Michael Lee-Chin LLD (Honorary) Executive Chairman

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There is an old Hebrew story about a King who had heard that Moses was a kind, generous, and courageous leader. Wanting to know more, he consulted his astrologers and had his phrenologists examine a portrait of Moses. They reported to the King that Moses was cruel, greedy, and self-centered. Now even more curious, the King went to Moses himself and found him to be a very good man, and related to Moses what his advisors had told him. Moses listened to the King and then agreed with what the astrologists and phrenologist had said. “They saw what I was made of, but they couldn’t tell you how I struggled against that so I would become what I am.”

From the beginning 20 years ago, we set out to build a business that would be fuelled by purpose, inspired by principles, and always took a long-term perspective in decision-making. We wanted to build a firm that would be a case study for other corporations, investors and students, in demonstrating that the principles of successful investing are not far removed from the principles of being successful in life; primarily requiring the traits of: Perseverance, Commitment, Discipline, Integrity, Transparency, Selflessness, Confidence, Principles-driven, and having a long-term perspective – life is not linear. In summary, we wanted to build a business that you, our investors, would be proud to be associated with.

The past 20 years have brought many proud moments and some indelible lessons. Prominent among the proud moments are: AIC Advantage Fund breaking $100/unit coming from $10/unit (20 years earlier), adherence to our investment principles (even in the face of publicly declining assets) and unrelenting media assault (evidenced in “Buy, hold and suffer,” The Globe and Mail, September 30, 2005), our portfolios’ transparency, our managers’ consistency of behavior, and “really walking the talk.” We are proud of the bench strength of our portfolio managers who all adhere to Warren Buffett’s adage: “I am a better businessman because I am an investor. I am a better investor because I am a businessman.” We are proud of winning the DALBAR award for service through the years.

There were some sad moments too – departure of some investors (at much lower prices), spooked by unrelenting negative media with AIC being singled out as one of five management companies accepting “market timers” as investors into our Funds when this practice was industry-endemic.

A role-model corporation must live for centuries. These past 20 initial years have taught us many invaluable lessons. These lessons are not only necessary for our future success but are instructive to our stakeholders, chief among them, our investors. Permit me to recount the major ones.

Successful Investing is Simple, Not Easy. The Power of an Enduring Value System.

It would be near impossible not to have succumbed to the pressures inherent in the extremes of the stock market over the past 20 years had we not been committed to our investment philosophy.

• It was easy after the market 23.7% decline of October, 1987, to have been out of stocks, instead of using this as an opportunity to be fully invested.
• It was easy during the first 6 months of 1990 to have fled stocks when the economy was buffeted by the proposed GST, Meech Lake, high interest rates, decline of the Canadian dollar, and the Iraqi invasion of Kuwait. An excerpt from our Semi-Annual Report of 1990 recalls our stance: “At a time when mutual fund management companies are being sold at historically low valuations, we are very bullish in this area (looking forward to favorable demographic shifts of “baby boomers”). At a time when investors are spooked by high interest rates, we are expecting lower interest rates imminently. History has shown that the contrarian attitude has always paid off over time. That being fully invested in the midst of crisis will pay off. That being optimistic and patient will eventually be rewarding. We are not about to defy History.”

Similarly in 1999, at the height of the boom in internet and technology stocks, it was difficult for many not to have participated.

… In conclusion, investing is all about putting out money to get more back in the future. In today’s environment we would rather put money in TD Bank trading at a P/E ratio of 14.5, implying that at today’s level of earnings, we would get our money back in 14.5 years, versus JDS Uniphase with a P/E of 200, implying it would take 200 years to get our initial investment back.” Today, 7 years later, the NASDAQ is still more than 50% below its high of 5048.62 (recorded on March 10, 2000).

Finally, it was easy over the past 4 years to have been caught up in the euphoria of the commodities and income trust boom. An excerpt from our 2005 Annual Report reminds us of the mood of the day: “In his book Short History of Financial Euphoria, John Kenneth Galbraith (Canadian-born author and economist) identified four trends that signify an investment mania:

1. Investors lose sight of risk and focus only on the rewards;
2. There is a general belief that there are new circumstances in the world that justify higher-than-normal valuations;
3. The illusion that despite temporary setbacks, values will continue to rise; and
4. The condemnation of those who express cynicism or caution to current bullish views. Needless to say, all four of these ingredients are alive and well in the current commodities and income trust boom.

The intellectual tight rope we are faced with today is how do we maintain a strong belief to buy quality stocks and focus on the longterm prospects of the fundamentals of the underlying business when (especially in Canada) the S&P/TSX Composite Total Return Index is being propelled to new heights literally every day by the current commodities boom. Our approach is to view this market as a market of individual stocks, not as a stock market.

The challenge is to isolate those good stocks trading at reasonable valuation.

Isolating value today is much more difficult then it was in the past, but we are confident that time will reward our contrary position.”

Our contrary position paid off over the past year – the income trust market was dealt a blow by our Minister of Finance when he proposed changes to tax rules applicable to income trusts, and the commodities sectors declined significantly. For example, on January 16, 2007, the price of oil closed at US$51 – down 35% from its high of US$78 (August 7, 2006). AIC’s success at consistently being out of step with the crowd-mentality is 100% attributable to our Enduring Value System, which has given us the confidence to persevere and “stay the course” when the market, pundits, and the media are caught up in the mood of the day. It has given us the strength and conviction to accept sacrifices without burden. It has given us the courage to handle tough situations with confidence.

While we are basking in superior out performance today, and while we can boast industry-topping performance over the past 15 and 20 years, we are confident that the next 20 years will bring its fair share of booms, busts, and volatility of unit-price. We are hopeful that our behaviour over the past 20 years will give you the confidence to entrust us with your family’s second most important asset, your wealth. Thank you.

Michael A. Lee-Chin
Executive Chairman
AIC Limited

The first half of 2006 has clearly not been short on news.

The markets went up in the first quarter and turned around and went down in the second quarter. Geopolitical tensions increased between the United States and Iran, the United States and North Korea and, most recently, in Lebanon between Hezbollah and Israel. The evolution towards a global marketplace continued with a number of large mergers having been completed and others pending. Most recently, discussions commenced between Nissan/ Renault and General Motors while, closer to home, Falconbridge is the target of two competing suitors, both trying to be the world’s largest player in the nickel and copper sectors. Alan Greenspan stepped down as Chairman of the U.S. Federal Reserve Board, arguably the institution that most influences global monetary policy, and was replaced by Ben Bernanke. Investment in “emerging markets” became mainstream with the countries of Brazil, Russia, India and China being commonly identified by the acronym BRIC. I could go on and on. However, most of this “news” was not really “new” and, therefore, does not provide us with any new insights.

However, in the first half of 2006, one event did take place that truly provides us with insights we can apply for the benefit of ourselves and society. Warren Buffett, the second richest person in the world, and arguably the best investor the world has ever seen, pledged to donate 85% of his Berkshire Hathaway stock to charity. The current estimated value of that pledge is a remarkable and unprecedented US$37 billion. As I have always maintained, Warren Buffett is a role model of mine. And, the job of a student is always to learn from the master – the role model.

First and foremost, we have to take note of Mr. Buffett’s humbling perspective on life and his resulting constancy of purpose. Mr. Buffett has indicated that, as far back as 1952, he and his wife agreed with Andrew Carnegie, who said: “huge fortunes that flow in large part from society should in large part be returned to society.” More than 40 years later, Mr. Buffett has not changed that perspective and is fulfilling his commitment. Whereas success often begets arrogance, Mr. Buffett has not fallen victim to that undesirable side-effect.

Secondly, let us look at the timing of Mr. Buffett’s gift. Back in 1952, the Buffetts agreed that, “to the extent we did amass wealth, we were totally in sync about what to do with it – and that was to give it back to society.” However, Mr. Buffett waited until now to make the pledge and the actual donation of the shares will take place over the next couple of decades. Why is that? It is in response to this question that Mr. Buffett introduces a number of important principles among them – a long-term perspective and the power of compounding at an above average rate of return. Mr. Buffett states: “I always had the idea that philanthropy was important today, but would be equally important in one year, 10 years, 0 years, and the future generally. And someone who was compounding money at a high rate, I thought, was the better party to be taking care of the philanthropy that was to be done 20 years out.” Mr. Buffett’s decision to take a longer-term perspective, combined with his ability to compound the growth of his wealth at an above average rate of return, greatly benefits the recipients of his donations. Whether we are accumulating wealth to fund our own retirement, our children’s education or to give back to society, the following principles are equally applicable:

• Take a long-term perspective which takes advantage of compounding;
• Maximize the benefit of compounding by having the wealth managed by the person or persons who compound at a higher rate.

Let us examine how Mr. Buffett’s philanthropy plan works. Again, Mr. Buffett is sticking to the principles that have succeeded for him in the past. Although he is giving away a sufficient amount of wealth to be spread across hundreds, if not thousands of charities, Mr. Buffett is not personally directing the donation to those thousands of charities. Instead his pledge is to five selected foundations, with five-sixths of the shares going to one specific foundation; namely, the Bill & Melinda Gates Foundation. In speaking about the Bill & Melinda Gates Foundation, Mr. Buffett notes, “If you think about it – if your goal is to return the money to society by attacking truly major problems that don’t have a commensurate funding base – what could you find that’s better than turning to a couple of people who are young, who are ungodly bright, whose ideas have been proven, who already have shown an ability to scale it up and do it right? You don’t get an opportunity like that ordinarily. I’m getting two people enormously successful at something, where I’ve had a chance to see what they’ve done, where I know they will keep doing it—where they’ve done it with their own money, so they’re not living in some fantasy world—and where in general I agree with their reasoning. If I’ve found the right vehicle for my goal, there’s no reason to wait.” Interestingly, those are the same principles that Mr. Buffett has applied in selecting businesses in which to invest, namely:

• Invest in high quality businesses, that you can understand, that have a track record of doing it right, and that have competent management that “eat their own cooking”; and
• Once you identify such businesses, seize the opportunity. Focus, don’t diversify. Invest now, don’t wait.

In his approach to philanthropy, Mr. Buffett has not abandoned the principles that have made him the most successful investor on the planet.

We live in a very dynamic and complex world that can get very confusing. However, Mr. Buffett provides us with principles that enable us not only to survive, but also to thrive in this environment:

• Be purposeful in life;
• Take a long-term perspective;
• Allocate capital to those who can produce the best returns; and
• Have confidence in your principles and move decisively.

At AIC, we have always held Mr. Buffett in the highest regard as our role model. His behaviours continue to reaffirm to us that we made a good choice.

Michael A. Lee-Chin
Chairman and Chief Executive Officer
AIC Limited

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