Waddell & Reed

Portfolio Perspectives


Look to core investing for exposure to opportunities across the valuation spectrum

Story Highlights

  • U.S. economy has been resilient in the face of fiscal uncertainty.
  • Two pillars of growth, domestic housing and energy investment, appear to be aiding economic strength.
  • The Fund’s managers look to exploit multi-year earnings catalysts felt to be underappreciated in the market in companies believed to have strong or strengthening competitive advantages.
  • Currently finding opportunities with firms in the midst of company-specific change that we believe will drive better-than-expected earnings in the future.
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Investment Team

Manager Name

Erik Becker

Portfolio Manager

Manager Name

Gus Zinn

Portfolio Manager

Over the past 12 months, the equity market posted strong returns led by the financial and consumer discretionary sectors. Despite political and fiscal uncertainty (culminating in the November election and last minute tax agreement), the U.S. consumer continued to be a positive source of economic growth.

Underpinning that strength was an improving housing market, which has had positive ramifications for employment, confidence, spending and the balance sheets of many major banks. The strength of the U.S. consumer provided an offset to stagnant growth in Europe and slowing emerging market growth, particularly in China. The Ivy Core Equity Fund portfolio management team of Erik Becker and Gus Zinn share their thoughts about 2012, the current market environment and outlook for the Fund.

For most of 2012, we took a relatively cautious approach by emphasizing companies that had specific catalysts that we felt would help them perform well in a slow-growth economic environment. We honed in on companies with internal catalysts such as management change, accretive acquisitions, accelerated capital return (buybacks and dividends) and underappreciated revenue streams. Concerned about sovereign credit risk in Europe and slowing growth in China, we became more cautious in late 2011 on companies with cyclical revenue streams. And we focused on companies more exposed to the domestic economy and less to growth outside the U.S. This approach served the Fund well throughout 2012.

In the first months of 2013, we are more positive on a number of key factors. First, the U.S. economy has been resilient in the face of a high level of fiscal uncertainty. This is largely the result, we believe, of two strong pillars of growth: U.S. housing and energy investment. Both areas look poised to continue to be additive to growth in 2013. Second, credit conditions in Europe appear to have dramatically improved since the summer when the European Central Bank essentially pledged unconditional support to ailing members. Economic growth continues to be weak, but it appears to us that inventories have adjusted and growth will no longer surprise to the downside. And finally, growth led in China appears at an inflection after policymakers intentionally slowed pockets of the economy that were overheating. Central banks around the world, whether in Japan, Brazil, Europe, or the U.S., have collectively engaged in hundreds of accommodative policy actions aimed at re-accelerating economic activity.

Seeking opportunity across the spectrum

We generally seek to invest at least 80% of Fund assets in equity securities, primarily common stocks of large companies that we believe have dominant market positions. Key to our strategy is our capability to invest across the market capitalization spectrum, offering us the potential to use our best ideas to impact performance. There are four key tenants of the Fund’s investment philosophy that have remained the same over the past several years.

First, we look to exploit multi-year earnings catalysts that we feel are underappreciated by the market in companies that are believed to have strong or strengthening competitive advantages. Second, we diversify these earnings catalysts across both company-specific and thematic ideas.

Third, we take a very flexible approach to the management of the Fund. We invest across the valuation spectrum as the name “core” would imply. We’re looking for the best ideas and we invest across a very wide spectrum from a market-cap standpoint. Fourth, we invest with conviction. This means having 40 to 50 stocks in the portfolio at any given point in time as opposed to owning anywhere from 80 to 100 names and looking like the index.

When we look to generate ideas, we are research analysts at our “core.” We draw strength from the large number of industries we covered while we were research analysts. Between the two of us, we have covered transportation, auto/auto parts, technology hardware and software, machinery, aerospace/defense, multi-industrials, electronics manufacturing services, retail/apparel and gaming/lodging. In addition, we rely heavily on our firm’s staff of highly experienced analysts, who conduct ongoing research into a range of companies and industries. They are talking to customers, competitors and suppliers as they gain a complete understanding of the companies they follow. We also spend a great deal of time with the management teams of the companies where we have interest. This helps us understand how each company operates and its plans for the future.

Examining investment philosophy

The Fund’s investment process is driven by the belief that changes in expectations for long-term earnings power drive stock prices. The goal is to have a relatively concentrated portfolio of companies expected to produce long-term earnings growth above expectations. We believe that focusing on companies with such advantages increases the likelihood that an earnings catalyst is likely to materialize and helps to manage downside risk. The portfolio is balanced between bottom-up, company-specific earnings catalysts and top-down thematic catalysts.

When it comes to company-specific catalysts, we take a hard look at what is driving each company. Is it a push toward new products? Is the company looking to completely change cost structures? Does it have a new management team that is reorganizing processes and people? Is it changing the way it utilizes capital? We feel it is important to understand every aspect of a company’s business and how it operates today as well as its plans for tomorrow.

On the thematic side, we look at major macroeconomic and political forces, cyclical inflections, changes in consumer behavior and technology shifts. Currently we are emphasizing three major themes in the Fund: global consumer brands, North American manufacturing renaissance and the mobile Internet.

Highlighting stock selection

One of the company-specific holdings we’d like to highlight is CBS Corp., a mass media company that creates and distributes industry-leading content across a variety of platforms to audiences around the world. We find this stock appealing for the following reasons:

  • Premium TV content is currently enjoying multiple levers of growth.
  • Retransmission fees for CBS are anticipated to grow from $300 million to $1 billion over the next five years, driving growth because of 100% incremental margins.
  • New platforms like Netflix and Amazon are presenting new opportunities to monetize off-air library content.
  • Increasing pay TV penetration globally is leading to an increased demand for premier content, which presents the network with more avenues for distribution.
  • Capital returns are increasing as management has returned a majority of cash back to shareholders in the form of dividends and share buybacks. Non-core assets for the network like CBS Outdoor, one of the world’s leading outdoor media companies, and an increasing cash balance have the potential to create a strong balance sheet.
  • We think CBS can grow free cash flow/share in the high teens from $3.20 per share to $4.50 per share levels by 2015.

One of the Fund’s theme catalysts is global consumer brands. We believe that this theme provides the Fund with significant long-term investment opportunity as companies levered to the worldwide adoption of premier global brands offer the rare combination of dominant established brands with sustainable runways for long-term growth. Examples of stocks within this theme include: Anheuser-Busch Inbev, Polo Ralph Lauren Corp., and Mead Johnson Nutrition Company.

Outlook

Despite feeling better about future economic growth, the current investment landscape favors uncovering companies that are not getting due credit for secular change, be it more efficient capital use, new revenue streams, merger and acquisition catalysts or cost restructuring. While it is our goal to remain balanced between companies with thematic versus company-specific catalysts, we are currently finding more opportunities with firms in the midst of company-specific change that we believe will driver better-than-expected earnings in the future. As always, we will continue to persistently look for profitable investment opportunities for the Fund’s shareholders.

Percent of net investments as of 12/31/2012: CBS Corp. 3.6%, Anheuser-Busch Inbev 3.0%, Polo Ralph Lauren Corp. 1.6% and Mead Johnson Nutrition Company 2.4%.


Past performance is not a guarantee of future results. The opinions expressed are those of the Fund manager and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through Feb. 25, 2013, 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. Because the Fund is generally invested in a small number of stocks, the performance of any one security held by the Fund will have a greater impact than if the Fund were invested in a larger number of securities. Although larger companies tend to be less volatile than companies with smaller market capitalizations, returns on investments in securities of large capitalization companies could trail the returns on investments in securities of smaller companies. An investment in the Fund is not a bank deposit and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. These and other risks are more fully described in the Fund’s prospectus. Not all funds or fund classes may be offered at all broker/dealers.

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 any of the Waddell & Reed Advisors Funds, call your financial advisor or visit www.waddell.com. Please read the prospectus or summary prospectus carefully before investing.

 

 

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