Investment Strategies ■ All Cap Value ■ Performance Commentary
1st Quarter 2013 All Cap Value Equity Commentary
The U.S. stock market bolted out of the gate with the Russell 3000 Value Index posting its best first quarter results since 1991. Emboldened by an uneventful sequestration, signs of economic improvement, several high profile buyouts, and ever-accommodative monetary policy, market participants firmly embraced equities. The advance was not only strong, but also broad-based, with returns fairly evenly distributed across economic sectors and industries. Traditionally defensive sectors including Consumer Staples, Healthcare, and Utilities led the charge, differentiating this “risk-off” rally from most other rallies over the past few years.
Portfolio Performance & Developments
The Cooke & Bieler All Cap Value portfolio performed well though trailed its Russell 3000 Value benchmark. This modest underperformance is consistent with Cooke & Bieler’s historical pattern of results during very strong up markets – particularly those lacking proportionate fundamental underpinnings. The most meaningful detractors were 1) frictional cash, which has a more pronounced impact during strong up or down periods, and 2) a 20% decline in one holding which has significant exposure to the housing industry. Given the ongoing improvement in the U.S. housing market, expectations for the firm have been moving higher. However, the company has yet to fundamentally deliver on those expectations. We think investors are failing to realize the lag inherent in the business and we have recently taken the opportunity to add to the position. Partially offsetting these detractors were meaningful contributions from an array of holdings including several of last year’s poorest performers.
Regarding the market environment, we have encouraged our clients for some time to take a balanced view of risk. More specifically, we have highlighted the massive valuation risk embedded in the fixed income universe and the relative opportunity in equities. Now, as we enter the second quarter of 2013, equity valuations still present a relative opportunity, albeit to a lesser extent. Indeed, with the S&P 500 Index up over 25% since the beginning of 2012 and the Russell 3000 Value Index up over 30%, the comparative appeal of equities has all but permeated conventional market wisdom. Noted bears are acquiescing by the day. Volatility is at a five year low. And with the S&P 500 breaching new records, the bulls point out that stocks are less expensive now than at any market high since 1980.
But despite this abundance of top down enthusiasm at the moment, the equity rally over the past year feels reluctant. Lacking the buoyancy they have exhibited during similarly strong market moves, investors cannot shake the nagging reality that stocks merely represent their least worst option at the moment. The truth is, absolute returns matter and most bottom-up practitioners will readily admit that the fat pitches of 2009, 2010 and 2011 are anything but obvious these days. Worse, the Damoclean event looming large in the bond market – the specter of higher rates – could prove almost as ruinous to equity investors.
For these reasons, we have been active in the Cooke & Bieler All Cap Value portfolio this year, shoring it up, trimming winners, revisiting our investment theses and seeking out enduring franchises at a discount. For example, we took the opportunity during the quarter to add to six holdings. Their valuations range from compelling to very compelling and we are confident that all will expand their earnings power meaningfully over the next three to five years. Our increased stakes in these companies improve both the valuation and quality profile of the portfolio, something we can also say about the portfolio’s new positions in three companies. To make room for these additions, four of the Cooke & Bieler All Cap Value portfolio’s positions were trimmed and three holdings were eliminated.
The net impact of these transactions is a portfolio with better fundamental prospects. The appreciation potential of many holdings admittedly is more subdued now than it was three months ago, but we still see good value looking at it holistically. We continue to search for new ideas, but are proceeding with a fairly high degree of caution with respect to fundamentals and valuation given the complacency we see creeping into the market. And, given our quality orientation, we feel good about the Cooke & Bieler All Cap Value portfolio should the market environment deteriorate. As we see it, reasonably valued franchises that compound earnings over the long-term guard against the potential headwinds of wholesale multiple contraction, having less room to fall and a greater ability to grow their way out of a hole.
Sources: FactSet, Russell
The material presented represents the manager's assessment of the All Cap Value institutional portfolio and market environment at a specific point in time and should not be relied upon by the reader as research or investment advice regarding any stock.