Equities: Value stocks rise to top in 4th quarter marked by sluggish overall performance

Value equity strategies emerged as the top performers in a quarter that saw relatively sluggish performance overall, according to Morningstar Inc.'s separate account/collective investment trust database. Six of the top 10 separate account domestic equity strategies for the year ended Dec. 31 were value strategies.

“The overall equity (universe) dropped in performance, I would say, quite significantly compared to the last quarter,” said Andy Kwon, data analyst for Chicago-based Morn-ingstar.

The median return for the fourth quarter was 0.99%, and while that is still in positive territory, it falls behind the median return of 5.82% for all stock portfolios in the third quarter. The Russell 3000 Index returned 0.25% for the quarter. The median return for the year ended Dec. 31 was 15.52%, while the Russell 3000 returned 16.42%.

Value equity strategies had the highest median return of domestic equity strategies in the fourth quarter at 2%, while blend strategies had a median 1.38% and growth, 0.05%.

Small caps were still dominating, accounting for five strategies in the top 10; that was a dip from the quarter previous, when eight of the top 10 strategies for the year ended Sept. 30 were small cap.

Only two of the previous quarter's top 10 strategies — both small-cap value — were present this quarter.

“Naturally you would assume that some of the top 10s may fall slightly down the chain,” Mr. Kwon said. “There were a few that dropped all the way down into the 90s. That was very interesting to see. I can't quite deduce what exactly happened, but it is definitely a big shift.”

One of the two managers that repeated in the top 10 took the top spot. For the year ended Dec. 31, Philadelphia-based Cooke & Bieler LP reported a gross return of 41.04% with its small-cap value strategy. For the year ended Sept. 30, the account came in third. The strategy looks for strong balance sheets as criteria for the 40 to 60 holdings in its concentrated portfolio.

Mehul Trivedi, partner and portfolio manager, said in a telephone interview that the strategy's success in 2012 was particularly broad-based.

“The top half of our holdings outperformed the top half of the Russell 2000 benchmark by 14% while the bottom half outperformed the bottom half of the Russell 2000 by 10%,” Mr. Trivedi said. “The bottom half of our portfolio has consistently outperformed the benchmark since 2008.”

The areas in which the firm particularly succeeded were in consumer discretionary stocks.

“In 2010 and 2011 (while) the market was occupied by the European crisis and the sluggish economy, we found companies with strong balance sheets, and the big-ticket consumer discretionary areas, like auto dealerships, housing, etc.,” Mr. Trivedi said.

Companies included among Cooke & Bieler's investments in the consumer discretionary category were Penske Automotive Group Inc., Stewart Information Services Corp. and Winnebago Industries Inc.

Coming in second was Brandywine Global Investment Management LLC's classic large-cap value strategy, with a one-year gross return of 40.75%.

“It's a fundamental, research-driven, large-cap strategy,” said Patrick Kaser, managing director and portfolio manager for the Philadelphia-based firm. “We're very much driven on original research, a collaborative process and really, as you may guess from the name, classic value metrics.”

The strategy has one of the lowest price-earnings ratios and one of the largest market caps among large-cap value separate accounts, according to Mr. Kaser.

“We look for the best combination within the value universe,” Mr. Kaser said. “The best combination of value, dividends, quality and earnings growth. It's not purely a "buy-the-cheapest-thing strategy.”

Mr. Kaser attributed a large part of the success of the strategy in 2012 to stock picking, particularly in the technology and financial sectors, and also attributed part of the success of the strategy avoiding utilities.

“We had a fairly sizable position in Apple (Inc.) that we sold late in the third quarter in the mid-($)600s. The typical client exited around ($650 per share). We also had a fairly large position in hard disks. Seagate (Technology LLC) was up 95% up, good stock picking there, and also for the fourth quarter, we bought Facebook (Inc.) below ($)20 and we had a 37% return.”

Mr. Kaser said the strategy no longer holds Facebook and has since repurchased Apple at a much lower price.

Coming in third was growth equity firm Mazama Capital Management Inc. and its emerging small-cap growth equity strategy, which returned 38.7% in the year ended Dec. 31.

The strategy, launched in December 2008, invests in stocks with an average weighted market cap of $500 million to $600 million, according to Ronald Sauer, chairman, CEO and chief investment officer of the Portland, Ore.-based firm.

The capitalization range is “a little bit higher than the microcap growth universe but obviously much lower than the standard small cap,” Mr. Sauer said.

“The one-year return obviously excites me you know, (but) the four-year annualized number is also very exciting for the strategy. Since we funded this strategy, it has returned 33.1% annualized,” Mr. Sauer said.

“It's just not a one-year phenomenon, which is even nicer,” he added.

“What excites me about the strategy since I funded it myself four years ago is that it reminds me a lot of managing to the Russell 2000 universe in the '90s. If you go back to the '90s, the Russell 2000 universe had a weighted market cap of about $600 (million) to $650 (million),” Mr. Sauer said.

Mr. Sauer said the success of the strategy has been due to a very diverse set of stocks within the consumer and health-care and technology sectors.

Stocks that have performed particularly well for Mazama in the past year include Chuy's Holdings Inc., eHealth Inc., Gentiva Health Services Inc., Geospace Technologies Corp., Immersion Corp., Shutterstock Inc. and SodaStream International Ltd., according to Mr. Sauer.

Donald Smith & Co. Inc.'s microcap value equity strategy came in fourth, with a one-year gross return of 37.23%.

The New York-based firm's concentrated strategy focuses on stocks at out-of-favor companies selling at discounts to tangible book value that have a positive outlook for earnings potential over the next two to four years.

“A lot of academic studies say that price-to-tangible-book is one of the best ways to price stock,” said Donald Smith, president and chief investment officer.

“Because it is microcap, we have usually around 30 to 40 names. It's pretty concentrated. We believe that (the reason) you don't put in 100 or 200 names (is) because usually the additional ones are not your high-conviction ones,” Mr. Smith said.

The strategy's success came partly as a result of the recovery of housing-related stocks, according to Mr. Smith.

“Our No. 1 performer was M/I Homes (Inc.); it was up like 176% for the year. Kimball (International Inc.) was up about 129%,” Mr. Smith said.

“Another one was Bassett (Furniture Industries Inc.), which was up 83%. Tuesday Morning (Corp.) is a retailer in the midst of a turnaround with new management, and there's some housing-related goods sold there; that was up 81%,” Mr. Smith added.

Transportation stocks also performed particularly well in 2012, according to Mr. Smith. Both Covenant Transport and Republic Airlines Inc. contributed to the success of the strategy with year-end returns of 86% and 65%, respectively.

The fifth-best performer for the year was the small-cap value equity strategy of San Diego-based Brandes Investment Partners LP, which had a one-year gross return of 36.12%.

The value manager also benefited from the housing market recovery. The manager practiced patience; all of the strategy's best-performing stocks in 2012 were bought in previous years, according to Mike Israel, portfolio manager for the small-cap value equity strategy.

“Homebuilders, for example, were poor performers in previous years. (They) started to perform really strongly in the end of 2011, an example of where we were thinking in the market and were rewarded for our patience,” Mr. Israel said.

“Some machinery companies that are more tied to household appliances, buildings products companies that are in businesses like sheetrock and drywall” are other examples, Mr. Israel said. “As the sentiment changed in the U.S. housing market, we saw great price appreciation in some of those.”

Some stocks that performed particularly well in these areas were Briggs & Stratton Corp., PulteGroup Inc., M.D.C. Holdings Inc. and USG Corp.

For the five years ended Dec. 31, 12th Street Asset Management Co. LLC again took the top two spots.

The Chicago-based manager's small-cap value strategy was No. 1 for the seventh straight quarter, with an annualized five-year gross return of 27.38% as of Dec. 31, followed by its Asset Opportunity portfolio at 21.54%.

Both portfolios primarily invest in environmental services, retail and transportation companies.

The median return for all separate account strategies in the Morningstar universe was an annualized 3.09% for the five years ended Dec. 31, while the Russell 3000 returned an annualized 2.05% during the same time period.

Among collective trusts, real estate strategies held the top two spots for the year ended Dec.31, while midcap equity strategies rounded out the top five.

Principal Global Investors' Global Property Securities led the way with a one-year gross return of 31.59% as of Dec. 31, followed by Real Estate Management Services Group LLC's real estate value opportunity strategy at 31.48%.

The rest of the top five strategies were Burgundy U.S. Small/Mid Cap Fund at 27.3%; BlackRock Extended Alpha Tilts at 27.17%; and CCI Smid Cap Growth Equity Fund at 25.24%.

The median one-year return for collective trusts as of Dec. 31 was 16.29%.