Thomas White American Opportunities Fund
The Thomas White American Opportunities Fund primarily invests in equity securities of mid-size U.S. companies. The Fund may also invest in equity securities of smaller and larger size U.S. companies.
Fund Manager Commentary
June 30, 2010
After the sustained uptrend over the previous four quarters, U.S. domestic equity prices corrected during the second quarter of 2010. Volatility returned to equity markets as weaker than expected economic data led to fears about the durability of the recovery. Also weighing down domestic equities were restrictive regulatory proposals for the financial services and energy industries, in addition to weak sentiment across the broader global markets due to concerns about rising public debt. Nevertheless, the equity price recovery near the end of the second quarter indicates that most of the fears have subsided and investor sentiment has improved.
The Thomas White American Opportunities Fund returned -9.09% for the quarter ended June 30, 2010, outperforming the benchmark Russell Midcap Index, which returned -9.87%. The Fund returned +18.73%, -9.56%, -1.44% and +4.43% for the trailing one-, three-, five- and ten-year periods, respectively, while the benchmark returned 25.13%, -8.19%, +1.22% and +4.24% for the same periods. Since inception, the Fund has annualized +4.90% versus +6.10% for the benchmark.
Economic data reported during the review period have been less than encouraging. However, it should be noted that the U.S. economy continues to recover faster than any of the developed economies in Europe as well as Japan. Economic activity has shown sustained improvement for more than a year since spring 2009, though private demand has not recovered as quickly as expected. Most forecasters, including most recently the IMF, expect the domestic economy to expand by around 3% this year, which is not significantly below the long term average. There is nothing unusual about the uneven nature of current economic trends, as historically most recoveries have followed this pattern. Even the slower than expected recovery in the labor market should be viewed against the dramatic escalation in job losses during the recession. It is only to be expected that, after a deep recession, employers will be more guarded in new hiring, and thus, unemployment will likely remain high for a while. This will inevitably have a calming effect on consumer spending as income levels will remain unchanged, as is currently the case.
Portfolio Review
The Thomas White American Opportunities Fund is designed to outperform the benchmark during declining markets, such as those seen during the second quarter of 2010. As of the end of the review period, the Fund led the benchmark by 19 basis points in annualized returns over the 10-year period, but lagged the benchmark for other periods. Portfolio turnover was low during the quarter, as we believe the Fund is now well-positioned in terms of sector diversification.
During the second quarter, auto dealer AutoNation, Inc. (+7.9%) and auto component manufacturer Wabco Holdings, Inc. (+5.2%) added value as vehicle sales continued to rebound. Toys and games manufacturer Hasbro, Inc. (+7.4%) outperformed on reported buyout interest from private equity groups. The strong revenue outlook in select overseas markets lifted restaurant operator Yum! Brands, Inc. (+1.9%), while off-price and heavy discount retailers such as BJ’s Wholesale Club, Inc. (+0.1%) and Ross Stores, Inc. (-0.3%) benefitted as consumers downshifted to value retailers in recent quarters. Healthcare REITs Nationwide Health Properties, Inc. (+1.8%) and Ventas, Inc. (-1.1%), commercial property REIT Realty Income Corp (-1.2%), as well as irrigation and landscaping equipment manufacturer The Toro Company (-0.1%) also returned more than the portfolio mean during the quarter.
Not surprisingly, several of the underperformers in the Fund’s portfolio during the quarter were stocks that are exposed to discretionary consumer spending. They included ocean cruise line operator Royal Caribbean Cruises Ltd. (-31.0%), animation movies producer DreamWorks Animation (-27.5%), furniture and home appliance rental services provider Aaron’s, Inc. (-23.2%), and manufacturer of recreation vehicles Thor Industries, Inc. (-21.4%). Plains Exploration & Production Co. (-31.3%), which has energy assets in the Gulf of Mexico, lost value on market fears about production restrictions after the recent oil rig accident in the region. Aerospace and defense contractor Alliant Techsystems, Inc. (-23.7%) was affected by the government decision to abandon a major space program, while defense products and services provider L-3 Communications Holdings, Inc. (-22.7%) declined after losing a contract. Business communication services provider Level 3 Communications Inc. (-32.7%), industrial services company Harsco Corp. (-26.4%), as well as electronic storage devices maker Western Digital Corp. (-22.6%) also lost value during the quarter.
Outlook
We believe that apprehensions about a double-dip recession are likely exaggerated. While select economic indicators have slowed in recent months, in our opinion, several other factors remain supportive of continued economic expansion. It is worth mentioning that the moderation in demand growth in important sectors is mostly because the uplifting effect of stimulus measures has eased. However, unlike several developed countries in Europe, the U.S. administration remains convinced that fiscal tightening at this point will hurt the recovery. Though the policy options are limited because of the high fiscal deficit, it is likely that the government will be inclined to sustain higher public spending.
Consumer price inflation has been weak over the last year, despite the robust recovery, and is forecasted to remain subdued. This will allow the Federal Reserve to maintain low interest rates for a longer period. Even if the Fed starts tightening its monetary policy later this year or early next year, interest rates will still be significantly lower than the long term average. Besides, the increased demand for U.S. securities due to global financial uncertainties has kept yields very low. As a result, long term mortgages and corporate debt are very attractively priced. The larger banks have started easing lending standards for better rated borrowers, while a recent Fed survey indicates that loan conditions for small businesses are not getting any tighter.
Most sectors are now enjoying strong earnings expansion, though top line growth is relatively subdued in select sectors. Despite the recent dollar appreciation, global demand for American goods has not declined, as evidenced by the positive export growth in May. Further, the sustained growth in imports this year suggests that domestic demand continues to revive. The proposed regulatory restrictions for the banking, financial services, and energy sectors will likely lead to a more subdued earnings outlook for those sectors. However, in our opinion, the effect of the proposed restrictions is unlikely to be as severe as feared. Also, the earnings drag from the proposed regulations has mostly been factored into the current valuations for these sectors.
Finally, as the earnings recovery has been impressive in recent quarters, the cash available at American firms is now the highest in several decades. While part of the cash surpluses will be returned to shareholders through stock repurchases, businesses are in a better position to finance capacity expansions without further equity dilution. In our opinion, the high cash levels may also lead to increased mergers and acquisitions in the future.
Thank you for staying invested in the Thomas White American Opportunities Fund. We are confident that equities will deliver superior long term returns and we remain committed to helping you achieve your investment goals.
Thomas White Emerging Markets Fund (Ticker: TWEMX) Launched June 28, 2010: We at Thomas White are pleased to announce the addition of the Thomas White Emerging Markets Fund to the Thomas White Funds Family. The Emerging Markets Fund will invest primarily in securities of companies located in or whose businesses are closely associated with the world’s emerging markets countries. The new fund will offer investors an opportunity to gain increased exposure to equity assets in some of the fastest growing economies in the world. As global economic power shifts to the large emerging economies, we believe firms in these markets are likely to enjoy better growth opportunities in the future.
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