The global equity meltdown in the third quarter arose from a darkening economic outlook and fears of a eurozone blow up, compounded by a lack of political will around the world to bring resolution to these problems. Not surprising, the fund’s overweight in globally-, commodity- and cyclically-oriented companies bore the brunt of these economic missteps and uncertainties. Year to date the fund underperformed both the S&P 500 and the Russell 1000 Value indices, which returned -8.68% and -11.24% respectively.
We believe the markets are behaving irrationally, as typically good news is greeted with sell offs and bad news with a price collapse. Positives exist, but are largely being ignored. There is a solid prospect that the U.S. and European governments will ultimately resolve their fiscal issues, whether this year or following the next U.S. election. Commodities are unlikely to drop significantly – China, Brazil and India remain growth economies and their incremental demand likely swamps the recessionary declines in developed nations. Perhaps most positive of all are valuations. By every metric we follow (price to earnings, price to cash flow and book value) the fund is now cheaper and presumably more defensive than it has been in the many years we have managed it, including a dark period in 2008. Stocks remain the cheapest asset class on an absolute basis and, absent significant earnings declines, should not be feared. Cash balances are also high, giving corporations a defense against market turmoil.
While negative economic conditions may linger and keep pressure on equity markets, we believe the fund will be resilient to further declines unless growth and earnings surprise us and collapse next year. The current level of negativity will work in reverse once either the ultimate bad news hits a low or fails to materialize and we remain almost wildly bullish should political dysfunction eventually reverse.
Contributors and detractors
The flight-to-quality mentality of investors in the third quarter helped fund holdings in the consumer staples, technology and health care sectors, as investors sought safety in less volatile industries. Budget-weary shoppers drove sales and earnings higher at TJ Maxx (NYSE:TJX), pushing the stock up. IBM (IBM), with its focus on booking growth and high-margin software, also posted gains. Lorillard continued to rank among the best performers for yet another quarter, gaining as cigarette growth for their Newport brand remained on track.
Conversely steel, coal and chemical stocks underperformed significantly on macroeconomic fears, largely attributable to concerns that Chinese growth may be slowing. Alpha Natural Resources (ANR), one of the largest producers of metallurgical coal and Cliffs Natural Resources (NYSE:CLF), which produces iron ore and coal, both posted losses. Celanese (NYSE:CE), a large global producer of acetic acid and derivative chemicals, also declined. Financial stocks underperformed as the Federal Reserve (the Fed) kept long-term interest rates lower than expected, harming the ability of banks and insurance companies to earn decent interest returns on longer dated assets.
The fund eliminated Visa (NYSE:V), Goldman Sachs (NYSE:GS), PNC (NYSE:PNC), and Schnitzer Steel (NASDAQ:SCHN).These sales reflect our view that cyclical commodity companies are likely to rebound on a near-term recovery, whereas financial holdings face a multi-year squeeze on earnings due to recent moves by the Fed to lower interest rates amidst a surfeit of new regulations. This has sharply reduced operating margins and makes us more negative on financial holdings over the next few years given the restrictions on their earnings power.
We anticipate next year’s election in the United States and the ultimate resolution of European financial chaos will be the denouement for the bear story. The market, nearing 2008 lows despite a surge of earnings gains since then, is poised for a significant rebound to more realistic and fair valuations should macroeconomic concerns be laid to rest. The Columbia Value and Restructuring Fund remains particularly well situated with respect to such a reversal. With a median value of only eight times expected earnings next year, the fund is nearly 25% cheaper than market indices, despite much improved quality and growth characteristics.
From a longer term perspective, rarely have there been times in U.S. history when investors have failed to make money owning the U.S. stock market over a ten-year period. The year 2010 marked the end of one such period. In each case, the next decade has returned between 12-17% annually, a significantly higher return than current expectations would lead one to expect. We remain optimistic that history will repeat itself.
Investors should consider the investment objectives, risks, charges and expenses of a mutual fund carefully before investing. For a free prospectus, which contains this and other important information about the funds, visit columbiamanagement.com. The prospectus should be read carefully before investing.
Columbia Funds are distributed by Columbia Management Investment Distributors, Inc., member FINRA and managed by Columbia Management Investment Advisers, LLC.
The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Columbia Management Investment Advisers, LLC (CMIA) associates or affiliates. Actual investments or investment decisions made by CMIA and its affiliates, whether for its own account or on behalf of clients, will not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not account for individual investor circumstances. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon, and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results and no forecast should be considered a guarantee either. Since economic and market conditions change frequently, there can be no assurance that the trends described here will continue or that any forecasts are accurate.
Additional performance information: 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.
Gross expense ratio: Fund expense ratios are calculated based on the Fund's average net assets during the Fund's most recently completed fiscal year (or based on estimated amounts for funds that have been in existence less than one year), and have not been adjusted for current asset levels. If adjusted for any decrease or increase in assets, expense ratios would be higher or lower, respectively, than the numbers shown above. Please see the Fund's prospectus for additional details.
The returns of the Class A shares shown (including since inception returns, which are since fund inception) include the returns of Class A shares of Value and Restructuring Fund, the predecessor to the Fund and a series of Excelsior Funds, Inc. (the ―Predecessor Fund‖), for periods after September 27, 2007, and include the returns of Shares class shares of the Predecessor Fund for periods prior to September 28, 2007. The returns shown reflect applicable sales charges, but have not been adjusted to reflect differences in expenses. If differences in expenses were reflected, the returns shown for the period prior to September 28, 2007 would be lower. The returns of the Class Z shares shown for periods prior to March 31, 2008 are those of the Shares class shares of the Predecessor Fund. The returns of Class Z shares shown have not been adjusted to reflect differences in expenses. The inception date of Class Z shares refers to the inception date of Shares Class shares of the Predecessor Fund.
The Russell 1000 Value Index measures the performance of those Russell 1000 Index companies with lower price-to-book ratios and lower forecasted growth values.
The Standard & Poor’s (S&P) 500 Index tracks the performance of 500 widely held, large-capitalization U.S. stocks.
It is not possible to invest directly in an index.