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Chartwell ETF Investment Letter

Tuesday, August 1st, 2006

Dear Client,

July was a stabilizing month for global investors as gained some ground after a turbulent May and June. Some major U.S. indices are now in red for the year and international markets are uneven leading to a premium on picking the right markets.

With the exception of the Asia and New Venture portfolios, all of our portfolios gained ground in July. For the year, The Core Conservative is up 10.9%, Global - up 8.4%, International - up 10.4%, Asia - up 8.4%, New Venture - up 2.3% and Gone Fishing - up 6.4%. The MSCI World Index is up 5.6% in U.S. dollars. The MSCI Far East Index, weighed down by a negative Japan is up only 0.49%.

Foreign currency exposure is definitely helping portfolio returns pretty much across the board. For example, look at how the British pound has done over the past decade. It is up 18% against the dollar and 30% against the Yen. It has also averaged a three-month yield of 5.25%. I have cooled on the Everbank foreign currency CDs because of their inflexibility and am leaning more towards the new foreign currency ETFs (see below).

The data on the U.S. economy is disconcerting with evidence that the overall growth rate and consumer spending is faltering. Investors are seizing on this data to predict no more Fed rate increases. This may be so but much of this is already priced into the market. Keep in mind that consumer spending accounts for 70% of the American GDP. Personal consumption rose 4.8% in first quarter but only 2.5% in the second.

I am not particularly worried about inflation except in the energy area. Worst case scenario, slower growth and inflation.

Changes in our portfolios will be on the conservative side, raising some cash, pulling back from pricey small caps and moving incrementally towards value.

The Doha trade round collapsed in acrimony when Pascal Lamy, head of the World Trade Organization, said he was suspending negotiations because they had failed to reach a compromise on farm trade. His decision came after the United States, the European Union, Brazil, India, Japan and Australia held a meeting to try to save the talks. Quite frankly, the U.S. is better off negotiating bilateral deals even with developing countries.

An interesting angle about developing countries unwillingness to open their markets is the fear of China. U.S. trade negotiator Susan Schwab had this to say in a recent WSJ interview: "The role of China in this equation," she said, concerned poor countries that fear China could crowd out rivals in the more open world trade that would result from a successful conclusion of the Doha Round of negotiations. "Some of the pushback you get ... is a reflection of developing-country concerns about China," Ms. Schwab said, suggesting those fears are shared by middle-income developing nations, such as Brazil and India, as well as countries in Africa and Asia farther down the income ladder. "It's poor countries all over the world," she said.

Here are the year-to-date numbers for Asian markets.

*Source: Bloomberg. In U.S. Dollars.

As concerns over potential overheating in the economy resurfaced, the People's Bank of China (PBOC) announced plans to raise the required reserve ratio for commercial banks from 7.5% to 8.0% effective July 5, another tightening measure, following a 0.27% interest rate hike in April.

The Reserve Bank of India (RBI) announced that India's current account deficit has doubled year-on-year to $10.6 billion, or 1.3% of GDP, for the fiscal year ending March 2006. The trade deficit widened to $51 billion driven by rising oil imports. It is important to note that a portion of the trade deficit is being financed by foreign portfolio flows ($12.5 billion) and also foreign direct investment ($7.5 billion).

Australia's Reserve bank is expected to raise rates after noting that inflation is accelerating beyond targets. Unemployment is at a 30 year low.

Consumer confidence in South Korea fell to a 10-month low of 97.4 in June, down from 98 in May according to the National Statistical Office. This was the fifth consecutive decline, as higher fuel prices and interest rates had a negative impact on consumer sentiment. A reading below 100 indicates that the majority of respondents have a pessimistic outlook.

Oji Paper said it wanted to buy Hokuetsu Paper, which is committed instead to selling a 24% stake to Mitsubishi Corporation. It is thought to be the first time a Japanese blue-chip company has made a hostile bid for a domestic competitor and may be a sign that Japan's corporate culture is opening up to Western-style business practices. One important part of the Japanese market resurgence has to be renewed M&A activity.

Consumer prices in Tokyo and across Japan rose in line with expectations, showing that prices are stabilizing in positive territory and the Bank of Japan has room to raise interest rates again. Tokyo's core consumer-price index rose 0.4% in July compared with a year earlier because of higher prices for gasoline and a tax increase on cigarettes. That marked the seventh straight month of increases and was in line with expectations. Tokyo's core CPI is considered an early indicator of price trends for the rest of Japan.

The IFC reported last week that a study it completed in Brazil showed that because of Brazil's onerous and maze of a tax system and bewildering bureaucracy, thousands of its companies only survive by operating illegally. On average, because of overlapping taxes across 13 states, company tax burdens would amount to 147% of gross profits.

Taiwan's President Chen Shui-bian's approval rating continued to slip further during June. In addition to his son-in-law's scandals related to insider trading, the First Lady was accused of accepting gift vouchers worth in excess of $100,000 and one of President Chen's top presidential aides was charged with bribery and insider trading. The opposition party recently undertook a motion to recall the president in the Legislative Yuan. However, the motion failed to pass, as it did not garner the necessary two-thirds majority vote.

One of our favorite individual stock picks HSBC Holdings reported a 15% rise in first-half net profit on strong revenue growth in new businesses and emerging markets and as costs declined in corporate and investment banking. HSBC also said that the global economy remains strong, led by intense growth in China, and that HSBC is well-positioned to benefit from shifts in the world economy.

Net profit in the six months rose to $8.73 billion, or 77 cents a share, from $7.6 billion a year earlier, well above the $8.1 billion average estimate of analysts surveyed by Dow Jones Newswires. Pretax profit before items -- which U.K. analysts consider a better measure of performance -- rose 18% to $12.52 billion from $10.64 billion and was also well above the $11.68 billion average estimate of analysts.

Here is some interesting commentary by Mark Headley, President of Matthews Funds.

"Just a few decades ago, China was just beginning to show signs of its relevance to the global economy, following over a century of imperial collapse, invasion, civil war and utopian failure. The epicenter of the China's new emergence was the region surrounding the British colony of Hong Kong. The city of Shenzhen on Hong Kong's border had been made one of a handful of experimental sites of foreign investment and even boasted one of China's two "experimental" stock markets. Up the murky Pearl River was China's long-time commercial center, Guangzhou, once known as Canton.

The transformation that had occurred in this region by the early '90s was almost entirely driven by Hong Kong entrepreneurs and Chinese money trickling out of hundreds of government entities. It was chaotic to the extreme. Rules were unclear and continuously changing. China's new business community had only the most tenuous understanding of international business practices. Meetings were fascinating affairs where savvy Hong Kongers only spoke Cantonese and Northerners, with Beijing political connections, only spoke Mandarin. The streets were crowded with belching trucks and constant construction all around.

Today, much of Shenzhen and Guangzhou are still crowded and chaotic, but the transformation into mature cities is unmistakable. Combined with the cluster of cities sitting along the Pearl River between them, something close to 20% of China's exports are produced in an area that can be driven across in less than two hours. Taking that drive recently, one senses the change from hardscrabble development to confident strength. Most roads are new and more are on the way. Cars and trucks are modern and driven with reasonable restraint. Shopping centers are huge and modern. The beauty of southern China's semi-tropical environment has not been blighted, and a surprising amount of the region resembles agricultural areas in Thailand.

While Shenzhen is clearly a new city, with areas that are reminiscent of Singapore's meticulous city planning and parts that closely resemble Tijuana, Mexico, Guangzhou is a real city. A few years ago, it was hard to tell anything through the haze of factory pollution and construction dust. Sadly bikes are almost an endangered species. Motorbikes are not, however, the constant menace they once were as the city moves aggressively to force citizens to use public transport, especially ultra-modern buses. Streets are crowded but with the feeling of a prosperous economic center. Ground is being broken on a Shanghai style city-center complete with the five-star hotels and glass skyscrapers so loved by politicians.

The real surprise comes as one leaves the old city and heads out to the new suburbs. Miles of residential development is rippling out in a series of massive projects. Closer to the city are typical Hong Kong high rise clusters with thousands of units on small amounts of land ranging from modest to very posh. Ten more minutes out of the city and you enter condo land with development after development offering a range of thematic environments for Guangzhou's professional class to choose from. From classic Chinese styles, adjusted to modern tastes, to Australian/Balinese designs, southern China's new middle class is offered a variety of choices that rivals southern California and looks to be better built. Prices remain far lower than in Hong Kong with a modest apartment available for about $75,000 to a modest McMansion for $500,000.

The region's new suburbia is a physical component of the domestic economy that has long been recognized as the "next step" for China's development. Homeownership and all the consumption of goods and services it engenders are the natural path towards a more balanced and mature economy. The current housing development would not have been possible without the mass housing privatization of the mid- '90s. That privatization program put millions of Chinese citizens on the road to afford today's modern apartment. The Pearl River Delta region continues to be a hub of global exports, but that export success is transforming the region into a very large domestic economy.

The real challenge for this bustling region is putting it all together into a cohesive whole. Hong Kong and Guangzhou are rivals as well as partners with regular disputes over the path to a more integrated economy. Could Shenzhen be incorporated into a greater Hong Kong region, or will it remain a bastion of Northerners penetrating China's south? Macau has struggled to remain relevant as the region moves forward, but sin was always its strength and its future seems sure to lead in the direction of the Las Vegas of Asia. Battles over bridges and pollution are ongoing and a rationally integrated region remains many years away.

Interestingly, the angst over Shanghai stealing Hong Kong's mojo, a constant topic five years ago, has been replaced by a deep insecurity that life across the border looks pretty much like life in Hong Kong. As one friend told me, there isn't much you can do here that you can't do over there and for a lot less. China's Pearl River is a giant experiment in how China will relate to the world and how Chinese will relate to each other. While the story is far from over, it looks better than one could have imagined not long ago."

New Chartwell Services for Members

We have brought on Ed Kaffel to help members with both buying and selling their life insurance policies. Ed is a smart, independent guy who sees insurance as a financial asset as well as a tool to protect your family. He has good contacts in the industry and is great on the service side. Ed has also helped several members sell their life policies for several times their cash surrender policies and helped the clients to use part of the proceeds to purchase a new better policy.

This is what the most respected publications in the world say about life settlements‰¥Ï.

"...elderly Americans with policies they do not need or cannot afford to keep have had little option but to let the policies lapse or sell them back to their insurers. On average they can get three times as much from life settlement firms as they can from the original insurers."

– The Economist, May 17, 2003

"Owners let nearly 90% of all term policies lapse‰¥Ï..What policyholders sometimes don‰¥út realize is that a policy is an asset that has market value... the value of a life settlements transaction is generally at least three times the underlying cash value of the policy.

– The Wall Street Journal, September 21, 2004

If you want to talk to Ed about buying or selling a life policy, please call him at 719-264-1503.

Also, many members have asked me for better ways to track their ETF portfolios. I have found a tracking service that also offers a deep bench of research and easy to use "point and figure" charting that I use to evaluate ETFs. The service is provided by MyPortfolioView.

Some key features include:

• The ability to track unlimited portfolios. (Build all the models your heart desires.)
• Unique scanning features that identify momentum changes in individual holdings as well as entire portfolios.
• A record of every transaction for future reference.
• Pull up and evaluate a chart on any Stock, ETF, or Mutual Fund in the US Markets.
  
• Unlimited Technical Support and training.

Would you like to convert your portfolio of individual stocks into a low cost, tax efficient and compact ETF portfolio? Or maybe you need your annual portfolio review? Take advantage of my personal and customized index services which leads to a clean portfolio designed to outperform the garden variety benchmarks. Call me at 719-264-1503 for more information.

Carl Delfeld
Investment Advisor

• ETF Specialist with Union Bank of Switzerland

• U.S. Representative,
  Asian Development Bank

• Forbes Asia Columnist

• Stockbroker in Tokyo, Hong Kong & Sydney

• U.S. Treasury consultant

• Graduate of Fletcher School of Law & Diplomacy

• Fellow at Keio and Sophia University, Tokyo, Japan

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