Columbia Large Cap Value Fund Q3 Investment Commentary
Columbia Large Cap Value Fund Class A shares returned 5.15% (excluding sales charge) for the third quarter. The fund underperformed its benchmark, the Russell 1000 Value Index, which gained 6.51% during the same period. Monthly fund performance is also available online at columbiamanagement.com.
The fund underperformed its benchmark index due to individual stock selection. More specifically, effective positioning in the utilities sector and solid stock selection in the financials and information technology sectors was not enough to offset poor stock selection in consumer staples, materials and industrials. Importantly, the fund maintained focus on finding undervalued, large-cap equities, which the team feels have the potential to deliver capital appreciation and income.
The third quarter rally in U.S. equity markets was sparked by the market's realization that there would be no Greek hard exit from the eurozone (at least for now) and that the European Central Bank (ECB) remains committed to defending the common currency (again, at least for now). While U.S. economic growth is not where the Federal Reserve (the Fed) would like it to be, there are positive signs. One such sign is the U.S. housing market, where prices are, once again, moving higher due to solid demand and low inventory levels. In response to the anemic economic growth, the Fed came out during the quarter and announced the third round of quantitative easing, signaling commitment to faster economic growth and higher employment. All this combined to create a strong rally off the summer lows into the fall, in spite of stubbornly high U.S. unemployment, slowing emerging markets specifically China and unresolved sovereign debt and currency issues in Europe.
Contributors and detractors
Individual stock selection in the consumer staples and materials sectors, along with our overweight in information technology were the three primary contributors to the fund's relative underperformance. While, by and large, the portfolio participated with the market in climbing the wall of worry, some of the fund's more stable defensive and lower-beta stocks did not.
Looking across sector exposures, our largest sector overweight in information technology was a drag to relative performance. However, all the rest of the performance story was stock specific. Within information technology, negative news around the PC supply chain weighed heavily on traditional technology heavyweights involved in the manufacturing of personal computers.
> Among our holdings, Intel got caught up in the negative news flow and declined with the other participants in the supply chain. Intel (INTC) designs, manufactures and sells microprocessors for personal computers and cell phones. As the world shifts to Apple (AAPL) products and to mobile computing, the market is taking a view that the traditional personal computing industry is in secular decline.
Being overweight consumer staples had very little impact during the quarter. This was due to continued market focus on higher yielding assets and an activist investor involved with Procter & Gamble and offset by the decline in tobacco stocks. While in prior quarters our exposure to tobacco was a positive, in the third quarter our largest single stock detractor was our position in Lorillard. Rotation away from tobacco, along with pricing concerns around Lorillard's largest brand, Newport, weighed heavily on the stock.
> Procter & Gamble (PG) is a consumer products company manufacturing a broad range of personal care products from laundry detergent to shaving products. A large, well-known activist hedge fund is currently attempting to engage the board to encourage C-level management change and splitting the company into different, more-focused parts.
> Lorillard (LO) is a producer of cigarettes for both the premium and discount segments of the domestic cigarette industry. Lorillard shares declined due to concerns about excess inventory in the channel and consecutive quarters of being unable to raise prices.
On the other side of sector exposures, our large underweight in financials was just about neutral to performance. However, our underweight in utilities where we are not finding much value at the moment gave a significant boost to relative performance. In financials, the U.S. banking system led by regional banks and super-regional banks looks to be on the other side of the valley, as credit quality remains stable and loan growth is picking up. Excellent stock picking within the sector, led by XL Group and Goldman Sachs, more than offset the slight relative performance headwind from the sector underweight.
> XL Group (XL) provides insurance and reinsurance coverage to industrial, commercial, professional and insurance companies around the world. The stock rallied strongly during the quarter on the back of better-than-expected earnings.
> Goldman Sachs (GS) provides investment banking services and investment management services, along with a wide range of financial services to individuals and institutions worldwide.
Within the energy sector, the combination of poor stock selection in what the fund owned, as well as what it did not own, led to the relative underperformance of the sector. Rather than seeing any fundamentally concerning issues, the underperformance was driven byindividual holdings moving sideways and not participating in the broader market and oil price rally during the quarter.
Finally, excellent stock picking in the consumer discretionary sector aided performance, particularly our position in Home Depot (HD), which participated in the housing-related stock rally during the third quarter. With low inventory levels, a renewed interest from buyers and some pent-up demand caused by low activity levels over the past few years, the housing market looks to be on the mend.
> Home Depot is the largest home improvement retailer in the country. Along with other housing-related businesses, the company saw a pickup in activity levels, as consumers began to reinvest in their homes.
Our base case is that the U.S. economy will muddle through at the current stall-speed pace. However, there are a number of topics which remain front and center in our current thinking. First, the combination of the upcoming election, along with the impending fiscal cliff which we believe will be avoided or, at least, the can will be kicked down the road gives us pause. Second, there are structural macro concerns in Europe which have not yet been permanently addressed and could become front page news at any time. Third, China is slowing, maybe to a greater degree than the market believes at the moment. Fourth, the relative price performance shift away from defensive areas of the market this last quarter represents a shift in risk-taking attitudes and may signal that the wall of worry is no longer there to climb.
In spite of these concerns there are a number of positives in place, not the least of which is the relatively positive corporate fundamentals we're seeing from U.S. corporations specifically. In addition to the better fundamental environment in the U.S., we are finding opportunities in many sectors outside traditional income-oriented sectors of the market. While we believe now is a logical time for the market to take a pause, we do not foresee any significant market correction.
Given our view of a generally positive backdrop for investing, offset by some very specific macro concerns, we remain focused on finding companies and industries across a broad spectrum of equity market sectors which have the right mix of what we are looking for. These include sustainable free cash flow generation, manageable balance sheets and attractive relative valuation. In finding those companies, we feel we can build a portfolio which can deliver competitive over-the-cycle returns and strong current income generation.
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.
1The returns shown for periods prior to the share class inception date (including returns since inception, which are since fund inception) include the returns of the fund's oldest share class. These returns are adjusted to reflect any higher class-related operating expenses of the newer share classes, as applicable. Please visit columbiamanagement.com/mutual-funds/appended-performance for more information.
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 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 S&P 500 Index (S&P 500 Index) is an unmanaged list of common stocks which includes 500 large companies. It is not possible to invest directly in an index.