Aerospace Could Fly
By Charles L. Norton, CFA Portfolio Manager

I’ve written about my positive outlook for pure-play defense stocks a couple of times over the past two weeks. But there’s another closely related business that I’m also particularly keen on, and that’s commercial aerospace. I’ll provide some ideas as to how to play this, but first some background.

While investors today seem focused on how sharp the U.S. slowdown may be, other parts of the world have enjoyed robust economic growth. Global Gross Domestic Product (GDP) growth, in turn, has typically generated a pickup in air traffic. Indeed, driven by fast-growing emerging markets, worldwide traffic growth appears to be surging – well above its long-term trend – and shows no signs of abating.

As traffic has risen and load factors, or the percentage of seats filled nears 80%, airlines have been seeking to boost revenue and profits by adding capacity, fertilizing what looks like a new upcycle in demand for commercial aircraft.

In previous cycles, most of this new demand came from North America and Europe. Even as recently as the 1990s, two-thirds of aircraft orders originated from these two regions; in earlier decades, it was an even higher percentage. And because the American and European economies are so tightly linked, aircraft demand ebbed and flowed simultaneously, exacerbating the severity of the aerospace cycle.

This time around, though, it looks different.

There is certainly a high threat level right now that is likely to persist for many years to come and historically budget growth tends to go hand-in-hand with high global threat levels, regardless of the political party in the White House or dominating Congress.

A third region of demand has emerged: Asia and the Middle East, driven by their fast-growing economies. In recent years, aircraft orders out of Asia and the Middle East have combined for nearly one-third of total orders, while the concentration of orders from North America and Europe has declined to less than one-half. Even better is that demand from these various regions now appears much less in sync.

The result: A longer-lasting supercycle, likely to extend to 2011 or possibly beyond.

Finally, there is the ongoing need to replace equipment that�s been damaged in combat.

Not only does more diversified geographic demand mean that the upcycle will likely be prolonged – perhaps as long as eight years – but, importantly, we believe that the inevitable downturn, when it does come, may be less severe.

So can triple-digit oil prices or a U.S. recession derail the aerospace supercycle? We do not believe so.

Oil’s surge has been demand-driven; a byproduct of fast-growing emerging-market economies. And, as mentioned above, global GDP growth should lead to increasing air travel, which should eventually spur more aircraft orders. Airline margins are a key indicator of future aircraft orders, and economic growth (more than fuel prices) seem the more important factor to airline profitability.

Further, next-generation airplanes like Boeing’s 787 are as much as 20% more fuel-efficient than their predecessors, so high fuel prices will likely increase the need to replace older planes with more economical ones.

Even with the U.S. economy stalling, aircraft demand is more diversified now than it has been in prior cycles – the U.S. is markedly less important to the big picture than it was 40 or 50 years ago. So long as global economic growth doesn’t come unglued, the supercycle should remain intact. Even the U.S. carriers, though, are facing aging fleets that may soon need to be modernized.

Our exposure to the prolonged aerospace upcycle comes from a leading aircraft maker but also through some of the leading aerospace suppliers, all of whom we believe will be beneficiaries of the supercyle.

At the Vice Fund, we just cannot ignore the aerospace supercycle, and, while there may be some turbulence along the way, we believe that the companies involved in supplying airplanes seem ready to fly.

1 Sanford C. Bernstein, “BA, EADS: Is $100 Oil a Problem for Commercial Aircraft Demand? It’s the Global Economy that Matters,” Jan. 7, 2008

Mutual fund investing involves risk; principal loss is possible. The Fund is nondiversified, meaning it may concentrate its assets in fewer individual holdings than a diversified fund. Therefore, the Fund is more exposed to individual stock volatility than a diversified fund. The Fund invests in foreign securities which involve greater volatility and political, economic and currency risks and differences in accounting methods. The Fund also invests in smaller companies, which involve additional risks such as limited liquidity and greater volatility.

Opinions expressed are those of Charles Norton, and is not intended to be a forecast of future events, a guarantee of future results, nor investment advice.

As of 12/31/07, the Vice Fund’s top ten holdings and the percent of net asset value they comprised were as follows: Altria Group 9.08%, Lowes Corp. 7.29%, Diago PLC 5.61%, MGM Mirage 5.54%, British American Tobacco PLC 5.40%, International Game Tech 5.40%, Boeing Co 5.08%, Inbev SA 4.87%, Sabmiller PLC 4.53%, Imperial Tobacco Group PLC 4.45%.

Fund holdings are subject to change and are not recommendations to buy or sell any security.

The funds' investment objectives, risks, charges and expenses must be considered carefully before investing. The prospectus contains this and other important information about the investment company,and it may be obtained from www.vicefund.com, or by calling Shareholder Services toll free at 866-264-8783.Read it carefully before investing.

Quasar Distributors, LLC, distributor. (01/08)