Samuel Dedio // Portfolio Manager // Artio US Smallcap (JSCAX)

Comments & Outlook

Although small-cap stocks underperformed in 2011, the asset class enjoyed a run-up in prices prior to that. In the near term, it will be difficult for small caps to stage a similar rally simply because they performed so well for such a long period of time. However, valuations are starting to look compelling in this arena.

Small-cap stocks perform best in a growing economy, so they suffered as global economic growth slowed in the second half of 2011. But if US economic growth continues to strengthen in 2012, that will bode well for small caps.

Recommended Strategies

Mutual fund investors should invest in funds that are diversified across multiple sectors. That approach can help dampen potential downside volatility. Diversification is also key when selecting individual stocks and pursuing particular investment styles. For example, investors will be best served by selecting a core fund that invests in both growth and value stocks.

What to Buy Now

WSFS Financial (NSDQ: WSFS) is a Delaware-based lender and the seventh-oldest bank in the US. It boasts 47 branches and about $4 billion in assets. The bank’s earnings are starting to recover, asset quality is improving and problem loans are declining. The firm has managed its expense base well and is building its franchise value by taking advantage of dislocations in its local market. Over the past year, two of its main competitors have been acquired. WSFS is now the fourth-largest bank in Delaware by deposits and holds a 15 percent market share. That also makes it a potential takeover target.

Semiconductor producer Skyworks Solutions’ (NSDQ: SWKS) stock was clobbered along with most of its sector during the second half of 2011. The company’s three key markets are the mobile Internet market, which involves smartphones; high-performance analog chips used in industries such as defense and computing; and vertical markets such as wireless utility meters. Global smartphone connections could experience 40 percent compound annual growth through 2014, driven by growth in Asia and Central America. This growth will be a huge driver of demand for semiconductors.

Peter Nielsen // Portfolio Manager // Sextant Core (SCORX)

Comments & Outlook

US markets continue to experience the benefits of safe-haven status because of uncertainty about the European sovereign-debt crisis. But if investors finally receive greater clarity about a potential resolution to this crisis, then it’s “risk on” again for equities.

Gold is often considered a dependable safe-haven investment. But some research suggests that long-term interest rates are inversely correlated to the price of gold. If that’s the case, the yellow metal may have difficulty producing further gains because long-term interest rates are already at low levels.

Fixed-income investments also face the specter of rising inflation. If core inflation rises, it will be difficult for interest rates to remain near historic lows. At some point, there could even be a selloff in Treasuries should core inflation continue its ascent.

While some analysts believe crude oil could be due for a selloff, we’re in an environment of tight oil supply and that bodes well for this commodity. Energy companies are producing massive cash flows and seem to be able to increase those cash flows every year. And when you factor in the increased tension between the US and Iran, you can’t help but be optimistic about oil. Oil will likely have an average price above $100 per barrel this year.

With regard to natural gas, we’re in a boom environment for natural gas drilling even though natural gas prices are depressed. The excess of natural gas supply is evidenced by the fact that storage levels are well above their five-year average. For now, drillers have been able to make the economics of that situation work for them.

Natural gas historically traded at roughly one-fifth the price of oil. But that ratio no longer applies. However, those differentials could have some meaning eventually, and natural gas prices could drift higher. But this is not a bullish call.

Recommended Strategies

Balanced portfolios that feature a mix of stocks and bonds outperformed the market by significant margins over the trailing five- and 10-year periods.

Our portfolio allocates 60 percent to equities and 40 percent to bonds. In times of uncertainty, we have occasionally increased our cash allocation, but we always revert to our fund’s mandate.

Our fund overweights financials by investing in corporate bonds, as opposed to equities. But these are very conservative financials, such as BB&T Corp.

Our bond sleeve is slightly underweight duration, with a lower duration than the Barclays Capital US Aggregate Bond Index. That hurt our performance in 2011 because there was a big rush to safety into US securities. But I don’t believe that strategy will hurt investors over the long term.

What to Buy Now

Express Scripts (NSDQ: ESRX) is a pharmacy benefits manager (PBM). The firm basically runs a mail-order prescription service for insurance companies, which is a cost-effective means of distribution. Express Scripts also distributes drugs through Walgreen Co (NYSE: WAG), but the two firms are currently embroiled in a dispute over payout rates. The PBM is incentivized to focus its distribution efforts on generic drugs because it enjoys higher margins on them.

The company’s business model aligns well with the federal government’s efforts to control costs in the health care system. And that could improve the odds that Express Scripts will overcome the government’s anti-trust concerns with regard to its pending acquisition of Medco Health Solutions (NYSE: MHS), its primary competitor in the PBM space.

Autoliv (NYSE: ALV) is a Sweden-based auto-parts manufacturer that specializes in high-margin safety systems. The firm doesn’t just produce seatbelts and airbags, but also the computer chips that control safety electronics.

Safety systems are emphasized in many car commercials, and are a key selling point for automobile manufacturers. Autoliv owns about 10 percent of the patents in this space, so it dominates the sector. The firm’s key valuation metrics are lower than the overall industry even as its revenue and earnings have grown faster than that of its peers. This makes Autoliv a good play for value investors.

European firms are being priced at a discount to equivalent firms in the US. But Sweden is not on the euro, and Autoliv sells extensively to American auto manufacturers. So my hunch is that their stock is being unfairly punished simply for being a European firm.

Your fund’s prospectus specifies a 15 percent cash allocation. But your cash allocation was roughly 24 percent at the end of November. What goes into a decision to raise cash?

Over the summer, there was an amazing amount of uncertainty in the market. And quite frankly, we didn’t like our exposure to Goldman Sachs via a bond position that we held. I couldn’t make sense of either their balance sheet or their exposure to risk. So we sold that position as well as a few others with which we weren’t comfortable, and that contributed toward our increased cash level.

Additionally, the fund continues to see inflows from 401(K) investors, so that’s further added to our cash holdings. Although I’m not a raving bull as far as the stock market is concerned, my goal is for our fund’s equity sleeve to become fully invested again in 2012.

Your fund has extraordinarily high inside ownership by the fund’s officers and trustees.

At Saturna Capital, our philosophy is that we eat our own cooking. My 401(K) may be modest, but it’s entirely invested in this fund, and I’m quite comfortable with that.