Meridian Funds' Commentary for Quarter Ended June 30, 2013
Stocks continued their positive performance during the quarter ended June 30, 2013. For the quarter, the S&P 500 gained 2.9%, the NASDAQ gained 4.2% and the Russell 2000, which includes smaller companies, gained 3.1%. Combined with the strong performance in the quarter ended March 31st 2013, stocks enjoyed a robust first half of 2013. Economic factors were mixed but relatively benign; optimism over the housing market continued to buoy the U.S., and economic declines in Europe appeared to be slowing if not stabilizing. Emerging markets fared poorly due to worries of slowing growth, particularly in China and Brazil, but did not appear to dampen the performance of U.S. domestic stocks. The yield on the ten-year U.S. Treasury bond jumped from 1.87% to 2.52% during the quarter as the economic outlook continued its gradual improvement and the market acknowledged potential endings for the Federal Reserve's quantitative easing programs. The best performing sectors during the quarter were financials, consumer discretionary and healthcare. The worst performing sectors were utilities, basic materials and energy. Financials performed well as rising rates and a steepening yield should improve the profitability of lending products. However, these same circumstances pressured the value of utility shares as higher rates are likely to simultaneously increase the competition for yield and reduce the value of dividends paid by these low growth companies.
GDP grew at 1.1% during the first quarter of 2013. This represented a meaningful appreciation from 0.4% in the previous quarter, but lagged traditional levels of GDP growth for a recovering economy. The increase in GDP was driven primarily by personal consumption expenditures, private inventory investment and residential fixed investment. This was offset by declines in government spending and exports. We are currently in the midst of second quarter corporate earnings reports and results to date are modestly encouraging for most of our portfolio companies. However, we continue to be concerned about historically high corporate profit margins. Estimates for S&P 500 earnings show that the earnings of non-financial companies are expected to decline for the quarter ended June 30, 2013. This indicates that profit margins may have peaked, and if that is the case then we believe future earnings growth could be difficult to achieve without an acceleration in revenue growth.
We continue to follow our long-established investment strategies and our stock selection discipline remains unchanged. History clearly shows that long-term investment results are improved by buying good companies or mutual funds consistently over an extended period of time.
As discussed further in the accompanying shareholder report, Aster Investment Management Co., Inc., the investment adviser to the Meridian Funds, entered into an agreement to sell its assets, including its rights with respect to the management of the Funds, to Arrowpoint AIM LLC. As a result of this agreement, shareholders of the Meridian Funds as of June 18, 2013 are being asked to approve an investment management agreement between Arrowpoint Asset Management, LLC ("Arrowpoint") and the Meridian Funds at a shareholder meeting scheduled for August 28, 2013. If the proposed management agreement is approved by shareholders, Arrowpoint would become the investment adviser to the Meridian Funds.
We welcome those new shareholders who joined the Meridian Funds during the quarter and appreciate the continued confidence of our existing shareholders.
Meridian Equity Income Fund ® (MEIFX)
The Meridian Equity Income Fund's net asset value per share at June 30, 2013 was $12.35. This represents an increase of 14.1% for the calendar year to date. The Fund's total return and average annual compound rate of return since inception January 31, 2005 were 64.6% and 6.1%, respectively. At the close of the quarter, total net assets were $28,697,158 and were invested 1.0% in cash and other assets net of liabilities and 99.0% in stocks. At the close of the quarter, there were 431 shareholders in the Equity Income Fund.
The Fund continues to invest in companies that we believe have the potential for capital appreciation and the ability to grow dividends. The Fund is diversified, with 49 holdings representing 44 different industry groups at June 30, 2013. At the end of the quarter ended June 30, 2013, the portfolio's average holding had a five-year average return on equity of 20.0% and an average dividend yield of 3.4%, both measures substantially higher than the average S&P 500 stock, with an average market capitalization of $46.2 billion and an average debt to capital ratio of 39.0%.
During the quarter, we purchased shares of Apple, Cisco Systems and Steelcase. We sold our shares in Cato, Digital Realty Trust and McDonalds.
Leggett & Platt (LEG) is a leading manufacturer of engineered products and components. As the pioneer of steel coil springs found in mattresses and furniture, the company continues to supply a variety of components to bedding and furniture manufacturers. Additionally, Leggett & Platt's broader product line includes retail store fixtures, office furniture components, automotive seating components and industrial steel wire and tubing. Customers choose Leggett & Platt as a supplier because the company's manufacturing scale and processes result in lower costs than customers can produce themselves. We believe earnings should grow based on the contribution of new products, cost reduction efforts and the improving housing market. Moreover, future dividend growth appears likely based on a 42-year record of dividend increases. We believe Leggett & Platt is an attractive investment based on its 3.8% dividend yield and positive growth outlook.
Meridian Growth Fund® (MERDX)
The Meridian Growth Fund's net asset value per share at June 30, 2013 was $44.31. This represents an increase of 11.4% for the calendar year to date. The Fund's total return and average annual compound rate of return since inception August 1, 1984 were 3,016.8% and 12.6%, respectively. At the close of the quarter, total net assets were $2,112,945,125 and were invested 6.0% in cash, cash equivalents and other assets net of liabilities and 94.0% in stocks. At the close of the quarter, there were 78,795 shareholders in the Growth Fund. We continue to follow the investment strategy that has served the Fund well for the past 29 years. Our portfolio remains diversified in mid-sized growth companies which in our opinion are predominantly market leaders, having strong returns on capital, solid growth prospects and that sell at reasonable valuations. The Fund is invested in 56 positions representing 31 industry groups along with Treasury Bills. Our heaviest areas of concentration continue to be the consumer and technology sectors.
During the quarter, we purchased shares of Brunswick, Genesee & Wyoming and QLIK Technologies. We sold our positions in Autodesk, Life Technologies, RPM International and Ritchie Bros.
Perrigo (PRGO) is a global manufacturer of over-the-counter (OTC) store brand and generic prescription pharmaceuticals, infant formulas, nutritional products and active pharma ingredients. The company is the dominant player in the OTC drug market with the largest distribution network and broadest range of product offerings. The OTC store brands have increased their market share by about 1-2% annually at the expense of national name product given their superior value proposition to both the consumer and retailers. Perrigo has numerous growth drivers over the next few years including the continued penetration of OTC store brands and introduction of new product categories. The stock sells at a reasonable valuation, in our opinion, given the company's strong management team, financial returns and long-term growth prospects.
Meridian Value Fund® (MVALX)
The Meridian Value Fund's net asset value per share at June 30, 2013 was $37.20. This represents an increase of 13.2% for the calendar year to date. The Fund's total return and average annual compound rate of return since June 30, 1995 to date were 951.4% and 14.0%, respectively. At the close of the quarter, total net assets were $704,522,621 and were invested 5.2% in cash, cash equivalents and other assets net of liabilities and 94.8% in stocks. At the close of the quarter, there were 29,032 shareholders in the Value Fund.
We continue to seek out-of-favor companies, typically having experienced an extended period of declining earnings. Often these companies have experienced outsized declines in their stock prices as the market reacts to these earnings declines. We research these companies to determine the factors behind the earnings decline and evaluate the company's response. Ideal investment candidates are those that are poised to resume sustainable growth and that are trading at a reasonable valuation based on potential earnings. The Fund is invested in 60 positions, representing 36 industry groups along with Treasury Bills. We continue to invest in companies of all market capitalizations and our largest areas of concentration are technology, industrials and transportation.
During the quarter, we purchased shares of Chiquita Brands, First Niagara Financial Group, Genesee & Wyoming, Informatica, Itron, National Instruments, Nvidia, Occidental Petroleum, Tempur-Pedic and Ubiquiti Networks. We sold our positions in Aecon Group, Corning, GATX, Monsanto, Newmont Mining, Ritchie Bros., Ultra Petroleum, UTI Worldwide and Zebra Technologies.
Haemonetics (HAE) is the market leader in blood management products for collection centers and hospitals. The company's equipment and related consumables allow collection centers to separate blood into the components of plasma, red cells and white cells. Hospital-based products include blood diagnostics, devices to salvage patient blood during surgery and software to manage blood supply. Earnings temporarily declined due to two product quality issues that management of Haemonetics has stated have been remedied. In our opinion, earnings growth may be expected to accelerate in the next few years as Haemonetics rolls out its automated whole blood collection solution to collection centers. Relative to the existing manual process, the company's automated solution speeds up the collection process and reduces discard rates. Cost and efficiency gains become more important to collection centers as hospitals better manage their blood supply. We believe the company is a compelling value at 12x our $3.50 estimate of earnings power.
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The Meridian Funds are no-load and there are no transaction fees or commissions charged when you purchase shares directly through our transfer agent, BNY Mellon Investment Servicing (U.S.), Inc. This is a very cost-effective way to purchase shares of the Meridian Funds if you do not need the services of a broker-dealer or if you make multiple purchases. The information provided in this report should not be considered investment advice or a recommendation to purchase or sell any particular security. There is no assurance that any securities discussed herein will remain in a particular Fund's portfolio at the time you receive this report or that securities sold have not been repurchased. Securities discussed are presented as illustrations of companies that fit a particular Fund's investment strategy and do not represent a Fund's entire portfolio and in the aggregate may represent only a small percentage of a Fund's portfolio holdings. It should not be assumed that any of the securities transactions or holdings discussed were or will prove to be profitable, or that investment decisions Fund management makes in the future will be profitable or will equal the investment performance of the securities discussed herein. Management's views presented herein and any discussion of a particular Fund's portfolio holdings or performance are as of June 30, 2013 and are subject to change without notice.