The S&P 500 Index finished the quarter with a total return of 2.46%.The Dow Jones Industrial Average rose 2.07% and the Nasdaq Composite declined 0.22% on a total return basis for the quarter. Eight of the ten sectors in the S&P 500 posted positive returns during the period. Energy and Telecommunications were the biggest outperformers with returns of 11.62% and 7.06%, respectively. Small-cap stocks outperformed mid-cap stocks, which beat large-cap names. Specifically, the Russell 2000 Index’s 3.79% gain surpassed the returns of both the Russell mid-cap Index and the Russell 1000 Index which posted 3.18% and 2.54%, respectively for the quarter. Value stocks beat their growth counterparts, as the Russell 1000 Value Index rose 4.58% compared to the 0.61% return of the Russell 1000 Growth Index over the same period. The US Dollar Index increased 1.65% for the quarter but is still down 2.52% for the year. Oil increased 26.06% and Gold rose 6.76% during the quarter.
The stock market managed to end the quarter up 2.46% despite a wealth of negative noise. The quarter started off with the leaking of the Panama Papers leading to the resignation of Iceland’s Prime Minister. This was followed by Brazil’s Senate voting in favor of an impeachment trial against the then President Dilma Rousseff. In the United States, Donald Trump and Hilary Clinton became the presumptive nominees of their respective parties. Terrorist attacks continued around the world with the mass shooting at a gay nightclub in Miami, the shooting and bombing at Istanbul’s Ataturk Airport, the killing of hostages in Bangladesh and the bombing in central Bagdad. At its June meeting, the Fed decided to leave rates unchanged reiterating a wait-and-see approach to further hikes. During the quarter the ECB began their corporate sector purchase program and conducted their first operation in their targeted longer-term refinancing operations. Finally, at the end of the quarter Britain shocked the world by electing to leave the European Union. This was followed by David Cameron announcing his resignation as Prime Minister while the British Pound Index declined 10.3% between 6/23/16-6/30/16.
During the second quarter of 2016, Opportunity Equity generated a total return of -9.68% (net of fees)1. In comparison, the strategy’s unmanaged benchmark, the S&P 500 Index, returned 2.46%.
Using a three-factor performance attribution model, security selection, interaction effects and allocation effects contributed to the portfolio’s underperformance. Amazon.com C300 1/17s, Pandora Media Inc. (P), Quotient Technology Inc. (QUOT), JPMorgan Chase & Co. Warrants, and PulteGroup Inc. (PHM) were the largest contributors to performance, while Intrexon Corp (XON), United Continental Holdings (UAL), American Airlines Group Inc. (AAL), Delta Air Lines Inc. (DAL), and Endo Pharmaceuticals (ENDP) were the largest detractors.
Relative to the index, Opportunity was overweight the Financials, Consumer Discretionary, Industrials, Information Technology, Health Care 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. In terms of sector allocation, the overweight position in the Health Care sector, which outperformed the index, contributed the most to the portfolio’s relative performance. On the other hand, the underweight in Energy, which outperformed the index, detracted the most from relative performance.
We initiated one position and eliminated six during the quarter, ending the quarter with 43 holdings where the top 10 represented 52.8% of total assets compared to 17.78% for the index, highlighting Opportunity’s meaningful active share of around 110%2.
- AMZN C300 1/17 rebounded from the first quarter surpassing its high at the end of 2015 to finish the quarter up 40.2%. Amazon was up after the release of first quarter results which showed accelerating revenue growth and strong margin expansion. During the quarter Amazon announced Amazon Video Direct which is an open platform for video content creators to upload video content. In addition, Amazon announced the expansion of their private label brands. Amazon provided Q2 revenue guidance of $28-30.5B.
- Pandora Media Inc. recovered in the second quarter ending the period up 39.1%. First quarter results were better than expected with revenue of $297MM vs consensus of $286MM. Management increased 2016 guidance for revenue and EBITDA after decreasing estimates in the first quarter. Advertising RPM was up and active listeners returned to growth. Pandora’s on-demand service is expected to launch by year’s end.
- Quotient Technology Inc. continued to rebound in the second quarter ending the quarter up 26.5%. QUOT beat first quarter estimates on revenue and EBITDA ($66.1MM/$4.4MM vs. $60.7MM/$2.7MM) with digital paperless transactions growing 50% YoY. Retailer IQ has gained some footing growing 47% QoQ. The company bought back an additional 1.7MM shares of stock during the period.
- Intrexon Corp declined 27.4% over the quarter, perpetuated by negative articles from an anonymous blogger on Seeking Alpha. First quarter results were slightly below consensus with revenues of $43.4M versus consensus of $46.3M. The company reported progress in the pipeline with some of the most interesting near-term opportunities including Oxitec (modified mosquitoes used to eradicate Zika), Intrexon Energy Partners (use of bacteria to convert natural gas to isubutonol (gasoline)) and ZioPharm (immune-oncology). In March, Chief Operating Officer Krish Krishnan and SVP Product Development Suma Krishnan departed Intrexon. In May, the company appointed Geno Germano to the new role of President of Intrexon and in June, Samuel Broder, Head of Health Sector, announced his retirement.
- Both United Continental Holdings and American Airlines Group Inc. declined during the quarter ending the period down 31.4% and 30.8%, respectively. Both companies report first quarter EPS beats but disappointing first quarter PRASM, with an 8% YoY decline for American and a 7% YoY decline for United. Both companies provided disappointing PRASM guidance for Q2 which further disappointed the market. American continued its buybacks completing $1.6B in the first quarter while announcing a new $2B buyback program to be completed by the end of 2017. United spent $1.5B on buybacks in the first quarter and reiterated their plan to complete the almost $1B remaining of its $3B share repurchase authorization by the end of 3Q16.
Read Samantha McLemore's 2Q 2016 Commentary.
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) 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.