Certified Annual Shareholder Report of a Management Investment Company · Form N-CSR
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1: N-CSR Certified Annual Shareholder Report of a 60± 258K
Management Investment Company
2: EX-99.CODE ETH Miscellaneous Exhibit 3± 13K
3: EX-99.CERT Miscellaneous Exhibit 3± 11K
4: EX-99.906 CERT Miscellaneous Exhibit 1 5K
N-CSR · Certified Annual Shareholder Report of a Management Investment Company
Document Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSR
CERTIFIED SHAREHOLDER REPORT OF REGISTERED
MANAGEMENT INVESTMENT COMPANIES
Investment Company Act file number 811-09120
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PRUDENT BEAR FUNDS, INC.
------------------------
(Exact name of registrant as specified in charter)
8140 WALNUT HILL LANE
SUITE 300
DALLAS, TX 75231
-----------------
(Address of principal executive offices) (Zip code)
DAVID W. TICE
DAVID W. TICE & ASSOCIATES, LLC
43-46 NORRE GADE, SUITE 137
CHARLOTTE AMALIE, ST. THOMAS, U.S. VIRGIN ISLANDS 00802
--------------------------------------------------------
(Name and address of agent for service)
1-800-711-1848
--------------
Registrant's telephone number, including area code
Date of fiscal year end: SEPTEMBER 30, 2006
------------------
Date of reporting period: SEPTEMBER 30, 2006
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ITEM 1. REPORT TO STOCKHOLDERS.
------------------------------
ANNUAL REPORT SEPTEMBER 30, 2006
PRUDENT BEAR FUND
NO LOAD SHARES
CLASS C SHARES
PRUDENT GLOBAL INCOME FUND
PRUDENT BEAR
FUNDS, INC.
PRUDENT BEAR FUND
NO LOAD SHARES
Prudent Bear Fund -
Date No Load Shares S&P 500 NASDAQ Composite
---- ------------------- ------- ----------------
9/30/96 $10,000 $10,000 $10,000
9/30/97 $8,356 $14,045 $13,739
9/30/98 $8,662 $15,315 $13,806
9/30/99 $5,529 $19,573 $22,383
9/30/2000 $5,001 $22,174 $29,935
9/30/2001 $8,441 $16,271 $12,216
9/30/2002 $11,435 $12,938 $9,553
9/30/2003 $9,997 $16,094 $14,564
9/30/2004 $8,794 $18,326 $15,460
9/30/2005 $8,425 $20,572 $17,537
9/30/2006 $9,091 $22,792 $18,407
For the period ended September 30, 2006
[Download Table]
Annualized
------------------------------------
One Five Ten Since
Year Year Year Inception
---- ---- ---- ---------
Prudent Bear Fund - No Load Shares 7.92% 1.50% (0.95)% (1.97)%
S&P 500 Index(1)<F1> 10.79% 6.97% 8.59% 9.27%
NASDAQ Composite Index(2)<F2> 4.96% 8.55% 6.29% 7.45%
PERFORMANCE DATA QUOTED REPRESENTS PAST PERFORMANCE, WHICH DOES NOT GUARANTEE
FUTURE RESULTS. THE INVESTMENT RETURN AND PRINCIPAL VALUE OF AN INVESTMENT WILL
FLUCTUATE SO THAT AN INVESTOR'S SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR LESS
THAN THEIR ORIGINAL COST. CURRENT PERFORMANCE MAY BE LOWER OR HIGHER THAN THE
PERFORMANCE QUOTED. PERFORMANCE DATA FOR THE MOST RECENT MONTH-END MAY BE
OBTAINED BY VISITING WWW.PRUDENTBEAR.COM. PERFORMANCE DATA SHOWN DOES NOT
REFLECT THE 1.00% REDEMPTION FEE IMPOSED ON SHARES HELD LESS THAN 30 DAYS. IF IT
DID, TOTAL RETURNS WOULD BE REDUCED.
(1)<F1> The Standard & Poor's 500 (S&P 500) Index is a capital-weighted index,
representing the aggregate market value of the common equity of 500
stocks primarily traded on the New York Stock Exchange. It is not
possible to invest directly in an index.
(2)<F2> The NASDAQ Composite Index is a broad-based capitalization-weighted
index of all NASDAQ stocks. It is not possible to invest directly in
an index.
This chart assumes an initial gross investment of $10,000 made on 9/30/96.
Returns shown for the Prudent Bear Fund - No Load Shares and the S&P 500 Index
include the reinvestment of all dividends. Returns shown for the NASDAQ
Composite Index do not include the reinvestments of dividends. The graph and the
table do not reflect the deduction of taxes that a shareholder would pay on fund
distributions or the redemption of fund shares.
PRUDENT BEAR FUND
CLASS C SHARES
Prudent Bear Fund -
Date Class C Shares S&P 500 Index NASDAQ Composite Index
---- ------------------- ------------- ----------------------
2/8/99 $10,000 $10,000 $10,000
3/31/99 $9,331 $10,363 $10,235
9/30/99 $9,393 $10,401 $11,419
3/31/2000 $7,858 $12,222 $19,014
9/30/2000 $8,423 $11,782 $15,272
3/31/2001 $11,905 $9,573 $7,652
9/30/2001 $14,101 $8,646 $6,232
3/31/2002 $11,947 $9,596 $7,673
9/30/2002 $18,920 $6,875 $4,874
3/31/2003 $17,379 $7,220 $5,577
9/30/2003 $16,420 $8,552 $7,430
3/31/2004 $15,157 $9,755 $8,292
9/30/2004 $14,332 $9,738 $7,887
3/31/2005 $13,790 $10,408 $8,313
9/30/2005 $13,636 $10,931 $8,947
3/31/2006 $14,142 $11,629 $9,729
9/30/2006 $14,609 $12,111 $9,391
For the period ended September 30, 2006
Annualized
------------------
One Five Since
Year Year Inception
---- ---- ---------
Prudent Bear Fund - Class C Shares 7.14% 0.71% 5.09%
S&P 500 Index(1)<F3> 10.79% 6.97% 2.54%
NASDAQ Composite Index(2)<F4> 4.96% 8.55% (0.82)%
PERFORMANCE DATA QUOTED REPRESENTS PAST PERFORMANCE, WHICH DOES NOT GUARANTEE
FUTURE RESULTS. THE INVESTMENT RETURN AND PRINCIPAL VALUE OF AN INVESTMENT WILL
FLUCTUATE SO THAT AN INVESTOR'S SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR LESS
THAN THEIR ORIGINAL COST. CURRENT PERFORMANCE MAY BE LOWER OR HIGHER THAN THE
PERFORMANCE QUOTED. PERFORMANCE DATA FOR THE MOST RECENT MONTH-END MAY BE
OBTAINED BY VISITING WWW.PRUDENTBEAR.COM. PERFORMANCE DATA SHOWN DOES NOT
REFLECT THE 1.00% REDEMPTION FEE IMPOSED ON SHARES HELD LESS THAN 30 DAYS. IF IT
DID, TOTAL RETURNS WOULD BE REDUCED.
(1)<F3> The Standard & Poor's 500 (S&P 500) Index is a capital-weighted index,
representing the aggregate market value of the common equity of 500
stocks primarily traded on the New York Stock Exchange. It is not
possible to invest directly in an index.
(2)<F4> The NASDAQ Composite Index is a broad-based capitalization-weighted
index of all NASDAQ stocks. It is not possible to invest directly in
an index.
This chart assumes an initial gross investment of $10,000 made on 2/08/99
(commencement of operations for the Class C Shares). Returns shown for the
Prudent Bear Fund - Class C Shares and the S&P 500 Index include the
reinvestment of all dividends. Returns shown for the NASDAQ Composite Index do
not include the reinvestments of dividends. The graph and the table do not
reflect the deduction of taxes that a shareholder would pay on fund
distributions or the redemption of fund shares.
PRUDENT GLOBAL INCOME FUND
Merrill Lynch
Pan-Europe Merrill Lynch Global
Prudent Global Citigroup Government Government Bond
Date Income Fund Europe WGBI 1-3 Year Index Index II
---- -------------- ----------- -------------- --------------------
2/2/2000 $10,000 $10,000 $10,000 $10,000
3/31/2000 $9,878 $10,058 $9,934 $10,282
9/30/2000 $9,340 $9,457 $9,326 $10,036
3/31/2001 $9,016 $9,919 $9,672 $10,203
9/30/2001 $9,578 $10,499 $10,295 $10,765
3/31/2002 $10,354 $10,112 $9,970 $10,288
9/30/2002 $11,736 $12,352 $11,761 $11,927
3/31/2003 $12,579 $14,008 $13,261 $12,870
9/30/2003 $13,618 $15,248 $14,395 $13,600
3/31/2004 $14,298 $16,553 $15,494 $14,551
9/30/2004 $14,183 $16,987 $15,783 $14,534
3/31/2005 $14,523 $18,499 $16,784 $15,336
9/30/2005 $14,263 $17,933 $15,834 $14,968
3/31/2006 $14,918 $17,644 $15,865 $14,657
9/30/2006 $15,329 $18,892 $16,870 $15,349
For the period ended September 30, 2006
Annualized
--------------------
One Five Since
Year Year Inception
---- ---- ---------
Prudent Global Income Fund 7.47% 9.86% 6.62%
Citigroup Europe WGBI(1)<F5> 5.35% 12.47% 10.02%
Merrill Lynch Global
Government Bond Index II(2)<F6> 2.55% 7.35% 6.64%
Merrill Lynch Pan-Europe
Government 1-3 Year Index(3)<F7> 6.54% 10.39% 8.17%
PERFORMANCE DATA QUOTED REPRESENTS PAST PERFORMANCE, WHICH DOES NOT GUARANTEE
FUTURE RESULTS. THE INVESTMENT RETURN AND PRINCIPAL VALUE OF AN INVESTMENT WILL
FLUCTUATE SO THAT AN INVESTOR'S SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR LESS
THAN THEIR ORIGINAL COST. CURRENT PERFORMANCE MAY BE LOWER OR HIGHER THAN THE
PERFORMANCE QUOTED. PERFORMANCE DATA FOR THE MOST RECENT MONTH-END MAY BE
OBTAINED BY VISITING WWW.PRUDENTBEAR.COM. PERFORMANCE DATA SHOWN DOES NOT
REFLECT THE 1.00% REDEMPTION FEE IMPOSED ON SHARES HELD LESS THAN 30 DAYS. IF IT
DID, TOTAL RETURNS WOULD BE REDUCED.
(1)<F5> The Citigroup Europe World Government Bond Index (WGBI) consists of
those fifteen sectors of the Citigroup Europe WGBI that are
geographically located in Europe, namely Austria, Belgium, Denmark,
Finland, France, Greece, Germany, Ireland, Italy, the Netherlands,
Portugal, Spain, Sweden, Switzerland and the United Kingdom. It is
not possible to invest directly in an index.
(2)<F6> The Merrill Lynch Global Government Bond Index II tracks the
performance of public debt of investment grade sovereign issuers,
issued and denominated in their own domestic market and currency. It
is a market value-weighted measure of these bonds. It is not possible
to invest directly in an index.
(3)<F7> The Merrill Lynch Pan-Europe Government 1-3 Year Index tracks the
total return performance of the outstanding debt of European sovereign
issuers. It is a market capitalization-weighted basket comprising
Euro participant, Denmark, Sweden, Switzerland, and U.K. sovereign
bonds issued in their respective domestic markets and denominated in
their local currency. This index is further segmented by debt issues
maturing from 1-3 years. It is not possible to invest directly in an
index.
This chart assumes an initial gross investment of $10,000 made on 2/02/00
(commencement of operations). Returns shown include the reinvestment of all
dividends. The graph and the table do not reflect the deduction of taxes that a
shareholder would pay on fund distributions or the redemption of fund shares.
November 1, 2006
Dear fellow shareholders:
The Prudent Bear Fund no-load shares returned 7.92% for the fiscal year ending
September 30, 2006, while the S&P 500 returned 10.79% and the NASDAQ Composite
Index provided a total return of 5.84%. All returns include reinvestment of
dividends.
Although our risk control measures benefited the fund's performance relative to
the general stock market, the ability to generate a positive return over the
period in a rising market was due, in large part, to strong performance from
precious metals mining companies. Even though they retreated sharply from their
highs set in May, major gold stock indices produced returns of 20% or more over
the 12 months.
The Prudent Global Income Fund returned 7.47% for the 12-month period as the
dollar index ended the period about 4% lower. (The dollar index compares the
U.S. dollar to a basket of currencies of our major trading partners.) The fund
benefited from the dollar's weakening as well as from strong performance from
its allocation to gold stocks. Shareholders also benefited from coupon income
generated from U.S. and foreign bond holdings. Despite rising interest rates
around the globe, bonds in the U.S. continue to boast higher yields than those
of most other industrialized countries.
ECONOMY, ONCE TOO HOT, NOW PERCEIVED AS 'JUST RIGHT'
It has been another extraordinary six months, notable for a highly unsettled
financial backdrop buffeted by dramatic swings in both market performance and
perceptions. Admittedly, the U.S. stock market has been much stronger than we
had anticipated. The Dow has recently traded to a string of all-time highs, and
many major indices - including the small- and medium-caps - are not far off
records posted earlier in the year. Bank stocks have advanced about 10% so far
this year, trading to new highs, and the broker/dealers have sprinted to upwards
of 20% year-to-date gains. Many stocks and groups, previously under pressure
from the prospect of rising interest rates, surging energy prices, and economic
retrenchment, have rallied sharply as sentiment has swung back to the too loudly
trumpeted "goldilocks" scenario.
A rapidly weakening housing market, to this point, has been perceived by the
stock and bond markets as a net positive. The slowdown has at least temporarily
restrained GDP growth, while market sentiment has shifted to the view that
current heightened inflationary pressures will prove fleeting. Expectations now
have the Federal Reserve commencing a loosening cycle early next year. This
prospect has enlivened bullish notions of perpetual economic expansion, robust
corporate profits, and low interest rates. Conventional market analysts have
been quick to ratchet up expectations for future stock market gains. In a
replay of familiar bubble dynamics, liquidity overabundance begets exuberance
that incites only greater financial excess.
Examining the landscape, we are anything but dissuaded from our dire credit
bubble thesis. In fact, there is today ample evidence of the type of
instability and volatility - especially with regard to perceptions and market
prices - that are hallmarks of a boom's capricious finale. And this is the most
unsound boom imaginable, fueled by a degree of credit and speculative excess
that even our careful reading of financial history had left us less than fully
prepared to fathom.
Disconcertingly, the economy's recent downshift has only incited a peddle-to-
the-metal mentality throughout the financial sector. It is worth noting that
non-financial debt growth has slackened somewhat this year as nominal GDP has
slowed markedly. Meanwhile, financial sector borrowings have actually
accelerated to a 10% annualized rate. The upshot of financial sector expansion
significantly beyond the funding needs of the real economy is easily
recognizable.
DESPITE HOUSING WOES, CREDIT GROWTH CONTINUES UNABATED
Through the year's first nine months, global investment grade debt issuance of
$1.3 trillion was running 16% ahead of 2005's pace, led by a 22% increase from
the U.S. Record global new "leveraged finance" surpassed $1.0 trillion, 14%
ahead of last year's pace, with U.S. leveraged lending increasing 19%.
Leveraged buyouts (LBOs), along with high-yield and "leveraged" lending are on a
record pace. Global M&A volume, already having surpassed $3.0 trillion, should
easily set a record. Global private equity is on track to raise an
unprecedented $400 billion this year. Syndicated bank lending is on pace to
reach a five-year high - going back to the fateful telecom debt bubble. And
despite the third-quarter slowdown, 2006 will post the strongest year of global
IPO issuance since the bubble year 2000. At the same time, inflated cash flows
and loose corporate debt market conditions have spurred record corporate share
repurchases.
Despite some earlier market and industry tumult, the hedge fund community raised
$44.5 billion during the third quarter, a three-year high. Year-to-date inflows
of $110 billion have already exceeded 2002's record $99.4 billion. Hedge fund
assets are said to have surpassed $1.4 trillion. And in a sign of the times,
former Treasury Secretary John Snow recently became chairman of Cerberus Capital
Management, a $16 billion hedge fund group. Clinton Treasury Secretary Lawrence
Summers accepted a managing director position at D.E. Shaw, while Paul O'Neill
is now an advisor to the Blackstone Group.
To be sure, global credit systems continue firing on all cylinders. Here at
home, total bank credit has been expanding this year at a 10% pace. Commercial
& industrial loans have expanded 15% annualized. Housing slowdown
notwithstanding, bank real estate loans have been growing at a 15% year-to-date
rate. Total system mortgage debt expanded 10.1% annualized during the first-
half, with 12.7% growth in commercial mortgages helping to offset a somewhat
slower 9.8% increase in household mortgage debt.
Citigroup, our nation's largest financial institution, expanded total assets by
$119 billion, or 30% annualized, during the third quarter. Citi's balance sheet
ballooned $275 billion, or almost 19%, during the past year to $1.75 trillion.
Bank of America is enjoying double-digit growth in both consumer and business
loans, with assets expanding 16% over the past year to almost $1.5 trillion.
JPMorganChase has posted 11% year-over-year commercial loan growth, with total
assets also up 11% the past year to $1.3 trillion. The bank's third-quarter
investment banking fees increased 44% from a year earlier to a record $1.4
billion. Though first mortgage originations have been somewhat below last
year's level, Wells Fargo has continued to achieve 10% growth in both consumer
and commercial loans. Total assets were up 15% from a year ago. And throughout
the U.S. banking system, intense competition and narrowing lending margins have
pressed bankers to press for greater loan volume.
In response to the industry-wide mortgage origination slowdown, almost without
exception the major financial institutions have moved aggressively to ensure
double-digit growth in home equity and commercial real estate loans. Yet likely
expending even greater influence upon the real economy, lenders have adopted
strategies to focus more intensively on small business and commercial lending.
And, today, the surest way to rapid lending growth is achieved through financing
mergers and acquisitions.
If the highly competitive lending business cannot secure adequate profits, the
focus then turns to the capital markets, trading, derivatives and investment
management. Never has pressure to meet Wall Street's elevated expectations been
as overwhelming, and rarely have financial conditions remained sufficiently
loose to emboldened institutions trying to exceed those expectations - in one
manner or another. Citigroup, Bank of America and JPMorganChase combined to
repurchase 120.5 million of their shares during the third quarter, increasing
year-to-date buybacks to an astounding 427.6 million.
Never to be outdone, the rapid expansion of bank credit is bettered by Wall
Street and its incredible securities-based credit apparatus. Broker/dealer
assets expanded 18% over the past year, with two-year growth of an astonishing
46%. The "big five" securities firms - Goldman Sachs, Merrill Lynch, Morgan
Stanley, Lehman Brothers and Bear Stearns - posted combined net revenue growth
during the first nine months of the year of $93.6 billion, up 33% from
comparable 2005. Compensation expense increased 36% during this period to $48.3
billion. And despite the marked slowdown in home sales, an irrepressible
mortgage-backed securities (MBS) and asset-backed securities (ABS) marketplace
lends support for another year of double-digit mortgage debt growth. Insatiable
demand for high-yielding instruments ensures that "private-label" MBS will post
another year of heady growth. One of this year's hottest products, the
collateralized debt obligation (CDO) marketplace is on pace for issuance of $400
billion, double last year.
Some analysts have been lulled into complacency by this year's 4.5% growth rate
in M2 "money supply." Meanwhile, outstanding commercial paper has expanded at a
19% rate this year to reach a record $1.92 trillion. Outstanding asset-backed
securities ended the second quarter at $3.22 trillion, up 20% year-over-year.
"Fed funds and repurchase agreements" continue to play prominently in the U.S.
financial sector expansion, expanding 17% during the past year and 40% over two
years. And reinvigorated by more enticing yields, money market fund assets have
expanded 13.6% over the past year to $2.26 trillion. Overall, there's been only
moderate slowing in total non-financial credit from last year's record $2.3
trillion, or 9.5%, expansion, the strongest pace of growth since 1986.
Yet when it comes to awe-inspiring growth, derivatives these days have no match.
Expanding unremittingly at double-digit rates, global derivatives markets have
reached nearly $300 trillion in notional value. Amazingly, positions have
tripled in size since 2000 to surpass four-times the total combined market value
of the world's equity and bond markets. Globally, the notional value of
interest-rate swaps jumped 25% over the past year to $250 trillion. U.S.
commercial bank derivative positions were up 24% over the past year to $119
billion. Interest-rate derivatives jumped 21% year-over-year to $98.7 billion,
with U.S. banks' credit derivative contracts ballooning 60% to $6.6 trillion.
Alarmingly, the global credit derivatives market has doubled over the past year
to $26 trillion, in the process demonstrating all the signs of problematic
excess. There is sound basis for presuming the mania that's enveloped the
credit default swap arena has been a primary driving force for this year's
insatiable demand for new corporate debt. With credit so readily available and
marketplace liquidity in surplus, writing corporate credit protection has been
as alluringly profitable as selling flood insurance in the midst of a long
drought. The only limiting factor is finding enough buyers of insurance. This
quandary has been at least partially ameliorated by the proliferation of Wall
Street structures incorporating highly leveraged pools of corporate credits that
then acquire hedging protection in the credit derivatives marketplace.
Meanwhile, this year's setbacks in energy and commodities trading have buoyed
"credit arbitrage" funds to the top of the global performance leader board. And
with success in this environment comes the bounty of huge investor inflows -
that then must be put to work. Ironically, heightened uncertainty and overall
global financial market volatility have only fanned the burgeoning bubble in
corporate debt. This manic backdrop has the Wall Street "structured finance"
mega-machine burning the midnight oil, with recent new products incorporating as
much as 15 to 1 underlying leverage in corporate credits.
CREDIT BUBBLE GOES GLOBAL
To be sure, bubble excesses are no longer confined to the U.S. credit system.
Throughout the Eurozone, the pace of private credit growth has accelerated to
better than 11%. Credit systems around the world today flourish with unequalled
leeway, posting double-digit growth across a wide spectrum of economies
including the United Kingdom, Scandinavia, Eastern Europe, Russia, Australia,
New Zealand, India, China, and throughout much of non-Japan Asia. Mirroring the
U.S., the Chinese economy has attained the status of one of history's
spectacular credit booms. Also luxuriating in the miraculous global liquidity
backdrop, India has set its sights on following in China's footsteps. And all
the while fanning the global boom, America's captivation with leveraged
speculation, derivatives, MBS, ABS, CDOs, CLOs (collateralized loan
obligations), LBOs, "repos," and who knows what else, has taken the world by
storm.
Little wonder global markets are these days characterized by such phenomenal
price volatility and, increasingly, severe price distortions and divergences.
Credit conditions and liquidity creation have remained, in our opinion, too
loose for too long, with each year of excess adding to the cumulate supply of
international "finance" focused intently on generating a rousing return. This
amassing global pool of "hot money" - absolutely unparalleled in scope and
dynamism - now revels in its freedom to rampage about. For the past several
years, this dynamic has imparted a stubborn upward price bias upon the vast
majority of global asset and commodity markets. Lately, however, a conflux of
heightened speculative excess, "crowded trades," and derivatives-related
leveraging has nurtured susceptibility to abrupt price reversals, sizable market
pullbacks, and some rather exceptional trading anomalies (i.e. natural gas
versus the industrial metals).
The abundantly liquid and highly speculative U.S. and global market backdrop has
proceeded to the point where any real or perceived scarcity risks foment panic
buying and spectacular price spikes. This has been the circumstance throughout
the energy and commodities complex, and is even a recurring factor for
securities markets around the world. Seemingly, myriad marketplaces share a
similar propensity for wild speculative runs on the upside, only to leave them
susceptible to equally dramatic price collapses and speculative routs on the
downside.
Earlier in the year, a liquidity-fueled speculative run propelled a synchronized
skyward lunge in global stocks, energy and commodities, and emerging debt and
equities markets, only to abruptly reverse in May and plummet collectively as
well. The nature of global market instability has been disconcerting, but so
far the vast sea of global liquidity has succeeded in keeping things afloat.
Fear that the Bank of Japan was removing global liquidity has dissipated, as
have notions of concerted global central bank "tightening." The bottom line is
that global credit systems are firing on all cylinders. Liquidity has stayed
readily abundant, which has ensured that bullishness perseveres; that
speculators have become only more emboldened; and that global economies have
remained resilient. Even Iceland and New Zealand, notable examples of
susceptibility to the whims of global finance, have defied predictions of
financial and economic hardship.
Sound the global system is not. This year's backdrop exudes instability and
uncertainty, characterized by wild volatility and some notable divergences among
various markets and asset classes. Importantly, there has been no letup in
upward price pressure for commodities in limited supply. Copper has posted a
better than 60% rise so far this year. The industrial metals nickel, tin, zinc
and lead have spiked to multi-year or record highs. Global drought conditions
and weather uncertainty have wheat prices up 50% to a 10-year high and corn
rising 50% to a multi-year high. Cotton, orange juice, sugar, coffee and other
staples have traded with significant volatility.
Take a deep breath and watch out below, however, when a presumed shortage fails
to materialize. An unexpectedly placid hurricane season and relative calm in
the Middle East tipped the energy markets where, in hindsight, an anomalous
throng of investors, speculators, and derivative traders were all loaded onto
the same side of the boat. A major liquidation of speculative positions surely
played a key role as the price of crude oil sank about 25% in the two months
following July's record $81 a barrel. And, of course, natural gas collapsed
better than 50%, in the process taking down the $6 billion Amaranth hedge fund.
With a segment of the leveraged speculator community rushing to stop the
bleeding, a contagious commodities rout saw the Goldman Sachs Commodities Index
drop 20% in two months from its August record high. The index, however, remains
about double the level from 2003.
Global market booms and self-reinforcing liquidity abundance have become reliant
upon - and beholden to - pervasive leveraged speculation. Such a predicament
eventually manifests as erratic market behavior. We've reached such a point,
and there's today no escaping chronic susceptibility to the whims of a highly
speculative and leveraged marketplace. Bubbles inflating, and others aged and
endangered, now emerge as a primary market focus. Moreover, there is a nagging
disquiet that the liquidity gala must at some point be interrupted or perhaps
even abruptly dissolved, a backdrop sure to intimidate the indecisive and
challenge even those of us with the strongest convictions. At this stage of the
cycle, we likely have little alternative than to become accustomed to formidable
speculative runs that set the stage for unsettling downdrafts - a challenging
environment for managing a short portfolio and our long positions.
COMMODITIES BULL MARKET NOT OVER
As for our long portfolio, we tend to view the recent commodities tumble in the
context of the first meaningful correction in what we expect will prove a
prolonged - and oftentimes topsy-turvy - bull market. Taking exception to
others' analyses, we do not believe the recent decline is evidence of a
turnabout in global liquidity. The confluence internationally of rampant
equities market inflation, minimal risk premiums, record debt issuance, and
booming emerging stocks and bonds instead confirm our view of ongoing credit and
liquidity over-abundance. Yes, gold and silver are considerably off earlier
highs. Not only do we doubt there's been a fundamental change in the liquidity
backdrop, it is our view that ongoing global developments only enhance the
metals stocks' investment merits. Perhaps the liquidity-induced equities,
emerging markets, and credit "arbitrage" booms have provided rather tough
competition of late for the precious metals and commodities overall. And
there's surely been heavy liquidation of energy and metals speculations. The
global "inflation trade," previously rather overcrowded, has by now seen the
crowd thinned.
With regard to the U.S. bubble economy, it is these days on notably less sure
footing. Of course, the onset of a major housing downturn is the most
noteworthy economic development. Unsustainable price inflation, gross
overbuilding and mounting inventories finally punctured grossly unrealistic
expectations. Home prices can and will decline. The major national
homebuilders - having previously taken full advantage of the speculative bubble
- now find themselves in the forefront of cancelled orders, evaporating waiting
lists, and costly price concessions. It was estimated that speculators
accounted for upwards of 25% to 30% of last year's home transactions.
Speculative buying has all but evaporated in many of the frothiest markets,
leaving bloated inventories and sharply diminished demand.
MORTGAGE BUBBLE STILL INTACT
In the next shareholder letter I could very well take a more pessimistic view of
short-term prospects for what clearly has the potential to develop into a full-
fledged housing disaster. Thus far, however - and defying many bearish analysts
- housing prices have remained relatively stable nationally, while posting thus
far modest reversals - perhaps retracing the past year or so of price inflation
- in the most extended markets.
As disciplined analysts, we will not dismiss the significance of what has to
this point been surprising general home price resiliency. Steep price declines
would have initiated a self-reinforcing wave of foreclosures and the onset of
lender angst and mortgage security holder fear and revulsion. Instead, lenders
remain keen to lend and MBS buyers eager to buy. That the mortgage finance
spigot remains wide open has certainly played a key role in sustaining narrow
spreads and seemingly insatiable demand for agency and "private-label" mortgage
securities. Curiously, credit market demand for adjustable-rate, negative-
amortization, "reset" and other "exotic" mortgages remains about as robust as
ever. Intense speculative demand for yield and the resulting proliferation of
CDOs and other "structured products" have created an insatiable appetite for
risky loans.
It was clearly constructive for the marketplace that yields responded promptly
to the prospect of economic moderation. Benchmark 30-year mortgage rates have
dropped 50 basis points from this summer's highs. And while I can write with
confidence that air has begun exiting local housing bubbles around the country,
the same cannot yet be said for the national mortgage finance bubble. Credit
availability has slackened little, if at all. Importantly, borrowers facing
potentially problematic adjustable- and teaser-rate mortgage payment resets are
being actively accommodated. Ongoing loose marketplace conditions empower
aggressive lenders with the capacity to offer mortgage terms favorable to
borrowers desperate to refinance, and at the same time appealing to booming ABS
and CDO marketplaces clamoring for higher-yielding fodder. The bottom line is
that, despite the housing downturn, total mortgage credit is on track for the
sixth consecutive year of double-digit growth and the ninth uninterrupted year
of at least 9% annual growth.
WAGE INFLATION GENERATING LITTLE INTEREST - FOR NOW
Irrepressible mortgage credit may have lost much of its capacity to inflate home
prices. Importantly, however, loose financial conditions are these days
boosting household sector income. Beyond question, rising compensation is today
a primary factor operating to sustain elevated home values, while at the same
time enlarging government tax receipts and inflating corporate cash flows. From
a macro credit analysis standpoint, income growth has now superseded housing
inflation as a paramount consequence of system excess.
Year-to-date, household personal income has expanded at an eye-opening 7.5%
rate. During the 12 months ended June 30th, "compensation of employees" (per
the Fed's quarterly "flow of funds" report) expanded at an 8.3% rate, the
strongest pace of expansion since 1984. For perspective, compensation growth
accelerated from 2005's 5.7%, 2004's 5.2%, 2003's 3.8%, and 2002's 2.5%. And in
the category of anomalous developments worthy of serious contemplation, federal
government personal income tax receipts surged 12.6% during fiscal 2006,
surpassing $1 trillion for the first time. Not to be left far behind, federal
spending jumped 7.4%. Hopefully governments at all levels are not extrapolating
this inflationary windfall as they did those from the late-'90s.
The upsurge in income inflation is not receiving the attention it deserves. For
one, this development marks the emergence of inflationary pressures from the
cozy confines of the asset markets, where they have been erroneously
characterized as "wealth creation." Rising income is as well a departure from
credit inflation-induced "wealth effect" over-consumption and inflated imports,
where it has been misconstrued as a virtue of free-trade and "globalization."
The nature of inflationary effects is changing, subtly perhaps, yet decidedly.
The global backdrop and the unusual structure of the contemporary U.S. economy
have surely impeded its normal headway. Though, as students of inflation
dynamics and processes, we appreciate how the fundamental progression of credit
excess eventually twists and turns its way to gains in remuneration. If
anything, shortages of skilled workers have turned more acute and broad-based.
Coupled with booming corporate earnings, swelling cash hordes, and ultra-easy
corporate credit conditions, the environment has become ripe for steadfast gains
in wages, salaries, bonuses, and stock grants. Most importantly, expectations
have changed, with workers today demanding and receiving the largest pay
increases in years.
The pervasive effects of accelerating household income growth are perhaps
becoming somewhat less ambiguous. Thus far, rising incomes have been performing
yeoman's work in sustaining inflated home prices, in the process buttressing the
mortgage finance bubble and prolonging the aged U.S. credit and economic
bubbles. Mollifying housing worries, compensation trends have supported
spending and in the process spurred only larger trade deficits. And the outward
torrent of finance associated with swelling current account deficits continues
to provide the major impetus for what has evolved into a global credit and
liquidity bubble. Again, we don't want to underplay the significance of U.S.
income trends.
DEPENDENCY ON FOREIGN INVESTORS ESCALATES
The "Rest of World" (ROW) accumulation of U.S. financial obligations is unlike
anything ever experienced in the long history of finance. Foreign holdings of
U.S. financial assets expanded, amazingly, at an almost $1.4 trillion annual
pace during the first-half. For perspective, ROW holdings increased an average
$393 billion per annum during the nineties, and didn't surpass $1 trillion for
the first time until 2004. The ROW stockpile of US financial assets has
ballooned 50% in just three years to $11.6 trillion. During this period, total
holdings of U.S. credit market instruments jumped 63% to $6.0 trillion, as
Treasuries holdings increased $636 billion (46%) to $2.0 trillion; agencies rose
$400 billion (59%) to $1.1 trillion; and corporate bonds including ABS surged
$1.2 trillion (80%) to $2.5 trillion. ROW's $800 billion annualized first-half
credit market instrument purchases accounted for a large percentage of total
Treasury and agency issuance.
It is worth noting that U.S. trade deficits have more than doubled since the
dollar's early 2002 peak. Total foreign central bank reserves have swelled an
incredible $1.3 trillion, or 38%, over just the past two years and will soon
surpass $5 trillion. China's reserves are up 366% since 2002 to about $1.0
trillion, now outranking Japan as our largest creditor. During this period,
Taiwan's reserves have about doubled to $260 billion and South Korea's have
increased two-fold to $230 billion. Russia's reserves have ballooned to $250
billion from less than $50 billion in early 2003, with Brazil's almost doubling
to $74 billion and India's reserves up 50% to $160 billion. Look no further
than massive U.S. current account deficits and the dollar balances gushing to
the rest of the world to largely explain the destabilizing global liquidity
glut.
The "recycling" of dollar liquidity back through U.S. securities markets has
over time severely distorted our credit system. For one, this process has
created enormous artificial demand for top-rated U.S. securities, as foreign
central banks and others direct the global flow of dollar balances to the
perceived safest and most liquid dollar-denominated instruments. Think of this
dynamic in terms of a massive credit system expansion - comprising the banks,
Wall Street, securitizations, finance companies, securities finance, etc. -
generating purchasing power that propagates mushrooming current account
deficits. This global flood of dollar balances is then funneled back to a
limited supply of requisite securities.
This unparalleled market intervention has not gone unnoticed by the enterprising
speculator community. Ramifications include the markets' perception of
uninterrupted liquidity and prevailing price support, breeding only more
emboldened leveraged speculation. The resulting tight supply of Treasuries and
agencies creates further price distortion, including a mischief-making
propensity for short-squeezes. And with the Treasury market anchoring market
yields generally, the process of dollar "recycling" has placed significant
downward pressure on yields across the board. Deficient real interest-rates,
then, promote only greater credit excess, resultant trade deficit expansion and
a more unwieldy "liquidity glut." We always thought "conundrum" a misnomer.
"Bubble effect" would be more explanatory.
Foreign "recycling" operations have recalibrated the yield curve and, this year
in particular, induced a consequential change in the nature of leveraged
speculation. Coveted "borrow-short-to-lend-long" speculative profits have
disappeared, that is unless speculators shifted their borrowing to low-yielding
currencies such as the yen and Swiss franc. In general, we would argue that
prospective returns from speculating within the entire upper-tier of the U.S.
fixed-income marketplace have been minimized by the massive flows to our most
liquid securities.
Importantly, this has squeezed the ballooning leveraged speculating community
only deeper into the higher-yielding debt universe, while shifting the
"structured finance" apparatus into high gear. The resulting pronounced boost
to credit availability and surge in liquidity throughout the corporate sector
have been self-reinforcing, nurturing a resurgent corporate debt boom and a
credit derivatives bubble. These speculative bubble dynamics explain the
insatiable demand for corporate debt that has provided a major impetus for the
commercial lending, junk bond, syndicated bank "leveraged lending," and global
M&A booms.
And while speculator flows from low-yielding currencies are today lending
support to the dollar, only foreign central bank accumulations of dollar
reserves on a massive, unprecedented scale could have forestalled a dollar
crisis. The consequences of this ongoing endeavor, however, are becoming
increasingly dire. Credit bubble excesses - at home and abroad - are left
unchecked to run to only more perilous extremes. We do not believe it is
hyperbole to warn that consequences include economic maladjustments and
financial instability beyond compare. Yet, credit bubble effects include
seductive "fundamentals" such as booming corporate profits, robust financial
markets, and economic resiliency, altogether presenting a convincing aura of
soundness and sustainability.
A major dilemma today, as we see it, is that massive positions are being
accumulated in dollar securities perceived as sound and liquid as "money."
Confidence that foreign central bank operations will interminably support both
U.S. securities markets and our currency promotes huge dollar instrument "carry
trades" and other speculations. In reality, "official" dollar buying
exacerbates excesses, dollar vulnerability and the risk of future speculator de-
leveraging and illiquidity. To be sure, irrepressible credit inflation, non-
productive debt growth, and unmanageable current account deficits guarantee that
the perception of "moneyness" (with regard to U.S. financial assets) is an
illusion to be shattered at some future date. Our fear is that the unavoidable
dollar crisis will now likely coincide with a crisis in market confidence at the
very heart of the U.S. credit system.
Manifestly, U.S. and global systems retain little capacity for adjustment or
self-correction. Our housing slowdown only incites heightened excess throughout
the credit system. The prospect for slower growth encourages an intense flurry
of mergers, acquisitions and leveraged buyouts incorporating progressively more
leverage. The prospect of the reversal of Fed "tightening" has equities
speculation raging in markets across the globe. Meanwhile, speculator mishaps
in energy and commodities trading only empower players operating in the fixed-
income and credit "arbitrage" arenas, in the process promoting only more
destabilizing system credit and liquidity excess.
Recently, markets have prospered from the view the Fed's next move will be a
rate cut. Through 17 rate increases, the bond market always took solace in
housing bubble fragility. Surely, Chairman Bernanke would today prefer not to
apply added pressure on faltering housing markets. At 5.25%, the Fed funds rate
is agreeable to the financial sector and markets. As bullish analysts see it,
the current rate structure would seem to procure double-digit corporate earnings
growth for as far as the eye can see. Even savers are offered respectable
nominal returns, while borrowers continue to enjoy free-flowing credit at
minimal real rates. The rate environment is today creating nothing in the way
of headwinds for asset markets or for the real economy.
There is, however, something quite askew with this glowing picture: The Fed has
willfully orchestrated the most transparent and agreeable "tightening" cycle,
yet without having ever actually tightened financial conditions. This
experiment in New Age central banking has suited market participants just fine,
as illustrated by the broker/dealer and NYSE Financial indices having surged 84%
and 37%, respectively, since rates were first nudged upward back in June of
2004. This does not, however, alter the harsh reality that credit and
speculative excesses have emerged more forceful and unwieldy with each passing
year. U.S. and global imbalances have been left to cumulate exponentially,
ensuring a dreadfully formidable adjustment period. In the final analysis,
what's askew is the Fed's misguided determination to avoid popping bubbles, an
irresponsible policy stance that has tacitly accommodated runaway excess.
A CENTRAL BANKS MOST PERILOUS PREDICAMENT
There is a particular scenario worthy of the title "A central bank's most
perilous predicament:" Follow the error of indulging credit, asset inflation and
speculative excess with a cycle of policy acquiescence and accommodation. In
the process, fashion a New Age policy doctrine readily endorsed by a highly
speculative marketplace, firmly locking the central bank into a perpetually
accommodative stance. This clinches acute system fragility - always inherent to
runaway financial and economic bubbles - that will further extort promises of
"asymmetrical" policy responses. The marketplace comes to perceive that already
loose financial conditions will be loosened aggressively at the first sign of
trouble. And, lastly, the most perilous predicament would have a central bank
resolutely circumventing the business cycle, precluding recessions while
convincing everyone that they're merely nuisances that can and should be
avoided. Most regrettably, this is precisely the predicament now facing the
Bernanke Fed.
It may have appeared logical for the Federal Reserve to tread ever so gingerly
in an environment fraught with asset and economic bubble vulnerability, while
financial fragility seemed to beckon for a degree of policy forbearance. And,
of course, no one welcomes the hardship and uncertainty that accompany bursting
bubbles.
There is, however, no escaping the reality that bubbles, along with their innate
frailty, are very much an outgrowth of an underlying financial structure, credit
infrastructure and monetary environment. It is also true that epic credit
bubbles are creatures fashioned by especially all-powerful dynamics and atypical
monetary backdrops, usually associated with the interplay of extraordinary
financial and economic phenomena. Once ingrained, they will categorically
exhibit every inclination to avoid simply rolling over and obligingly exhausting
themselves. Characteristically, they will defy the hopes and prayers of central
bankers.
The stakes inevitably become too high. Years of financial sector expansion,
innovation and evolution work to embed a systemic propensity for ever-expanding
excess. Speculators, elemental to bubbles, develop a predilection for
increasingly audacious risk-taking (and leveraging), emboldened after
persevering and prospering through years of mostly ups and a few downs and close
calls. Eventually, limitless liquidity is presumed. And the greater the scope
of bubble excess the more assured the marketplace is of unconditional central
bank benevolence. Meanwhile, the maladjusted bubble economy is sustained only
by ever larger doses of credit and asset inflation.
Until a catalyst coerces a change in behavior, lenders will go on lending,
borrowers will keep on borrowing; and speculators will relish in speculating.
An increasingly commanding Wall Street today stops at nothing when it comes to
creating and unloading securities, as well as inventing new products and
creative vehicles for financing more and larger deals. And, quite naturally,
uninterrupted growth becomes the imperative - for financier, lender, borrower,
businessperson, central banker and politician - growth that, not coincidently,
is essential for avoiding the scourge of deflating bubbles.
So the Fed is forced to choose among two unattractive options: Administer
sufficient pain to exact a bubble-terminating change in conduct, or acquiesce to
ever more destabilizing degrees of excess, distortion and maladjustment.
Unfortunately, it is the nature of commanding credit bubbles - as we've been
witnessing - to provide absolutely no policymaking middle ground.
As investment managers operating in such an extraordinary environment, we must
be prepared for markedly opposing scenarios. Foremost, we recognize that we may
face the prospect of having to endure somewhat longer the continuation of credit
bubble "blow-off" excess. At the same time, however, current financial and
economic fragility leave the U.S. financial markets and economy acutely
susceptible. Our role is not to predict but to prepare for - and react to - any
environment that might present itself.
The current liquidity-induced stock market rally is challenging. Not drifting
from our investment mandate, our portfolio posture remains significantly more
short than long. We have, however, lessened our overall risk profile. We've
become especially focused on liquidity, covering some individual shorts while
increasing the relative size of our index futures position. Our strategy is to
reduce portfolio "beta" when the stock market is going against us and work to
avoid short squeezes when they proliferate, while at the same time maintaining
exposure to the downside of highly speculative stock markets. And as frustrating
as loose financial conditions, liquidity over-abundance and rampant speculative
excess are to us market bears, they do always create exceptional profit
opportunities. We remain focused, analytically diligent, disciplined and
determined to capture some of these opportunities for our shareholders.
Our strategy for Prudent Global Income has changed little over the past year.
We reduced our already small exposures to the Japanese yen and Iceland krona,
while increasing positions in the Canadian dollar and Swedish krona. We booked
some gains and reduced our gold exposure somewhat when gold stocks surged this
past spring. With most global central banks in a tightening bias, we continue
to keep the duration of our portfolio of major industrialized government bonds
at less than one year. Portfolio yield continues to benefit from reinvesting
funds in higher-yielding short-term debt instruments. Due to the significant
interest-rate differentials, we retain some exposure to U.S. Treasury bonds. In
conclusion, the portfolio remains structured to benefit from the secular bear
market in the U.S. dollar that we expect to continue.
Sincerely,
/s/David W. Tice
David W. Tice
Past performance does not guarantee future results.
Opinions expressed in this letter are those of the fund manager, are subject to
change and are not guaranteed.
THE PRUDENT BEAR FUND REGULARLY MAKES SHORT SALES OF SECURITIES, WHICH INVOLVES
UNLIMITED RISK INCLUDING THE POSSIBILITY THAT LOSSES MAY EXCEED THE ORIGINAL
AMOUNT INVESTED. THE FUND MAY ALSO USE OPTIONS AND FUTURE CONTRACTS, WHICH HAVE
RISKS ASSOCIATED WITH UNLIMITED LOSSES OF THE UNDERLYING HOLDINGS DUE TO
UNANTICIPATED MARKET MOVEMENTS AND FAILURE TO CORRECTLY PREDICT THE DIRECTION OF
SECURITIES PRICES, INTEREST RATES AND CURRENCY EXCHANGE RATES. THE FUND MAY
ALSO HOLD RESTRICTED SECURITIES PURCHASED THROUGH PRIVATE PLACEMENTS. SUCH
SECURITIES MAY BE DIFFICULT TO SELL WITHOUT EXPERIENCING DELAYS OR ADDITIONAL
COSTS.
THE PRUDENT GLOBAL INCOME FUND INVESTS IN FOREIGN SECURITIES, WHICH INVOLVE
GREATER VOLATILITY AND POLITICAL, ECONOMIC AND CURRENCY RISKS AND DIFFERENCES IN
ACCOUNTING METHODS. THE FUNDS MAY ALSO INVEST IN GOLD, WHICH INVOLVES
ADDITIONAL RISKS, SUCH AS THE POSSIBILITY FOR SUBSTANTIAL PRICE FLUCTUATIONS
OVER A SHORT PERIOD OF TIME.
The S&P 500 Index is a broad based unmanaged index of 500 stocks, which is
widely recognized as representative of the equity market in general. The NASDAQ
Composite Index is a market capitalization-weighted index that is designed to
represent the performance of the National Market System, which includes over
5,000 stocks traded only over-the-counter and not on an exchange. You cannot
invest directly in an index.
Please refer to the Schedule of Investments on page 30 for a list of holdings as
of 9/30/06. Fund holdings and sector allocations are subject to change at any
time and are not recommendations to buy or sell any security.
Beta measures the sensitivity of rates of return on a fund to general market
movements.
Cash flow: measures the cash generating capability of a company by adding non-
cash charges (e.g. depreciation) and interest expense to pretax income.
While the funds are no-load, management and other expenses still apply. Please
refer to the prospectus for further details.
Must be preceded or accompanied by a current prospectus.
EXPENSE EXAMPLE
SEPTEMBER 30, 2006
As a shareholder of the Prudent Bear Fund or the Prudent Global Income Fund
(each a "Fund" and collectively the "Funds"), you incur two types of costs: (1)
redemption fees and (2) ongoing costs, including management fees; distribution
and/or service fees; and other Fund expenses. This Example is intended to help
you understand your ongoing costs (in dollars) of investing in each Fund and to
compare these costs with the ongoing costs of investing in other mutual funds.
The Example is based on an investment of $1,000 invested for the period 4/01/06
- 9/30/06.
ACTUAL EXPENSES
The first line of the table below provides information about actual account
values and actual expenses. Although the Funds charge no sales load or
transaction fees, you will be assessed fees for outgoing wire transfers,
returned checks and stop payment orders at prevailing rates charged by U.S.
Bancorp Fund Services, LLC, the Funds' transfer agent. If you request that a
redemption be made by wire transfer, currently a $15.00 fee is charged by the
Funds' transfer agent. You will be charged a redemption fee equal to 1.00% of
the net amount of the redemption if you redeem your shares less than 30 calendar
days after you purchase them. Individual retirement accounts (IRAs) will be
charged a $15.00 annual maintenance fee. To the extent the Funds invest in
shares of other investment companies as part of its investment strategy, you
will indirectly bear your proportionate share of any fees and expenses charged
by the underlying funds in which the Funds invest in addition to the expenses of
the Funds. Actual expenses of the underlying funds are expected to vary among
the various underlying funds. These expenses are not included in the example
below. The example below includes, but is not limited to, management fees,
shareholder servicing fees, fund accounting, custody and transfer agent fees.
However, the example below does not include portfolio trading commissions and
related expenses or other extraordinary expenses as determined under generally
accepted accounting principles. You may use the information in this line,
together with the amount you invested, to estimate the expenses that you paid
over the period. Simply divide your account value by $1,000 (for example, an
$8,600 account value divided by $1,000 = 8.6), then multiply the result by the
number in the first line under the heading entitled "Expenses Paid During
Period" to estimate the expenses you paid on your account during this period.
HYPOTHETICAL EXAMPLE FOR COMPARISON PURPOSES
The second line of the table below provides information about hypothetical
account values and hypothetical expenses based on the Funds' actual expense
ratio and an assumed rate of return of 5% per year before expenses, which are
not the Funds' actual returns. The hypothetical account values and expenses may
not be used to estimate the actual ending account balance or expenses you paid
for the period. You may use this information to compare the ongoing costs of
investing in the Funds and other funds. To do so, compare this 5% hypothetical
example with the 5% hypothetical examples that appear in the shareholder reports
of the other funds. Please note that the expenses shown in the table are meant
to highlight your ongoing costs only and do not reflect any transactional costs,
such as sales charges (loads), redemption fees, or exchange fees. Therefore, the
second line of the table is useful in comparing ongoing costs only, and will not
help you determine the relative total costs of owning different funds. In
addition, if these transactional costs were included, your costs would have been
higher.
PRUDENT BEAR FUND
NO LOAD SHARES
[Download Table]
BEGINNING ENDING EXPENSES PAID
ACCOUNT VALUE ACCOUNT VALUE DURING PERIOD*<F12>
4/01/06 9/30/06 4/01/06 - 9/30/06
------------- ------------- -------------------
Actual +<F8> (1)<F10> $1,000.00 $1,037.30 $12.29
Hypothetical ++<F9> (2)<F11> $1,000.00 $1,013.00 $12.15
+<F8> Excluding dividends on short positions, your actual cost of
investment in the Fund would be $8.95.
++<F9> Excluding dividends on short positions, your hypothetical cost of
investment in the Fund would be $8.85.
(1)<F10> Ending account values and expenses paid during period based on a
3.73% return. The return is considered after expenses are deducted
from the fund.
(2)<F11> Ending account values and expenses paid during period based on a
5.00% annual return before expenses.
*<F12> Expenses are equal to the Fund's annualized expense ratio of 2.41%,
multiplied by the average account value over the period, multiplied
by 183/365 (to reflect the one-half year period).
PRUDENT BEAR FUND
CLASS C SHARES
[Download Table]
BEGINNING ENDING EXPENSES PAID
ACCOUNT VALUE ACCOUNT VALUE DURING PERIOD*<F17>
4/01/06 9/30/06 4/01/06 - 9/30/06
------------- ------------- -------------------
Actual +<F13> (1)<F15> $1,000.00 $1,033.10 $16.08
Hypothetical ++<F14> (2)<F16> $1,000.00 $1,009.25 $15.90
+<F13> Excluding dividends on short positions, your actual cost of
investment in the Fund would be $12.75.
++<F14> Excluding dividends on short positions, your hypothetical cost of
investment in the Fund would be $12.62.
(1)<F15> Ending account values and expenses paid during period based on a
3.31% return. The return is considered after expenses are deducted
from the fund.
(2)<F16> Ending account values and expenses paid during period based on a
5.00% annual return before expenses.
*<F17> Expenses are equal to the Fund's annualized expense ratio of 3.16%,
multiplied by the average account value over the period, multiplied
by 183/365 (to reflect the one-half year period).
PRUDENT GLOBAL INCOME FUND
[Download Table]
BEGINNING ENDING EXPENSES PAID
ACCOUNT VALUE ACCOUNT VALUE DURING PERIOD*<F20>
4/01/06 9/30/06 4/01/06 - 9/30/06
------------- ------------- -------------------
Actual (1)<F18> $1,000.00 $1,027.60 $6.41
Hypothetical (2)<F19> $1,000.00 $1,018.74 $6.39
(1)<F18> Ending account values and expenses paid during period based on a
2.76% return. The return is considered after expenses are deducted
from the fund.
(2)<F19> Ending account values and expenses paid during period based on a
5.00% annual return before expenses.
*<F20> Expenses are equal to the Fund's annualized expense ratio of 1.26%,
multiplied by the average account value over the period, multiplied
by 183/365 (to reflect the one-half year period).
PRUDENT BEAR FUND
ALLOCATION OF PORTFOLIO ASSETS - SEPTEMBER 30, 2006
Common Stocks 15.7%
Warrants 0.4%
Purchased Put Options 0.7%
Short Transactions -37.3%
Futures -35.4%
Does not include investments used for collateral or short-term cash investments.
PRUDENT GLOBAL INCOME FUND
ALLOCATION OF PORTFOLIO ASSETS - SEPTEMBER 30, 2006
Common Stocks 7.6%
Convertible Bonds 0.4%
Corporate Bonds 2.8%
Foreign Treasury Obligations 70.1%
Short-Term Investments 18.3%
Other Assets in Excess of Liabilities 0.8%
STATEMENTS OF ASSETS AND LIABILITIES
SEPTEMBER 30, 2006
[Enlarge/Download Table]
PRUDENT BEAR PRUDENT GLOBAL
FUND INCOME FUND
------------ --------------
ASSETS:
Investments, at value
Unaffiliated issuers (cost $615,533,756
and $331,892,234, respectively) $638,499,212 $343,166,485
Affiliated issuers (cost $28,834,775 and $728,252, respectively) 48,658,049 331,757
Deposit at brokers for short sales 13,074,490 --
Receivable from broker for proceeds on securities sold short 229,327,569 --
Receivable for futures contracts 563,875 --
Receivable for investments sold 1,105,394 --
Receivable for capital shares issued 2,839,126 557,376
Interest and dividends receivable 3,823,603 3,472,746
Cash 9,656,272 1,530
Other assets 1,092,590 27,530
------------ ------------
Total Assets 948,640,180 347,557,424
------------ ------------
LIABILITIES:
Securities sold short, at value
(Proceeds of $224,218,951 and $0, respectively) 254,133,820 --
Payable for securities purchased 7,404,155 --
Payable for capital shares redeemed 3,320,903 539,077
Payable to Adviser 730,995 219,664
Dividends payable on short positions 337,100 --
Accrued expenses and other liabilities 1,125,647 571,889
------------ ------------
Total Liabilities 267,052,620 1,330,630
------------ ------------
NET ASSETS $681,587,560 $346,226,794
------------ ------------
------------ ------------
NET ASSETS CONSIST OF:
Capital stock $815,960,312 $328,949,315
Accumulated net investment income (loss) 8,460,169 (3,038,000)
Accumulated undistributed net realized gain (loss) on long
transactions, short transactions, option contracts expired or
closed, futures contracts closed and foreign currency translation (148,587,782) 9,542,197
Net unrealized appreciation (depreciation) on:
Investments 42,788,730 10,877,756
Short transactions (29,914,869) --
Futures contracts (7,119,000) --
Foreign currency translation -- (104,474)
------------ ------------
TOTAL NET ASSETS $681,587,560 $346,226,794
------------ ------------
------------ ------------
NO LOAD SHARES:
Net assets $650,304,909 $346,226,794
Shares outstanding (250,000,000 shares
of $.0001 par value authorized) 111,307,474 28,140,337
Net asset value, redemption price and offering price per share $ 5.84 $ 12.30
------------ ------------
------------ ------------
CLASS C SHARES:
Net assets $ 31,282,651
Shares outstanding (250,000,000 shares
of $.0001 par value authorized) 5,562,226
Net asset value, redemption price and offering price per share $ 5.62
------------
------------
See notes to the financial statements.
STATEMENTS OF OPERATIONS
YEAR ENDED SEPTEMBER 30, 2006
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PRUDENT BEAR PRUDENT GLOBAL
FUND INCOME FUND
------------ --------------
INVESTMENT INCOME:
Interest income $26,586,015 $ 9,240,390
Dividend income on long positions (net of foreign taxes
withheld of $0 and $10,837, respectively) 630,287 140,039
----------- -----------
Total investment income 27,216,302 9,380,429
----------- -----------
EXPENSES:
Investment advisory fee 6,683,343 2,602,970
Administration fee 447,682 248,146
Shareholder servicing and accounting costs 547,814 368,072
Custody fees 83,045 58,058
Federal and state registration 81,365 36,236
Professional fees 109,973 111,116
Distribution expense - No Load shares 1,274,335 867,657
Distribution expense - Class C shares 249,337 --
Reports to shareholders 45,607 24,465
Directors' fees and expenses 17,635 17,985
Insurance expense 64,696 50,728
Miscellaneous expense 25,555 25,955
Dividends on short positions 3,847,576 --
----------- -----------
Total expenses 13,477,963 4,411,388
----------- -----------
NET INVESTMENT INCOME 13,738,339 4,969,041
----------- -----------
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:
Realized gain (loss) on:
Long transactions from sales of unaffiliated issuers 20,838,629 5,939,783
Long transactions from sales of affiliated issuers 19,395,955 --
Short transactions (8,407,285) --
Option contracts expired or closed (4,545,159) --
Futures contracts closed (1,977,543) --
Foreign currency translation -- (1,333,301)
----------- -----------
Net realized gain (loss) 25,304,597 4,606,482
Change in unrealized appreciation (depreciation) on:
Investments 16,746,345 13,125,816
Short transactions (20,557,621) --
Futures contracts (8,164,000) --
Foreign currency translation -- 195,361
----------- -----------
Net change in unrealized appreciation (depreciation) (11,975,276) 13,321,177
----------- -----------
Net realized and unrealized gain on investments 13,329,321 17,927,659
----------- -----------
NET INCREASE IN NET ASSETS
RESULTING FROM OPERATIONS $27,067,660 $22,896,700
----------- -----------
----------- -----------
See notes to the financial statements.
STATEMENTS OF CHANGES IN NET ASSETS
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PRUDENT BEAR FUND
--------------------------------------
YEAR ENDED YEAR ENDED
SEPTEMBER 30, 2006 SEPTEMBER 30, 2005
------------------ ------------------
OPERATIONS:
Net investment income (loss) $ 13,738,339 $ (269,475)
Net realized gain (loss) on:
Long transactions from sales of unaffiliated issuers 20,838,629 4,007,205
Long transactions from sales of affiliated issuers 19,395,955 7,670,028
Short transactions (8,407,285) (17,840,922)
Option contracts expired or closed (4,545,159) (20,290,717)
Futures contracts closed (1,977,543) (11,990,125)
Change in unrealized appreciation (depreciation) on:
Investments 16,746,345 18,359,981
Short transactions (20,557,621) (295,702)
Futures contracts (8,164,000) 806,437
------------ ------------
Net increase (decrease) in net assets resulting from operations 27,067,660 (19,843,290)
------------ ------------
DISTRIBUTIONS TO NO LOAD SHAREHOLDERS
FROM NET INVESTMENT INCOME (4,250,205) --
------------ ------------
DISTRIBUTIONS TO CLASS C SHAREHOLDERS
FROM NET INVESTMENT INCOME (169,533) --
------------ ------------
CAPITAL SHARE TRANSACTIONS (Note 2):
Proceeds from shares issued 510,760,585 194,797,082
Redemption fees 382,022 101,802
Shares issued to holders in reinvestment of dividends 3,712,744 --
Cost of shares redeemed (286,725,206) (189,689,072)
------------ ------------
Net increase in net assets resulting
from capital share transactions 228,130,145 5,209,812
------------ ------------
TOTAL INCREASE (DECREASE) IN NET ASSETS 250,778,067 (14,633,478)
NET ASSETS:
Beginning of period 430,809,493 445,442,971
------------ ------------
End of period (including accumulated net investment
income (loss) of $8,460,169, and
($2,574,436), respectively) $681,587,560 $430,809,493
------------ ------------
------------ ------------
See notes to the financial statements.
STATEMENTS OF CHANGES IN NET ASSETS (CONT.)
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PRUDENT GLOBAL INCOME FUND
---------------------------------------
YEAR ENDED YEAR ENDED
SEPTEMBER 30, 2006 SEPTEMBER 30, 2005
------------------ ------------------
OPERATIONS:
Net investment income $ 4,969,041 $ 4,415,701
Net realized gain (loss) on:
Long transactions from sales of unaffiliated issuers 5,939,783 24,989,235
Long transactions from sales of affiliated issuers -- 746,835
Short transactions -- (284)
Foreign currency translation (1,333,301) (824,046)
Change in unrealized appreciation (depreciation) on:
Investments 13,125,816 (25,883,686)
Foreign currency translation 195,361 (710,832)
------------ ------------
Net increase in net assets resulting from operations 22,896,700 2,732,923
------------ ------------
DISTRIBUTIONS TO NO LOAD SHAREHOLDERS
FROM NET INVESTMENT INCOME (603,095) (30,557,779)
FROM NET REALIZED GAINS (1,753,869) (5,448,501)
FROM RETURN OF CAPITAL -- (1,588,575)
------------ ------------
TOTAL DISTRIBUTIONS (2,356,964) (37,594,855)
------------ ------------
CAPITAL SHARE TRANSACTIONS (Note 2):
Proceeds from shares issued 149,501,678 237,659,061
Redemption fees 32,998 23,783
Shares issued to holders in reinvestment of dividends 2,128,752 33,574,236
Cost of shares redeemed (168,987,580) (356,146,412)
------------ ------------
Net decrease in net assets resulting
from capital share transactions (17,324,152) (84,889,332)
------------ ------------
TOTAL INCREASE (DECREASE) IN NET ASSETS 3,215,584 (119,751,264)
NET ASSETS:
Beginning of period 343,011,210 462,762,474
------------ ------------
End of period (including accumulated net investment
loss of $3,038,000 and $614,000, respectively) $346,226,794 $343,011,210
------------ ------------
------------ ------------
See notes to the financial statements.
PRUDENT BEAR FUND
FINANCIAL HIGHLIGHTS
Selected per share data is based on a share outstanding throughout each period.
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NO LOAD SHARES
---------------------------------------------------------------------
YEAR YEAR YEAR YEAR YEAR
ENDED ENDED ENDED ENDED ENDED
SEPT. 30, SEPT. 30, SEPT. 30, SEPT. 30, SEPT. 30,
2006 2005 2004 2003 2002
---- ---- ---- ---- ----
Per Share Data:
Net asset value, beginning of period $5.47 $5.71 $6.84 $8.31 $6.31
----- ----- ----- ----- -----
Income from investment operations:
Net investment income (loss)(1)<F21>(2)<F22> 0.15 (0.00)(4)<F24> (0.02) (0.05) 0.06
Net realized and unrealized
gains (losses) on investments 0.28 (0.24) (0.78) (0.96) 2.08
----- ----- ----- ----- -----
Total from investment operations 0.43 (0.24) (0.80) (1.01) 2.14
----- ----- ----- ----- -----
Redemption fees 0.00(4)<F24> 0.00(4)<F24> 0.00(4)<F24> -- --
----- ----- ----- ----- -----
Less distributions:
Dividends from net investment income (0.06) -- (0.33) (0.22) (0.14)
Distributions from net realized gains -- -- -- (0.24) --
----- ----- ----- ----- -----
Total distributions (0.06) -- (0.33) (0.46) (0.14)
----- ----- ----- ----- -----
Net asset value, end of period $5.84 $5.47 $5.71 $6.84 $8.31
----- ----- ----- ----- -----
----- ----- ----- ----- -----
Total return 7.92% (4.20)% (12.03)% (12.58)% 35.47%
Supplemental data and ratios:
Net assets, end of period (000's) $650,305 $411,780 $429,469 $541,452 $521,030
Ratio of total expenses to average net assets 2.49% 2.58% 2.28% 2.30% 2.29%
Ratio of dividends on short positions
to average net assets 0.72% 0.73% 0.44% 0.44% 0.40%
Ratio of expenses to average net assets
excluding dividends on short positions:
Before expense reductions 1.77% 1.85% 1.84% 1.86% 1.89%
After expense reductions(5)<F25> 1.77% 1.85% 1.83% 1.83% 1.84%
Ratio of net investment income (loss)
to average net assets 2.60% (0.03)% (0.38)% (0.71)% 0.93%
Portfolio turnover rate(3)<F23> 104% 129% 138% 178% 266%
(1)<F21> Net investment income (loss) per share before dividends on short
positions for the periods ended September 30, 2006, September 30,
2005, September 30, 2004, September 30, 2003, and September 30, 2002
was $0.19, $0.04, $0.00, $(0.02), and $0.08, respectively.
(2)<F22> Net investment income (loss) per share represents net investment
income (loss) divided by the average shares outstanding throughout
the period.
(3)<F23> Portfolio turnover is calculated on the basis of the Fund as a whole
without distinguishing between the classes of shares issued.
(4)<F24> Amount calculated is less than $0.005.
(5)<F25> See Note 5 in Notes to the Financial Statements.
See notes to the financial statements.
PRUDENT BEAR FUND
FINANCIAL HIGHLIGHTS (CONT.)
Selected per share data is based on a share outstanding throughout each period.
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CLASS C SHARES
---------------------------------------------------------------------
YEAR YEAR YEAR YEAR YEAR
ENDED ENDED ENDED ENDED ENDED
SEPT. 30, SEPT. 30, SEPT. 30, SEPT. 30, SEPT. 30,
2006 2005 2004 2003 2002
---- ---- ---- ---- ----
Per Share Data:
Net asset value, beginning of period $5.29 $5.56 $6.68 $8.14 $6.23
----- ----- ----- ----- -----
Income from investment operations:
Net investment income (loss)(1)<F26>(2)<F27> 0.11 (0.04) (0.07) (0.10) 0.01
Net realized and unrealized
gains (losses) on investments 0.26 (0.24) (0.75) (0.94) 2.03
----- ----- ----- ----- -----
Total from investment operations 0.37 (0.28) (0.82) (1.04) 2.04
----- ----- ----- ----- -----
Redemption fees 0.00(4)<F29> 0.01 0.00(4)<F29> -- --
----- ----- ----- ----- -----
Less distributions:
Dividends from net investment income (0.04) -- (0.30) (0.18) (0.13)
Distributions from net realized gains -- -- -- (0.24) --
----- ----- ----- ----- -----
Total distributions (0.04) -- (0.30) (0.42) (0.13)
----- ----- ----- ----- -----
Net asset value, end of period $5.62 $5.29 $5.56 $6.68 $8.14
----- ----- ----- ----- -----
----- ----- ----- ----- -----
Total return 7.14% (4.86)% (12.72)% (13.21)% 34.18%
Supplemental data and ratios:
Net assets, end of period (000's) $31,283 $19,029 $15,971 $13,059 $7,842
Ratio of total expenses to average net assets 3.24% 3.33% 3.03% 3.05% 3.04%
Ratio of dividends on short positions
to average net assets 0.72% 0.73% 0.44% 0.44% 0.40%
Ratio of expenses to average net assets
excluding dividends on short positions:
Before expense reductions 2.52% 2.60% 2.59% 2.61% 2.64%
After expense reductions(5)<F30> 2.52% 2.60% 2.58% 2.58% 2.59%
Ratio of net investment income (loss)
to average net assets 1.85% (0.78)% (1.13)% (1.46)% 0.18%
Portfolio turnover rate(3)<F28> 104% 129% 138% 178% 266%
(1)<F26> Net investment income (loss) per share before dividends on short
positions for the periods ended September 30, 2006, September 30,
2005, September 30, 2004, September 30, 2003, and September 30,
2002, was $0.14, $(0.00)(4), $(0.04), $(0.07), and $0.04,
respectively.
(2)<F27> Net investment income (loss) per share represents net investment
income (loss) divided by the average shares outstanding throughout
the period.
(3)<F28> Portfolio turnover is calculated on the basis of the Fund as a whole
without distinguishing between the classes of shares issued.
(4)<F29> Amount calculated is less than $0.005.
(5)<F30> See Note 5 in Notes to the Financial Statements.
See notes to the financial statements.
PRUDENT GLOBAL INCOME FUND
FINANCIAL HIGHLIGHTS (CONT.)
Selected per share data is based on a share outstanding throughout each period.
[Enlarge/Download Table]
YEAR YEAR YEAR YEAR YEAR
ENDED ENDED ENDED ENDED ENDED
SEPT. 30, SEPT. 30, SEPT. 30, SEPT. 30, SEPT. 30,
2006 2005 2004 2003 2002
---- ---- ---- ---- ----
Per Share Data:
Net asset value, beginning of period $11.53 $12.41 $12.49 $11.15 $ 9.31
------ ------ ------ ------ ------
Income from investment operations:
Net investment income 0.17(2)<F32> 0.12(2)<F32> 0.16(2)<F32> 0.11(1)<F31> 0.14(1)<F31>
Net realized and unrealized
gains (losses) on investments 0.68 (0.03) 0.35 1.65 1.94
------ ------ ------ ------ ------
Total from investment operations 0.85 0.09 0.51 1.76 2.08
------ ------ ------ ------ ------
Redemption fees 0.00(3)<F33> 0.00(3)<F33> 0.00(3)<F33> -- --
------ ------ ------ ------ ------
Less distributions:
Dividends from net investment income (0.02) (0.81) (0.55) (0.28) (0.23)
Distributions from net realized gains (0.06) (0.12) (0.04) (0.14) (0.01)
Return of capital -- (0.04) -- -- --
------ ------ ------ ------ ------
Total distributions (0.08) (0.97) (0.59) (0.42) (0.24)
------ ------ ------ ------ ------
Net asset value, end of period $12.30 $11.53 $12.41 $12.49 $11.15
------ ------ ------ ------ ------
------ ------ ------ ------ ------
Total return 7.47% 0.56% 4.15% 16.03% 22.54%
Supplemental data and ratios:
Net assets, end of period (000's) $346,227 $343,011 $462,762 $480,104 $126,191
Ratio of operating expenses
to average net assets:
Before expense reductions 1.27% 1.31% 1.31% 1.34% 1.55%
After expense reductions(4)<F34> 1.27% 1.31% 1.27% 1.34% 1.50%
Ratio of net investment income
to average net assets 1.43% 0.97% 1.24% 0.69% 1.34%
Portfolio turnover rate 57% 232% 98% 117% 82%
(1)<F31> Net investment income per share is calculated using ending balances
prior to consideration of adjustments for permanent book and tax
differences.
(2)<F32> Net investment income per share represents net investment income
divided by the average shares outstanding throughout the period.
(3)<F33> Amount calculated is less than $0.005.
(4)<F34> See Note 5 in Notes to the Financial Statements.
See notes to the financial statements.
PRUDENT BEAR FUND
SCHEDULE OF INVESTMENTS
SEPTEMBER 30, 2006
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SHARES VALUE
------ -----
COMMON STOCKS -- 15.7%
BASIC MATERIALS -- 10.2%
1,500,000 Alberta Star Development Corp.(a)<F35> $ 2,160,591
1,000,000 Alberta Star Development Corp. (Acquired 9/20/05, Cost $333,753)(a)<F35>(b)<F36>(c)<F37>(d)<F38> 1,440,394
900,000 Anatolia Minerals Development Ltd.
(Acquired 12/15/04, Cost $1,275,345)(a)<F35>(b)<F36>(c)<F37>(d)<F38> 3,035,563
714,715 Aquiline Resources, Inc.(a)<F35> 2,794,278
275,000 Aurora Energy Resources, Inc. (Acquired 3/22/06, Cost $850,662)(a)<F35>(b)<F36>(c)<F37>(d)<F38> 2,337,285
5,512,798 Capstone Mining Corp.(a)<F35>(e)<F39> 7,792,638
592,000 Capstone Mining Corp.
(Acquired 12/21/05 & 5/12/06, Cost $617,436)(a)<F35>(b)<F36>(c)<F37>(d)<F38>(e)<F39> 836,824
705,883 Capstone Mining Corp. (Acquired 5/11/06, Cost $805,208)(a)<F35>(b)<F36>(c)<F37>(d)<F38>(e)<F39> 997,804
1,363,778 