Gabelli Asset Fund shareholder comentary for the second quarter 2014.
To Our Shareholders,
For the quarter ended June 30, 2014, the net asset value (“NAV”) per Class AAA Share of The Gabelli Asset Fund increased 4.3% compared with an increase of 5.2% for the Standard & Poor’s (“S&P”) 500 Index. See page 2 for additional performance information.
Gabelli Asset Fund: The Economy
The second quarter of 2014 offered its share of surprises: first quarter GDP was revised to –2.9%, ten year U.S. Treasury rates declined to 2.5% after ending 2013 at 3.0%, tensions worsened in Ukraine, and the previously little known group ISIS executed a lightning fast takeover of much of oil rich northern Iraq. Perhaps the biggest surprise, however, was that in the face of these dynamics, the S&P 500 marched up over 5%. Clearly, the market is looking at other variables. Job growth continues to improve and the housing market is showing pockets of strength, but neither to the extent that would cause the Federal Reserve to accelerate the withdrawal of stimulus; interest rates are likely to remain historically low well into 2015.
The market has also been heartened by a surge in mergers and acquisitions (M&A), as quarterly global transaction volumes more than doubled year-over-year, exceeding $1 trillion for the first time since 1998. Several years ago, we noted that we expected a “Fifth Wave” of post-World War II M&A, fueled by low interest rates and a dearth of organic growth opportunities. Two additional ingredients – rising corporate confidence and the pursuit of tax domiciles outside of the U.S. – have recently swelled that wave. We believe that a virtuous cycle of more deals and awakening animal spirits has been set into motion, which should extend the M&A trend into the foreseeable future.
As we have written in the past, the level and trajectory of interest rates and inflation are likely to have the biggest impact on future M&A and the stock market. Spurring the economy to outgrow an eventual normalization of rates is the needle that central banks around the world must thread. There are certainly many obstacles to achieving this goal, including geopolitical instability. The price of oil, often a barometer of global tensions, rose substantially in the quarter and is a factor we monitor carefully, as it could snuff the global recovery.
Gabelli Asset Fund: Activists All Around
While Russian President Vladimir Putin and Federal Reserve Chair Janet Yellen have been active in their respective spheres, we concern ourselves here with the rising tide of so-called shareholder activists. Tracing their history to the conglomerateurs of the 1970’s and raiders of the 1980’s, today’s activists tend to be more institutionalized, even partnering with other corporations, as Valeant Pharmaceuticals did recently with Pershing Square in a bid for Allergan (0.1% of net assets as of June 30, 2014). Often seen among the varied goals of activists are changes in capital structure, corporate transactions (e.g. a sale or spin-off) and improved governance or operations. The toolbox used to pursue these measures includes a combination of public relations and proxy contests.
We take a nuanced view as to the long term impact of these campaigns – it depends on the target, the objectives, and the activist. Although we would not consider ourselves activist investors, your Advisor issued a Magna Carta of Shareholder Rights in 1988 which states: “We are neither for nor against management. We are for shareholders.” The document goes on to list a number of governance policies we favor (e.g. cumulative voting, golden parachutes, one share/one vote) and oppose (e.g. poison pills, super dilutive option plans). Unlike many of today’s headline grabbing activists, we do not typically enter a situation seeking change. However, if we believe a company in which we have invested is harming its shareholders, we will be tireless in protecting (y)our interests.
Gabelli Asset FundL Deals, Deals, and More Deals
The Fund was a significant beneficiary of deal activity in the second quarter. Suntory’s (less than 0.1% of net assets as of June 30, 2014) acquisition of Beam for $83.50 per share, announced in January, closed in April. Beam was the global distilled spirits business that resulted from the October 2011 split-up of Fortune Brands and Fortune Brands Home & Security Inc (NYSE:FBHS) (0.2%). The product of another split-up, Hillshire Brands Co (NYSE:HSH) (0.9%), from the result of Sara Lee’s separation of its meats and coffee units, became the subject of a bidding war in the quarter, with Tyson Foods, Inc. (NYSE:TSN)’s (less than 0.1%) agreeing to pay $63.00 per share. Covidien plc (NYSE:COV) (0.1%), itself a result of Tyco International Ltd. (NYSE:TYC)’s original 2007 breakup, agreed to be acquired by Medtronic, Inc. (NYSE:MDT), which sought, among other things, Covidien’s domicile in Ireland. Finally, on the heels of Comcast Corporation (NASDAQ:CMCSA) (NASDAQ:CMCSK)’s (0.7%) acquisition of Time Warner Cable Inc (NYSE:TWC) (0.3%), AT&T Inc. (NYSE:T) (less than 0.1%) agreed to acquire DIRECTV (NASDAQ:DTV) (1.7%) for $95 per share in cash and stock. We had long believed a telecom operator would covet DIRECTV’s premium brand and customer base. We believe the continued strong pace of financial engineering will facilitate more deal activity in the future.
Gabelli Asset Fund: 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 are presented as of June 30, 2014.
Gabelli Asset Fund: AMETEK Inc.
AMETEK, Inc. (NYSE:AME) (1.7% of net assets as of June 30, 2014) (AME – $52.28 – 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.
Gabelli Asset Fund: Brown-Forman Corp.
Brown-Forman Corporation (NYSE:BF.B) (NYSE:BF.A) (1.6%) (BF/A – $92.34 – NYSE; BF/B – $94.17) is a leading international distilled spirits producer. Distilled spirits is an advantaged category that enjoys high margins, low capital requirements, strong free cash flow generation and good pricing power. The company’s renowned global brands include Jack Daniel’s Tennessee whiskey, Southern Comfort, Finlandia vodka, Woodford Reserve bourbon, and el Jimador and Herradura tequilas. Jack Daniel’s is one of the world’s most valuable spirits brands, enjoying strong growth both in the U.S. and internationally as consumers increasingly choose to drink American whiskies. The company grew net sales by 6% and earnings per