U.S. stocks were mixed in the third quarter. Major large-cap indexes rose to new all-time highs for most of the period despite ongoing unrest in the Middle East and Ukraine and the Fed's tapering of its asset purchases. Mid- and small-cap shares stumbled, however, amid concerns about valuations and risks. Domestic bond returns were mixed. Long-term Treasury bonds performed well as long-term interest rates dipped to their lowest levels in more than a year. High yield bonds declined and underperformed investment-grade issues, as credit spreads widened in response to risk aversion. Leveraged loans held up better than high yield bonds but still fell slightly.
The Capital Appreciation Fund returned 0.11% in the quarter compared with 1.13% for the S&P 500 Index and −0.87% for the Lipper Mixed-Asset Target Allocation Growth Funds Index. For the 12 months ended September 30, 2014, the fund returned 13.82% versus 19.73% for the S&P 500 Index and 11.51% for the Lipper Mixed-Asset Target Allocation Growth Funds Index. The fund's average annual total returns were 13.82%, 13.19%, and 8.99% for the 1-, 5-, and 10-year periods, respectively, as of September 30, 2014. The fund's expense ratio was 0.71% as of its fiscal year ended December 31, 2013.
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During the quarter, we decreased cash reserves and added selectively to the portfolio's stock allocation, purchasing equities during periods of weakness. Within equities, we have been marginally reducing the portfolio's sensitivity to the economic cycle, in part by adding to health care and trimming financials and consumer discretionary stocks. The portfolio's bond allocation was about the same as it was at the end of the second quarter, but this masks some changes. We reduced the allocation to Treasury bonds and increased our exposure to high yield bonds, which struggled during the quarter. We maintained a bias toward higher-quality high yield bonds. In addition, we marginally added to the portfolio's bank loan positions, but it has become more challenging to find attractive buying opportunities.
Given valuations, complacency in the equity and fixed income markets, and signs of speculative excess (such as leveraged loans with limited covenants and merger activity fueled by low-cost debt and high stock prices), we believe the conditions are in place for a meaningful correction. Industry fundamentals have worsened broadly in recent months, and earnings expectations for many companies may be too high. Macroeconomic trends overseas also appear to be weakening, which could place additional pressure on U.S. equities. However, our views are not intended to signal that we believe a correction is imminent. In fact, equities could continue rising due to the lack of attractive alternatives given how low yields are in all fixed income asset classes.