To Our Shareholders,
For the quarter ended December 31, 2013, the net asset value (“NAV”) per Class AAA Share of The Gabelli Asset Fund increased 9.2% compared with an increase of 10.5% for the Standard & Poor’s (“S&P”) 500 Index. See page 2 for additional performance information.
The fourth quarter provided a fitting end to a remarkable year. Despite recurring drama in Washington, recession in Europe, and turmoil in emerging markets, the U.S. equity market ended the year 170% above its March 2009 low, representing a compounded annual return of over 22%. Unfortunately, the past is little help in divining the future: stocks do not go up because they went up, and they do not go down because they went up. Stocks ultimately move because of changes in their fundamentals. Our job is to understand those fundamentals and balance the risk and reward of each stock selection. At any given moment, the market presents stocks that are cheap and those that are dear. Finding cheap stocks may be more difficult than it was five years ago, but this just means we need to dig a little deeper.
We are optimistic, as it appears for the first time in many years that the world is poised for a synchronized recovery. Indeed, the U.S. is entering its fourth consecutive year of expansion. The housing market is rebounding, job growth is slowly improving, and government policy, which heretofore probably has not added to growth, is unlikely to hinder the rebound as pre-election gridlock sets in. Even the geopolitical stage seems free of major conflict, though flashpoints throughout the Middle East, between China and Japan, and between Russia and its neighbors remain concerning.
Deals, Deals and More Deals
Worldwide M&A volume totaled $2.4 trillion in 2013, a decline of 6% from 2012. Fourth quarter worldwide volume was particularly disappointing, down approximately 30%. Despite this pause in deal making, the Fund benefited from a number of transactions in 2013, including Joh. A. Benckiser’s acquisition of D.E Master Blenders, ConAgra’s (0.1% of net assets as of December 31, 2013) purchase of Ralcorp, Media General’s (0.3%) merger with New Young Broadcasting, and Verizon’s (0.3%) announcement that it would purchase the 45% of Verizon Wireless owned by Vodafone (0.1%).
Financial engineering activity, on the other hand, was very strong, with 27 spin-offs completed in the U.S. and over 20 already announced for 2014. Among the 2013 spin-offs held by the Fund are News Corp. (0.4%) and CST Brands (0.2%). A key attraction of financial engineering, in our view, is that it facilitates future tax- efficient M&A. This dynamic adds to our conviction that 2014 will be a busier year for deals.
Let’s Talk Stocks
The following are stock specifics on selected holdings of the Fund. Favorable earnings prospects do not necessarily translate into higher stock prices, but they do express a positive trend that we believe will develop over time. Individual securities mentioned are not necessarily representative of the entire portfolio. For the following holdings, the percentage of net assets and their share prices stated in U.S. dollars or U.S. dollar equivalent terms are presented as of December 31, 2013, except as noted.
AMETEK Inc. (AME)(1.8% of net assets as of December 31, 2013) (AME – $52.67 – NYSE) is a leading global manufacturer of analytical instruments for the process, aerospace, and industrial markets, and a leading producer of electric motors and blowers for the floor care and outdoor power equipment markets. In the near term, the company continues to experience significant growth in its longer cycle businesses in the aerospace, power generation, and process industries. Longer term, the company continues to make acquisitions to augment growth. In the Electronic Instruments Group, AMETEK expects one half to two thirds of its revenue growth to come from acquisitions. The company is focused on acquiring differentiated businesses with revenues of $30-$100 million. Differentiated businesses compete on the basis of product capability, have higher growth rates, and offer superior returns. In the Electromechanical Group, AMETEK’s key strategy is to reduce costs by increasing efficiency and moving noncore operations to low cost countries such as Mexico, the Czech Republic, and China.
Cablevision Systems Corp. (CVC) (0.9%) (CVC – $17.93 – NYSE) provides broadband, TV, and phone service to over three million subscribers in the New York metropolitan area. An industry pioneer, CVC has developed the most advanced plant in the country and converted over 70% of its subscribers into triple play (video, phone, and broadband) customers. In the process, Cablevision achieved industry-leading average monthly subscription revenues and margins. This peak performance led the company to become a victim of its own success; combined with competition from Verizon FiOS (0.3%) in approximately half its footprint, Cablevision saw reduced growth and a sagging share price in 2012/2013. The company’s efforts to address these declines appear to be paying off. Management has also been active on the financial front, spinning off Madison Square Garden (0.7%) in February 2010 and AMC Networks (0.6%) in June 2011 and repurchasing over 10% of shares outstanding. Early in 2013, Cablevision agreed to sell its Optimum West (formerly Bresnan) systems to Charter Communications (less than 0.1%), capturing an attractive equity return. Cablevision is now a single-market, pure-play cable operator, which could facilitate an eventual consolidation of the company in our view
Chemed Corp. (CHE)(0.3%) (CHE – $76.62 – NYSE) , based in Cincinnati, OH, is a holding company that owns the Vitas hospice company and the Roto Rooter plumbing business. Vitas is the nation’s largest hospice company, with almost $1 billion in annual sales. The company is currently facing headwinds from government billing changes and a regulatory investigation, but its management is working hard to protect margins and it should begin to move beyond these issues in 2014. Roto Rooter is enjoying steady revenue growth and record profitability as the economy, particularly the housing market, improves. With strong free cash flow and modest capital expenditures, Chemed is returning the vast majority of its cash flow to shareholders via significant share repurchases.
Chemtura Corp. (CHMT)(0.1%) (CHMT – $27.92 – NYSE) is a global developer, manufacturer, and marketer of engineered specialty chemicals. Its products are used as additives, ingredients, or intermediates, serving major industries such as agriculture, building & construction, consumer, energy, electrical & electronics, transportation, and general industrial. Since its emergence from Chapter 11 in November 2010, under the leadership of Craig Rogerson, the management team has focused on actively managing its portfolio via investments in three vertical markets (transportation, electronics & energy, and agriculture), while monetizing businesses with below-target long-term potential. The recent sale of Consumer Products and the potential sale of AgroSolution (presently undervalued) continue the company’s trend toward a more focused business portfolio. Potential net proceeds of $1.2B will be used for debt reduction, share repurchasing, investments in the remaining operations, and potential bolt-on acquisitions. The remaining operations, Industrial Performance Products (petroleum additives and urethanes) and Industrial Engineered Products (bromine & flame retardants and organometallics), are expected to grow revenues via innovations, share gain, and geographic expansion, while bottom line will benefit from internal actions. In addition, market demand for flame retardants used in electronics and insulation foam applications should improve. We estimate that the “New Chemtura” (exclusive of Consumer