Investment Commentary

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Overview

The market again confounded skeptics in the third quarter, as the S&P 500 Index rose more than 15%. While recent economic news has been mixed, this rally has shown all the hallmarks of a classical snapback, as fear of the market is replaced by fear of missing the next market upturn. There are several reasons for this optimism.

Foremost, this has been a liquidity-driven market. Jamie Dimon, CEO of J.P. Morgan, recently estimated that nearly $1 trillion of excess cash is held in money market funds, waiting to be invested. With interest rates on cash near zero, the stock market’s 2.1% dividend yield has appeared attractive.

Also attractive are company valuations, which remained reasonable, as corporate earnings stabilized. U.S. companies did a terrific job cutting costs in this recession, with results now showing up in their profits. A good example is industrials, where companies have been sensibly priced at current revenues. If a global rebound occurs, there may be significant upside to both the revenues and earnings, which could lead the entire sector higher.

An upside was also reflected in the many large corporate acquisitions announced over the past several weeks. Combined with high valuations placed on recent initial public offerings, the financial markets have reemerged as an alternative to bank financing. This has been a huge step forward, marking a break from the past 18 months of stagnation.

Emerging markets also pointed to a continued rebound. Brazil has now officially emerged out of a recession, and China and India continued to lead worldwide commodities demand. This stood in marked contrast to the situation in the United States. Here, fiscal policies have been largely short term in nature and are now winding down. The average U.S. consumer has appeared to spend at a stable, but permanently lower, rate than before.

We therefore continue to believe that future growth for U.S. companies will likely come from abroad, and that globally oriented companies will benefit disproportionately, as money is reinvested and valuations rise. Stock selection in the fund has remained focused on this theme. Over the next few years, we anticipate that holdings should remain positioned to achieve above-average growth rates.

Performance¹

The fund continued with strong performance, as the vestiges of the credit crisis abated. It has outperformed the S&P 500 Index returns of 15.61% for the third quarter and 19.26% year to date. Perhaps the biggest nonevent of the quarter was that no pullback occurred in September despite media predictions. Commodities again led the results, with copper and coal companies such as Southern Peru Copper and Consol Energy contributing the most to third-quarter performance. Grupo Mexico was also up because of both copper prices and the successful resolution of its Asarco subsidiary’s bankruptcy filing.

Our consumer holdings in Black & Decker and Newell Rubbermaid both gained, as investors grew more comfortable with U.S. domestic spending. Similarly, Host Hotels & Resorts, a hotel REIT, also gained.

Agricultural, shipping and construction-related companies performed the worst and were down 5% on weak farmer demand for new equipment, while General Maritime lost 22%, as shipping fares hit a multiyear low. Aecom, in the engineering space, fell 15% on lower global demand for its services. All three of these companies are late-cycle names that should benefit several quarters after demand strengthens.

Fund Activity

We continued to upgrade the overall quality of the fund in the third quarter. CIT was eliminated because of significant dilution to shareholders. CBS was sold on a belief that the much anticipated rebound in advertising will do little to offset the longer term secular decline of the media space. Embraer-Empresa, the Brazilian aerospace company, was sold because of limited near-term prospects for its regional and business jet enterprises. Foundation Coal was acquired by our other portfolio holding Alpha Natural Resources.

Outlook and Positioning

As noted above, the surprise of the third quarter was that the bull trend continued unabated and that no pullback occurred. We continue to believe that much of the bad news is now known, quantifiable and likely priced in. That is one reason to expect stock prices to ultimately reflect the underlying corporate earnings power, which should result in higher valuations.

U.S. policies remain a concern, as most political debates revolve around higher spending rather than fiscal discipline. This could inevitably lead to lower U.S. growth if the private sector is deprived of resources, either through higher taxes or higher government debt. We believe that delays in passing significant legislation may allow U.S. companies to show true growth in their revenues and earnings.

It is worth repeating that we believe that exposure to emerging markets, either directly or indirectly, will be rewarded, as growth rates remain higher abroad than in the United States. As a result, the fund has focused its stock selection on globally oriented companies that offer better long-term prospects. Our exposure to material and energy stocks has partly been a reflection of this focus.

Global mergers and acquisitions have been announced with fair regularity, a trend that we expect to continue. This could be positive for our investments, as many of our companies may be potential takeover candidates by strategic acquirers who can accelerate their restructuring. This trend also implies that credit markets may open up, which historically has benefited the portfolio, as our companies can again refinance their debt, reinvest in growth opportunities and restructure more aggressively.

Performance data quoted represents past performance, and current performance may be lower or higher. Past performance is no guarantee of future results.

Please read and consider the investment objectives, risks, charges and expenses for any fund carefully before investing. For a prospectus, which contains this and other important information about the fund, contact your Columbia Management representative or financial advisor or go to www.columbiamanagement.com.

The Standard & Poor’s (S&P) 500 Index is an unmanaged index that tracks the performance of 500 widely held, large-capitalization U.S. stocks.

Unlike mutual funds, indices are not investments, do not incur fees or expenses and are not professionally managed. It is not possible to invest directly in an index.

Since economic and market conditions change frequently, there can be no assurance that the trends described here will continue or that the forecasts will come to pass. The views and opinions expressed are those of the portfolio managers and analysts of the affiliated advisors of Columbia Management Group, are subject to change without notice at any time, may not come to pass and may differ from views expressed by other Columbia Management associates or other divisions of Bank of America. These materials are provided for informational purposes only and should not be used or construed as a recommendation of any security or sector.

There is no assurance that any securities discussed herein will remain in an account’s portfolio at the time you receive this report or that securities sold have not been repurchased. It should not be assumed that any securities transactions or holdings discussed were or will prove to be profitable, or that the investment recommendations or decisions made in the future will be profitable or will equal the investment performance of the securities discussed herein.

Columbia Management Group, LLC (“Columbia Management”) is the investment management division of Bank of America Corporation. Columbia Management entities furnish investment management services and products for institutional and individual investors. Columbia Funds are distributed by Columbia Management Distributors, Inc., member FINRA and SIPC. Columbia Management Distributors, Inc. is part of Columbia Management and an affiliate of Bank of America Corporation.