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Westport Asset Management’s Westport Fund Second Quarter 2014 Commentary

Vera Yuan

Vera Yuan

81 followers

Economic growth as measured by gross domestic product contracted at the surprising rate of 2.9% in 1Q 2014 after a strong second half of 2013. Harsh winter weather and a revision to the estimated impact from the implementation of the Affordable Care Act (also known as “Obamacare”) account for much of the weakness. Recent economic statistics, especially employment, indicate a strong rebound. The economically weak first quarter and emphatic support for continuing near zero short term interest rates by the new Federal Reserve Chairwoman Janet Yellen saw the yield on the 10-year Treasury bond decline from 3.0% at year-end 2013 to 2.5% at June 30, 2014.

Faced with declining rates on fixed income securities, investors sought equities with relatively high dividend yields – utilities and REITs. These two industry sectors provided returns of 19.2% and 17.3%, respectively, in the first half, the two highest among the ten industry sectors that comprise the Russell Midcap® Index and contributed 233 basis points i of the Index’s 867 basis point return. The Westport Fund Class R shares returned 486 basis points in the first half of 2014 with virtually no utilities or REITs among its portfolio holdings. The remaining shortfall of 148 basis points occurred in the final two weeks of the second quarter and was the result of investor concerns about the trajectory of future financial performance for some of the Westport Fund’s larger portfolio holdings. For example, FMC Corp (FMC). produced a negative 38 basis point return when it made an earnings preannouncement that a combination of compressed North American planting schedules and a severe drought in Brazil would reduce its sales of agricultural chemicals in the second quarter. The cancellation of a large order for Airbus A-350 aircraft by the United Arab Emirates caused investors to question the bright outlook for commercial aircraft production. Precision Castparts Corp. (PCP), a major supplier of aerospace components, saw its shares decline, decreasing portfolio return by 32 basis points in this period. These events appear transitory and should not have a long term impact on valuation.

Lipper, Inc. provides an additional reference point for assessing the Westport Fund’s first half 2014 performance. The Lipper category average for Mid-Cap Growth funds ii, the category to which Morningstar assigns the Westport Fund, returned 3.73%, compared to 4.86% for the Fund’s Class R shares. Comparing long term results, the Westport Fund Class R shares average annual return has outperformed that of the Russell Midcap® Index 11.23% to 9.53% over the 16 ½ years since the Fund’s inception. Lipper places the Westport Fund in its multi-cap core category where the average annual return over the 16½ year period is 6.53%. The Westport Fund’s investment focus on the long term and on companies with a competitive advantage has been instrumental in producing these results.

Of the 43 portfolio holdings at the end of the first half of 2014, 31 holdings provided positive returns and 12 holdings provided negative returns. The best performing industry sector for the Westport Fund in this period was Oil & Gas Producers, which included three exploration and production companies. This sector provided 261 basis points to the portfolio return compared to the 105 basis points from the Energy holdings in the Russell Midcap® Index. The domestic oriented company, EOG Resources, Inc. (EOG), returned 39% in the first half of 2014 and was the primary driver of the sector’s performance, contributing 157 basis points. Anadarko Petroleum Corp. (APC) contributed 84 basis points to the Fund’s performance on a return of 38% after settling the Tronox litigation that arose from its purchase of Kerr McGee Corp. in 2006. Stone Energy Corp. (SGY) provided a return of slightly more than 35% for the first half and added 27 basis points to the Fund’s performance. Continued growth in the world economy has been supporting oil prices and a very cold winter in the U.S. provided the impetus for higher natural gas prices. Health care holdings were the second largest industry sector contribution to the Fund’s performance at 128 basis points, similar to the 138 basis points contribution of the health care sector to the Russell Midcap® Index. The best performer among the portfolio holdings in health care was Universal Health Services, Inc., Class B shares (UHS) which contributed 64 basis points to performance with an 18% return in the first half. The largest detractor among the Fund’s holdings was MasterCard, Inc., Class A shares (MA), at minus 45 basis points from a 12% decline in its share price. After an excellent performance in 2013 where earnings growth outpaced expectations and the stock price responded accordingly, 2014 has seen continued earnings growth but a reduction in the price/earnings multiple iii attached to those earnings. The imposition of financial sanctions against Russia for its annexation of Crimea raised questions about MasterCard Inc.’s long term presence in Russia and its earnings growth. However, the outlook is positive as transactions in many countries will continue to move from paper based systems for commerce to electronic transactions.

Two new positions were established in the portfolio during the first half of 2014. Bed Bath & Beyond, Inc. (BBBY) was added to the portfolio after it provided a disappointing outlook for the remainder of the fiscal 2014 year. The focus of investor concerns is on the company’s ability to improve multi-channel sales by expanding its internet marketing capabilities. The company is a retail leader in domestic merchandise and household furnishings. A new position was also established in Zebra Technologies Corp., Class A shares (“Zebra”) (ZBRA), a provider of industrial products used for data collection and automatic identification systems. When Zebra announced in mid-April that it would purchase the mobile-computing services unit of Motorola Solutions, Inc., its share price declined. Investors were concerned with the historical performance of this Motorola, Inc. unit, the fact that it was approximately the same size as Zebra and that the cash transaction would transform Zebra’s balance sheet from debt-free to heavily leveraged. Both companies offer bar code and radio frequency identification used to control inventories but service different end markets. The Motorola Solutions, Inc. unit will enhance mobile and network capabilities. Sales in the first half included Brown & Brown, Inc. (BRO), Albemarle Corp. (ALB), Core Laboratories N.V (CLB), State Street Corp. (STT) and WSFS Financial Corp. (WSFS) as they met our expectations. Forest Oil Corp. (FST) was eliminated as the opportunity for a turnaround faded.

Investors should consider the investment objectives, risk, and charges and expenses of The Westport Funds carefully before investing; this and other information about the Funds is in the prospectus, or summary prospectus, which can be obtained by calling 1-888-593-7878 or at our website www.westportfunds.com. Read the prospectus or summary prospectus carefully before you invest.

The views expressed and any forward-looking statements are as of the date of the publication and are those of the portfolio managers and/or the Advisor. Future events or results may vary significantly from those expressed and are subject to change at any time in response to changing circumstances and industry developments.

There are special risks associated with small and mid-capitalization issues such as market illiquidity and greater market volatility than larger capitalization issues.

i Basis Point is a unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.

ii Mid-Cap Growth Funds – Funds that, by portfolio practice, invest at least 75% of their equity assets in companies with market capitalizations (on a three-year weighted basis) below Lipper’s USDE large-cap floor. Mid-cap growth funds typically have above-average characteristics compared to the S&P MidCap 400 Index.

iii Price Earnings multiple (P/E) is the price of a stock divided by its earnings per share.

Portfolio composition is subject to change at any time and should not be considered a recommendation to purchase or sell a particular security. On June 30, 2014, the following securities comprised these respective percentages of the Westport Fund: FMC Corp. (4.1%), Precision Castparts Corp. (5.0%), EOG Resources, Inc. (6.1%), Anadarko Petroleum Corp. (3.3%), Stone Energy Corp. (1.1%), Universal Health Services, Inc., Class B shares (4.6%), MasterCard, Inc., Class A shares (3.9%), Bed Bath & Beyond, Inc., (0.8%), Zebra Technologies Corp., Class A shares (0.8%), Motorola, Inc. (0.0%), Brown & Brown, Inc. (0.0%), Albemarle Corp. (0.0%), Core Laboratories N.V. (0.0%), State Street Corp. (0.0%), WSFS Financial Corp. (0.0%),, Forest Oil Corp. (0.0%).


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