June 30, 2009

Kent Croft, CIO and Portfolio Manager
Russell Croft, Portfolio Manager

Manager's Commentary - 2Q 2009

Market Environment

The first half of 2009 has been an eventful period. The stock market advanced substantially during the second quarter of 2009 and built on the sizable gains posted near the end of the first quarter, although the markets lost some momentum in June. Share prices rose for much of the quarter on economic reports.

We have seen some encouraging signs that led to a significant move up from the intraday bottom reached on March 6. Despite this strong upward move, we do not expect the economy and markets to move straight up, rather we expect to 'muddle along' for a period. We remain optimistic the economy can keep improving, moving us further past the bottom of the recession. Some positives and negatives are:

Positives:

1. As of July 2, 2009 both the 3-month LIBOR rate (a measure of liquidity) and the TED spread (a measure of perceived risk) were at their 52 week lows at 0.58% and 0.39%, respectively. This compares to October 10, 2009 peaks of 4.82% and 4.64%, respectively.

2. U.S. durable goods orders, a leading indicator for manufacturing activity, have improved during the second quarter with April and May both up 1.8% versus expectations for overall declines.

3. Purchasing Managers Indices (PMI) have improved worldwide suggesting a bounce back in manufacturing output. The U.S. ISM index has improved from a low of 35.6 in January to 44.8 in the most recent reading in June. JP Morgan's Global PMI Index improved from 37.3 to 45.3 between April and May, the largest two month gain in the series' history.

4. The Organization for Economic Cooperation and Development (OECD) recently raised its economic outlook for the 30 member nations for the first time in two years. They raised their '09 and '10 GDP expectations to -4.1% and 0.7%, respectively and noted they expect the U.S. to lead the group out of the recession.

5. In a sign that financial markets are being repaired, JP Morgan, Goldman Sachs, and Morgan Stanley were among ten banks approved to buy back about $68 billion in preferred shares associated with TARP which frees them from added oversight that curbed lending, hiring and pay.

6. The value in money market mutual funds and savings accounts is currently at $3.7 trillion dollars or about 45% of the S&P 500's market capitalization.

Negatives:

1. After losing 467,000 more jobs in the month of June, the U.S. unemployment rate has reached 9.5%, its highest rate in 26 years.

2. Despite significant government actions that caused mortgage rates to fall to a record low of 4.78% earlier in the year, they remain elevated at 5.3% which, while still historically low, has slowed new mortgage and refinancing activity.

3. As incomes rose more than spending, the U.S. savings rate increased to 6.9% in May, the highest level in 15 years, which stoked fears over the future willingness to spend by the American consumer, which makes up about 70% of GDP.

4. The most recent reading of consumer confidence fell in June to 49.3 from 54.8 previously despite economists' expectations for a slight gain month-over-month.

5. Housing prices have continued to decline falling 18.12% in April year-over-year. Also, construction spending in May fell 0.9%, more than the -0.6% expected and a turnaround from growth of 0.6% in April.

Positioning the Portfolio: Generating Ideas

At the portfolio, we are value oriented with a contrarian bent. Through extensive research, we generate investment ideas from a variety of sources - both internal and external. We continually monitor about 200 stocks, building a portfolio of approximately 60- 80 companies that represent out best ideas. We are classic stock pickers who look at the stock market from the bottom-up.
As value-oriented investors, we look to buy stocks at 80-cents-on-the-dollar and are constantly searching for advantageous entry points. The recent volatility in the markets created opportunities to add to our existing holdings. We are cautiously optimistic and our most important task is to position the portfolio to take advantage of the opportunities that arise out of this market volatility.

We continue to believe we can find good long term investments in the current market. We have added some new names to the portfolio that we believe will be good long term holdings for the Croft Value Fund. A few examples:

Valmont Industries Inc. (VMI)

• VMI is a small conglomerate with 3 strong business, irrigation, utility/highway structures and metal coatings.
• 33% of earnings from irrigation systems that increases crop yields and saves water. At $4 corn system pays for itself in 3 years. Water prices should increase over time, especially in California, further reducing payback period and the return on investment.
• 25% of earnings from utility towers: used for power lines. VMI should benefit from upgrade to the grid and expanding use of alternative energy.
• 25% of earnings from highway structures and lighting: benefits from new highway bill later this year, stimulus and infrastructure spending around the world.
• We estimate $5.00 EPS in 2010. 14 x 2010 estimated EPS with 15% 5 year growth prospects.

Nalco Holding Co. (NLC)

• NLC is a provider of water treatment applications to prevent corrosion, contamination and the build up of harmful deposits.
• 45% of earnings are derived from industrial and institutional water treatment- low risk, steady growth. Cooling water (boilers), wastewater treatment (municipal and industrial), and corrosion control.
• 35% of earnings derived from energy services, upstream and downstream. Levered to higher oil prices via increased drilling, benefits from trend towards heavier and sourer crude which require increased use of corrosion control products.
• Hired a new CEO in 2008 who is aggressively cutting costs. We believe the company is conservatively estimating $100 mln cost savings. $27mln was already achieved in the difficult 1st Q of 2009.
• We Estimate $1.20 EPS in '10, with earnings power above $2 in a couple years.

MetLife Inc. (MET)

• MET provides individual insurance, employee benefits and financial services with offices throughout the U.S. and internationally.
• MET currently trades at a significant discount to its book value. We believe that as markets turn around the company could generate over $4.50 in normalized earnings which would equate to an return on equity of over 10%.
• MET has the opportunity to grow their international business robustly as only about 15% of earnings come from outside of the U.S. currently yet they have experienced 20% CAGR over the past 5 years in these markets.

Genzyme Corp. (GENZ)

• Genzyme is a fully integrated biotechnological company with a diversified portfolio of diagnostic and therapeutic products. About half of revenues come from their leading enzyme replacement therapy franchise.
• GENZ trades at 12X next year's earnings despite a 15%+ consensus long term growth rate, a very diversified portfolio of drugs, and multiple pipeline opportunities with significant upside.
• Through their Mozobil drug they are leveraged to the high growth stem cell industry. Mozobil is effective at creating stem cells in the blood of patients with blood cancer.
• Recent manufacturing worries have been an overhang on the stock, but due to the positive long term trends in biotech and Genzyme's particularly advanced and diversified product portfolio, we view it as an attractive long term holding.

Tyco International Ltd. (TYC)

• Tyco International is a fire, security and engineered products company. It reports in five segments: ADT Worldwide (electronic security), Fire Protection Services, Flow Control, Electrical and Metal Products and Safety Products.
• TYC has growth potential as fire and security remain fairly defensive while multiple expansion should result from a worldwide macroeconomic improvement as well as successful operational initiatives.
• TYC trades at a discount to the industrial group at 11.5X '10E earnings and the stock has been hurt by worries over consumer spending and new commercial activity but we feel the discount on the shares is overblown due to the fact that 52% of revenues are recurring and only 10% come from new construction.
• Due to their strong free cash flow (11%) and solid balance sheet (19% debt to market cap), the company is likely to resume buying back the $900 million in shares remaining under their current authorization which, at current depressed prices, would be highly accretive.

(These are not specific stock recommendations. They are part of a diversified portfolio.)