Growth Fund
September 30, 2008
Strategy
The third quarter of 2008 was a challenging one for Evergreen Growth Fund, as stocks were battered in a market hard hit by credit turmoil and recession fears. Throughout the period, we maintained our focus on the disciplines that have served us well through the years, investing in companies with superior growth prospects at reasonable prices. In these turbulent times, we currently remain confident that our strategy is sound and should produce solid returns over the long-term.
For the quarter, Evergreen Growth Fund Class A shares declined by 8.13%, trailing the 6.99% fall in the benchmark Russell 2000 Growth Index. While periods such as this are never pleasant, they do provide great opportunity for long-term investors to accumulate high quality companies at exceptional values.
Contributors to performance
During the quarter, we had strong performance in Financials, an area where the winners and losers were clearly delineated as the credit crisis played out. We emphasized well-capitalized companies that had little to no exposure to the sector’s problem areas. Instead, we focused on companies that we believed had opportunities to gain significant market share from struggling competitors. Standout performers included Stifel Financial Corp., Greenhill & Co., HCC Insurance Holdings Inc. and PrivateBancorp Inc. Stifel, which raised capital during the quarter to grow its business and capitalize on the industry upheaval, was successful in adding retail brokers, investment banking teams, sales and trading professionals and research analysts. Greenhill, a merger & acquisition advisory firm, hired key senior advisors from large investment banks. Strongly capitalized property and casualty insurer HCC Insurance Holdings saw its shares rise as investors saw an opportunity for it to gain share from troubled competitor American International Group (AIG) in several business lines. In the case of PrivateBancorp, the company raised capital to support significant loan growth and positioned itself as a major factor in the Chicago market by hiring away a significant number of commercial bankers from LaSalle after its acquisition by Bank of America Corp.
We also outperformed in Energy as that group pulled back dramatically with the decline in oil and gas prices. We had been skeptical about the large move in energy prices during the first half of the year, and were more focused on services companies with more stable business models as opposed to the exploration companies that had risen the most sharply. This strategy paid off in the third quarter as energy prices retreated dramatically on economic concerns and the unwinding of the speculative commodity trade that had sent stocks soaring in the first half of the year. Other areas of outperformance included Consumer Staples as well as Consumer Discretionary. In Consumer Staples, the standout performer was Longs Drugs Stores Corp., which received a buyout offer from CVS Caremark at a price premium of more than 30%. We sold the stock on the announcement, given the substantial premium offered. We redeployed the proceeds into Flowers Foods Inc. Flowers Foods is one of the largest bakery and snack food companies and has a strong history of earnings growth, high returns and significant cash generation. The company has used this cash for strategic acquisitions and share repurchases and has gained market share in the bread market. We also outperformed in Consumer Discretionary on the strength of holdings such as Marvel Entertainment, Inc., which benefited from the success of the first two films in its self-produced film slate, “Iron Man” and “The Incredible Hulk.”
Elsewhere, in Health Care, genetic analysis provider SEQUENOM, Inc. continued to soar as the company announced encouraging data for its noninvasive prenatal test for Down Syndrome. We took profits and trimmed the position, given its explosive move over the last two quarters. However, we continue to believe the company has a huge opportunity to take market share from the current screening tests, which are more invasive in nature. Also in Health Care, two contract research companies, PAREXEL International Corp. and Icon PLC, were strong performers as they continued to benefit from greater outsourcing of clinical research. In Information Technology, we had contributions from our positions in subscription software firms Concur Technologies, Inc., Blackboard, Inc. and Vocus, Inc.
Detractors from performance
Health Care was our largest detractor during the quarter, despite the very strong performance generated by SEQUENOM, Inc., and the contract research companies. Problem stocks included Cephid and inVentiv Health, Inc. Cephid, which manufactures molecular testing systems for detecting drug resistant organisms like MRSA, reported disappointing second quarter revenues and lowered its full-year outlook. Its non-core businesses came in below plan and, more importantly, its GeneXpert module placements were down sequentially and year over year. Pharmaceutical services company inVentiv Health substantially lowered second-half 2008 earnings guidance, given the challenging environment for drug marketing and no pickup in drug approvals in sight. Both stocks were sold. While these holdings were a disappointment, a large portion of our underperformance came from not owning the small, single-product biotech companies that rebounded strongly during the quarter. These stocks have enjoyed strong runs from time to time, but we have avoided them given their risky binary outcome profiles.
Information Technology was also a performance detractor in the quarter. ATMI Inc., a company that sells consumables to semiconductor manufacturers worldwide, pre-announced another weak quarter after having missed earnings last quarter on weakness in the semiconductor supply chain. We reduced our position on the initial disappointment, but we have maintained some exposure given our enthusiasm for prospects for several new products coming in 2009. Ultimate Software Group, Inc., a provider of payroll and human resources management software to small and medium sized businesses, sold off due to investor concerns over weaker employment growth and longer-than-anticipated implementation times for some of its larger new business deals. We continued to hold the stock, as we believed investor fears were overstated and the company’s subscription model and competitive position were attractive. We also retained our investments in two other underperforming Information Technology stocks: Switch & Data Facilities Co., Inc., and Equinix, Inc. Both companies have built out large data centers and have successfully accessed the capital markets over the last several years. Despite tight credit markets, these companies have fully funded business plans and accelerating free cash flow growth. Additionally, the current tight credit environment may reduce competitors’ access to capital, potentially limiting the number of new data center builds.
Another difficult area was Telecommunication Services. PAETEC Holding Corp. reported a disappointing quarter as the slowing economy had a much more significant impact on company results than originally expected. This was due to PAETEC’s higher exposure to usage revenue relative to other emerging carriers. The stock was sold as we believed results may continue to be pressured through the remainder of the year. Also in the sector, TW Telecom, Inc., sold off when it announced it was experiencing weaker revenue growth due to the slowing economy. While the demand for its data services remained strong, the small non-core business segment was particularly weak. We continued to hold the stock because it has low usage exposure, however we will be vigilant for any additional deterioration in the business. The Materials sector was another underperforming group as our holdings in Flotek Industries Inc. and Compass Minerals International Inc. were hard-hit. Flotek, which supplies products to the drilling industry, was weak on declining energy prices as well as some operational difficulties. Compass, a specialty fertilizer company, pulled back sharply after its surge earlier in the year. Finally, our positions in the Industrials sector held back results with weakness at General Cable Corp. and Hexcel Corp. General Cable traded off on concerns of a worldwide economic slowdown. Hexcel, a producer of advanced composites used in commercial aerospace, retreated on concerns about an economic overall slowdown coupled with production cuts due to a labor strike at Boeing Co. We trimmed the position, but currently continue to believe the company will benefit from a prolonged aerospace cycle.
Management outlook
As we enter the fourth quarter, Evergreen Growth Fund is overweight in Information Technology and Telecommunication Services, two areas where currently we are finding strong companies with what we believe are excellent growth prospects and reasonable valuations. Our weightings in Health Care, Consumer Staples, Financials, and Energy are essentially in line with the Russell 2000 Growth Index. We are underweight Industrials and Materials at present, given our concerns about the economy. We also have retained our underweight in Consumer Discretionary for now, given concerns about the many headwinds the consumer currently faces and our skepticism about earnings expectations for many companies.
In Information Technology, we reduced our weighting in semiconductors and semiconductor equipment companies and expect there may be several difficult quarters ahead for the industry. We note that many stocks are currently trading at multiples of cash, but we only feel confident with those that have the strongest product cycles right now. We currently maintain a large overweight in subscription software names where we expect the companies may weather the current economic storm by selling customers productivity enhancements with very high returns on dollars spent. An example is Concur Technologies Inc., where we see much lower risk of earnings dislocations and note the company is aggressively buying back stock right now. Our largest position is Blackboard Inc., a vendor of learning management software to colleges and, increasingly, K-12 systems. We view this company as more insulated from the economic weakness. In all, we think strong product cycles may save the day over a much weaker economy. We also believe technology companies are overcapitalized at present and therefore are less exposed to tighter credit markets.
In Health Care, we have a large underweight in biotechnology names, but strong exposure to gene testing and analysis companies that are on the forefront of many significant new applications. We also see strong momentum from contract research organizations (CROs) that may benefit from a difficult approval environment at the Food and Drug Administration (FDA). In medical devices, we currently are focusing on companies that sell lower-cost items such as diagnostic kits or small ticket items that have recurring revenue streams. We are avoiding high cost capital equipment companies as hospital budgets may be squeezed by the credit crunch.
We are currently underweighting Industrials and Materials. With tightening credit and slowing economic growth in the United States, which has spread globally, these areas may underperform near term. Within Industrials and Materials, we presently remain focused on companies that have specific catalysts or defensive business models.
We believe Financials may be in a bottoming process that began to emerge last quarter as stock prices recovered. Troubled companies are being acquired by stronger companies or placed into government receivership, forcing the industry to rationalize excess capacity. This process began over a year ago, and while the headlines are disturbing, we are beginning to see investment opportunities emerge. We think strong companies like Stifel Financial Corp., Greenhill & Co., HCC Insurance Holdings Inc. and PrivateBancorp Inc. may have opportunities to gain market share from weak competitors and use their strong balance sheets for strategic acquisitions. Additionally, the steep yield curve, aggressive monetary and fiscal policies and industry consolidation are creating additional opportunities for companies to emerge from the current financial upheaval.
The Consumer Discretionary area remains very challenging, we believe. The sector is vulnerable to many factors pressuring consumer spending, including declines in housing values, the diminished availability of credit, high energy prices and the specter of rising food and services inflation. In this difficult environment, we are focusing on companies with less economic sensitivity, such as Marvel Entertainment Inc., and education companies like Strayer Education Inc. and Capella Education Co. In Consumer Staples, we are emphasizing companies that provide life’s necessities, such as Flowers Foods Inc. and Chattem Inc., a maker of personal care products.
We currently remain confident in our investment policy and process, which has served us well over many years. Our focus is still on seeking rapidly growing small cap companies, with sustainable business models that trade at reasonable valuations. We believe this is a solid strategy for the long-term.
Fund performance
Fund inception date: 04/15/1985
Performance as of: 09/30/2008
| 3-Month Return | YTD Return | 1-Year Return | 3-Year Return | 5-Year Return | 10-Year Return | Return Since Inception |
| Class A | ||||||
| -13.41% | -25.29% | -27.19% | -3.06% | 4.25% | 5.75% | 9.30% |
| Class A at NAV | ||||||
| -8.13% | -20.73% | -22.75% | -1.13% | 5.49% | 6.38% | 9.58% |
| Max Sales Charge | Expense Ratio Net* | Expense Ratio Gross* |
| Class A | ||
| 5.75% | 1.26% | 1.27% |
*As per prospectus dated 02/01/2008. Net ratio includes voluntary waivers and/or reimbursements. The fund's investment advisor may cease these voluntary waivers and/or reimbursements at any time.
Past performance is no guarantee of future results. The performance quoted represents past performance and current performance may be lower or higher. Investment return and principal value of an investment will fluctuate so that investors’ shares, when redeemed, may be worth more or less than their original cost. To obtain performance information as of the most recent month-end, go to EvergreenInvestments.com/Fund Information. Performance at NAV does not include the effect of sales charges. Performance includes the reinvestment of income dividends and capital gain distributions.
Historical performance shown for Class A prior to its inception is based on the performance of Class C, the original class offered. The historical returns for Class A have not been adjusted to reflect the effect of the 12b-1 fee for Class A. This fee is 0.25% for Class A. If this fee had been reflected, returns for Class A would have been higher.
The advisor is reimbursing a portion of the 12b-1 fee for Class A. Had the fee not been reimbursed, returns for Class A would have been lower.
The fund's investment objective may be changed without a vote of the fund's shareholders.
Mid cap securities may be subject to special risks associated with narrower product lines and limited financial resources compared to their large cap counterparts, and, as a result, mid cap securities may decline significantly in market downturns.
The stocks of smaller companies may be more volatile than those of larger companies due to the higher risk of failure.
Net asset value (NAV) is the value of one share of the portfolio excluding any sales charges. Had sales charges been included, performance would be lower. Prices shown reflect the prior business day's closing net asset value (NAV) prices. Prices are available for weekdays only, and are not available for weekends or NYSE holidays. Orders for redemptions placed before 4:00 p.m. Eastern time will receive that day's closing share price. If received after 4:00 p.m., you will receive the next business day's closing share price.
Public offering price (POP) is the price of one share of a fund including any sales charges.
The previous information is the opinion of the portfolio manager(s) of the fund, and it is not intended as investment advice.