As filed with the Securities and Exchange Commission on September 4, 2008

 

 

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 811-09303 & 811-09923

Kinetics Mutual Funds, Inc. & Kinetics Portfolios Trust

(Exact name of registrant as specified in charter)

555 Taxter Road, Suite 175
Elmsford, NY 10523
(Address of principal executive offices) (Zip code)

U.S. Bancorp Fund Services, LLC
615 E. Michigan Street
Milwaukee, WI 53202
(Name and address of agent for service)

(800) 930-3828
Registrant’s telephone number, including area code

Date of fiscal year end: December 31, 2008

Date of reporting period: June 30, 2008

 

 

 

Item 1.  Report to Stockholders.

 

 

(Kinetics Mutual Funds, Inc.)

 

 

 

 

 

Dear Fellow Shareholders:

 

We are pleased to present the Kinetics Mutual Funds’ Semi-Annual Report for the six-month period ended June 30, 2008. On balance, the Kinetics Family of Mutual Funds had disappointing results for the first half of 2008, with declines of 18.85% for The Paradigm Fund, 24.37% for the Small-Cap Opportunities Fund, 28.10% for the Market Opportunities Fund, 19.98% for the Internet Fund, and 23.47% for The Global Fund. Our Medical Fund had a modest decline of 2.88%, the Water Infrastructure Fund declined by only 2.26%, and the Multi-Disciplinary Fund, since its inception on February 11, 2008, declined by 2.90%. This compares with first-half 2008 declines of 11.91% and 13.55% for the S&P 500 Index^(l) and the NASDAQ Composite Index⁽²⁾, respectively.

 

Over time, we have informed you that our long-term investment results will be driven by the underlying business operations of the companies we own. This is an outgrowth of our low-turnover investment strategy. Based on the first six months of this year, one would think that the operations of our companies suffered greatly. This, to a very large measure, is not the case at all. The upward shift in the equity risk premium cut across virtually all holdings, but it was most dramatic in our financial services and Chinese holdings. We believe our positions in these companies have very little credit risk and are being lumped into a class of investments, unfairly in our opinion, that are having real operational and financial problems. A great many of our companies are reporting earnings in line with our expectations; yet, the stocks are down, in some instances substantially. With the passage of time, we expect our companies to be separated from the troubled ones. At present, we believe our Funds offer significant value for long-term investors.

 

We continue to inform our shareholders through our website, www.kineticsfunds.com. This website provides a broad array of information, including recent portfolio holdings, quarterly investment commentaries, newsflashes, recent performance data, and online access to account information.

 

 

Kinetics offers the following Funds to investors:

 

The Paradigm Fund focuses on companies that currently have, or which should soon have, sustainable high returns on equity. The Fund has produced attractive returns over the last 81/2 years.

 

The Small Cap Opportunities Fund focuses on undervalued and special situation small capitalization equities that have the potential for rewarding long- term investment results.

 

The Medical Fund is a sector fund, offering an investment in scientific discovery within the promising field of medical research, particularly in the development of cancer treatments and therapies. As a sector fund, The Medical Fund is likely to have heightened volatility.

 

The Internet Fund is a sector fund that focuses on companies engaged in the evolution of Internet-related developments. As such, this Fund has been, and is likely to continue to be, quite volatile. The Internet Fund is not designed to be a major component of one’s equity exposure. We view a segment of this Fund’s holdings as publicly traded venture capital and are quite aware that many of these investments will not fulfill their early promise. However, we expect that, over time, some small percentage will develop into excellent investments, allowing the Fund to produce overall attractive, albeit lumpy, returns.

 

The Global Fund’s mandate was changed in March 2008 to focus on international investments, currently with particular emphasis on China and other Asian markets.

 

The Market Opportunities Fund focuses on those companies that benefit from increasing transactional volume, such as publicly-traded exchanges, or that act as facilitators, such as gaming companies, airports and publicly-traded toll roads.

 

The Water Infrastructure Fund is a sector fund that invests in global companies engaged in water infrastructure and water-specific natural resources, as well as related activities. This fund is sub-advised by Aqua Terra Asset Management, LLC.

 

 

The Multi-Disciplinary Fund is a unique fund that utilizes a two part investment strategy, which includes fixed income securities and a derivative component. The derivative component generally involves selling written equity put options.

 

The Kinetics Government Money Market Fund is a short-term investment vehicle that provides a useful service for those participating in our equity product offerings.

 

Peter B. Doyle

President

Kinetics Mutual Funds, Inc.

 

 

 

 

Prior to writing this commentary, we re-read our investment commentary from the 2007 semi-annual report. The paragraph below is worth restating, especially given the turmoil surrounding the capital markets:

 

“Equities investing, which constitutes deferred consumption, requires patience because stock price movements in the short term, 1 to 2 years, are often random. To allow the business operations of the companies one owns to start generating decent returns requires a 3 to 5 year time horizon, if not longer. Thus, as always, we would counsel any investor with cash needs expected to develop in less than 3 years to invest in more conservative alternatives, such as U.S. Treasuries. The preceding comment is merely the recognition of the nature of stock investing and not a prediction of what is going to unfold in the shorter term. Too frequently, investors experience a poor investment result even when they are with capable managers, primarily because the time horizon of the investor is out of sync with the parameters of stock investing and/or because the individual investor is chasing recent past performance.”

 

The question that investors in the Kinetics’ Funds (with the exclusion of the Medical and Water Infrastructure Funds) must be asking themselves is this: “Has Kinetics become so wedded to its positions that it cannot admit its mistakes, or has it been rejecting, or, at least heavily discounting, data that would invalidate its views?” In other words, has Kinetics fallen into a malaise such that it is standing by passively, watching as dire events unfold? This particular assessment, perhaps, might seem self-evident given our exposure to financial services stocks and Chinese stocks, which every other holder seems to be reducing. In addition, it is human nature to seek out data that supports one’s views and to disregard that which does not. This mental tendency is well known to us and something we go to great lengths to avoid.

 

Any success that we have had historically or plan to have in the future is rooted in the facts as we understand them. Investment success is directly correlated to a correct analysis of data, one’s reasoning and temperament. We have no emotional ties to our companies and would sell them if we believed that their business returns were somehow permanently impaired. Further, we never

 

would have purchased them if we had not believed that we were receiving value for the prices originally paid.

 

As a long-term stock investor, one can hope to approach (receive) the actual returns of the businesses themselves, in much the same way one achieves a return from a bond coupon. A stock’s performance inevitability must be linked to the underlying business itself. One does not own a piece of paper, but rather, a fractional interest in a real company. If you purchase at par (100% of face value) 10-year Treasury notes with a 5% coupon and hold them to maturity, your annualized rate of return, over the life of the notes, will be 5%. This is true even if at the end of year three the notes trade at a price of $50. Of course, for that particular year you would have a large negative return. However, your annualized return from year three onward would be vastly higher than your original expected return, but your ultimate annualized return on original investment would be 5%. An investor who purchased the notes at a price of $50 would have a very different return profile in relation to her cost basis, but from that point forward the return to both investors (original and new) would be identical.

 

Prior to the recent stock market downturn, we believed we owned a collection of companies that would collectively generate a very high rate of return for our investors, with the passage of time. Nothing that has occurred over the last six months has dissuaded us from that view. In fact, based on the logic set forth above, we believe the return profile of our Funds has improved dramatically as a result of the downturn, in much the same way as that of the investor who purchased the notes at a price of $50. This statement, however, does not mean that our Funds cannot go lower from here, but it does mean that we believe our Funds are performing well below their perceived channel rates of return. In order for them to achieve such channel rates of return, their future returns, at some point, must be far higher.

 

From our perspective, at the exact time when our investors are most concerned they should actually be the most optimistic. If we, in fact, did originally identify excellent businesses, which are now suffering from a temporary collective price decline, investors should be hopeful. This is the reason for our own optimism. With

 

few exceptions, we believe our companies have a higher intrinsic worth today than they did at the start of the year.

 

Even a casual observer of the stock market believes that stock prices, in the short-term, are driven by fear and greed. The current decline in the market stems from the conviction that the economy is going into, or already is in, a severe downturn, principally as a consequence of the “de-leveraging” of the financial services sector, initially stemming from the sub-prime mortgage market and later blossoming into a full blown liquidity crisis. While the Federal Reserve has been accommodating, some believe an earnings collapse will occur sometime in the future, making stocks a bad bet despite the absolute and relative low interest rate environment.

 

We are of the belief that the system is not de-leveraging. If you visit the website of the Federal Reserve at www.federalreserve.gov, you can verify this conclusion for yourself. Under the section All Statistical Releases, you can find the weekly collective balance sheet of U.S. commercial banks. The numbers do not reveal a de-leveraging, or a meaningful diminution of credit. The net worth of the banks is fairly robust, despite the massive write-downs taken. This information can explain why Ben Bernanke, on June 10^th, stated “The risk that the economy has entered a substantial downturn appears to have diminished over the past month or so.” We cannot confirm, based on Federal Reserve statistics, a massive de-leveraging. Thus, we do not believe that the primary fear driving the market has any basis in fact. Our financial system cannot function in its current form without leverage, and it appears the Federal Reserve will take the necessary steps to maintain the availability of such leverage. The prospective return profile for the financial intermediaries (which assume real capital risk) would not support a system that hopes to operate in today’s environment without leverage. Furthermore, we believe the de-leveraging of a Lehman Brothers does not mean a de-leveraging of the entire system.

 

A second website that should be visited is that of MBIA.com. Recently, MBIA’s Chief Executive Officer, Jay Brown, authored several shareholder letters. MBIA resides at the eye of the credit crisis storm and has been targeted by prominent short-sellers as being effectively bankrupt. Mr. Brown displays little fear for the

 

financial health of his company and expresses a good deal of derision for the rating agencies. One cannot read these commentaries and remain neutral regarding the prospects for MBIA. Mr. Brown’s view is in accord with that of the famed value investor, Marty Whitman. We have never seen a company where two more extreme views exist among well-regarded investors (short-sellers vs. famed value investors). This situation cannot go on indefinitely, as certain MBIA-related events are expected to occur, which will reveal which side has done the proper analysis. While both sides can ultimately make money, only one side is going to have an accurate perception of the company’s financial health.

 

Another illuminating website to visit is bankstocks.com. This website is the creation of Tom Brown and Vernon W. Hill. Mr. Brown is a highly regarded financial analyst who is known for his independent views. He has written a number of articles regarding the financial crisis that seem to be rooted in factual data, as opposed to mere opinion. Several recently published articles advance the view (a distinctly minority view) that the sub-prime loss estimates are too pessimistic. According to data analyzed by Mr. Brown, the problems in sub-prime mortgages peaked in November of 2007. This view is consistent with that of my colleague Murray Stahl, as purported in the early part of this year, to the effect that others were making unrealistically draconian assumptions.

 

The default rate, by definition, must decline as the shutdown of the sub-prime market guarantees such a result. The problem vintages are becoming seasoned, and we believe the losses have almost certainly been overstated, leaving aside the confusion over mark-to-market accounting, which would require, as shown in our Treasury Notes example above, a write-down of 50% of our equity investment, despite the fact that we know that we will receive our entire principal back.

 

We have listened to the views of a great number of “financial experts,” and based on available data, we cannot confirm the validity of their extremely negative views. That is not to say that the housing crisis, the liquidity crisis and inflationary pressures have not had their effect on the health of the economy. However, an objective analysis of these conditions does not support the type

 

of sell-off that has occurred for many of our companies. The more interesting question investors should be asking is: “Why has economic activity held up so well nine months into this crisis?” The answer, in our opinion, is that there are an abundance of positive factors (most notably the large capital expenditures going on in the utility sector and exports) that are having a very salutary effect, but which never get written about in the financial press. A cursory reading of headlines would cause one to expect to see massive bread lines in Manhattan, one of the world’s financial capitals.

 

Should investor sentiment change, which we expect to occur, our Funds are poised for an impressive rebound. The last time we saw such massive dislocation was in the utility sector at the time of the collapse of Enron in 2001. Most analysts and investors had extremely negative views, unsupported by the underlying facts, which created tremendous opportunity. Companies like Williams Companies rebounded from a price of under a $1 a share to over $35 today. For us, the price of admission for excellent long term results is heightened volatility risk. This risk, while perhaps psychologically and emotionally unpleasant for most, is not synonymous with the permanent erosion of capital. Today’s conditions are, in our opinion, an investor’s ideal scenario.

 

We thank you for your confidence and look forward to more prosperous times.

 

Peter B. Doyle

Chief Investment Strategist

Disclosure

This material is intended to be reviewed in conjunction with a current prospectus, which includes all fees and expenses that apply to a continued investment program, as well as information regarding the risk factors, policies and objectives of the Funds. Read it carefully before investing.

 

Mutual Fund investing involves risk. Principal loss is possible. Because the Funds [other than The Paradigm Fund, The Small Cap Opportunities Fund, The Market Opportunities Fund and The Kinetics Government Money Market Fund] invest in a single industry or geographic region, their shares are subject to a higher degree of risk than funds with a higher level of diversification. Internet and biotechnology stocks are subject to a rate of change in technology, obsolescence and competition that is generally higher than that of other industries and have experienced extreme price and volume fluctuations. International investing [for The Global Fund, The Water Infrastructure Fund, The Paradigm Fund, The Market Opportunities Fund, The Small Cap Opportunities Fund and The Internet Fund] presents special risks including currency exchange fluctuation, government regulations, and the potential for political and economic instability. Accordingly, the share price for these Funds is expected to be more volatile than that of a U.S.-only fund. Past performance is no guarantee of future performance.

 

As of March 14, 2008, The Global Portfolio, formerly known as the Internet Emerging Growth Portfolio, changed its name and investment mandate.

 

Because smaller companies [for The Global Fund, The Small Cap Opportunities Fund and the Water Infrastructure Fund] often have narrower markets and limited financial resources, they present more risk than larger, more well established, companies.

 

Non-investment grade debt securities [for all Funds], i.e., junk bonds, are subject to greater credit risk, price volatility and risk of loss than investment grade securities. Further, options contain special risks including the imperfect correlation between the value of the option and the value of the underlying asset. Investments [for the Multi-Disciplinary Fund] in futures, swaps and other derivative instruments may result in loss as derivative instruments may be illiquid, difficult to price and leveraged so that small changes may produce disproportionate losses to the Fund. To the extent the Funds segregate

assets to cover derivative positions, they may impair their ability to meet current obligations, to honor requests for redemption and to manage the Funds in a manner consistent with their respective investment objectives. Purchasing and writing put and call options and, in particular, writing “uncovered” options are highly specialized activities that entail greater than ordinary investment risk.

 

As non-diversified [other than The Kinetics Government Money Market Fund] Funds, the value of Fund shares may fluctuate more than shares invested in a broader range of industries and companies.

 

An investment in the Kinetics Government Money Market Fund is neither insured nor guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the Fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the Fund.

 

Unlike other investment companies that directly acquire and manage their own portfolios of securities, The Kinetics Mutual Funds pursue their investment objectives by investing all of their investable assets in a corresponding portfolio series of Kinetics Portfolios Trust.

 

The information concerning the Funds included in the shareholder report contains certain forward-looking statements about the factors that may affect the performance of the Funds in the future. These statements are based on Fund management’s predictions and expectations concerning certain future events and their expected impact on the Funds, such as performance of the economy as a whole and of specific industry sectors, changes in the levels of interest rates, the impact of developing world events, and other factors that may influence the future performance of the Funds. Management believes these forward-looking statements to be reasonable, although they are inherently uncertain and difficult to predict. Actual events may cause adjustments in portfolio management strategies from those currently expected to be employed.

 

The Nasdaq Composite (NASDAQ) and the Standard & Poor’s 500 Index (S&P 500) each represent an unmanaged, broad-basket of stocks. They are typically used as a proxy for overall market performance.

 

Distributor:  Kinetics Funds Distributor, Inc. is not an affiliate of Kinetics Mutual Funds, Inc. Kinetics Funds Distributor, Inc. is an affiliate of Kinetics Asset Management, Inc., Investment Adviser to Kinetics Mutual Funds, Inc.

 

For more information, log onto www.kineticsfunds.com.

 

July 1, 2008 — Kinetics Asset Management, Inc.

 

 

 

Shareholders incur two type of costs: (1) transaction costs, including sales charges (loads) on purchase payments, reinvestments of dividends or other distributions made by the Fund, redemption fees, and exchange fees, and (2), ongoing costs, including management fees, distribution and/or service (12b-1) fees, and other Fund expenses. This example is intended to help investors understand the ongoing costs (in dollars) of investing in the Funds 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 on January 1, 2008 and held for the entire period from January 1, 2008 to June 30, 2008.

 

Actual Expenses

 

The first two lines of each of the accompanying tables provide information about actual account values and actual expenses. Unlike other mutual funds that directly acquire and manage their own portfolio securities, each Feeder Fund invests all of its investable assets in a corresponding Master Portfolio, a separately registered investment company. The Master Portfolio, in turn, invests in securities. With this type of organization, expenses can accrue specifically to the Master Portfolio or the Feeder Fund or both. Each Feeder Fund records its proportionate share of the Master Portfolio’s expenses on a daily basis. Any expense reductions include Feeder Fund-specific expenses as well as the expenses allocated from the Master Portfolio.

 

The Feeder Funds will charge shareholder fees for outgoing wire transfers, returned checks, and exchanges executed by telephone between the Feeder Fund and any other series of Kinetics Mutual Funds, Inc. The Feeder Fund’s transfer agent charges a $5.00 transaction fee to shareholder accounts for telephone exchanges between any two series of Kinetics Mutual Funds, Inc. The Feeder Fund’s transfer agent does not charge a transaction fee for written exchange requests. IRA accounts are assessed a $15.00 annual fee. Finally, as a disincentive to market-timing transactions, the Feeder Funds will assess a 2.00% fee on certain redemption or exchange of Fund shares held for less than thirty days after purchase. These fees will be paid to the Feeder Funds to help offset transaction costs. The Feeder Funds reserve the right to waive the redemption fee, subject to their sole discretion, in instances deemed not to be disadvantageous to the Feeder Funds or shareholders.

 

You may use the information provided in the second line, together with the amounts 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 second 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 third and fourth lines of each of the accompanying tables below provide information about hypothetical account values and hypothetical expenses based on the Feeder Funds’ actual expense ratio and an assumed rate of return of 5% per year before expenses, which are not the Feeder 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 Feeder 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.

Expense Example

 

 

 

 

 

 

 

 

See Notes to the Financial Statements.

 

 

 

 

 

See Notes to the Financial Statements.

 

 

 

 

 

See Notes to the Financial Statements.

 

 

 

 

 

See Notes to the Financial Statements.

 

 

 

 

 

See Notes to the Financial Statements.

 

 

 

 

See Notes to the Financial Statements.

 

 

 

See Notes to the Financial Statements.