Are the Storm Preparations Too Much?
Fourth Quarter 2011 Investment Perspective and Outlook
Cornerstone Capital Management, Inc.
December 31, 2011

Despite a slowly recovering US economy, equity market correlations remained high and macro factors made stock picking difficult in 2011. Who would have predicted that bond yields would drop after a downgrade of US government debt? The overtly antagonistic environment toward business activity from the Obama administration and the dysfunction in Washington regarding budgets and deficit reduction, among other things, has detracted from the confidence that corporations and investors need to make long-term investments. Rising bond yields are forcing European leaders to address their unsustainable rates of deficit spending. Despite a high single digit rate of economic growth in China, investors fear that Chinese economic growth may slow to less than 6% (a "hard landing"). Investor sentiment oscillated wildly throughout the year based on each of these factors, ultimately causing US equity market indices to close the year near where they began the year.

We began the year with a bullish outlook and generated strong returns in the cyclical stocks of the Energy, Industrial, and Technology sectors. Our stock selection in the Technology, Healthcare, and Industrial sectors was particularly strong. Part of our success early in the year came from one of our Energy holdings, Petrohawk Energy Corp., which was acquired by BHP Billiton Ltd. for a 65% premium (as of 12/31/11 the fund did not hold either BHP Billiton or Petrohawk Energy Corp). We have been long-term shareholders of Petrohawk and one of the largest institutional shareholders premised on the value of their assets in some of the most prolific natural gas locations in the country.

The market began to roll over in late July, accelerating to the downside until October 3, all a result of the concerns mentioned above. By maintaining our investment discipline and exposures however, we generated strong returns from October 4 onward, led by the Energy and Industrial sectors and to a lesser extent the Consumer Staples and Materials sectors. Consequently, we regained some lost ground in the 4th Quarter, generating a return of 11.34% versus the Russell 1000 Growth Index return of 10.60%.

Outlook
The stronger performance of US equities relative to foreign equity markets has been due to a deterioration of growth prospects elsewhere and, to a lesser extent, a flight to the safety of a stumbling sub-par economic recovery here in the US. The US equity market is still attractively priced - if we can get past our current issues.

In addition to our domestic issues, there are over €1.47 trillion of debt that must be rolled over from the 10 largest euro area countries in 2012. It seems reasonable to believe that within the next few months, one or more auctions of new notes may fail, ultimately resulting in a sovereign default which triggers Credit Default Swap (CDS). This increasingly likely circumstance has unknown consequences due to the magnitude of cross holdings throughout the world's financial system. It is our belief that ultimately the European Central Bank (ECB) will come to the rescue and a tighter political union will be formed among the euro zone countries which gives more power to the core. However, the path that the market may take during that potential calamitous transition could be very rocky indeed. As a result, as discussed above, we took some risk out of our portfolios this past quarter despite stabilization in leading indicators.

We have not been alone. Many investors have positioned their portfolios defensively in anticipation of a gathering storm. Are investors "overly prepared"? Are they too pessimistic? Much has been said about the $2 trillion on corporate balance sheets and the $3 trillion in sovereign funds - the majority of which is earning a negligible if not negative real rate of return. In addition, the valuation of the equity market is not demanding. In a near zero interest rate environment, with the prospect for 2% GDP growth in the US and more than 3% outside the US in 2012, with housing affordability the most attractive in decades, with labor productivity high, inflation receding, and leading indicators trending higher, trillions of dollars invested in cash or fixed income, short interest near record levels, and leverage ratios by many hedge funds low, the market should be trading at 15 – 17 x forward earnings. Instead, the S&P500 is trading at 12.3 x forward earnings and seems ripe for revaluation higher when we can get some clarity on the issues we face. We will remain vigilant, looking for signs of stabilization, ready to deploy assets more aggressively when investor pessimism is overly negative.

Thank you for your continuing support.

Thomas G. Kamp, CFA
Pesident, Chief Investment Officer

Earnings Growth is not a measure of the funds performance. Forward earnings are the profits that are expected to be generated during a future period of time and are not predictive or a guarantee of future performance.

A correlation coefficient is a measure of the interdependence of two random variables that ranges in value from -1 to +1, indicating perfect negative correlation at -1, absence of correlation at zero, and perfect positive correlation at +1.

Fund holdings are subject to change and are not recommendations to buy or sell any security. Current and future holdings are subject to risk.