Market Sector Update
- U.S. equity markets started 2013 on a strong note with the S&P 500 rising 10.6% in the first quarter. The rally was fairly broad based with seven of the 10 major sectors up double-digit percentages.
- Typically defensive areas of the market led the way with health care, utilities and consumer staples as the top performing sectors. The more cyclical areas, which would typically lead in a strong market, lagged with technology and materials, the worst performers.
- Within sectors, there was a consistent rotation into buying last year’s laggards as companies like Best Buy, Avon Products and Hewlett Packard (not holdings for the Fund) were among the top performers in the S&P 500 for the quarter.
- While first quarter outperformance of 2012 laggards is not unprecedented, the defensive sector leadership in a strong up market is unusual. Reasons for this include inflows from global investors looking for stability and dividend yield as an alternative to low yielding fixedincome investments. A second contributing dynamic is continued shareholder activism, which has been targeting underperforming companies with less than optimized balance sheets and excess capital.
Portfolio Strategy*
- This type of equity market environment led to difficult relative performance for the Fund’s strategy and it underperformed the S&P 500 benchmark for the quarter.
- Underperformance was primarily driven by stock selection. The significant rotation to 2012 laggards within consumer staples, financials and technology was the primary factor driving security selection underperformance.
- Performance from the largest holdings was more mixed than usual with Apple Inc. and Capital One Financial Corp. both posting negative absolute returns in the quarter, offset by strong outperformance by CBS Corp. and Kansas City Southern Railway.
- We have continued to increase the cyclical exposures, while reducing some of the more stable areas that had performed well over the past year. While this decision hurt us in the quarter, we still feel confident in this move.
- Currently, the top focus is increasing the weightings of our highest conviction multi-year ideas.
- We are more likely to add to cyclical positions that have recently underperformed, than chase more defensive areas. Industries such as the food group have enjoyed significant year-to-date appreciation, primarily driven by valuation expansion rather than unexpected earnings improvement. This is not something we view as sustainable.
Outlook
- Our outlook for the U.S. equity market remains constructive. While the economic data is at times choppy, the U.S. remains on a path toward sustainable economic growth.
- We consistently look for companies that we believe have both a multi-year outlook for earnings power significantly above current market expectations and a strengthening competitive position within their respective industries.
- Our expertise is not centered on buying stocks because they are takeout candidates or predicting shortterm bounces in stocks that are oversold.
- While relative performance suffers in environments like first quarter 2013, our confidence remains high that staying focused on our strategy will produce multi-year outperformance.
*Apple Inc., Capital One Financial Corp., CBS Corp. and Kansas City Southern Railway (1.9%, 3.0%, 3.2% and 2.2% of net investments at 03/31/13, respectively.)
The opinions expressed in this commentary are those of the Fund's manager and are current through March 31, 2013. The manager’s views are subject to change at any time based on market and other conditions, and no forecasts can be guaranteed. Past performance is no guarantee of future results.
S&P 500 is unmanaged index of common stocks. It is not possible to invest directly in an index.
Risk Factors. As with any mutual fund, the value of the Fund’s shares will change, and you could lose money on your investment. 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 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.