Citywire june 2011

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  • Given the ongoing uncertainty in the economy and the markets, we think the stocks of higher quality, more stable companies can hold up relatively well. Across a variety of measures, S&P senior debt ratings, Value Line financial strength ratings, average Return on Equity, and dividend yield, the portfolio compares favorably. The chart shows higher quality stocks vs. lower quality stocks (measured by S&P common stock rankings). The chart shows that lower quality stocks outperformed higher quality stocks during the market rebound that began in March 2009, although higher quality stocks have narrowed the gap more recently. We think maintaining an attractively valued portfolio is important, as well. P/E ratios can be an indicator of sentiment, reflecting how much an investor is willing to pay for a company’s earnings. Lower valuations are associated with lower expectations, which can benefit a portfolio in more challenging equity markets. In our research and valuation work, we are putting extra emphasis on the potential downside associated with each new purchase. This is reflected in the price levels (upside and downside) that we come up with for each idea. Key investment themes for us are rising commodity prices, tight credit conditions, potentially higher interest rates and tax rates, and the possibility of a weakening dollar resulting from the burgeoning debt load of the U.S. government.
  • Citywire june 2011

    1. 1. Investing in U.S. Equities Today—Economic Backdrop, Market Valuation and Expected Returns Ty Nutt Team Leader, Portfolio Manager Delaware U.S. Value Nik Lalvani, CFA Portfolio Manager Delaware U.S. Value June 2011
    2. 2. <ul><li>Investment Approach </li></ul><ul><li>Economic and Market Outlook </li></ul><ul><li>Portfolio Positioning </li></ul>Presentation Outline
    3. 3. Years of experience Role 28 Portfolio Manager, Team Leader D. Tysen Nutt, Jr. 22 Portfolio Manager Anthony A. Lombardi, CFA 19 Portfolio Manager Robert A. Vogel, Jr., CFA 17 Investment Specialist Carl D. Rice, CFA 10 Portfolio Manager Kristen E. Bartholdson 14 Portfolio Manager Nikhil G. Lalvani, CFA Delaware U.S. Value <ul><li>Strategy founded in 1978 </li></ul><ul><li>Only two team leaders since inception </li></ul><ul><li>Process has remained consistent throughout </li></ul>Our History
    4. 4. <ul><li>We believe stock prices are influenced by human emotion and crowd psychology </li></ul><ul><li>We seek to capitalize on discrepancies between estimated intrinsic value and price, buying at times of excessive pessimism and selling at times of undue optimism </li></ul><ul><li>We develop relatively concentrated portfolios that reflect our deep conviction </li></ul>Distinguishing Characteristics <ul><li>Team-based decision-making </li></ul><ul><li>Disciplined multi-factor screening process </li></ul><ul><li>Low turnover, long-term investment horizon (3-5 years) </li></ul><ul><li>Mandated diversification across all 10 economic sectors </li></ul>Delaware U.S. Value Value Philosophy
    5. 5. Investment Process Sell Disciplines Opportunity Universe Screen Preliminary Research Portfolio Construction In-Depth Fundamental Research Delaware U.S. Value
    6. 6. <ul><li>Total credit market debt is still near all-time-high levels as a percent of GDP </li></ul><ul><li>Higher debt levels have been associated with slower economic growth and lower employment growth during the past 60 years </li></ul>
    7. 7. <ul><li>Unemployment, especially long-term unemployment, remains a problem </li></ul><ul><li>Nearly 44% of unemployed individuals have been out of work for six months or longer (approximately 32% have been out of work for one year or longer) </li></ul>
    8. 8. <ul><li>After leveling off from their precipitous decline, home prices have been trending downward over the past three quarters </li></ul>
    9. 9. <ul><li>The correlation between retail gasoline prices and inflation expectations has been reasonably high over the past 20 years </li></ul>
    10. 10. <ul><li>Overall, the broad market (S&P 500 Index) appears overvalued, based on its 5-year normalized P/E ratio </li></ul>
    11. 11. <ul><li>The broad market ranks in the 8 th decile (more expensive) in terms of normalized P/E, for both the 1926-to-date period and the 1957-to-date period </li></ul>
    12. 12. <ul><li>Chart conveys a sense of “unfinished business” with respect to the possibility of establishing a secular low (bottom line of channel) </li></ul>
    13. 13. <ul><li>Leuthold’s quality assessment based on profitability, leverage, and earnings consistency </li></ul><ul><li>Lower quality stocks have outperformed since the market low of March 2009, but have trailed since the market peak in 2007 </li></ul><ul><li>The longer-term trend over the past 20 years has favored higher quality stocks </li></ul>
    14. 14. <ul><li>Within the S&P 500 Index, high quality stocks are more attractively valued than low quality stocks, based on normalized P/E ratio </li></ul>
    15. 15. <ul><li>Earnings growth rates tend to be cyclical; earnings growth peaks have generally been associated with more challenging equity markets during the past 30 years </li></ul>
    16. 16. <ul><li>The broad market also looks overvalued based on dividend yield </li></ul>
    17. 17. <ul><li>Typical of secular bear markets, the DJIA ended the 1965 - 1981 period near its starting level but experienced considerable volatility in between </li></ul><ul><li>While the price low was reached in 1974, the valuation low didn’t occur until 1981 </li></ul>
    18. 18. <ul><li>After a strong rebound from the1974 secular low, stock prices leveled off and became more range-bound </li></ul><ul><li>We think the current environment for stocks could be similar, given the magnitude of the market’s rise and its full valuation </li></ul>
    19. 19. <ul><li>Staying with “Quality” (data as of 5/31/11) </li></ul><ul><ul><li>Investment-grade balance sheets (S&P senior debt ratings) </li></ul></ul><ul><ul><ul><li>BBB- or better for 32 of 33 companies </li></ul></ul></ul><ul><ul><li>Higher dividend yield </li></ul></ul><ul><ul><ul><li>2.72% vs. 2.21% for Russell 1000 Value vs. 1.89% for S&P 500 </li></ul></ul></ul><ul><ul><li>Higher average ROE: 15.5 vs. 13.3 for Value Index </li></ul></ul><ul><li>Insisting on “Cheapness” (data as of 5/31/11) </li></ul><ul><ul><li>Weighted average FY2 P/E ratio of 12.0x vs. 14.5x for Value Index </li></ul></ul><ul><ul><li>13 stocks with forward P/E ratios of 10x or below </li></ul></ul><ul><ul><li>19 stocks with price-to-book ratios below 2.0x </li></ul></ul><ul><li>Focusing on Downside Risk </li></ul><ul><ul><li>Seeking stocks with less potential downside exposure </li></ul></ul><ul><ul><li>Stressing our bear case analysis during fundamental research </li></ul></ul><ul><ul><li>Weighing the trade-off between upside target price and downside risk price </li></ul></ul><ul><li>Seeing the Big Picture </li></ul><ul><li>* Credit Restraint * Higher Interest Rates </li></ul><ul><li>* Commodities * Monetary Debasement </li></ul>Key Themes for Delaware U.S. Value FY2 PE Ratio FY2 PE Ratio
    20. 20. Most Recent Sale National Oilwell Varco (NOV) – April 2011 <ul><li>Initial purchase in October 2009 amid negative sentiment toward energy stocks; earnings expectations for NOV had fallen due to large reduction in active rigs </li></ul><ul><li>Stock performed well over our relatively short holding period </li></ul><ul><ul><li>outperformed sector and benchmark—total return of approximately 90% </li></ul></ul><ul><ul><li>reached upside price target of $80 </li></ul></ul><ul><ul><li>trailing P/E ratio effectively doubled, from 10x to 20x </li></ul></ul><ul><li>Sentiment had improved significantly </li></ul><ul><ul><li>percentage of analysts with buy ratings rose from 60% to 83% </li></ul></ul><ul><ul><li>analysts’ average target price moved from $47 to $92 </li></ul></ul><ul><li>NOV’s risk/reward trade-off no longer looked attractive to us </li></ul><ul><li>Sale reduced portfolio’s target weight in energy to 12% </li></ul>The example above is for illustration purposes. The information should not be considered a recommendation to buy, hold, or sell and should not be relied upon as research or investment advice.
    21. 21. Most Recent Purchase Raytheon Co. (RTN) – April 2011 <ul><li>5 th largest and most broadly diversified U.S. defense contractor </li></ul><ul><ul><li>no program comprises >5% of sales; 20% of 2010 sales were non-U.S. </li></ul></ul><ul><li>RTN under pressure due to concerns about potential cuts in military spending </li></ul><ul><li>Believe current market valuation overly discounts effect of cuts and doesn’t reflect ongoing international growth potential; RTN trading near 10-year lows </li></ul><ul><li>Attractive quality attributes include A- senior debt rating, $3.6 billion in cash, modest net debt position, interest coverage ratio of 23x, 3%+ dividend yield </li></ul><ul><li>Less than 3% exposure to supplemental budget (which funds current wars) </li></ul><ul><li>Tenuous geopolitical climate supportive of ongoing investment in military technology and equipment </li></ul>The example above is for illustration purposes. The information should not be considered a recommendation to buy, hold, or sell and should not be relied upon as research or investment advice.
    22. 22. Performance Performance results presented before the reduction of Delaware Investments advisory fees. Management fees, and any other expenses incurred in the management of the account will reduce your return. After inclusion of management fees, annualized performance for the 1 year, 5 year and since inception periods was 32.36%, 3.21%, and 5.79%, respectively. PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS.
    23. 23. Performance Performance results presented before the reduction of Delaware Investments advisory fees. Management fees, and any other expenses incurred in the management of the account will reduce your return. PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS.
    24. 24. Performance PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS. Source: PSN. Reproduced pursuant to a licensing arrangement with PSN, which permits redistribution of this material. Presented as supplemental performance information consistent with GIPS standards, which can be found at www.cfainstitute.org. Although presented in a manner consistent with applicable requirements, by providing this performance information Delaware Investments is not claiming ownership of the entire performance record. The performance from April 1, 2004 through May 31, 2011 represents the Delaware Investments Large-Cap Value – Focus composite track record. The performance from January 1, 1994 through March 31, 2004 represents the track record generated by certain members of the existing portfolio team while employed by Merrill Lynch Investment Managers.

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