Third Quarter 2008
The market environment during the third quarter was characterized by uncertainty, volatility, and government intervention. Some investors were seeking safety at any cost, and others appeared to be looking to call a bottom on the back of government intervention. Company fundamentals were largely ignored in favor of broader macroeconomic calls during the quarter, and Systematic's bottom-up focus on company specifics was not rewarded.
The recent market environment can be illustrated through an examination of the performance of two factors: earnings estimate revisions and price-to-book value. Investors shunned those companies with the best earnings estimate revisions, while rewarding those with the lowest price-to-book ratios. In many cases, the companies with the lowest price-to-book ratios were the most distressed, and some were on the verge of bankruptcy. However, they were precisely the companies most likely to benefit from a government bailout. Furthermore, as investors grappled with the thought of a looming recession, they seemed unwilling to believe that companies with improving earnings estimates would be able to sustain those estimates in a slowing economy.
Disappointing absolute returns were widespread during the quarter, as seven of ten economic sectors within the Russell 1000 Value Index depreciated. Financials, consumer staples, and health care were the only three to appreciate. Financials rebounded after a very difficult first two quarters, and the other two sectors have historically performed well in difficult markets. The Fund also struggled; its disappointing absolute returns are most attributable to the energy, industrials, and materials sectors.
The majority of underperformance for the quarter came from stock selection in the industrials and materials sectors, as investors priced in a global slowdown, if not a recession. Within industrials, Walter Industries (-56.3%) and Genco Shipping & Trading Ltd. (-41.4%) were the worst performers. Freeport-McMoran Copper & Gold (-33.0%) and Mosaic Co. (-51.3%) struggled during the quarter, after being two of the best performers in the materials sector through June.
On the positive side, stock selection was strongest within financials and partly offset the abovementioned detractors. BB&T (+80.3%) had a good quarter due to its conservative underwriting standards, and it appears positioned to gain market share in a challenging environment. JPMorgan Chase (+37.6%) also appreciated last quarter and should benefit from acquiring Bear Stearns and Washington Mutual. The fund has also benefited by avoiding many of the worst-performing finance stocks that were Index constituents.
The outlook for the equity markets is unclear, since home prices continue to decline, credit conditions have worsened materially, and unemployment has increased. On the bright side, commodity prices have eased substantially, and inflation readings are likely to recede significantly in the months ahead. However, the amount and effectiveness of government intervention remain the wildcard moving forward.
At times of extreme volatility, it is often tempting to abandon time-tested strategies due to the pull of fear and greed. However, experience teaches that it is exactly these times it is most important to follow one's discipline and not let emotion take over. Sticking to its discipline is precisely what Systematic is doing and will continue to do going forward.
This commentary reflects the viewpoints of the portfolio manager, Systematic Financial Management, as of 10/08/08.
Disclosure
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The performance shown represents past performance and is not a guarantee of future results. Current performance may be lower or higher than the performance data quoted. The investment return and the 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. From time to time the advisor has waived fees or reimbursed expenses, which may have resulted in higher returns. The listed returns and yields on the Fund are net of expenses and the returns and yields on the indices exclude expenses. Current performance of the Fund may be lower or higher than the performance quoted.
The Fund invests in value stocks, which may perform differently from the market as a whole and may be undervalued by the market for a long period of time. Value stocks may underperform growth stocks during given periods.
Any sectors, industries, or securities discussed should not be perceived as investment recommendations. The views expressed represent the opinions of Managers Investment Group and are not intended as a forecast or guarantee of future results. Any securities discussed may no longer be held in an account’s portfolio. It should not be assumed that any of the securities transactions discussed were or will prove to be profitable, or that the investment recommendations we make in the future will be profitable.
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