Market Commentary
The S&P 500 Index finished the quarter with a total return of 1.35%, after enduring the worst ever first two weeks of the year and hitting a 22-month low by February 11th. The Dow Jones Industrial Average beat it rising 2.20% and the Nasdaq Composite declined 2.39% on a total return basis for the quarter. Eight of the ten sectors in the S&P 500 posted positive returns during the period. Telecommunications and Utilities were the biggest outperformers with returns of 16.61% and 15.56%, respectively. Mid-cap stocks outperformed large-cap stocks, which beat small-cap names. Specifically, the Russell MidCap Index’s 2.23% gain surpassed the returns of both the Russell 1000 Index and the small-cap Russell 2000 Index which posted 1.17% and -1.53%, respectively for the quarter. Value stocks beat their growth counterparts, as the Russell 1000 Value Index rose 1.64% compared to the 0.74% return of the Russell 1000 Growth Index over the same period. The US Dollar Index declined 4.10%, Oil increased 3.51%, while Gold had its best quarter since 3Q86 rising 16.5% during the quarter.
The stock market began the year with the largest decline ever in the first two weeks of the new year, sparked by fears of a China slowdown, worries about the impact of anticipated Fed rate increases and concerns that oil price declines signified a weakening global economy. This trend continued with the S&P 500 hitting a 22-month low by February 11th but the market subsequently rebounded despite continued geopolitical conflict. In January, North Korea conducted its fourth nuclear detonation followed by two ballistic missile launches in March. In response, the U.N. Security Council implemented new sanctions on North Korea. The Zika virus was declared a public health emergency in February as Zika was linked to the increased cases of Microcephaly in Brazil. Europe was hit with another terrorist attack in Belgium which claimed 32 victims sparking renewed fear of security risks that the migrant crisis poses. In March, an agreement between the EU and Turkey came into effect in an effort to help tackle the migrant crisis. The United Nations criticized the plan. Japan surprised markets by adopting negative interest rates in January. This was followed by the ECB cutting interest rates further and expanding its asset-purchase program to $88B a month in a bid to boot inflation. Finally, the Fed left rates unchanged adopting a wait-and-see approach to further hikes.
The result of the market version of the Disney attraction Mr. Toad’s Wild Ride was that the S&P ended the quarter about where it began, although that masked widely divergent results, with low volatility, bond proxies doing very well, and economically sensitive, higher volatility names doing much worse.
Strategy Highlights
During the first quarter of 2016, Opportunity Equity returned -11.26% (net of fees).1 In comparison, the strategy’s unmanaged benchmark, the S&P 500 Index, returned 1.35%.
Using a three-factor performance attribution model, security selection, interaction effects and allocation effects contributed to the portfolio’s underperformance. Quotient Technology Inc. (QUOT), Intrexon Corp. (XON), Groupon Inc. (GRPN), Apple C95 1/18 and KB Home (KBH) were the largest contributors to performance, while AMZN C300 1/17, Valeant Pharmaceuticals International Inc. (VRX), Pandora Media (P), Platform Specialty Products Corp. (PAH), and Amazon.com Inc. (AMZN) were the largest detractors.
Relative to the index, Opportunity Equity was overweight the Financials, Consumer Discretionary, Industrials, Information Technology and Materials sectors on average during the quarter. With zero allocation to Utilities, Consumer Staples, Telecommunications, and Utilities the strategy was dramatically underweight these groups and more moderately underweight the Health Care sectors. In terms of sector allocation, the underweight position in the Health Care sector, which underperformed the index, contributed the most to the strategy’s relative performance. On the other hand, the underweight in Consumer Staples, which outperformed the index, detracted the most from relative performance.
The strategy initiated three positions and eliminated fourteen during the quarter, ending the quarter with 48 holdings where the top 10 represented 49.56% of total assets compared to 17.77% for the index, highlighting Opportunity Equity's meaningful active share of around 104%.2
Top Contributors
- Quotient Technology Inc. rebounded in the first quarter ending the quarter up 55.23%. QUOT beat fourth quarter estimates on paperless transaction growth. Fourth quarter results beat estimates with revenue of $69.4M versus the Street estimates of $59.8M. Transactions were up 25% year over year with digital paperless up 58% year over year. During the fourth quarter, the company bought back 2.1M shares and authorized a new $50M buyback program.
- Intrexon Corp increased 11.74% over the quarter, supported by the WHO’s announcement that Intrexon’s technology to fight Zika virus is worth a try. In addition, the FDA released a preliminary report that found no reasons to block the field trial of Intrexon’s mosquitoes. XON is still awaiting the final decision, which could take some time. Fourth quarter results were in line with consensus, with revenues of $41.5M versus the Street consensus of $42M.
- Groupon Inc. sharply recovered over the quarter increasing 30.07% during the period supported by strong fourth quarter results with outperformance on both top and bottom line. During the fourth quarter, Alibaba disclosed a minority stake in Groupon of 5.6%. This was followed by the announcement of a $250M investment from Atairos, an independent private investment company. The investment is accompanied by a working relationship with Comcast Corporation to identify strategic partnership opportunities. In addition, Michael Angelakis, Chairman and CEO of Atairos, joined Groupon’s Board of Directors. Groupon also announced the approval of a $200M share repurchase program.
Top Detractors
- AMZN C300 1/17 declined from its high at the end of the fourth quarter, to end the first quarter of 2016 down 23.43%. Amazon was down after the release of fourth quarter results which showed in-line revenues but a miss on margin (4.9% versus consensus of 5.1%). Annual results showed World-wide Prime membership growing 51% year over year in 2015. Over the quarter, Air Transport Services Group announced an agreement with Amazon to operate an air cargo network in the US. Prime Free Same-Day delivery was expanded to 11 new metro areas.
- Valeant Pharmaceuticals International Inc. continued to decline ending the period down 74.26%. Problems continued to negatively impact Valeant’s performance as an undisclosed SEC probe came to light. This was followed by a fourth quarter miss on EPS and a lower 2016 guidance. This new guidance created default concerns due to covenant requirements. By the end of the quarter, Valeant announced that it is searching for a new CEO and that Bill Ackman will join the board. No new issues were discovered by the Ad Hoc committee in relation to Philidor.
- Pandora Media Inc. had a volatile quarter ending the period down 33.21%. Fourth quarter results were roughly in-line but 2016 guidance was changed to an EBITDA loss of $80-$60M as a result of $120M investment in the product development of a subscription on-demand service. Over the quarter, Pandora announced that the current CEO, Brian McAndrews, would be replaced by founder, Tim Westergren, effective immediately.
Read Samantha McLemore's 1Q 2016 Letter to Investors.
1For important additional information on Opportunity Equity strategy performance, please click on the Opportunity Equity GIPS Composite Disclosure. This additional information applies to such performance for all time periods. Past performance is no guarantee of future results.
2Active share represents the share of strategy holdings that differs from the benchmark index holdings. The greater the difference between the asset composition of the strategy and its benchmark, the greater the active share.
Contact LMM to obtain information on how Top Contributors and Top Detractors were determined and/or to obtain a list showing every holding’s contribution to Strategy performance.
Investment Risks: All investments are subject to risk, including possible loss of principal.
The views expressed in this report reflect those of the LMM LLC (LMM) strategy’s portfolio manager(s) as of the date of the report. Any views are subject to change at any time based on market or other conditions, and LMM disclaims any responsibility to update such views. The information presented should not be considered a recommendation to purchase or sell any security and should not be relied upon as investment advice. It should not be assumed that any purchase or sale decisions will be profitable or will equal the performance of any security mentioned. Past performance is no guarantee of future results.
©2016 LMM LLC. LMM LLC is owned by Bill Miller and Legg Mason, Inc.
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