Portfolio Review
As expected gross domestic product (“GDP”) rebounded from the first quarter 2014 contraction of 2.1%, expanding at a 4.6% rate in the second quarter. The recovery in GDP was broad-based with virtually all major components improving – personal consumption, fixed investment, inventory change, net exports and government expenditures. The Federal Reserve continued to taper its purchase of Treasury and mortgage-backed securities and signaled the quantitative easing program would end in October 2014.
Anticipating the potential effects of economic weakness in Europe, Russian aggression in the Ukraine, further adjustments to economic policy in Japan and the transition in monetary policy by the Federal Reserve, investors reduced risk by decreasing equity commitments during the quarter especially among small and midcap equities.
The S&P 500 Index returned 1.13% for the third quarter of 2014 but the Russell Midcap® Index and S&P MidCap 400® Indexi (“S&P MidCap”) along with the Russell 2000® Indexii provided negative returns. The benchmark Russell Midcap® Index returned a negative 166 basis pointsiII in the third quarter, the S&P MidCap returned a negative 398 basis points and the Westport Fund Class R shares returned a negative 252 basis points. Investors faced with low rates on fixed income securities - a reaction to the Fed’s quantitative easing program – have migrated to equity securities with higher dividend yields supporting REIT prices. The ten industry segments in the Russell Midcap® Index and the S&P MidCap have different weightings but one segment of the Russell Midcap® Index is devoted to REITs, while the Westport Fund has no REITs among its portfolio holdings. Of the Russell Midcap® Index’s ten industry segments, the Westport Fund Class R shares outperformed the Index in six segments and underperformed in four. Of the industry segments, Materials and Processing saw the poorest relative return versus the Index at a negative 109 basis points with the largest detractor, FMC Corp. (FMC, Financial) (agricultural and food products), at a negative 92 basis points. Drought in South America, compressed North American planting schedules and bumper crops of corn and soybeans have led to reduced applications and sales of agricultural chemicals. Slowing growth in China, little growth in Europe and continued increases in U.S. oil production raise questions about the oil price needed to balance supply and demand. Not surprisingly, energy was the other major disappointing industry segment in the quarter, subtracting 98 basis points on a relative basis from Fund results versus its benchmark Index. While the share prices of all three energy portfolio holdings were down, EOG Resources, Inc. (EOG, Financial), after an excellent first half, decreased the Fund’s return by 107
basis points. In the first nine months of 2014 energy was the best performing industry segment and EOG Resources, Inc. contributed 57 basis points to the Fund’s return. The largest positive contributor to third quarter performance was Universal Health Services, Inc., Class B shares, at 49 basis points. In addition, there were three out of favor but positive contributors to the quarter’s performance. International Rectifier Corp. (IRF, Financial) (power semiconductors) agreed to be acquired by Infineon Technologies AG at $40 per share in cash, producing a third quarter gain over 40%. PetSmart, Inc. (PETM, Financial) (retailer of pet products and services) appreciated 17% in the quarter due to acceptable earnings and a board decision to evaluate “strategic alternatives,” including a sale of the company.
This course of action was aggressively advanced by an activist investor. Finally Bed, Bath & Beyond, Inc. (BBBY, Financial) (retailer of domestic merchandise and household furnishings) gained nearly 15% in the quarter due to somewhat better earnings relative to expectations and a large share repurchase, facilitated by the company’s strong balance sheet.
For the first three quarters of 2014 the Westport Fund Class R shares lagged the S&P 400 MidCap Index by 100 basis points and the Russell Midcap® Index by 465 basis points – impacted by many of the same factors as the third quarter. Turning to long-term results, the Westport Fund Class R shares average annual return over the 16¾ years since the fund’s inception has been an outperformance of 10.88% vs 9.27% for the Russell Midcap® Index. Lipper classifies the Westport Fund a multicap core fund and the average annual return over the 16¾ years since the fund’s inception for this category is 6.38%. Two portfolio holdings were eliminated in the third quarter of 2014 – American Eagle Outfitters, Inc. (AEO, Financial) and McCormick & Company, Inc. (MKC.V, Financial) as future returns were viewed as unlikely to reach the levels needed for retention in the portfolio.
Investors should consider the investment objectives, risk, and charges and expenses of The Westport Funds carefully before investing; this and other information about the Funds is in the prospectus, or summary prospectus, which can be obtained by calling 1-888-593-7878 or at our website www.westportfunds.com. Read the prospectus or summary prospectus carefully before you invest.
The views expressed and any forward-looking statements are as of the date of the publication and are those of the portfolio managers and/or the Advisor. Future events or results may vary significantly from those expressed and are subject to change at any time in response to changing circumstances and industry developments.
There are special risks associated with small and mid-capitalization issues such as market illiquidity and greater market volatility than larger capitalization issues.
i The S&P MidCap 400® Index seeks to track the performance of mid-cap U.S. equities, representing more than 7% of available U.S. market cap. It is designed to measure the performance of 400 mid-sized companies in the U.S., reflecting this market segment’s distinctive risk and return characteristics.
ii The Russell 2000® Index is an index measuring the performance of approximately 2,000 small-cap companies in the Russell 3000 Index, which is made up of 3,000 of the biggest U.S. stocks. The Russell 2000 serves as a benchmark for small-cap stocks in the United States. iii Basis Point is a unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.
Portfolio composition is subject to change at any time and should not be considered a recommendation to purchase or sell a particular security. On September 30, 2014, the following securities comprised these respective percentages of the Westport Fund: FMC Corp. (3.4%), EOG Resources, Inc. (5.4%), Universal Health Services, Inc., Class B shares (5.2%), International Rectifier Corp. (0.7%), Infineon Technologies AG (0.0%), PetSmart, Inc. (1.3%), Bed, Bath & Beyond, Inc. (0.9%), American Eagle Outfitters, Inc. (0.0%), McCormick & Company, Inc. (0.0%).
