The Olstein Strategic Opportunities Fund’s second quarter letter to shareholders for the period ended June 30, 2014.
Dear Fellow Shareholders:
For the fiscal year ended June 30, 2014, load-waived Class A shares of the Olstein Strategic Opportunities Fund had a return of 26.25% compared to total returns of 25.58% for the Russell 2500® Index and 24.61% for the S&P 500® Index. The past fiscal year also marked an important milestone – it was five years ago that equity markets began their strong recovery from the market low of March 9, 2009. For the five years ended June 30, 2014, load-waived Class A shares of the Olstein Strategic Opportunities Fund had an average annual return of 22.31%. Over the same time period, the Russell 2500 Index and the S&P 500 Index and had average annual returns of 21.63% and 18.83%, respectively.
Olstein Strategic Opportunities Fund’s Market Outlook & Strategy
Despite an unexpected contraction in the U.S. economy during the first quarter of the year, as well as rising global tensions due to serious conflicts in Eastern Ukraine and in the Middle East, equity markets continued to chug along with the benchmark Russell 2500 Index increasing 5.95% for the first six months of the year. With the strong market run now five years old, many market forecasters continue to speculate on a market correction or pullback in 2014. Yet, despite a rocky and volatile start to the year, and in light of the resilience of the market and improving economic picture, we believe our portfolio of undervalued small- and mid-sized companies is properly structured to reach the Fund’s capital gains objectives in the current environment.
Although we expect the market for small- to mid-sized equities could be somewhat volatile in the near term as the Fed continues to taper its extraordinary monetary stimulus program, we also expect stronger economic data and improved company performance to highlight the strength of the U.S. economy. As in the past, we believe a key beneficiary of the improved economy will be smaller companies with strong financials and sustainable excess cash flow, whose revenues come mainly from domestic sources and whose stock is not being properly valued by the market according to our metrics.
We believe the market volatility that has characterized the start of 2014 has provided an excellent opportunity to find viable investment opportunities in small- and mid-sized companies. In our search for value, we continue to focus on three crucial, company-specific factors: (1) a commitment to maintain a strong financial position as evidenced by a solid balance sheet; (2) an ability to generate sustainable free cash flow; and (3) management that intelligently deploys cash balances and free cash flow from operations to increase returns to shareholders.
Olstein Strategic Opportunities Fund’s Leaders
The stocks which contributed positively to performance for the twelve month reporting period include: Harman International Industries Inc./DE/ (NYSE:HAR), Spirit Airlines Incorporated (NASDAQ:SAVE), Legg Mason Inc (NYSE:LM), Smith & Wesson Holding Corp (NASDAQ:SWHC) and Dillard’s, Inc. (NYSE:DDS). As of the close of the fiscal year, the Fund continues to hold each of these companies in the portfolio.
Olstein Strategic Opportunities Fund Laggards
Laggards during the twelve month reporting period include: Fairway Group Holdings Corp (NASDAQ:FWM), Potbelly Corp (NASDAQ:PBPB), URS Corp (NYSE:URS), Ethan Allen Interiors Inc. (NYSE:ETH) and Arctic Cat Inc (NASDAQ:ACAT). During the fiscal year, the Fund eliminated its holdings in Fairway Group Holdings Corp. The Fund continues to hold Potbelly Corporation, URS Corporation, Ethan Allen Interiors Inc. and Arctic Cat Inc.
Olstein Strategic Opportunities Fund’s Portfolio and Performance Review
At June 30, 2014, the Fund’s portfolio consisted of 51 holdings with an average weighted market capitalization of $3.52 billion. Throughout the fiscal year ended June 30, 2014, we continued to modify the portfolio in light of the volatility in the overall market. By paying strict attention to our company valuations, we reduced or eliminated positions in which the discounts from our calculation of intrinsic value were no longer large enough to justify the size of our position. At the same time, we increased or added new positions in what we believe to be well run, conservatively capitalized companies selling at a significant discount to our calculation of intrinsic value.
During the fiscal year, the Fund initiated positions in twenty- three companies and strategically added to established positions in another eight companies. Positions initiated during the reporting period include: ADT Corp., ANN INC., CECO Environmental Corp., Dillard’s, Inc., Esterline Technologies Corporation, The Greenbrier Companies, Inc., GSI Group Inc., Harmonic Inc., Integra LifeSciences Holding Corporation, Itron, Inc., Kadant Inc., NOW Inc., Nutraceutical International Corporation, PetSmart, Inc., Potbelly Corporation, Sealed Air Corporation, Standard Motor Products, Inc., Steelcase Inc., UFP Technologies, Inc., UniFirst Corporation, URS Corporation and Xylem Inc. Over the course of the fiscal year, the Fund eliminated its holdings in twenty-two companies and strategically reduced its holdings in another six companies. The Fund eliminated or reduced its holdings in companies that either reached our valuation levels, or where, in our opinion, changing conditions or new information resulted in additional risk and/ or reduced appreciation potential. We redeployed proceeds from such sales into opportunities that we believe offer a more favorable risk/reward profile. During the fiscal year, the Fund eliminated its holdings in Alaska Air Group, Inc., City National Corporation, Columbus McKinnon Corporation, DENTSPLY International Inc., Diebold, Incorporated, Fairway Group Holdings Corp., The Finish Line, Inc., Hillenbrand, Inc., Korn/Ferry International, Littelfuse, Inc., Maidenform Brands, Inc., Measurement Specialties, Inc., MICROS Systems, Inc., Microsemi Corporation, Mistras Group, Inc., NCR Corporation, Schweitzer-Mauduit International, Inc., Standex International Corporation, Team, Inc., Teradyne, Inc., Thor Industries, Inc. and The Timken Company.
Olstein Strategic Opportunities Fund’s Review of Activist Holdings
As of June 30, 2014, the Fund was invested in ten activist situations, which represented approximately 27% of the Fund’s equity investments and six of its top ten holdings. In general, these situations fit our definition of an activist investment, where Olstein Capital Management or an outside investor (usually a hedge fund or private equity investor), seeks to influence company management to adopt strategic alternatives that we expect to unlock greater shareholder value.
The Fund’s activist holdings as of June 30, 2014, include women’s apparel retailer, ANN INC., specialty apparel and accessory retailer, Express, Inc., electronic equipment company, Harman International Industries, Incorporated; gaming company, International Game Technology; money management firms, Janus Capital Group, Inc. and Legg Mason, Inc.; retailer of pet products, PetSmart, Inc., specialty eatery, Potbelly Corporation, flavor and fragrance and color systems manufacturer, Sensient Technologies Corporation, and engineering and technical services company, URS Corporation (sold by the Fund in July after receiving a takeover offer at a material premium). We continue to monitor the progress of the company management and outside activist investors involved in these situations as they work to increase shareholder value through a specific plan for improving each company’s results. While each investment is at a different strategic stage, we believe the actions that have been proposed or implemented should increase shareholder value through improved future operating results.
With each of our activist situations, one of the most important variables we consider, especially during tough economic times, is “how long do we expect it to take for this company to improve its operations and results?” Although we know from experience that successful turnarounds don’t happen overnight, we do expect specific improvements in operations to occur within a defined period of