We are pleased with the Meridian Growth Fund’s (the “Fund”) outperformance during the quarter, which was driven by our discipline of using fundamental research to identify high-quality growth businesses with predictable and recurring revenues, high returns on capital and attractive risk-reward profiles. We then look to build a durable fund based on these ideas that seeks to manage downside risk in tough, turbulent markets and keeps up with the broader market in bull market environments.
We believe the period from the market’s peak early in March is a good demonstration of this. From the market’s peak in early March, the fund captured just 71% of the market’s downside move, falling 6.5%* as compared to 9.2% for the Russell 2500 Growth to the April low. From that low point the fund was then able to capture 90% of the upside going into the end of the quarter, rising 8.0%* versus the index’s gain of 9.0%. We believe this focus on going down less in down markets can result in long-term outperformance due to the power of compounding. By maintaining discipline and a long-term focus, we welcome increased volatility in the market and believe these short-term gyrations can create opportunities to invest capital.
FUND SUMMARY
During the second quarter of 2014, the Fund returned 3.15%*, compared to 2.90% for its primary benchmark, the Russell 2500 Growth Index.
From a sector point of view, the largest contributor was the industrial sector, which contributed 2.11% driven by the fund being overweight relative to the index and strong individual stock selection. Conversely, the consumer discretionary sector was the largest detractor, with stock selection negatively weighing on performance by 1.05%. The fund’s primary overweight remains industrials, with primary under weights in materials, health care and consumer staples.
The largest individual contributors to performance during the quarter were:
•Polypore International (PPO) develops, manufactures and markets specialized membranes used in separation and filtration processes. The stock rallied strongly during the second quarter as it signed a new agreement with a customer that includes possible access to one of the world’s fastest growing electronic vehicle brands. We believe the company has substantial earnings growth potential driven by increases in capacity utilization of their lithium ion separator manufacturing facilities as electronic vehicles increase their share of total automobile production. We took advantage of the strong stock move to trim some of the position during the quarter.
•Prestige Brands (PBH) is the largest independent provider of over-the-counter products in North America. Examples of their brands include Chloraseptic, Dramamine, PediaCare and Efferdent, to name a few. We added to the position during the first quarter when the stock was one of the largest detractors, selling off for short-term reasons. The company experienced a decline in items stocked at one of the company’s largest customers, but we believe this is a temporary situation and our long- term thesis remains unchanged. This proved timely as the company demonstrated stabilized results during the second quarter and announced an acquisition, which drove the stock higher. Prestige Brands has an asset-light business model that focuses exclusively on the marketing and distribution of these brands, which results in a growing, scalable and high-return business model. We continue to hold the position.
•Clean Harbors (CLH) provides a variety of environmental remediation and industrial waste management services. After being a laggard in the first quarter, during which time we also added to the position, the stock reacted strongly to both stabilizing business trends and the announcement that an activist investor was involved in the security. We remain attracted to the company’s large barriers to entry and pricing power in their core businesses and the recovery that we believe is on track in some of the company’s more cyclical businesses. We took advantage of the strength in the quarter to trim some of the position.
The main detractors during the quarter were:
•VistaPrint (VPRT) declined during the quarter as the first calendar quarter represented what we believe will be one of the worst comparisons for the company as it transitions away from high turnover, low order value and low margin customers to low turnover, high order value and high margin customers. As the pricing model and customer focus transitions, we believe we will see improved returns on invested capital and customer retention metrics. All of these combined should drive rapid earnings growth and high levels of free cash flow. We have been adding to the position on the weakness.
•The Advisory Board Company (ABCO) provides best practice research and analysis to the health care industry. The stock declined during the quarter when the company announced earnings that included higher than expected expense growth. We believe these investments are good uses of capital that will enhance the business model and long-term growth profile of the company. We continue to see a strong need for the company’s services and held our position during the quarter.
•Wolverine World Wide (WWW) manufactures and markets branded footwear globally. The stock declined during the quarter as investors wait for a turnaround in one of their key brands, Sperry. We continue to be attracted to the company’s strong portfolio of brands, the long- term international growth opportunity and the strong management team. We trimmed the stock during the quarter; however, we still maintain a large position in the stock.
OUTLOOK
As we look forward, we continue to find small- and mid-cap growth companies that fit our criteria for large growing markets, defensible business models and excellent management teams. While we believe valuation multiples are still elevated, we do not believe they are at their peak. We will continue to focus on stocks that can perform well independent of the economy and we will use periods of volatility as a buying opportunity.
