Westport Asset management Q2 letter to shareholders
The U.S. equity market indices recorded low single digit returns in the second quarter of 2013 as investors experienced higher levels of volatility during May and June. Both bond and stock prices declined and the U.S. ten-year Treasury Bond yield reached its highest level since 2011 during the last weeks of the period. The quarter ended with the Dow Jones Industrial Average*, the S&P 500® Index*, and the Nasdaq Composite Index* returning 2.91%, 2.92%, and 4.52% respectively. The increase in market volatility and interest rates was due to the comments by members of the Federal Open Market Committee (FOMC) during June that seemed to suggest that the central bank might scale back the pace of its bond purchases sooner than was expected. However, more recent comments indicate that any reduction in monetary stimulus efforts would require economic strength, improved unemployment and low inflation consistent with the scenario laid out by Chairman Bernanke in his news conference on June 19, 2013. In reaction the yield on the 10 year Treasury rose from 1.62% on May 2, 2013 to 2.49% on June 28, 2013.
During the second quarter the Westport Select Cap Fund –Class R shares rose 2.74%, slightly trailing the Russell 2000® Index’s gain of 3.08%. For the first six months, the Westport Select Cap Fund’s R shares outperformed the Index with an increase of 16.19%, compared to a rise of 15.86% for the Russell 2000® Index. Since inception 15½ years ago the Westport Select Cap Fund has outperformed by just over 3% points a year, 9.72% to 6.71% both compounded annually. Data provided by Lipper, Inc., provides an interesting over-view of the Select Cap Fund’s first half performance. In this context, we believe the Westport Select Cap Fund’s performance was quite satisfactory.
By far the biggest contributor to first half performance was the Westport Select Cap Fund’s largest holding, Universal Health Services, Inc., Class B shares. This operator of acute care and mental health hospitals gained over 38% and contributed 393 basis points to performance. Once again investors focused on the company as a prime beneficiary of the 2014 implementation of the Affordable Care Act, known by most commentators as “Obamacare.” The second largest contributor to first half performance was Willis Group Holdings plc, the international insurance broker. The shares rose over 21% and added 204 basis points to performance. The company’s business turnaround continues and could be accelerated by actions expected to be announced this quarter by the new CEO.
Making the third largest contribution for the half was Precision Castparts Corp., the components supplier to the aerospace industry. After being essentially flat in the first quarter, the stock rose over 19% in the second quarter, adding 177 basis points to performance. As we had anticipated, the shares rose as problems with Boeing’s 787 were resolved. Two other positions contributed over 1% point to first half performance – FEI Company, a manufacturer of precision microscopes, rose nearly 32%, adding 173 basis points, and DeVry, Inc., our remaining for-profit education company, was up over 30% and contributed 139 basis points. On the negative side, most decliners had insignificant impacts. The only detractors from performance of note were IPG Photonics Corp., a leader in the manufacture of high power fiber lasers, and Forest Oil Corp., an independent oil & natural gas producer, which lowered performance by 55 and 50 basis points respectively. While there was no new merger and acquisition activity during the half, the previously announced acquisition of Plains Exploration & Production Company by Freeport-McMoRan Copper & Gold, Inc. was completed. The Fund received cash in exchange for its shares which resulted in a large long-term capital gain (proceeds of $49.01 per share versus our average cost of $18.34). During the second quarter portfolio changes included the elimination of the General Communication, Inc. –Class A position.
The performance data quoted represents past performance; past performance is not indicative of 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. The Fund’s current performance may be lower or higher than the data quoted. Investors may obtain performance information year-to-date the following business day and to last month-end, within 7 business days, at www.westportfunds.com.
The Westport Fund Class R shares’ 3.02% return for the second quarter exceeded that of the Russell Midcap® Index by 81 basis points. The Fund’s portfolio responded more favorably to the rise in long-term interest rates in the quarter than the Index did – proportionately smaller weighting in yield supported positions. Stock selection provided satisfactory results in the second quarter for the Westport Fund with 33 portfolio holdings providing a positive return versus 16 with a negative return amongst all holdings with a weighting greater than 25 basis points.
The largest contributor to performance during the second quarter was Precision Castparts Corp., also the Fund’s largest holding, contributing 69 basis points. This was followed by Lender Processing Services, Inc. which provided 60 basis points in response to an acquisition offer from its former parent, Fidelity National Financial, Inc. for cash and common stock with a $33.25 valuation. The two biggest detractors from portfolio performance in the second quarter were Trimble Navigation Ltd. and Teradata Corp., at 31 basis points and 26 basis points, respectively. Both were hurt by a pause in information technology procurement. The total performance reduction from the 16 holdings with negative returns for the second quarter was 151 basis points. From an industry segment perspective, the largest detractor from results in the second quarter relative to the Russell Midcap® Index was Consumer Discretionary and Services at 72 basis points. The best relative performance from an industry segment was Materials and Processing at 124 points led by Precision Castparts Corp.
Unsurprisingly, with the rise in long-term interest rates, the lack of REIT’s was a positive contributor to relative portfolio performance in the second quarter. Portfolio holdings returns were more consistent in the first half of 2013 with only 5 negative contributors among fifty-one holdings with weighting greater than 25 basis points. The two largest were also Teradata Corp. and Trimble Navigation, Ltd., which combined subtracted 74 basis points from overall performance for the half. On the positive side, Universal Health Services, Inc. –Class B shares, Precision Castparts Corp., and Lender Processing Services, Inc. contributed 86, 79, and 77 basis points, respectively. On a relative basis versus the Russell Midcap® Index, Consumer
Discretionary and Services continued to be the largest detractor at 262 basis points. Also on a relative basis, Utilities subtracted 81 basis points and REIT’s subtracted 51 basis points. These three industry sectors accounted for 94% of the Fund’s first half underperformance. The Westport Fund’s average annual return has outperformed that of the Russell Midcap® Index by over 200 basis points for the 15½ years since its inception, 10.62% vs. 8.50%, respectively. It also compares favorably to the 5.47% for the Lipper Multi Cap Core Index which consists of mutual funds with holdings in the small,medium and large capitalization categories. A focus on the long-term and avoidance of short-term fads, even those that seem compelling,