December 31, 2007
For the year, the Croft Value Fund returned 19.01 percent versus 5.48 percent for the S&P 500 benchmark. The fund outperformed the S&P 500 by more than 13 percent in 2007, marking the 5th consecutive year and 7th out-of-the-last 8 years it has beat the benchmark. The Croft Value Fund returned 17.8 percent in 2006 and has a 3-year annualized return of 15.84 percent and 5-year annualized return of 18.85 percent. Since inception, the fund has an annualized return of 11.23 percent. (Please see Performance Section for Annualized Comparisons)
Market Environment
We witnessed tremendous volatility in equity prices in the past year. Most broad-based indices surpassed record price levels during the year then fell on various concerns in the credit market. There were many factors that affected the market such as rising oil prices and continued global growth, but much of the significant swings throughout the year can be linked to the following two events:
1. On the downside, increased concern about the sub-prime mortgage market starting in late July and August that caused a credit crisis well beyond the housing industry. Increasing foreclosures exposed weakness in a wide range of mortgage-backed securities and shook confidence in the overall economy.
2. On the upside, an abbreviated rally came after the Federal Reserve's half point cut in interest rates to 4.75% on Sept 18 and further quarter point cuts on October 31 and December 11 can be credited for at least a part the year's strong finish. The change in the rate was big news because the Fed held it steady at 5.25 percent the previous nine times it had met. Whether or not these moves will signal sustained good times is still in question.
Performance Contributors
On a sector level, the fund was helped most by solid stock selection within its industrial, agriculture, and energy holdings. The portfolio also benefited from several names with exposure to international markets.
- Rising oil prices drove performance for several of the portfolio's energy holdings. Petrobank Energy & Resources is an explorer and producer of oil and natural gas properties in Columbia and Canada and is the portfolio's largest holding. It is up 228% for the year. Ultra Petroleum Corporation is a natural gas explorer and producer whose main holdings are in Wyoming. The company's share price is up 50% since the start of the year and it remains one of the top 10 holdings in the fund.
- The portfolio has benefited from our holdings connected to a renewed infrastructure build out. Foster Wheeler Limited's share price has appreciated by 181% over the past 12 months due to increased demand for oil and gas processing infrastructure and it is currently our second largest holding. General Cable Corporation designs and manufactures products such a copper, aluminum, and fiber optic wire and cable products that are integral parts of the ongoing domestic and international electrical infrastructure build out and the company's shares have appreciated by 32% since it joined the portfolio on April 16, 2007.
- The fund has significant holdings designed to take advantage of the increased demand for agricultural products. CF Industries manufactures fertilizer products that are essential for increasing crop yields and demand for their product has resulted in a 329% gain in share price for the year. Deere & Company is a top manufacturer of farm equipment and shares are up 96% since the beginning of the year. Both of these companies are top 10 holdings in the fund.
Performance Detractors
On the negative side, the portfolio was hurt by weak performance of its holdings within financials and the retail sector. Subprime and the credit crunch dragged down the financial sector, and fears over slowing consumer spending had a negative impact on consumer discretionary.
- Within financials, large cap bank holdings Bank of America and Citibank fell by 23% and 47% respectively due to their exposure to the subprime meltdown. Insurance companies also lagged the overall market this year and our holdings in AIG were down 19% on overall industry weakness.
- Consumer spending was negatively impacted by continuing weakness in the housing market and uncertainty in the overall domestic economy. Our holdings in home improvement retailer Lowe's Companies fell by 27% during the year. Similarly, shares of Sears Holdings Corporation were down 21% from the beginning of the year to August 7. We eliminated our position in the company on that date due to our waning confidence in management's ability to execute at an operational level. Shares of another one of our holdings, discount shoe and accessory company Collective Brands Inc., fell by 46% due to consumer spending worries.
Rating
Morningstar Rating
The Croft Value Fund has a 5-star Overall Morningstar Rating. The fund has an overall 5-star rating for the 3- and 5-year periods and is ranked in the top 2 percentile of its Morningstar category.
Lipper Awards
The Croft Value Fund is recognized as a "Lipper Leader" in the "Total Return" category in its "Multi-Cap Value" peer group. This is the highest attainable score meaning it outperforms at least 80% of the 1209 different funds in the peer group in the "Mid-Cap Value" category.
Positioning and Outlook
The nature of the market is that it will always have periods of volatility. Looking ahead into 2008, the environment remains uncertain, especially relating to economic growth, employment, credit and housing. When such market uncertainty exists, experienced stock pickers tend to outperform. As value-oriented investors with a contrarian bent, we are constantly searching for advantageous entry points.
Our faith in the investment process of seeking relative valuation with a contrarian tilt accomplishes two important goals. First, it puts us in a good position to buy quality stocks for 80-cents-on-the-dollar and hold them for 3 to 5 years to allow the market to realize their full value. Second, our approach helps us to find opportunities in any market cycle and the recent volatility should afford us an opportunity to find relative value in some traditional growth industries, such as information technology.
Our focus on long term growth and solid fundamentals gives us the ability to find opportunities in industries such as financials and consumer discretionary that have been taken to the wood shed and beaten up. With this in mind, in 2008 we will be taking a hard look at the financial and housing sectors for opportunities presented by their relative recent underperformance. We will also focus on the depressed US manufacturing stocks that may be down too far due to excessive negative sentiment in the current market environment.
We believe that our philosophy of investing is relatively risk averse. As always, we attempt to reduce portfolio downside through diversification and extensive bottom-up research while avoiding the vagaries of market timing. Currently the Value Fund owns shares of companies across 30 different industries.
Investment Risks
Risks include stock market fluctuations due to economic and business developments.