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Small-cap stocks moved higher as investors look beyond recession
As the federal government injected an enormous amount of liquidity into the financial system, the economy showed signs of healing. Measures of business and consumer confidence showed improvement, as did housing and manufacturing activity. As the yield gap narrowed between Treasuries and other fixed-income sectors, corporate-bond issuance and merger-and-acquisition activity rose, both signs that stimulus programs were beginning to take hold. In this environment, the U.S. stock market continued to move sharply higher in the third quarter. Small-cap equities outperformed large-cap equities for the third quarter. The Russell 1000 Index, a broad proxy for large-company stocks, returned 16.07% while the Russell 2000 Index, which tracks small-company stocks, returned 19.28% for the same period. Value outperformed growth across the market capitalization spectrum. Within the Russell 2000 Growth Index, all 10 economic sectors posted positive returns, led by the energy, materials and consumer discretionary sectors. Telecommunications, consumer staples and utility sectors lagged the benchmark return.
In this environment, the Columbia Small Cap Equity strategy modestly underperformed its benchmark, the Russell 2000 Index.
Health care, industrials and technology led relative returns for the quarter
For the third quarter, the strategy’s overweight in the health care, industrials and technology sectors aided returns. Standout performers in the health care sector included Hi-Tech Pharmacal, Obagi Medical Products and Staar Surgical. Large positions in Benchmark Electronics and Kforce continued to recover from bear-market lows, as did AAR.
For the year to date, financials have been the strategy’s strongest relative sector, driven both by anunder weight in the sector and stock selection.
Stock selection in consumer discretionary and materials detracted
Although the strategy’s returns in the consumer discretionary sector were healthy on an absolute basis, they lagged the benchmark, in part, because the strategy was underweight in retail stocks, which generated outsized gains for the sector. Retail stocks rose on the prospect of a better economy and recovering consumer spending even though actual retail statistics continued to be negative.
Elsewhere in the portfolio, both Res-Care and CEC Entertainment had a negative impact on performance. CEC is the parent company of Chuck-E-Cheese, which reported weak same-store sales driven by weak consumer spending and the swine flu scare.
Small-cap team update
In August, it was announced that Jeff Hershey would be joining our team in Hartford effective August 31, 2009. As many of you know from previous communications, we did an extensive search and spoke to many candidates with impressive backgrounds. Jeff was our first choice. His background includes 15 years of investment experience, most of which has been small-cap related. Jeff shares the team’s general investment philosophy and has already begun to contribute to our team.
Merger-and-acquisition activity picked up
Many strategists feel that we are on the doorstep of higher merger-and-acquisition activity. Against a backdrop of rising stock prices and higher confidence in an economic recovery, several large, high-profile strategic acquisitions were announced in the month of July. Three of these announcements affected securities in the portfolio: Noven Pharmaceuticals, Varian and MSC Software. Bidding on MSC Software was eventful. The company has suffered for years with less-than-stellar performance and multiple management changes. Even so, we thought that the original price offer was less than fair value. Two months later, a competing offer was made by a financial buyer at a higher price. The two potential buyers offered several subsequent competing bids before the board ultimately settled on an offer from the original strategic buyer at a price that was 10% higher than its first bid. Although we are a far cry from the frenzied 2007 merger and acquisition environment, we are seeing early signs that potential buyers with strong balance sheets are dusting off their shopping lists. Also, with improving capital markets, we may begin to see some of the financial buyers come out of hibernation.
Market outlook
The market’s strong recovery off its March lows was driven by “less bad” conditions and reduced operating expenses in the second quarter. During the third quarter, prospects for top- line improvements emerged, as well as continued cost discipline. There were mild signs of economic improvement. The ISM Manufacturing Index exceeded 50% in August, indicating expansion. However, it declined in September. Yet, the ISM Service Index indicated expansion in September. Some traction is being generated because inventory destocking has largely run its course. Inflation data, including wages, continued to be benign. Productivity was up 6.6% in the second quarter, with unit labor costs down 5.9%. At least for now, companies are meeting lower demand with much less labor. With today’s low rate environment, there are concerns about the prospect of higher inflation on the horizon. However, we expect the Federal Reserve Board to stay vigilant regarding inflation.
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 1000 Index is an unmanaged index that tracks the performance of 1,000 of the largest U.S. companies based on market capitalization.
The Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index, which represents approximately 8% of the total market capitalization of the Russell 3000 Index.
The Russell 2000 Growth Index is an unmanaged index that measures the performance of those Russell 2000 Index companies with higher price-to-book ratios and higher forecasted growth values.
The Russell 2000 Value Index tracks the performance of those Russell 2000 Index companies with lower price-to-book ratios and lower forecasted growth values.
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 transaction 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. |