Columbia Select Large-Cap Value Fund Q4 Letter
Portfolio sector allocation
During the quarter, the top portfolio sector weights included financials, energy and industrials.
The financials sector was a top performer in the portfolio in the fourth quarter, rising on strong performance from the banking industry. Banks continued to operate profitably, even within a restrictive regulatory environment. Portfolio holding Bank of America (BAC) was the top contributor for the quarter (and the year), climbing as it successfully implemented cost-cutting initiatives. Portfolio holding Citigroup was another solid contributor during the period, rising after replacing its CEO and announcing a 5% reduction in headcount. We believe the financials sector will continue to perform well in 2013 as profitability increases further. Changes in dividend taxation may introduce a short-term disincentive for owning financial stocks, but we do not expect investors to abandon dividend-paying stocks entirely, particularly in a very low-yield environment.
Energy stocks traded in line with the price of oil during the quarter and ended the period essentially flat. Strong outperformance in the energy sector was driven by portfolio holding Valero Energy (VLO), which benefited from the level price in oil. (A higher price per barrel eats into refiners' margins.) On a relative basis, portfolio outperformance in the energy sector was also driven by not owning ExxonMobil (XOM). The oil giant was essentially flat in 2012, as investors shunned large producers in a weak economic environment. The laggard in the energy sector during the quarter was portfolio holding Williams Companies (WMB), one of the largest energy infrastructure operators in North America. (The company owns more than 35,000 miles of pipeline.) Williams performed well for the year but struggled during the quarter, as investors rotated to higher beta energy names. Energy fundamentals look very strong as we enter 2013, with economies in China and the eurozone showing signs of improvement. Barring an economic slowdown, we expect demand for energy to increase in 2013.
We continue to have a positive view of industrials (and materials) companies. Relative underperformance in the materials sector was largely driven by new portfolio holding Freeport McMoRan (FCX). Freeport McMoRan is the world's largest publicly traded copper company; we added the stock to the portfolio in October. The company has global reserves of copper, gold and other metals, a strong balance sheet, and, despite weakness in the global economy, generates significant free-cash-flow, even at lower copper prices. Freeport McMoRan shares fell during the quarter after the company announced the acquisition of an oil and gas company. (Investors would have preferred that the company remain focused on copper and metals.) We believe the long-term demand for metals remains positive, particularly from China and Asia, where large infrastructure projects continue to move forward, and expect Freeport McMoRan to recover as it returns to trading in line with the price of copper.
Relative underperformance in the consumer discretionary sector was driven by weakness at retailer Gap. Gap has been a strong performer in 2012, successfully implementing changes to store displays and introducing merchandise in line with customer tastes. In November, Gap (GPS) reported disappointing earnings, which spooked investors. We believe this is a temporary setback for the retailer and plan to maintain our position. We closed our position in General Mills (GIS) during the quarter. The diversified food products maker is a high-quality name, but management addressed the explosion in demand for the Greek yogurt too late in our view. (Yogurt is approximately 9% of sales at General Mills.) Additionally, rising input costs for cereal and increasing competition in the category have been squeezing net margins. With declining potential for stock gains, we elected to close the position.
Market overview and outlook
There are substantial catalysts that could fuel a strong rally in equities in 2013, but it could all come to nothing if Washington lawmakers are unable to reach agreement on reducing the nation's spending and revenue deficit. U.S. housing data continues to strengthen, economic data in the United States and China has improved, European leaders have made progress solving the region's debt crisis and mountains of corporate cash could be made available for deployment. These factors are all catalysts that could support equity gains in the new year. As we write, leaders in Washington have agreed to increases in taxes on the wealthiest Americans, which may help alleviate some of the revenue deficit, but looming fights on spending cuts and the U.S. debt ceiling promise to be acrimonious. Passage of the revenue increases was bipartisan, but the tone in Washington remains bitter and generally uncompromising. Inaction on the spending cuts and the debt ceiling could make a technical default on debt, a ratings downgrade and a recession in 2013 real possibilities.
In the near term, we believe that the market will continue to be macro-driven, with news out of Washington, Europe and China, rather than company fundamentals, driving share prices. If a sustained market rally occurs in 2013, we believe it will be driven more by price/earnings ratio expansion than earnings growth (which we expect to be limited; there is very little companies can do to further control expenses without damaging operations). We do not believe that inflation is an imminent threat to investors. While we expect demand for commodities to rise, spare capacity in the system remains, obviating the prospect of wage inflation. Some inflation in commodity prices is not a bad thing, and the Fed and other policy makers would probably be satisfied with an inflation level around 2%, which would indicate a strong economy.
Outside of Washington, other risks for investors remain. Recurring strife in the Middle East or Europe would cause unwelcome shocks that could drive share prices down. Barring unfortunate events, however, we believe the positive catalysts could drive equities higher as we enter 2013.
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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.
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