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Commentary - December 31, 2011
Global uncertainty continued the trend of “risk-on,” “risk-off” in the fourth quarter of 2011. Market anxiety reflected investor concerns regarding the financial crisis, as economies and markets remained reliant on central banks to pump cash into the financial system. But such market-propping measures cannot last forever, and investors agonized that central banks lack the tools to offset the economic drag from years of excess debt accumulated by consumers and governments. This was evident within the European Economic Union. The European Union dominated headlines with its inability to stabilize its balance sheets as the E.U. continued to debate the appropriate amount of budget austerity and debt write-downs. Given the current pace of negotiations, we expect that the European issues will extend well into 2012, continuing to provide a backdrop of uncertainty. The focus of the market on macro issues, such as contagion in the sovereign debt markets, European recession, structural reform in Italy and Spain and U.S. Federal budget deficit, have led investors to view these issues as binary. This binary view of potential outcomes, coupled with the increased use of ETFs and herd mentality on the part of hedge funds has resulted in higher than normal market correlation and volatility. We expect this environment to continue until some form of resolution appears on the horizon. In contrast to Europe, we continue to be cautiously optimistic about the outlook for the U.S. in 2012 for three reasons: (1) Household Debt Service and Financial Obligation Ratio, according to the Federal Reserve, continue to decline from 2007 third quarter peaks; (2) the manufacturing sector expanded for the 28th consecutive month in December, according to a survey conducted by the Institute of Supply Management; and (3) corporate balance sheets are flush with cash. However, the U.S. is not without its risks, primarily the national deficit and housing. Current political gridlock ahead of the election will make it difficult to deal with the budget deficit and national debt, serving to extend the issue into 2013. A continued decline in home values is an additional drag on the U.S.’s economic outlook. A reversal in home prices and sales velocity would serve to stimulate the economy through increased lending and employment. We are positive on the outlook for our stocks based on bottom-up expectations and the three reasons stated above, however, we are still aware of the macro headwinds that continue to plague the markets. The Russell 2000® Growth Index advanced 15.0% in the fourth quarter, but still finished the year in negative territory with a -3.7% return. The best and worst performing sectors in the index were a near reversal of what was experienced in the third quarter, reinforcing the emotional swings of the market. The strongest performing sectors in the fourth quarter included energy (+28%) and industrials (+21%). Third quarter winners proved to be fourth quarter relative losers with consumer staples (+7%) and utilities (+9%) delivering the lowest returns of any sector within the index. Correlations of individual stocks within each sector continued to be high, as pessimism over Europe’s debt issues gave way to optimism that a resolution could be reached. In the fourth quarter, fewer than 30% of small-cap growth managers outperformed the Russell 2000® Growth Index (+15.0%) and the average small-cap growth manager advanced 13.2%. The Roxbury Small-Cap Growth Fund handily outperformed the average small-cap growth manager by generating a 14.4% return, but slightly lagged the index in the quarter. Our overweight position in consumer discretionary detracted from returns as did stock selection in financials and industrials. The portfolio was positively impacted by the strength of stock selection in healthcare and consumer staples. Despite the strong returns generated in the fourth quarter, the Roxbury Small-Cap Growth Fund declined 5.2% for the twelve months ending December 31, 2011 compared to a decline of 3.7% for the Russell 2000® Growth Index. The current environment gives us a great deal of optimism about our goal to generate strong relative returns. In over a decade of managing small-cap portfolios, we have never seen our fund demonstrate the valuations it has in the past quarter. In addition, we are starting to see periods of time when the market is focused on the “bottom-up fundamentals”. This is evident in our analysis of earnings season returns. Roxbury’s Small-Cap Growth Fund has historically outperformed the benchmark during the first month of a quarter, a proxy for the earnings reporting season. Over the longer run, performance in the following two months tends to contain more macro noise as there are fewer bottom-up fundamental events. Over the past two years we outperformed the benchmark in the first month of the quarter, but have suffered negatively from macro noise in the following two months. We are hoping that over the longer-term, those non-reporting months are at worst a neutral, allowing our ongoing insight into bottom-up fundamentals to be better reflected in stock performance. While the market’s attention to company specific fundamentals has recently been fleeting, our performance during the reporting season has given us confidence that the tide will turn. We look for this trend to continue and hopefully for the value of the companies in our portfolio to be recognized by the market. We are “investors” and we will continue to implement our fundamentally based process to identify what we believe are high quality growth companies that are attractively valued. We strongly believe that it is not a matter of if the portfolio gets rewarded, but when the portfolio gets rewarded for the strength of the underlying companies. Small-Cap Fund (RSCIX) Very truly yours, Robert C. Marvin, CFA, CPA Brian P. Smoluch, CFA David G. Swank, CFA, Nick A. Blankl, CFA Performance quoted represents past performance and there is no guarantee of future results. The investment return and principal value will fluctuate so that shares, when redeemed, may be worth more or less than the original cost. Current performance may be higher or lower than the performance data quoted above. Please call 800-497-2960 to obtain current and the most recent month-end performance data. A redemption fee of 1.00% of the total redemption amount (calculated at market value) may be imposed if shares are sold within 60 days of the purchase of such shares. This fee will apply to redemptions processed for the purpose of receiving redemption proceeds or processing an exchange between the Funds. Gross expense ratio: 1.25% The fund invests in small capitalization companies which present a greater risk of loss than investments in large companies and in growth companies which can be more sensitive to the company’s earnings and more volatile than the stock market in general. The fund may also invest in foreign securities which are subject tot risks including currency fluctuations, economic and political change and differing accounting standards. The fund may invest in derivatives and IPO’s, which are highly volatile. Additional risk information may be found in the fund prospectus. |