Investment Commentary

Fund Performance

Review of the Quarter¹

During the third quarter, equity markets continued to recover lost ground fueled by lower quality stock appreciation, posting another round of solid returns. Nevertheless, Columbia Mid Cap Value Fund underperformed the Russell Midcap Value Index’s 23.62% return given the fund’s higher quality holdings relative to the stocks in the benchmark. The fund’s absence in the telecommunications services sector, combined with strong stock selection in the health care sector, were more than offset by negative selection in consumer discretionary, industrials, materials and utilities.

On the positive side, not owning stocks of companies in the telecommunications services sector was a positive for the quarter. We have had a long-standing underweight in this sector, as we continue to be challenged to uncover companies that adhere to our process of buying inexpensive stocks with improving margins.

The fund’s underweight exposure to the health care providers and services and pharmaceuticals industries were a positive to relative performance. Elsewhere in consumer staples, the fund benefited as it did not own the stocks of any discount food retailers in the fund. In addition, personal products company Avon was a positive to performance. Earlier in the quarter, the company reported better-than-expected second-quarter profits, attributed to stronger-than-expected underlying sales and operating profit growth.

While overall allocation was a small positive in consumer discretionary, the fund’s underweight in several industries, including media, was a negative as several companies returned high double-digit returns and an international news and publishing company enjoyed triple-digit returns. In addition, auto parts maker BorgWarner was a drag on performance in August and September after reporting its quarterly earnings. We continued to favor Borg’s position within the auto parts segment, as it manufactures fuel efficiency products that should continue to gain traction among a diverse group of domestic and international automobile manufacturers. Our selections in retail were negatives on a relative basis for American Eagle Outfitters and Foot Locker. Shares of both stocks fell earlier in the quarter but rebounded in September to finish the quarter in double-digit territory.

In financials, REIT Plum Creek Timber was the single largest detractor on a relative basis from the sector’s quarterly performance. During the quarter, Plum Creek did not benefit from a rebound in commercial real estate stock as it owns timberland property and has greater ties to demand for saw logs and other forest products. Commercial banks suffered losses on both an absolute and relative basis with TCF Financial and Bank of Hawaii. Such losses were on a relative basis with City National and Cullen/Frost Bankers. TCF underperformed due to investor concerns over lingering consumer mortgage problems and fears that legislation would limit the bank’s ability to maintain its fee income streams. We maintained our position on the belief that TCF could maintain its fee revenue and that its high-quality mortgage book could continue to produce positive returns. Not owning many of the insurance names that did well during the quarter was also a drag on performance. In September, we trimmed the fund’s position in Greenhill on concerns over its valuation.

In industrials, stock selection was negative. Navistar International detracted from performance. Early in the quarter, the company lost a much-anticipated contract from the Pentagon to a competitor. We retained our holding in the company, however, as we continued to believe that a recovery in truck demand, driven by an aging fleet and more stringent emissions requirements, may lead to upside. In September, we initiated a position in Manpower, as we believed that stabilization and sequential improvements in temporary staffing levels both domestically and internationally may benefit the company and lead to upside.

In utilities, selection in the multi-utilities industry was negative. The Public Service Enterprise Group detracted from returns. While Sempra Energy, PG&E and Wisconsin Energy had positive absolute returns, they were negatives on a relative basis. Florida Power & Light was also a negative, as weak commodity prices and weak demand led to uncertainty around new wind projects. As a result, we trimmed the fund’s holding in the company on concerns over the speed of the recovery in their regulated business.

Outlook

Considering where the market was only six months ago, many investors are wondering if valuations are becoming stretched and if value opportunities can still be found at these new levels. There have been many discussions around whether the recovery will be V-shaped (sharp recovery) or W-shaped (double-dip recovery) and if the positive news of stabilization has already been priced in the stocks. The team still believes that there are margin expansion opportunities in many industries going forward. As seen during last quarter’s earnings season, many companies did a great job bringing their cost base down, which has enabled them to surpass revised and lowered analysts’ profitability estimates. In many instances, companies have planned for little to no growth in the near term, which would make some of their cost cutting efforts permanent. With the cost base of these firms coming down significantly, one possibility would be that even a modest positive move of 2%-3% in top-line revenue growth could generate powerful margin expansion stories going forward. This effect has already been seen in the technology sector as inventories were drastically reduced during the downturn, only to have some of these companies regain confidence to replenish their inventories as demand perked up off the bottom. While the economy is certainly still not in a strong position, it is at least improving directionally. The team feels that many of the overarching risks, especially to the financial system, are at least known to the market overall. In general, we are not expecting a significant market selloff, barring any large extraneous event given this environment. As always, we remain focused on the core tenets of our investment process. These include a focus on operating margins of undervalued companies that we expect to expand, as well as a focus on broad portfolio-level risk. We believe these factors will provide our investors with a solid risk-versus-reward proposition over the long term.

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 Midcap Value Index measures the performance of those Russell Midcap companies with lower price-to-book ratios and lower forecasted growth values. The stocks are also members of the Russell 1000 Value index.

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 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.