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Matthew Norris, CFA
Portfolio Manager
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Waddell & Reed Advisors Value Fund – August 2011
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There has been little doubt recently that investors are nervous. Up, down, up, down, up, down, it is hard to know where to turn. The reasons for the uncertainty have been obvious: S&P’s downgrade of U.S. long-term debt, fear of losing money, recession anxiety reminiscent of 2008, sovereign debt issues in Europe, gross domestic product growth is stagnant and the list goes on.
But the other issue obvious to astute investors is that now may be just the right time to take advantage of the volatility in an uncertain market and look for good deals. The old adage “buy low, sell high” is never more important than investing with a value strategy in mind. Buying a company’s stock at a price that one feels is below its true market value can be smart.
Everybody wants a good deal
Say you go to a local retailer to purchase a pair of blue jeans. The brand you normally purchase is marked down from $75 to $50. This seems like a good deal, so you buy a pair. A few months later, the same store is having a sale. If you purchase one pair of your favorite jeans for $50, you can get another pair for just a penny. This purchase translates into two pairs of jeans for about $25 each. Both scenarios represent good deals and are perceived as value purchases.
Value funds seek to take advantage of opportunities in a volatile market
Value investors believe that, over time, the market’s tendency to focus on short-term events and performance can drive stock prices to low levels, creating buying opportunities among temporarily undervalued investments. When the Russell 1000 Value Cumulative Return and the Russell 1000 Growth Cumulative Return are compared over time, value investments have provided attractive results when reviewed against their growth counterparts. 1
Mutual funds that use a value strategy work in much the same way as the “good deal jeans example.” These funds search specifically for what managers feel are undervalued companies — financially sound, quality firms with stock prices that have been beaten down due to transitory factors that are unrelated to their fundamental health. Value funds can be used to capitalize on market opportunities and add diversification to a growth-oriented portfolio, though diversification cannot ensure a profit or protect against loss.
Our investment approach
We start with detailed research, looking at one company at a time to find those whose stocks we feel are trading substantially below our estimate of their intrinsic value. It is critical in value investing to clearly understand what companies are worth and their plans for the near- and longer-term future. We seek to purchase quality companies at what we believe to be discounts because of their potential opportunities to regain full value and make money for Fund shareholders. We do not deviate from this approach in response to short-term market events. Instead, we stay the course and look for value over the long term.
Our investment approach is simple. We use both top-down (assess the market environment) and bottom-up (research individual companies) analysis in our selection process. In general, in selecting securities for the Fund, we evaluate market risk, interest rate trends and economic climate. Equities selected must represent value in a combination of relative and absolute measures. We attempt to concentrate the Fund’s equity holdings in companies with leading positions in their respective industries, and that have solid management teams, strong balance sheets and high barriers to competition. Our overall objective is to provide long-term accumulation of capital.
Companies considered for the Fund must:
- Trade at a notable discount – significantly below their intrinsic value by about 30-50 percent as determined by normalized earnings
- Have a catalyst for improving fundamentals (cash flow, earnings and balance sheet)
- Appear poised to deliver sound investment returns
Recent holdings of Waddell & Reed Advisors Value Fund
Given current market conditions, we have found several undervalued yet high-quality, growing companies with great balance sheets and business models. Some of our most recent value purchases have been in the energy, information technology and financial sectors. Most notable among the purchases were:
- RenaissanceRe Holdings Ltd., a provider of reinsurance and insurance coverage and related services. This stock is currently trading around book value with earnings growth of more than 18 percent per year for the past decade. We believe this stock offers an opportunity for us to purchase an “investment seed” at a discount that has the potential to bear fruit over time. 2
- Regency Energy Partners, L.P., a provider of midstream natural gas and natural gas line services. This security is currently offering a dividend of more than 7.5 percent and has a history of raising its dividend every quarter, which we believe translates into an opportunity to gain from the appreciation of the stock, (i.e. hopefully, “buying low and\selling high”) but also adding additional dividend income to shareholders. 3
- Marathon Oil Corporation, a company engaged in exploration and production, oil sands mining and integrated gas. It has a current price/earnings ratio of 6 while compared to the current price/earnings ratio of the market at 13. We feel this translates into an excellent value opportunity for this company.” 4
The Waddell & Reed Advisors Value Fund has historically delivered a strong, long-term performance record. The Fund occasionally experiences short-term volatility, but as long-term investors, we view those volatile periods as opportunities rather than threats. The Fund purchases high-quality companies when their stock price appears below the value we believe is correct for that company. In turn, we sell those same names when they reach what we feel are appropriate valuations. We believe bottom-up, company-by-company analysis will produce solid returns over the long term.
Remember, value investing means “good value,” not cheap companies. We focus on knowing the difference between firms that are temporarily underappreciated or misunderstood and those that will be unable to weather the storm for a comeback.
1Source: Zephyr StyleADVISOR. Russell 1000 Value is an unmanaged index comprised of securities that represent the large cap sector of the stock market. Russell 1000 Growth is an unmanaged index comprised of securities that represent the large cap sector of the stock market. It is not possible to invest directly in an index. Index performance results do not take into account the fees and expenses of the individual investments that are tracked. Results include reinvested dividends. Past performance is no indication of future results.
2As of 8/18/2011: RenaissanceRe Holdings Ltd. represented 2.5 percent of net assets in the Fund.
3As of 8/18/2011: Regency Energy Partners, L.P. represented 3.7 percent of net assets in the Fund.
4As of 8/18/2011: Marathon Oil Corporation represented 2.2 percent of net assets in the Fund.
The opinions expressed are those of the Fund manager and is not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through August 18, 2011, and are subject to change due to market conditions or other factors.
Consider all factors. As with any mutual fund, the value of the Fund’s shares will change, and you could lose money on your investment. The value of a security believed by the Fund’s managers to be undervalued may never reach what is believed to be its full value, or such security may decrease. Not all funds or fund classes may be offered at all broker/dealers. These and other risks are more fully described in the Fund’s prospectus.
Investors should consider the investment objectives, risks, charges and expenses of a fund carefully before investing. For a prospectus, or if available a summary prospectus, containing this and other information for the mutual funds offered by Waddell & Reed, call your financial advisor or visit us online at www.waddell.com. Please read the prospectus or summary prospectus carefully before investing.