Mairs & Power Q3 Commentary
Some of the worst performing stocks were American Express (-2%), Hershey (-2%), Associated Banc (0%), Allete (0%), and H.B. Fuller (0%).
Much of the market's strength in the third quarter can be attributed to the August 9th announcement by the Federal Reserve of a third round of quantitative easing (QE3). However, part of this performance may also be due to the simple fact that, in general, things are not quite as bad as many had feared. The U.S. economy continues to plod along, Europe continues to make choppy, but forward progress, and corporate America continues to do quite well. Not surprisingly, bonds trailed stocks in the third quarter and returned 1.73% as measured by the Barclays US Government Credit Index. This brings the year-to-date return for the Barclays U.S. Government/Credit to just 4.43%. We continue to be optimistic regarding the outlook for stocks, but would not be surprised should a pullback occur given the recent strong performance. We remain cautious on the bond market, and believe that while interest rates will probably remain low in the immediate future due to the actions of the Federal Reserve, ultimately they will move higher.
There is no question that the economic recovery in the U.S. has been unexceptional, and because of this lackluster growth, risks clearly remain, especially given the situation in Europe as well as the upcoming "Fiscal Cliff". However, there has been one bright spot that has recently emerged; the U.S. residential housing market appears to be recovering. Sales of both new and existing homes have risen meaningfully over the past year, helped by a stable economy and record low mortgage rates. Home prices also appear to have stabilized, and in the second quarter of this year prices actually increased for the first time in almost five years. A stabilization in pricing will help further stimulate demand, which in turn will improve sales and help lift prices even higher. While housing currently accounts for much less of the economy than it has historically, and significantly less than during the boom years, it is vitally important to maintaining positive economic growth in the future. It was the collapsing real estate market that precipitated the 2008 financial crisis, so any stabilization is a major psychological lift for consumers, especially since a house is the single largest investment for most people. Furthermore, the housing industry also tends to drive a lot of related sales, such as furniture and miscellaneous household improvements. So if this rebound in the housing market continues, it will provide a much needed boost to the economy from a sector that most people had assumed would not be a contributor anytime soon.
The investment business likes to move fast, and Mairs and Power is an anomaly with its methodical, deliberate style of investing. However, many people do not realize that all this activity incurs costs, and often times these costs outweigh the benefits. For example, if you were to ask most portfolio managers about their investment horizon, they would likely claim that they are long-term investors. There is a quick way to test whether that is the case: look at their turnover ratio. Turnover is just what the name implies; a measure of how often the investment manager "turns over" the portfolio. The average equity mutual fund has a turnover rate of roughly 100%, implying that the average holding period for a security is one year. The Mairs and Power Balanced Fund has a turnover rate of around 9%, implying an average holding period of 11 years. Now this measure can be a bit misleading, as the implied holding period is an average and it is unlikely all stocks are held for that exact length of time. But a more important point is that studies have shown that total annual trading costs for a portfolio with 100% turnover may be as high as 1%, which, similar to a high expense ratio is a hurdle that must be overcome. A higher turnover rate will often result in higher realized taxes, another form of costs for taxable accounts. So while not a perfect measure, the turnover rate for a portfolio can provide some valuable insights, and if an investment manager claims to be a long-term investor and their turnover is 100%, it is clear that their definition of "long-term" and yours may be significantly different.
While the turnover rate is usually used to measure the holding period of individual securities in a portfolio, it is also a useful concept that can be applied to client behavior (i.e. how long does an investor hold a mutual fund). There can be significant costs to an investor who changes mutual funds too frequently. John Bogle, legendary founder of Vanguard and the first proponent of index funds, has tried to educate investors on this issue. Bogle has pointed out that over the 25-year period from 1980-2005, the annual return on the S&P 500 was just over 12%. The average equity mutual fund during the same period returned close to 10%, which not surprisingly, is simply the market return less expenses, including the above-mentioned trading costs. However, the real eye-opening result of Bogle's study is that the average investor in those funds earned considerably less (approximately one-third less on average with an even wider gap for the most popular funds). Why is this? Because many investors chase performance, buying funds after they have outperformed and selling them after they have under-performed. The costs incurred in this turnover are staggering, and there is little doubt the average investor would be much better off if they selected a good mutual fund and stayed with it for the long-term. As long-term investors ourselves, that is advice we strongly recommend.
William B. Frels
President and Lead Manager
Ronald L. Kaliebe
Vice President and Co-Manager
The Fund's investment objectives, risks, charges and expenses must be considered carefully before investing. The summary prospectus or full prospectus contains this and other important information about the Fund, and they may be obtained by calling Shareholder Services at (800) 304-7404, or visiting www.mairsandpower.com. Read the summary prospectus or full prospectus carefully before investing.
Performance data quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Current performance of the Fund may be lower or higher than the performance quoted. As of the prospectus dated April 30, 2012, the Mairs and Power Balanced Fund had an annual expense ratio of 0.80%. For most recent month-end performance figures, visit the Fund's website at www.mairsandpower.com, or call Shareholder Services at (800) 304-7404.
1) Performance information shown includes the reinvestment of dividend and capital gain distributions, but does not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption of Fund shares.
(2) The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. It is not possible to invest directly in an index.
(3) The Composite Index reflects an unmanaged portfolio of 60% of the S&P 500 and 40% of the Barclays Capital Government/Credit Bond Index.
(4) The Dow Jones Industrial Average is an indicator of stock market prices based on the share values of 30 bluechip stocks listed on the New York Stock Exchange.
(5) The Lipper Balanced Funds Index is a non-weighted index of the 30 largest funds within the Lipper Balanced Fund investment category. This Index does not include the effect of expenses, is not representative of any specific fund or product and cannot be invested in directly.
All investments have risks. The Balanced Fund is designed for long-term investors. Equity investments are subject to market fluctuations, the fund's share price can fall because of weakness in the broad market, a particular industry, or specific holdings. Investments in small and midcap companies generally are more volatile. International investing risks include among others political, social or economic instability, difficulty in predicting international trade patterns, taxation and foreign trading practices, and greater fluctuations in price than United States corporations. The fund is subject to yield and share price variances with changes in interest rates and market conditions. Investors should note that if interest rate rise significantly from current levels, bond fund total returns will decline and may even turn negative in the short-term. There is also a chance that some of the Fund's holdings may have their credit rating downgraded or may default.
The stocks mentioned herein represent the following percentages of the total net assets of the Mairs and Power Balanced Fund as of September 30, 2012: MTS Systems 2.0%, Sturm Ruger 0.6%, Deluxe 1.7%, Pentair 2.0%, Home Depot 1.8%, American Express 0.6%, Hershey 0.4%, Associated Banc 0.4%, Allete 0.6% and HB Fuller 1.9%. All holdings in the portfolio are subject to change without notice and may or may not represent current or future portfolio composition. The mention of specific securities is not intended as a recommendation or offer for a particular security, nor is it intended to be a solicitation for the purchase or sale of any security.
Barclays U.S. Government/Credit Index is composed of high-quality, investment-grade U.S. government and corporate fixed income securities with maturities greater than one year.