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| LETTER FROM THE CIO
Rarely have we seen markets exhibit such extreme and concentrated performance as we experienced during the second quarter. The price of oil was the dominant theme, followed closely by the continued stress in the credit markets. As a result, energy was one of the few small-cap sectors to generate positive returns in the Russell 2000 ® index during the second quarter, soaring a remarkable 47 percent. This was primarily a function of the price of oil increasing nearly 40 percent during the quarter to $140 per barrel. Most other sectors were decidedly negative, with multiple sectors experiencing double-digit declines. Financials were the worst performing sector in the Russell 2000 ® Index with a decline of 12.5 percent, followed by Autos and Transportation declining 10.5 percent. Credit losses continue to mount, and recessionary concerns have not abated. Our bottom-up, fundamental approach to investing generates diversified portfolios for our clients. However, when performance is uniquely concentrated based on singular-macro themes, such diversification can hamper performance. Time has proven the long-term benefits of a diversified portfolio, and we remain confident in our process. Despite such concentrated market performance, I am pleased to report that most of our products outperformed their respective benchmarks during the second quarter. Bear markets are often defined as a 20 percent decline in market value, and since October of last year, most major indices have experienced such a decline at some point. We recognize periods such as these are difficult for our clients, and we are never satisfied with delivering negative absolute returns, regardless of our relative outperformance. However, while very frustrating in the short-term, there is an invigorating element created by substantial market declines. Compelling valuations are created, and we believe our disciplined investment process is well-suited to identify and exploit opportunities as they are created. Current market conditions remain volatile, and credit remains tight. We have highlighted the risk premium between high yield (Baa rated) corporate bonds and 10-year treasuries as one proxy for credit availability, and this spread remains very high by historical standards. We continue to believe a narrowing of the risk premium should correlate with improved small-cap returns. We are now entering the reporting period for second quarter results, and I remain optimistic that your portfolios are well-positioned. As always, I welcome any questions or comments you have regarding Kennedy Capital Management. We greatly appreciate the opportunity you have given us to manage your account. Sincerely, *Please not that the performance information provided herein is preliminary, unaudited and subject to change without notice, although it is considered to be accurate as of the date of this letter. A complete performance presentation is an integral part of this letter and, if not attached, is available upon request. Past performance is not indicative of future results. The information provided in this letter should not be considered a recommendation to purchase or sell any particular security. There is no assurance that any securities discussed herein will remain in a Kennedy Capital Management, Inc. ("KCM") portfolio at the time you receive this letter or that securities sold have not been repurchased. Allocations among industries, sectors and securities may vary and are subject to change without notice. Any securities discussed do not represent an account's entire portfolio and in the aggregate may represent only a small percentage of an account's portfolio holdings. It should not be assumed that any of the industry or sector allocation decisions mentioned or securities transactions or holdings discussed were or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the industries, sectors or securities discussed herein. A complete list of all securities recommended by KCM in the preceding year is available upon request by writing to KCM, 10829 Olive Boulevard, St. Louis, MO 63141. Russell Investment Group is the source and owner of the Russell 2000® Index and the Russell Midcap® Index data contained or reflected in this letter and all trademarks and copyrights related thereto. The Russell 2000® Index and the Russell Midcap® Index are unmanaged groups of securities used to measure market performance, they represent total returns (including reinvestment of dividends) and they are used for comparative purposes only. One cannot invest directly in an index. |
St. Louis, Second Quarter, 2008—