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Review of the Quarter1
Columbia Select Small Cap Fund outperformed its benchmark, the Russell 2000 Index in the third quarter. The fund also outperformed its benchmark year to date through September 30, when all of the broad equity indices were up.
Although it is impossible to predict if this positive trend in the markets will continue, we do note the work of Potomac Research. They observe, in contrarian fashion, that the slightest market pullback could cause investors to revert back to the bomb shelter mentality of early March 2009. Their conclusion: This jittery abundance of caution in combination with investors holding excessive cash reserves makes the market’s path of least resistance higher. Our take is that investors want to buy stocks at the low prices that widely prevailed from late October 2008 to early March 2009, but with today’s greater sense of certainty and comfort. In our opinion, that’s not too likely.
As a practical matter, the dominant characteristic of the second calendar earnings season was that better-than-expected earnings were achieved more through tighter cost controls and less through increasing revenues (margin expansion). Generally, in the quarters ahead, if companies are able to increase revenues, we think this could be the formula for impressive earnings.
We believe that the unemployment rate, now approaching 10%, will remain stubbornly high for a long time. That belief is based upon the recognition that the U.S. economy has not suffered as deep a recession as we are currently experiencing for almost 20 years. The preceding period of sustained growth created an environment of overemployment. The recession provided a motivation to get employment, productivity and output realigned. If this is the case, this could create political considerations, have implications for the federal deficit and be a serious drain on consumer confidence — even as the stock market does better on the back of margin expansion.
Our approach is typified by stock selection or bottom-up analysis, as opposed to top-down or a big picture assessment. Nonetheless, evaluating the portfolio by broad economic sectors during the quarter, we were overweighted in the following: consumer discretionary, energy, information technology, industrials and materials. Underweighted sectors included financials, health care, telecommunications and utilities. The greatest contribution came from the overweights in information technology and consumer discretionary. Conversely, relative costs came from underweights in financials and health care.
Contributors and Detractors 1
The quarter’s top-performing issues within economic sectors were RV manufacturer Thor Industries and Whole Foods Markets; information technology issues Power Integrated Devices and Varian Semiconductor; materials and industrial companies Walter Energy and Kansas City Southern Railway; energy issue, Helmerich & Payne; and in finance, Greenhill, a boutique investment bank and Legg-Mason, a mutual fund manager.
Issues that detracted from quarterly results were harder to define by economic sector, but included consultancy issues Wilmington Trust and Diana Shipping, FTI and Navigant Consulting, the water utility Aqua America, Molina Health, the brokerage firms Cowen Group and GFI Group, and industrial/materials firms OM Group and bearing manufacturer Kaydon.
Outlook
In terms of activity, we are becoming more positive on the banking sector following a period of low to no exposure for many years. The industry is getting funding at historically low rates and making a good differential margin spread in lending and investment activities. Many of the weaker competitors have been identified through stress testing, and capital positions have improved through better capital market conditions and capital raising. In general, we believe upcoming quarters will see easier earnings comparisons, which is not currently reflected in stock prices. Our two new bank entrants are Wintrust Financial and Zion’s Bancorp. We have also bolstered our energy weighting through the purchase of St. Mary Land & Exploration as natural gas prices are hitting the lowest levels in years. Finally, we have introduced Bucyrus International, a manufacturer of equipment for most surface extractive industries. New positions have been financed through reductions in some of this year’s very successful issues, such as Walter Energy, F5 Networks and Power Integrated Devices. Other sources of funds have come through the elimination or reduction of underperforming issues such as Navigant Consulting, Wilmington Trust and MPS Group.
In general, we have been gravitating toward companies that may benefit from improving exports, a weaker U.S. dollar, improving international economies and the potential for emergent inflationary trends.
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 Russell 2000 Index is an unmanaged index that tracks the performance of the 2,000 smallest of the 3,000 largest U.S. companies, based on market capitalization.
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.
1 Determinations of contributors and detractors are based on performance relative to the fund’s benchmark.
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. All results shown assume reinvestment of distributions and do not reflect the deduction of taxes that a shareholder would pay on fund distributions or the redemption of fund shares.
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. |