Home Value Investing Westport Funds Q3 Letter: Buys Potash, Willis Group

Westport Funds Q3 Letter: Buys Potash, Willis Group

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Westport Q3 letter to shareholders

Dear Fellow Shareholder:

The U.S. equity markets posted broad-based returns for the third quarter despite a high level of uncertainty created by both the Federal Reserve’s failure to implement the much anticipated “tapering” of QE3 and concerns that Washington will be unable to quickly end the government shutdown and prevent a government default. The quarter ended with the Dow Jones Industrial Average (INDEXDJX:.DJI), the S&P 500 INDEX (INDEXCBOE:SPX), and the NASDAQ Composite (INDEXNASDAQ:.IXIC) returning 2.12%, 5.24%, and 11.20% respectively. Market returns in the quarter were fueled by the continuing moderate U.S. economic expansion and the Federal Reserve’s quantitative easing (“QE”).

During the third quarter the Westport Select Cap Fund’s (“Select Cap Fund”) R shares rose 7.95%, trailing the Russell 2000® Index’s gain of 10.21%. For the first nine months of 2013, the Select Cap Fund’s R shares underperformed the Index with an increase of 25.43%, compared to a rise of 27.69% for the Russell 2000® Index. However, over the past twelve months the Select Cap Fund has outperformed, gaining 31.18% compared to 30.06% for the Index. Since inception 15¾ years ago the Select Cap Fund has outperformed by just under 3% points a year, 10.09% to 7.26%, both compounded annually. Even though the Select Cap Fund trailed the Index during the quarter, it was not due to poor stock selection as the five declining stocks cost collectively only 68 basis points in performance. Of these, IPG Photonics Corporation (NASDAQ:IPGP) was off over 7% for the three months, costing 39 basis points. A manufacturer of precision lasers, IPG Photonics Corp. has been an outstanding performer for the Fund, rising over six-fold from our original purchase price and nearly 100% in 2012. Some consolidation was to be expected. Seven of the Fund’s positions had positive returns but not as much as the Index’s 10.21%. However, the balance of the holdings, in fact, outperformed the benchmark, rising anywhere from 49% to 12%. The largest positive contributor for the quarter again was the Fund’s largest holding, Universal Health Services, Inc., Class B shares, whose shares rose over 12% and added 136 basis points. For the first nine months of the year the shares have risen over 55%, contributing 556 basis points. Investors have come to realize the company’s favorable position as the start-up of the Affordable Care Act neared. In addition, second quarter results topped expectations for earnings, cash flow and admissions. FEI Company (NASDAQ:FEIC) was the quarter’s second largest contributor, gaining over 20% and adding 135 basis points. As our shareholders may recall, this company’s electron microscopes allow users to see images at the atomic structure level. Concerns over strength in demand for the company’s products was alleviated by management’s disclosure that second quarter orders exceeded shipments, resulting in a rising backlog. This strength could bode well for earnings later this year and into 2014. The third most important contributor for the quarter was Big Lots, Inc., the close-out retailer, whose share price rose nearly 18%, adding 82 basis points. The company’s new CEO has been well received by investors as it is hoped that his merchandising expertise will bring an acceleration in sales and improved profitability. Reflecting the importance of timing and portfolio weighting, the Fund’s third largest position, Willis Group Holdings PLC (NYSE:WSH), the international insurance broker, underperformed in the quarter with a gain of just over 6% but had the Fund’s fourth largest positive contribution at 66 basis points. However, for the nine months of the 2013 the shares are up over 29%, contributing 283 basis points. The Fund did have one acquisition in the quarter. After several months of rumors, Saks, Inc., a long-term holding in the Fund, announced an agreement to be acquired by Hudson’s Bay Company in a cash deal for $16 per share. The Fund’s cost on this position is $3.42 per share. Portfolio changes included the addition of one new position, Radian Group Inc (NYSE:RDN), a provider of residential mortgage insurance. Also, portfolio positions in Saks Inc (NYSE:SKS) and Universal Health Services, Inc. (NYSE:UHS) – Class B were reduced during the quarter.

The performance data quoted represents past performance; past performance is not indicative of future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. The Fund’s current performance may be lower or higher than the data quoted. Investors may obtain performance information year-to-date the following business day and to last month-end, within 7 business days, at www.westportfunds.com.

The Westport Fund benefited from the shift in investor focus from yield surrogates to companies more closely linked with the economy, especially its Energy and Materials sector holdings. For the third quarter the Westport Fund Class R share return was just about 8% at 7.96% versus 7.70% for the iShares Russell Midcap Index Fund (ETF) (NYSEARCA:IWR). The return for the Westport Fund’s Energy sector exceeded that of the Russell Midcap® Index by 94 basis points and the corresponding figure for the Materials & Processing sector was 60 basis points. The industry sector for the Westport Fund which showed the greatest underperformance relative to the Russell Midcap® Index was again the Consumer & Discretionary sector at 101 basis points. Stock selection was beneficial to third quarter performance with 44 of 56 holdings providing positive returns. The total negative contribution was 91 basis points and the single largest detractor from the Westport Fund’s third quarter return was teen retailer American Eagle Outfitters, Inc. at negative 28 basis points. The largest positive contributor to the Westport Fund’s third quarter performance was EOG Resources Inc (NYSE:EOG) at 98 basis points. EOG Resources is one of the most successful exploration companies at discovering and producing oil from shale formations within the United States. FMC Corp (NYSE:FMC)provided the second largest positive contribution to third quarter results with 62 basis points. The company is a diversified supplier of crop protection chemicals and intermediate building blocks for a broad range of end markets including foods, medications, and batteries. Other notable contributors were MasterCard, Inc. – Class A, a global payment company, with 49 basis points and Pall Corporation (NYSE:PLL), a leader in filtration and purification technologies, with 45 basis points. Even with modest outperformance in the last two quarters, the Westport Fund’s year to date performance is still dominated by the effects of QE3 on first quarter investor behavior. The Consumer Discretionary & Services sector was the largest detractor at 362 basis points on a relative basis versus the Russell Midcap® Index while the Utilities sector subtracted 107 basis points relative to the corresponding Russell Midcap® Index sector. These two sectors accounted for 111% of the Fund’s Class R share’s 422 basis point year to date underperformance. In the 15¾ years since its inception, the Westport Fund Class R share’s average annual return has outperformed the Russell Midcap® Index by over 200 basis points, 10.97% versus 8.87%, respectively. The Westport Fund Class R share’s performance inception to the end of the third quarter also compares favorably to the 5.83% for the Lipper Multi-Cap Core Index which consists of mutual funds with holdings in the large, medium and small capitalization categories. A focus on value and long term holdings heavily influenced this result. A number of portfolio holdings with low weighting were eliminated in the quarter.

The largest new addition is Agrium Inc. (TSE:AGU) (NYSE:AGU), a fertilizer company. Potash is a key plant nutrient and global export sales are dominated by two associations, one in Canada and one in Eastern Europe. The North American export association – Canpotex –includes potash producers Potash Corp./Saskatchewan (NYSE:POT) (TSE:POT), The Mosaic Co (NYSE:MOS) and Agrium. The Eastern European export association includes Belaruskali of Belarus and Uralkali OAO (LON:URALL) (OTCMKTS:URALL) of Russia. During the third quarter Uralkali announced that it would no longer market potash with Belaruskali and would move from using price as a key determinant for production levels to producing close to its full capacity. Predictions of substantially lower prices for potash immediately followed and share prices declined for all of the public companies. This provided an opportunity for the Westport Fund to establish a position in Agrium which was affected by Uralkali’s actions but whose business mix cushions the influence of lower potash prices. First, potash is a relatively small component of Agrium’s product slate with nitrogen based fertilizer being the most important product. Further, Agrium has a retail operation which is unrivaled in size and scope in North America and provides a large portion of Agrium’s operating profits. While North American farmers are likely to postpone fertilizer purchases in the third quarter to see at what level potash prices and possibly other nutrient prices settle, it is likely that they will represent a delay and not lost sales. Further, although Uralkali is a public Russian company it is not impossible for the Belaruskali-Uralkali export association to be reconstituted by their host governments. Longer term the outlook for crops such as corn and soybeans is quite positive which should lead to increasing demands for fertilizers.

We thank you for your continued investment in The Westport Funds. Please visit our web site, www.westportfunds.com, for additional performance and portfolio information. As always, should you have any questions regarding The Westport Funds, please feel free to contact us at 1-888-593-7878.


The Westport Funds

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