PERIOD FMR* Taxable S&P 500 DOW JONES Nasdaq
1st Qtr 5.62% (1.29%) (.92%) 2.17%
2nd Qtr .74 1.30 .75 (0.001)
3rd Qtr 7.83 (2.30) (3.40) (7.40)
YTD 14.73 .23 (3.60) (5.32)
Five Mile River’s portfolio of conservative value stocks with emphasis on free cash flow, dividends, and real assets performed well in the third quarter. The market this year continues to exhibit a tight trading range with moderate volatility. Our performance through the end of the third quarter is somewhat higher than our +10% expectation for the year because of the excellent returns from several of our energy and utility holdings.

The spike in energy prices is the one new important piece of fundamental news worth highlighting for a moment. This abnormal spike to $55 a barrel for oil and over $7.00 per million cubic feet for gas has been precipitated by production and delivery problems in Russia, Nigeria, Norway, Iraq; and most recently the U.S. Hurricanes have caused the shut-in of significant production in the Gulf of Mexico with serious damage to many offshore pipelines. The confluence of all of these incidents along with rising demand from China and other rapidly growing economies in Asia has created what we believe to be short-term speculative bubble in energy prices. While we are unlikely to return to the days of cheap energy prices of $20/barrel oil and $2.00/mcf gas, these higher prices will gradually bring about higher capital expenditures by the industry to develop higher cost reserves as the managements of these companies revise their long-term forecasts for prices upon which they base their capital investment decisions. No doubt this will be an expensive winter for heating homes and businesses, but the probability of materially lower prices by March of 2005 is very high from these unsustainable levels. The short-term impact from this spike works with a somewhat lagged effect and will slow consumer spending in the fourth and first quarter of next year and could last into the spring if prices do not retreat materially before year-end.

Many economists have already made downward adjustments to 2005 GDP forecasts for the U.S. economy to account for the impact of these high prices. Nevertheless, the impact of high energy prices is not what it was when we experienced a spike in 1980 as the inflation adjusted oil price would have had to reach over $70/barrel to be similar to our early 80’s experience. The U.S. economy is more energy efficient today so the impact will be less than what the nightly headline news would otherwise have you believe. The salutary effect of this unfortunate energy price spike is that long-term interest rates have actually come down since the end of June while the FED has been gradually raising short-term rates. As the FED has moved to raise short rates to an equilibrium level for the economy, energy prices have and will continue to act as a brake on spending. Thus, fewer increases by the FED may be necessary to put these rates back to a normalized level from historical lows. This will sustain housing at a higher level than otherwise would have been the case after such a torrid pace. On the plus side, less aggressive tightening will make equities more attractive on a total return basis than bonds. Five Mile River’s energy holdings have been concentrated in natural gas, not oil, and in pipelines carrying petroleum products that produce reliable steady fee income. We are not participating in the speculative oil price bubble with any of our holdings in FMR, but we are benefiting from the spillover effect on natural gas prices.

We would like to re-emphasize that in a low stock price volatility environment where there has not been a single day that market changed more than 2%, DIVIDENDS matter a lot to achieving our objective of low double-digit returns. The recent dramatic increase in Texas Utilities dividend from $.50 to $2.25 and subsequent appreciation in the stock provide strong evidence of the important role of cash being returned to shareholders. In the past three years, the 376 dividend paying stocks in the S&P 500 have outperformed the 124 non-payers in total return, which is what we are focused on with a large percentage of the names in our portfolio. Since 12/31/01, the total return of dividend paying stocks is approximately 24% vs 8% for the non-payers and about 3% for the S&P500. The numbers for 2004 are even more compelling where the dividend payers are up about 7% versus –4% for the non-payers. New additions in the quarter include Gaylord Entertainment, primarily a hotel owner/operator with key assets in Tennessee, Orlando, and Dallas as well as the Grand Ole Opry, ResortQuest, and BassPro stores. We see significant opportunity to enhance shareholder value from both asset restructuring and timely expansion in the lodging industry. Citizens Communications is a local and rural telecommunications company that is also restructuring and refocusing its assets. It is paying a large one-time dividend of $2.00 per share and initiating a recurring annual dividend of $1.00 per share that will consume approximately 70% of its free cash flow. Management’s interests are clearly aligned with shareholders from this bold value creating decision. Finally, we continue to look for anomalies in today’s markets where over reaction to news events (e.g. recent insurance investigations by NY attorney general) creates opportunities to buy quality growth names that may have become undervalued.

As an SEC registered company we file an ADV II form annually describing our business. Please contact us if you would like a copy.

Please do not hesitate to call either Martha, Todd or Lee if you have any questions about your portfolio as we always look forward to speaking with you and welcome your comments.


Sincerely,

Lee Garcia

Todd Robbins

Martha Robbins

* Results are net of management fees and are not audited.

DISCLAIMER

This letter is not meant as a general guide to investing, or as a source of any specific investment recommendation, and makes no implied or express recommendation concerning the manner in which any client’s accounts should or would be handled as appropriate investment decisions depend upon the client’s investment objectives. Any offer to sell or the solicitation of an offer to buy any interests in any securities may be made only by means of delivery of a Five Mile River Investment Management Agreement and or other similar materials which contain a description of the material terms and various considerations and risk factors relating to such securities or fund. Different types of investments and/or investment strategies involve varying levels of risk, and there can be no assurance that any specific investment or investment strategy will be either suitable or profitable for a client’s or prospective client’s portfolio, and there can be no assurance that investors will not incur losses.