26 Apr 2011 Pzena Investment Management - Q1 2011 Commentary ( Portfolio )
Despite crisis in the Middle East, devastation in Japan and floods in Australia, the equity markets put in an impressive performance in the first quarter of 2011. The Russell 1000 Value Index rose 6.46%, while the S&P 500 Index was up 5.92%. The reason behind this strength was that the underlining fundamentals for recovery remained solid, as economic data continued to improve including the employment data for March. Corporate profitability also remained strong. At the same time, however, inflation concerns did build in the quarter as commodity prices generally stayed strong, with crude oil leading the way. Not surprisingly, energy stocks and, to a lesser extent, basic materials and producer durables were the strongest performers in the benchmark index.

Exxon Mobil’s (integrated petroleum) shares appreciated in the first quarter of 2011, along with the energy sector and the rise in oil price. Exxon Mobil had announced excellent Q4 2010 results in early February, with earnings ahead of consensus expectations, and gave guidance for further share buybacks in Q1 2011 of up to $5 billion. Willis Group (insurance broker) was up as the company reported Q4 2010 results. Operating earnings per share were in line at $0.54 versus the consensus which was at $0.55. The company’s organic fee growth was 4% year over year and was helped by strong international growth. The company also announced a new expense reduction initiative. With the rise in Willis’s stock, we have used the strength to trim our positions some.

Microsoft’s (software) shares were weak this quarter. The market has consistently ignored Microsoft’s strong earnings results, as its detractors worry about perceived threats to Microsoft’s franchise. We believe the growth of smart phones and tablets seems to mostly be additive, and not cannibalistic to traditional PCs, and our view is that much of the skepticism is priced in to the share price.

We remain very positive about the Fund’s holdings, both in terms of the quality of the names we hold as well as its low valuation. Despite its steady rise, the portfolio still trades on an average price-to-normal earnings of only 7.5x and remains at the low end of its historical average and at a sizable discount to the universe median of 12.1x.