Meridian Contrarian Fund’s letter to shareholders for the year ending June 30, 2014. H/T Dataroma
During the year ending June 30, 2014, the S&P 500 (INDEXSP:.INX) and the Russell 2500 (INDEXRUSSELL:R25I) (small and medium sized companies) returned over 24.6% and 25.5%, respectively. Continued accommodative Fed policy, along with improvements in housing, employment and manufacturing were all supportive macro-economic factors that drove an overall increase in earnings and valuation for the indices.
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The current low interest rate environment and the longer-term trends of globalization and technology-enhanced productivity form a powerful recipe for cash flow generation and capital markets activity. In addition to helping drive strong US equity market returns over the past few years, these market forces are contributing to positive capital flows into equities, increased corporate debt and equity issuance—and a healthy pick-up in merger and acquisition activity (M&A). M&A has traditionally been a barometer of overall CEO confidence, and, according to Bloomberg, the dollar value of global M&A during the first half of 2014 increased 89% over the same period a year ago, suggesting investors are not alone in their sanguine view of the future.
While optimism abounds for the market as a whole, it is worth a reminder that the stock market is not the economy. Underlying economic data may not be as robust as stock prices would suggest. First half 2014 US GDP growth is set to come in around 1% (2% annualized) and significant slack remains in the labor market. Reforms and deleveraging in Europe create the specter of deflation in the region and widespread geopolitical tensions remain at the top of the list of overall global risks.
At Arrowpoint and the Meridian Funds, we are not economic prognosticators, nor traders; our value-add is fundamental research first and foremost. We seek to combine attractive asymmetric risk/reward investments within a risk-managed equity portfolio. The intended outcome is to preserve capital in volatile market environments without sacrificing upside participation in up markets.
As our first year as Investment Adviser to the Meridian Fund family comes to a close, we are excited about enhancements that have been made to the client service side of the business. This includes the establishment of quarterly commentaries and a new website with substantially improved data and functionality. Please visit us at www.meridianfund.com or Arrowpoint Partners at www.ap-am.com for more information on our strategies.
On behalf of all the Meridian and Arrowpoint team members, thank you for your continued trust, confidence and investment in the Meridian Fund family.
Meridian Contrarian Fund: Portfolio Performance and Composition (Unaudited)
Discussion of Fund Performance
The Meridian Contrarian Fund-Legacy Shares returned 23.31% during the twelve-month period ending June 30, 2014, which compares to the primary benchmark, the Russell 2500 Index, which returned 25.58%. The strategy’s secondary benchmark, the S&P 500 Index, returned 24.61%.
The Meridian Contrarian Fund’s investment strategy remains unchanged. We continue to seek out-of-favor companies that we believe, despite suffering temporary problems, have good long-term prospects for earnings growth supported by defensible positions in their industries, attractive return on capital and strong or improving balance sheets. Over the long term we believe this contrarian investing process can outperform the market.
Holdings in the financial sector were the largest contributor to the fund’s underperformance. The fund was underweight in the financial sector by 12.9%, which negatively impacted the portfolio. The information technology sector was our largest contributor to performance. The fund benefited from an 8.5% overweight as well as individual stock selection that outperformed the sector in the benchmark by an average of 2.8%. Industrials were another positive contributor, with both an overweight relative to the benchmark and strong individual stock performance. As it relates to stock selection, the portfolio was underweight in REITs, which were strong performers for the index overall, driven by the decline in interest rates in the first half of 2014. Utilities benefited from the same decline in interest rates and our under allocation was another detractor to the portfolio.
Meridian Contrarian Fund’s top three contributors
Our top three contributors to performance were Broadridge Financial Solutions, Inc. (NYSE:BR), EOG Resources Inc (NYSE:EOG), and Ubiquiti Networks Inc (NASDAQ:UBNT).
- Broadridge Financial Solutions, Inc. (NYSE:BR) is a leading provider of investor communication and securities processing services. This has been a long-term investment for the Contrarian Fund. There has been limited change in the company’s stock price for a number of years due to softness in event-driven investor communications and continued investments in future growth that lowered current profitability. In 2013 these headwinds waned, leading to renewed earnings growth, multiple expansion, and strong stock performance.
- Long-term holding EOG Resources Inc (NYSE:EOG) is a large, diversified oil and gas exploration and production company. The stock fell out of favor when the company made poorly timed investments to expand natural gas production just prior to a precipitous drop in natural gas prices. We saw this as an opportunity because the company possessed both the management acumen and attractive resource base to efficiently pivot production away from natural gas to oil. EOG continues to execute this strategy with better than expected oil production and higher oil prices driving strong stock performance during the fiscal year. We maintain our position in the stock.
- Ubiquiti Networks Inc (NASDAQ:UBNT) designs and manufactures wireless broadband infrastructure equipment and other communications. Ubiquiti initially came to our attention in early 2013 after suffering declines in earnings. While being optimistic about overall market demand, our research led us to conclude that the problems facing the company were temporary and we invested in the stock. Management executed on the turnaround, which drove both revenue and earnings growth. As a result the stock has more than doubled from our initial purchase price.
Meridian Contrarian Fund’s top three detractors
The top three detractors from performance were Aeropostale Inc (NYSE:ARO), Haemonetics Corporation (NYSE:HAE) and Compass Minerals International, Inc. (NYSE:CMP).
- Aeropostale Inc (NYSE:ARO) operates a chain of apparel stores aimed at young teenagers. The company had successfully operated a fast fashion model for many years that drove strong growth and returns on capital. The company suffered declining earnings in 2012 as its customers shifted their fashion preferences and struggling competitors cut prices. We believed that Aeropostale would benefit as improving inventory positions at competitors eased price competition and as the addition of a new head of design improved the company’s fashion offerings. This did not materialize, however, and the company has continued to struggle. We sold the position at a loss in August 2013.
- Haemonetics Corporation (NYSE:HAE) is the leader in blood separation and blood management products for collection centers and hospitals. The company hit our screen after two minor product recalls negatively impacted earnings. We believed the impact would prove short-lived, and that earnings growth would reaccelerate with the introduction of a new blood collection system. However, the company ended up losing a large contract, which was not in harmony with our thesis, and we sold the stock.
- Compass Minerals International, Inc. (NYSE:CMP) is a leading producer of rock salt and specialty potash fertilizer. Its unique collection of resource assets has helped the company generate historically high returns on capital. We invested in Compass as we believed that earnings were due to turn after four years of weak road salt demand driven by mild Northeast winters and production problems at its potash mines. During 2013 the potash industry was rocked by the potential collapse of a European cartel, which led to falling potash prices. Facing significant uncertainty for the future of the potash market, we sold the stock.
We continue to remain focused on individual stock selection and portfolio construction that identifies quality companies that we believe are experiencing temporary disruptions to their businesses. These disruptions enable us to buy the businesses at attractive prices and provide the portfolio with what we believe is an attractive risk-reward profile for our shareholders.
Thank you for your continued investment in the Meridian Contrarian Fund.
Jamie England, Larry Cordisco and Jim O’Connor