid- to large-cap growth companies do not trade as ADRs. Examples include Hyflux (Singapore), Kurita Water (Japan), and Solon (Germany).

Based on the performance of the Bank of New York (BNY) Developed Market ADR index relative to that of the MSCI EAFE index, the limitations of the ADR-only universe have been a negative. Over its eight year history, the ADR index underperformed EAFE in six years, and lagged by more than 100 basis points on an annualized basis over three-, five- and eight-year periods.

Another concern is that the ADR universe peaked in 2001 and has been shrinking ever since. In contrast, London, where there are fewer regulatory requirements such as Sarbanes-Oxley, is becoming the exchange of choice for depositary receipts. This trend is expected to continue.

Johnston Asset Management has been running fully-discretionary portfolios (which can hold both ordinary shares and ADRs) for more than five years. Initially, there was significant overlap between the holdings and performance, but more recently, a number of stocks without an ADR facility have made it through the intense scrutiny inherent in our investment process, and have become positions in our fully-discretionary portfolios. As of 12/31/07, our fully-discretionary portfolios have outperformed our ADR-only portfolios over the one-, three- and five-year periods on an annualized basis.

There is no guarantee that this outperformance will continue, but we believe that over the long term, it is best for clients to be invested in portfolios that have the flexibility to access all attractive investment opportunities in the non-US universe. Such a large portion of the investment universe is excluded from possible inclusion in ADR-only portfolios that over time, a significant number of attractive investment opportunities are likely to be missed.

We have created three new vehicles to make it easier to invest with us in our International product. Two are LPs for individuals and Foundations & Endowments; the third is a Group Trust for ERISA accounts. They offer monthly liquidity and modest minimums, as well as greater access to ordinary shares and the opportunity for defensive hedging.