Olstein Strategic Opportunities Fund’s letter to shareholders for the year ended December 31, 2014.
Dear Fellow Shareholders:
For the year ended December 31, 2014, load-waived Class A shares of the Olstein Strategic Opportunities Fund appreciated 12.34% compared to total returns of 7.07% and 13.69% for the Russell 2500™ Index and the S&P 500 ® Index, respectively. For the six-month reporting period ended December 31, 2014, load-waived Class A shares of the Olstein Strategic Opportunities Fund appreciated 6.77% compared to total returns of 1.06% for the Russell 2500™ Index and 6.12% for the S&P 500® Index over the same time period.
Olstein Strategic Opportunities Fund: Market Outlook & Strategy
The calm that prevailed in U.S. equity markets for most of the past three years was disrupted by an increase in market volatility during the second half of 2014, as many investors reacted negatively to the planned end of the Fed’s asset purchase program known as quantitative easing, and to rapidly falling oil prices. Yet, despite an increase in market volatility, we are continuing to find opportunities to purchase the equity securities of what we believe to be undervalued small- to mid-sized companies meeting our stringent investment criteria. Although we expect the market for small- to mid-sized equities to continue to be somewhat volatile in the near term, we also expect stronger economic data and improved company performance to highlight the growing strength of the U.S. economy. As in the past, we believe a key beneficiary of the improved economy will be smaller companies whose revenues come mainly from the U.S. market.
With the strong market run more than five years old, many forecasters have been contemplating a market pullback in the near future. While there are always forecasters predicting the next downturn, we believe it is important for investors to weather market events and periods of short term volatility by favoring the equities of financially strong companies, selling at a discount to our calculations of intrinsic value based on its normalized ability to produce stable or growing free cash flow and run by managements that have a demonstrated history of deploying that cash to the benefit of shareholders.
We believe the market volatility that has characterized the start of 2015 provides an excellent opportunity to find viable undervalued 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 which in our opinion is not yet being valued by the market, and (3) management that intelligently deploys cash balances and free cash flow from operations to increase returns to shareholders.
Olstein Strategic Opportunities Fund: Portfolio and Performance Review
At December 31, 2014, the Fund’s portfolio consisted of 49 holdings with an average weighted market capitalization of $3.33 billion. Throughout the reporting period ended December 31, 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 reporting period, the Fund initiated positions in ten companies and strategically added to established positions in another sixteen companies. Positions initiated during the reporting period include: Blount International, Daktronics, DSW, First Niagara Financial, Fox Factory, Lifetime Brands, Patterson Companies, Wabash National, The Wendy’s Company, and Wesco International . During the reporting period, the Fund eliminated its holdings in twelve companies and strategically reduced its holdings in another three 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 quarter, the Fund eliminated its holdings in Aegion, Ann, Avery Dennison, AVX, CareFusion, Charles River Laboratories, Ethan Allen Interiors, International Game Technology, PetSmart, Teleflex, UFP Technologies and URS.
As reported in our last letter to shareholders, URS Corporation and International Game Technolog entered into merger agreements with strategic acquirers during the reporting period, resulting in the sale of both companies from the Fund’s portfolio as the price of each company’s stock reached our valuation. We also sold specialty retailer, Ann Inc. (ANN), following a March 2014 announcement of a significant private equity investor establishing a material position. Increased scrutiny from activist investors during the reporting period caused the company’s stock price to rise fairly rapidly to our valuation level. As value investors who usually have to wait patiently for a company to improve operating results and for the market to ultimately recognize the value we see, these acquisitions and private equity investments not only came as a pleasant surprise, they allowed us to reach our value in each company over a much shorter holding period.
Olstein Strategic Opportunities Fund: Leaders
The stocks which contributed positively to performance for the six-month reporting period include: PetSmart, Janus Capital, CareFusion, Sealed Air and Patterson Companies. As of December 31, 2014, the Fund maintained positions in Janus Capital, Sealed Air and Patterson. On December 14, 2014, PetSmart announced that it had entered into definitive agreement to be acquired by private equity firm BC Partners for $83 per share in cash. The Fund sold its holdings in PetSmart as the price of the company’s stock approached the announced acquisition price representing a substantial premium to the Fund’s average cost for PetSmart. Similarly, on October 5, 2014, Becton Dickinson (BDX) announced that it had entered into a definitive agreement to acquire CareFusion for $58 per share. The Fund sold its holdings in CareFusion as the price of the company’s stock approached the announced acquisition price representing a substantial premium to the Fund’s average cost for the company’s stock.
Olstein Strategic Opportunities Fund: Laggards
Laggards during the six month reporting period include: Smith & Wesson Holding, NOW Inc., Potbelly, Aegion and Standard Motor Products. At the close of the reporting period, the Fund continues to hold Smith & Wesson, NOW Inc., Potbelly Corp. and Standard Motor Products in its portfolio. The Fund eliminated its position in industrial goods/infra- structure company Aegion, after we lost confidence in company management and its ability to effectively implement a clear, consistent strategy. We were initially attracted by the company’s prospects, approximately three years ago, as it transitioned from a company whose earnings were dominated by municipal sewer servicing to being a well-rounded pipeline service provider with increased exposure to energy and mining and structural and construction businesses. During the recent stages of this transition, however, management has continued to provide excuses for underperforming business segments and overall poor company performance without articulating a clear strategy for moving forward.
Olstein Strategic Opportunities Fund: Review of Activist Holdings
As of December 31, 2014, the Fund was invested in twelve activist situations, representing approximately 28% of the Fund’s equity investments, and two of its top ten