Global Small Cap Fund

Global Small Cap Fund Commentary

Fund Commentary - September 30, 2011

The S&P Developed SmallCap Index  fell in the third quarter as a result of the growing Euro crisis and concerns about weaker economic growth around the globe. The Euro crisis was compounded by a mix of sovereign debt concerns, bank funding problems, and a hesitant response by European policy makers. During the quarter, sovereign debt concerns spread from Greece itself to the bond markets of Italy and Spain, prompting the European Central Bank to intervene which helped stabilize those markets. Both Italy and Spain adopted additional fiscal tightening measures. As sovereign spreads rose, banks in the affected countries found their cost of funding rising in tandem, while access to short-term U.S. dollar funding also dried up. In early October, policy makers appeared to show more resolution to address both sovereign concerns, as well as any possible shortfalls in bank capital.

This financial crisis came against the background of growing fears of a renewed global economic downturn. Commodity prices fell sharply as employment data and business survey data came in weaker than expected. However, the economic data remained mixed overall, and it was by no means certain that an actual downturn, as opposed to a growth pause, was the most likely outcome.

During the quarter, the Portfolio Sub-Advisor increased the Fund's exposure in Health Care and Financials, while exposure decreased in Consumer Discretionary and Industrials. Within Health Care, the Portfolio Sub-Advisor added Patterson Companies Inc., a dental products distributor and Vectura Group plc, a developer of respiratory disease therapies. In Financials, the Portfolio Sub-Advisor added to existing positions in Scor SE, Everest Re Group Ltd. and Hiscox Ltd. Within Consumer Discretionary, the Portfolio Sub-Advisor trimmed a position in home builder Persimmon plc. Lastly, within Industrials, staffing services provider Randstad Holding NV was reduced and Owens Corning, a leading building materials producer, and Huntington Ingalls Industries Inc., a military shipbuilder, were sold.

From a sector perspective, Financials and Materials had the strongest positive impact on a relative basis. Strong security selection in Financials was mainly due to Lancashire Holdings Ltd. A contributor during the second quarter as well, Lancashire was one of only a few financial stocks globally to rise in value during the third quarter. Quarterly results beat expectations partly due to limited exposure to the major natural catastrophes of 2011. Within Industrials, the Portfolio Sub-Advisor's underweight, coupled with good stock selection, contributed to relative performance. Outperformance was largely due to the Portfolio Sub-Advisor's position in Anvil Mining Ltd. Anvil is a junior development company that has expanded production and exploration of copper and silver while trading at very low multiples. The company's largest shareholder, Trafigura, initiated a strategic review with an aim to sell its stake. Late in the quarter, Minmetals Resources Ltd. announced a takeover offer at a 39% premium relative to the stock's previous closing price.

Health Care holding Pharmaceutical Product Development Inc. (PPDI), a global contract research organization focused on drug discovery, rose significantly as the company announced they were in the process of completing a strategic review, including the possible sale of the company. The stock appreciated materially on this news, prompting us to sell some of our position into the strength. Mueller Industries Inc., a manufacturer of plumbing, HVAC, refrigeration and industrial products, was a top contributor to the Portfolio. Higher copper prices have supported increased selling prices, leading to solid top-line performance. In addition, financial conglomerate Leucadia National Corp. has been aggressively buying shares of the company. We used the run up in the stock on these events as an opportunity to pare back our position.

Geographically, the strongest relative contributions came from our underweight and strong stock selection in the United States, as well as strong stock selection in Canada. During the third quarter of 2011, detractors were primarily attributed to Industrials, Consumer Discretionary, and Energy. Underperformance within Industrials was largely driven by the Fund's exposure to professional staffing companies. Staffing companies have continued to come under pressure as concerns over a potential recession increases. The Dutch market, which has lagged in recovery relative to other European markets, has particularly impacted the Fund's positions in USG People NV and Randstad. The Portfolio Sub-Advisor believes there is substantial upside in both stocks over the cycle with limited downside from current levels.

Consumer Discretionary underperformance was largely due to positions in Pandora A/S, Kloeckner & Co. SE and Emperor Watch & Jewellery Ltd. Lastly within Consumer Discretionary, Emperor Watch & Jewellery detracted from overall performance. The only Hong Kong listed luxury watch retailer with a sizable jewelry business, Emperor Watch significantly improved margins during the first half of the year due to price hikes and increasing contribution from its higher-margin jewellery segment. The company has increased its overall store count by adding 18 stores this year in China, with plans to add 2 additional stores before the end of the year. The stock sold off late in the third quarter on concerns of a hard landing in China. However, the Portfolio Sub-Advisor has yet to witness any substantial evidence of this effect.

It is the Portfolio Sub-Advisor goal to navigate this marketplace through wise stock selection that exploits company-specific opportunities as opposed to investing in companies that are more heavily dependent on a particular direction of the global economy. The Portfolio Sub-Advisor continues to have an intense focus on strong balance sheets that provide both protection and opportunity. The opportunity for many companies will come from finding ways to grow their earning power now that most management teams have exhausted the benefits available to them through cost cutting. The Portfolio Sub-Advisor believes the Fund should be rewarded very well over time however, for the moment, the environment calls for tightening seat belts, clenching your teeth and bearing the volatility. After risk aversion passes, the Portfolio Sub-Advisor believes equity markets could experience a very strong market rally.