Market Commentary as of 9/30/08
All Hands on Deck!
September 2008 marked the most significant government intervention in the capital markets and the economy since the Great Depression, as entities across the globe moved to address the ongoing credit crisis. We are hopeful that the effort will ultimately lead to improved credit conditions and more favorable equity performance. All US stock indexes posted sharp declines during September, regardless of market capitalization or style, though small-cap stocks continued to fare significantly better than did mid- and large-caps. Indeed, for the quarter, the Fund posted a small, positive return versus a comparable decline in its Russell 2000 Index benchmark.
As we mentioned in our second quarter commentary, we had begun to move away from the Energy sector and into Financials and Consumer Discretionary. These portfolio shifts, which were based on fundamentals and valuations, paid off nicely during the third quarter, as energy stocks dropped sharply (more than 30%) and, surprisingly, Financials was the best performing sector of the Russell 2000 in gaining 17%. In addition, two-thirds of the Fund's outperformance versus the benchmark came from its underweight positions in Materials and Energy, as well as an overweight stake in Consumer Staples.
Strong stock selection in Consumer Discretionary, Healthcare, Energy, and Financials contributed to the balance of the outperformance over the index. Solid execution at Quality Systems, a leading healthcare IT firm that specializes in electronic patient record and physician practice software, continued to boost its shares. For-profit education company Corinthian Colleges gained ground on favorable enrollment trends and an internal solution to issues relating to the financing of student loans. Bank of the Ozarks, a best-in-class regional bank based in Arkansas, continues to perform well having avoided most of the problems in the credit markets.
Sub-par stock selection within the Industrials and Technology sectors detracted from performance. Oil and natural gas services and equipment company Willbros Group declined, despite quarterly revenue and earnings that were above expectations, due to profit taking in the commodity markets and investor concerns regarding the company's need to obtain financing to take on new infrastructure projects. Poultry producer Pilgrim's Pride fell sharply during September on lowered guidance from management due to an incorrect commodity hedge that created a loss and put the company in violation of its bank covenants. Fortunately, the stock was not a full position, as we think the firm's financial stress impairs its ability to recover, causing us to exit the position. THQ experienced an earnings shortfall due to the muted success of what were expected to be hit video games. The poor results are sure to delay the anticipated re-acceleration of revenues and earnings and resulted in lowered guidance. It too was sold from the portfolio, with the assets redeployed into video game-maker Take-Two Interactive—a holding in which we have greater confidence.
Buys and Sells
Other sales during the quarter included ACCO Brands and a basket of technology stocks. The continued deterioration in the office product market, with no relief in sight, led to the sale of ACCO. We eliminated Double Take, Emulex, and TIBCO Software due to deteriorating fundamentals and better relative opportunities. As a result, the portfolio's technology weighting declined measurably.
The fund boosted five stocks to full positions during the quarter, the most notable of which were rent-to-own retailer Aaron Rents, and regional banks Glacier Bancorp and the previously mentioned Bank of the Ozarks. Aaron Rents has a management team that has worked together since the 1980s and the company continues to grow its 16% market share by focusing on customer service, product availability and simple payment terms for credit-constrained consumers. The stock recently corrected amid the weakening consumer environment and lowered guidance on accelerated store growth. We think, however, that the company's flexible balance sheet and operating model provide an opportunity to re-energize profitability as the company resumes growing prudently. Management's industry experience and pioneering customer credit model are components of a competitive advantage that the company uses in tough times to solidify its market position.
Glacier Bancorp employs a unique acquisition strategy that leaves the purchased bank's brand and management team in place while offering the new subsidiary the financial and operating resources of the parent company. The firm has consistently produced robust top and bottom-line growth, and is benefitting from the underlying economic strength of the Rocky Mountain region, through 86 offices located in Montana, Idaho, Utah, Washington and Wyoming.
Buy the Best
The stock market historically has faced periods of sharp, sudden declines and can stay in a downward volatile pattern for a while. Difficult periods such as 1981-1982, 1987-1988, 1990-1991 and 2001- 2003 occurred during our tenure as investment professionals, and the outlook at each time seemed daunting. Our experience during those times, however, forms the core of our investment philosophy, and provides us with the solutions for recovery. One of TAMRO's mantras is to, “Buy the best when they are depressed.” Our research has shown that companies with tenured, stable management and superior financials that have executed well relative to their peers over the long haul have not only survived, but thrived coming out of such down periods.
As we look ahead, across the board industry consolidation seems a likely outcome from the current crisis. This is already evident in the financial sector with Wells Fargo and JPMorgan gobbling up troubled rivals. In an often emotionally driven profession, it is important to stick to one's discipline, be consistent, and tune out the external noise in order to make the best investment decisions possible. Thus, we continue to position the Fund to benefit from an eventual recovery. As indicated by the recent transactions described above, Financials, Consumer Discretionary, and Consumer Staples are now the three largest sectors in the portfolio, with overweight positions relative to the benchmark. The portfolio is underweight Technology, Industrials, and Energy, and holds no Materials stocks.
TAMRO Capital Partners
Alexandria, Virginia
As of September 30, 2008, Quality Systems comprised % of the portfolio's assets, Corinthian Colleges - %, Bank of the Ozarks - %, Willbros Group – %,Take-Two Interactive - %, Aaron Rents - %, and Glacier Bancorp - %.
Note: Small company stocks may be subject to a higher degree of market risk than the securities of more established companies because they tend to be more volatile and less liquid.
The views expressed above are for informational purposes only and is not intended as investment advice. Since the date of the commentary, economic, market conditions and the portfolio manager's views may have changed. Holdings and weightings are subject to change daily. Holdings are provided for informational purposes only and should not be construed as a recommendation to buy or sell the securities mentioned.
Past performance does not guarantee future results. Investment return and principal value of mutual funds will vary with market conditions, so that shares, when redeemed, may be worth more or less than their original cost.