Waddell & Reed

Portfolio Perspectives

Staying positive in a volatile market

Story Highlights

  • The past 12 months have been robust for the U.S. equity market.
  • Fiscal stability and continued accommodative monetary policy both in the U.S. and abroad appear to be two factors aiding expansion in valuation levels.
  • 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

Erik Becker, CFA

Co-Portfolio Manager

Gus Zinn, CFA

Co-Portfolio Manager

Although the U.S. economy has grown more slowly in the past few months, we anticipate that the return to spring and summer is bringing about re-growth in the markets and providing a potential upturn in equities. While volatility will always be a factor, it is important to focus on the constructive aspects of the economy and the opportunities they present. The Waddell & Reed Core Investment Fund portfolio management team of Erik Becker and Gus Zinn share their thoughts about the past 12 months, the current market environment and outlook for the Fund.

The past 12 months have been a robust period for the U.S. equity market. Price-to-earnings (P/E ) expansion drove the majority of the market’s return during the period. This expansion in valuation levels can likely be attributable to greater hopes for economic acceleration, a flight from fixed-income investments, a more stable fiscal path in the U.S. and continued accommodative monetary policy domestically and abroad. Three of the four sectors that outperformed the market (consumer discretionary, industrials and financials) were beneficiaries of better optimism on future U.S. and international growth.

For most of 2013, health care also outperformed the market, largely a result of accelerating research and development success within pharmaceuticals and biotechs. Volatility over the past couple of months has indicated a rotation from growth investing to value investing. There has also been recent market outperformance in utilities and defensive sectors.

Keeping an eye on the economy offers benefits

For the past year, there has been a more cyclical tilt in the portfolio. This positioning remains due to our belief that economic data will continue to strengthen while monetary policy will remain accommodative. We continue to find value in companies whose business is more levered to an improving economy than companies that have a more defensive non-cyclical business.

Most of the Fund’s recent outperformance has been driven by stock selection. Key contributors have been Facebook, Inc., Pentair, Inc. and Applied Materials, Inc. Sector weighting versus the benchmark has also produced positive performance with underweight positions in defensive sectors providing the largest of these contributions.

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.

  1. 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.
  2. We diversify these earnings catalysts across both company-specific and thematic ideas.
  3. 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.
  4. 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 talk to customers, competitors and suppliers to 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. We look at such things as:

  • New products
  • Changes or enhancements in cost structures
  • Management team that are reorganizing processes and people
  • New capital allocations

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.

Staying constructive

Our outlook on the U.S. equity market continues to be constructive. We believe that we are still at the early stages of an unwinding of excess optimism in the bond markets. After funneling nearly $1.2 trillion into bond funds between 2008 and the beginning of 2013 (and taking nearly $600 million out of domestic equity funds), we think that investors are grappling with the potential for zero or negative returns in bond funds as interest rates normalize. To us, this means the prospect of significant inflows into equities over the mid- to long-term, and the possibility of higher equity valuations is strong.

Whether the short-term environment favors growth or value stocks, or one style versus another, the Fund’s multi-year investment strategy remains unchanged. The Fund’s goal is to invest in companies ahead of the market’s rising expectations, and to seek companies we believe offer competitive positioning to be industry leaders.

We continue to look to identify two broad sets of catalysts for the companies the Fund owns. Roughly half of the portfolio is expected to see earnings improvement driven by underappreciated macro themes. For example, we believe the adoption of the mobile internet remains a significant global theme that is reshaping most industries. Even though most consumers in developed economies have mobile devices, usage continues to increase. This is a benefit to Fund holdings such as Facebook and Alliance Data Systems Corp., whose sales growth rates are uniquely tied to more consumers moving more everyday tasks to mobile devices.

The other set of catalysts is based on earnings outperformance driven by company-specific actions. The Fund recently added Delphi Automotive PLC, a leading global supplier of technologies for the automotive and commercial vehicle markets. Headquartered in England, Delphi operates major technical centers, manufacturing sites and customer support services in 32 countries, with regional headquarters in Luxembourg, Brazil, China and Troy, Michigan. We think Delphi has a dominant position in providing automakers content to the high-growth areas of fuel economy, infotainment and active safety technologies. It appears that these business initiatives will drive greater than expected revenue growth and margin expansion in the future.

Top 10 holdings as of 03/31/2014: Bank of America Corp. 4.1%; Canadian Pacific Railway Ltd. 3.9%; Applied Materials, Inc. 3.7%; American International Group, Inc. 3.3%; Pentair, Inc. 3.2%; MasterCard, Inc. 3.2%; Citigroup, Inc. 3.1%; Anheuser-Busch InBev 3.0%; Adobe Systems, Inc. 3.0% and Noble Energy, Inc. 3.0%.

Past performance is no 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 June 2, 2014, and are subject to change due to market conditions or other factors.

Risk 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.


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