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Quarterly Newsletter
Volume XIV Issue III October 2011

Market Overview
The U.S. equity markets retreated over the past three months as the temporary economic soft patch seen this spring has yet to reaccelerate. Confidence began to erode in late July due to brinkmanship partisan politics over the U.S. debt ceiling. While a U.S. default was averted by raising the debt ceiling, the incident resulted in a downgrade of the U.S. credit rating. Fears of a sovereign default in Europe intensified over the quarter as various conflicting news heightened uncertainty. Additionally, Chinas effort to moderate inflation and defuse a potential real estate bubble has slowed economic growth in the worlds second largest economy. Waning confidence from political developments and fears of slower global growth overwhelmed positive earnings announcements resulting in declining stock prices (see table below). Nine of the ten Standard & Poors economic sectors were weaker by the end of the quarter. Only utilities managed to advance 0.2% The Federal Reserve revised their economic growth forecast downward for the year, but still expects the economy to improve. In late September, Fed Chairman Bernanke announced additional measures to help stimulate growth, specifically Operation Twist where the Fed will shift the securities on their balance sheet from shorter-term bonds into longer-term bonds and mortgage-backed securities in an effort to further reduce longer-term interest rates and mortgage rates (see table below). The U.S. dollar advanced over the quarter as a flight to safety from Europe resulted in stronger demand for dollar denominated U.S. Treasury bonds. A stronger U.S. dollar can suppress the prices of many global commodities priced in U.S. dollars. Wheat, corn, cotton, coffee, and oil prices all declined. Gold was one of the few commodities that rose (see table below). Developed international equity markets and emerging market equities also reversed gains seen earlier in the year mainly due to uncertainty in Europe and fears of slower growth in China. Grace Y. Lau, CFA Elliot C. Kauffman, CFA
U.S. Equity Returns Table
Source: Thompson Reuters

U.S. Treasury Yield Table

Source: Bloomberg

Broad Indices Table

Source: Thompson Reuters

Index

Q3 2011 Returns -11.5% -13.8% -12.2% -21.9%

YTD 2011 Returns -3.9% -8.6% -8.3% -16.9%

10/2011 3 month 2 year 5 year 10 year 30 year 0.01% 0.24% 0.88% 1.79% 2.77%

4/2011 0.04% 0.76% 2.18% 3.41% 4.47%

10/2010 0.15% 0.41% 1.22% 2.47% 3.70% Gold (GLD) Crude Oil U.S. Dollar Index International Equity Markets (EFA) Emerging Equity Markets (EEM)

Q3 2011 Returns 8.3% -17.0% 5.9% -20.6% -26.3%

2011 Returns 13.9% -13.3% -0.2% -16.0% -25.4%

Dow Jones S&P 500 NASDAQ Russell 2000

Professional Staff

Grace Y. Lau, CFA

Chief Executive Officer

Carter A. Pearl, CFA

Senior Portfolio Manager

Elliot C. Kauffman, CFA

Senior Portfolio Manager

Daniel S. Flack, CFP, CFA

Portfolio Manager

Brian Metke
Operations Specialist

PacWest Financial Management 1643 E. Bethany Home Road Phoenix, AZ 85016

Tel: (602) 997-8882 Toll Free: (888) 997-8882 Fax (602) 997-8887

Improving Investment Results

Behavioral finance studies human behavior and cognitive reasoning as they apply to investing. Over the years, this field has identified numerous psychological biases innate to humans that tend to frustrate the achievement of investment goals. We can learn the lessons identified by behavioral finance to become better investors and thus improve investment results. Loss aversion, first documented in a 1979 research study, is the tendency of individuals to allocate more weight to losses than to gains of an equal amount. For example, losing $100 hurts more than the pleasure of gaining $100 is enjoyed. Various subsequent studies have estimated that for most people, the pain from a loss of a particular dollar amount is twice as strong as the pleasure of a gain of the same dollar amount. In 1995, the first study of myopic loss aversion, which is loss aversion combined with the tendency to evaluate results over short time periods, found that investors who evaluate the performance of their equity exposures over inappropriately short periods of time will tend to prefer more and more conservative investments during times of market adversity. A 2005 study showed that myopic loss aversion is very much ingrained in the human brain. The experiment went as follows: At the start of the study, a participant was given $20 and told that the study will encompass 20 rounds. At the start of each round, the participant would be asked if he/she would like to invest $1 on the results of a fair coin flip. If the coin lands on heads, the participant would receive $2.50 but if the coin landed on tails, the participant would lose $1. Given the asymmetric payoff, it would be in the participants best interest to invest in every round. Additionally, the outcome in a prior round should not impact the participants decision to invest in the next round because after all the last coin flip has no effect on the next coin flip. Nevertheless, the study found that participants invested in only 58% of the rounds and invested less than 40% of the time after a round in which they had suffered a loss. The researchers concluded that fear causes people to ignore advantageous opportunities, especially if they had previously suffered a loss. Every year, Dalbar, Inc., (a leading independent expert for evaluating investment companies) conducts a study on the quantitative analysis of investor behavior. The results of this years study, which were consistent with the conclusions of prior years, showed that the returns achieved by individual mutual fund investors fell short of both the market indices and professional investment management. For the twenty-year period ending in 2010, self-managed equity investors earned a 3.83% annualized return and fixed income investors earned 1.01%. Over the same time period, the S&P 500 Index earned 9.14% and the Barclays Aggregate Bond Index earned 6.89%. Dalbar claims that the reason for the underperformance is primarily due to psychological factors that result in making changes at inopportune times. The study found that the average equity investor has a retention period of 3.22 years and that all long-term mutual funds continue to be held for less than five years. Specifically, the study concludes that investors who limit the time retention for investments erode the alpha (risk adjusted out-performance) created by professional investment management. At PacWest, we aim to mitigate the dangers of myopic loss aversion in our investment decision making process by continually evaluating results over multiple time frames. After all, measuring performance from the most recent high will always result in perceiving a loss. A better method is to evaluate the potential for appreciation given the current price and prospects rather than react to shorter-term price volatility. Nevertheless, we understand that even temporary losses feel painful. So, please feel free to call us with any concerns. Elliot C. Kauffman, CFA

Record Keeping - Save or Shred

Permanent Retention Birth, Marriage, and Death certificates Medical Records Wills Trust agreements List of financial assets Alimony, custody or prenuptial papers Military papers Photos or videotape of valuables Stock/Mutual Fund purchases (until sold) House records such as canceled checks on major improvements (until sold) 6 Years Tax returns (after filing) Tax related documentation Casualty/theft loss documentation Medical bills (after payment) Loan records (after payoff) Insurance policies (after expiration) Major purchases checks & receipts Year-end brokerage statements 1 Year Canceled checks Shred Most non-tax related checks over 1 year old All but most recent cumulative pay stub Clearly expired product warranties Records of cars/boats no longer owned