Meridian Growth Fund Annual Annual Review

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Sep 05, 2014

On September 5, 2013, we began managing the Meridian Growth Fund. It is our distinct honor to take the helm of this venerable fund, which was founded by Richard Aster nearly 30 years ago. Through rigorous fundamental research, disciplined portfolio construction, and a focus on managing risk before reward, we hope to expand upon Meridian Growth Fund’s legacy. We will use the same process and philosophy that served us well managing another mutual fund for 7 years. Namely, our investment philosophy is centered on four key tenets:

1. Employ fundamental research to identify high-quality growth businesses with predictable and recurring revenues, high returns on invested capital, and attractive risk-reward profiles.

2. Build a durable portfolio that first and foremost protects capital in tough, turbulent markets and secondarily keeps up with the broader market in bull market environments.

3. Always think about risk before reward. Almost 30 years of combined experience in small- and mid-cap markets have taught us the importance of sidestepping the landmines and pitfalls that trip up many other investors.

4. Protect and grow your hard-earned savings. To this end, we believe strongly that it’s important that we eat our own cooking; we plan to allocate a significant percentage of our own net worth to Meridian Growth Fund.

In our opinion, this disciplined process combined with decades of experience, extensive resources, and a long-term investment horizon are the key ingredients required for consistent outperformance versus our peers and our benchmark. We look forward to many rewarding years stewarding your capital.

Performance overview

The Meridian Growth Fund – Legacy Shares returned 17.31% during the twelve-month period ending June 30, 2014, underperforming its primary benchmark, the Russell 2500 Growth Index, which rose 26.26%. There were several factors that impacted performance during the period.

The first was the portfolio manager transition that occurred on September 6, 2013. Prior to our portfolio management responsibilities, the portfolio underperformed the index by 4.12%. As part of the transition, we repositioned some of the portfolio’s holdings to be consistent with our philosophy and process.

The relative underperformance during the second half of the fiscal year ending June 30, 2014 was driven by the low-quality characteristics, such as low returns on capital, low profit margins and often negative earnings per share, of the stocks that performed best early in 2014. This underperformance was partially offset by the strong relative performance (seen in the low downside capture rates) during the market selloff from March to April 2014.

The Meridian Growth Fund seeks to invest in high-quality (defined by overall profitability) and attractively valued stocks, which means the fund may underperform in periods such as the first quarter of this year.

The second period of meaningful relative performance differential was the selloff from the index’s peak in the first week of March through the low in early April. During that time the fund captured just 70% of the market’s decline, with the Russell 2500 Growth falling 9.17% and the fund falling 6.46%. This experience is consistent with our goal of capturing less downside than the market in turbulent, volatile environments. By putting risk and downside protection at the forefront of our process, we believe we will be better positioned to deliver strong long-term absolute and relative returns.

The top contributors to performance during the period were Trimble Navigation, Sensata Technologies, and Cadence Design Systems.

• Trimble Navigation (TRMB, Financial) provides location-based solutions to its customers that enhance their productivity and profitability. The recovery in construction end markets and continued strong demand from the farm economy resulted in strong overall financial results for the company and a strong stock price. We trimmed the position as it began to exceed the upper end of the market cap range that we invest in.

• Sensata Technologies (ST, Financial) develops, manufactures and sells sensors and controls. We are attracted to the company’s large growth opportunity, which is driven by increased sensor penetration in industries such as automobiles and general industrial opportunities. We find Sensata’s business model to be attractive given the stability of its revenues, strong operating leverage and excellent management team. During the period, the company benefited from a rebound in European automobile sales and deployed capital in several small accretive acquisitions. We have been trimming the position modestly as the stock approaches our price target.

• Cadence Design Systems (CDNS, Financial) provides software technology, design and consulting services and technology. Its primary product is electronic design automation software for the semiconductor industry. The stock rose as the company and industry transition began to show in its operating results. Specifically, industry consolidation has resulted in an improvement in pricing power. Cadence has successfully transitioned to a recurring revenue model, and we expect it to begin deploying its capital via stock repurchases. We trimmed the position modestly during the quarter.

The top three detractors to performance during the period were VistaPrint, Sally Beauty Holdings and CHC Group.

• VistaPrint (VPRT, Financial) declined during the period due to a business model transition that has weighed negatively on short-term financial performance. We continue to believe that after the transition the company will have lower customer churn, higher customer duration, higher average selling prices and higher reorder rates. All of these combined should drive high operating leverage and substantial earnings growth. We have been adding to the position on weakness.

• Sally Beauty Holdings (SBH, Financial) distributes and retails beauty products. During the period, the stock declined due to the impact of weather and some overall weakness in consumer spending. We have been adding to the position as we believe the company is well positioned to grow domestically, expand internationally and continue buying back stock, which should drive strong earnings growth for the long term.

• CHC Group (HELI, Financial) is a service provider to the offshore oil and gas industry. The stock declined during the period as the company’s growth trajectory did not exceed investor expectations. We added to the position during the period as we remain confident it will achieve our long-term growth and cash-flow targets. The overall industry continues to show strong growth, and the company’s own business is improving as it restructures contracts at higher prices with longer terms.

We remain committed to employing fundamental research to identify high-quality growth businesses with predictable and recurring revenues, high returns on invested capital and attractive risk-reward profiles. We seek to build a durable, all-weather portfolio that protects capital in tough, turbulent markets and keeps up with the broader market in bull market environments.

Thank you for your investment in Meridian Growth Fund and for your confidence in us.

Chad Meade and Brian Schaub