This report and the financial statements contained herein are submitted for the general information of the shareholders of the Sector Rotation Fund (the “Fund”). The Fund’s shares are not deposits or obligations of, or guaranteed by, any depository institution. The Fund’s shares are not insured by the FDIC, Federal Reserve Board or any other agency, and are subject to investment risks, including possible loss of principal amount invested. Neither the Fund nor the Fund’s distributor is a bank.
The Sector Rotation Fund is distributed by Capital Investment Group, Inc., Member FINRA/SIPC, 17 Glenwood Ave, Raleigh, NC, 27603. There is no affiliation between The Sector Rotation Fund, including its principals, and Capital Investment Group, Inc.
This Annual Report was first distributed to shareholders on or about November 29, 2012.
Dear Fellow Shareholder:
As of September 30, 2012, The Sector Rotation Fund (the “Fund”) had a total one year return of 15.48%, as compared to the S&P 500 Index’s return of 30.20% (Please refer to the “performance update” page for additional performance information). I attribute the performance to several factors:
| 1. | Over the last year I have put a large emphasis on risk management. Beginning in the 4th qtr of 2011, I started pulling back the risk of the portfolio. This was done by selling several highly appreciated holdings. I like locking in gains. I also used several S&P 500 inverse ETF's as a hedge against a pull back. To date the pull back has not occurred and that shaved some of the upside. |
| 2. | I also have installed a buy stop order on SPXU. This order will remain active until it is either cancelled or executed. It is one of my preferred methods to reduce risk, and has a tax benefit by not realizing capital gains to the shareholders. |
| 3. | The fund still holds several assets such as Rising Rate funds which have not performed well, along with TIPS and High Yield Bonds that have performed well while providing income but in no means can keep up with a 30% S&P 500 increase. |
| 4. | With 8% unemployment, $4.00 gasoline, $16.2 Trillion in national debt, the housing market still near the bottom, the S&P 500 double its 2009 bottom and the fiscal cliff just weeks away my focus is on risk management. |
I always say every person needs to have three numbers on their refrigerator. 1. Their weight. 2. Their total debt. 3. Their Beta.
The Third Quarter in Review
Looking back at the third quarter, there was plenty of good news: Consumer spending is holding up well, and the housing market has showed some signs of rebounding. That said, many headwinds remain for the U.S. economy. Unemployment is high, investment spending is low, exports are dropping, and concerns remain about the European sovereign debt crisis and the U.S. fiscal cliff. Plus, it’s an election year.
The Consumer is back
Consumer inflation rose 0.6% month-over-month in September, bringing inflation in at 2.0% year-over-year. That was up from 1.7% year-over-year at the end of last quarter. Still, September consumer confidence (as indicated by the Conference Board) hit a seven-month high of 70.3. That was reflected in spending data: Retail sales increased over 0.6% month-over-month in August after falling each month in the second quarter of 2012, consumer spending grew at a 1.5% annualized pace in the second quarter of 2012. We project a third-quarter gain in line with that number.
Housing is so-so
Existing home sales rose 7.8% in August (placing them up 9.3% year-over-year). That has reduced the number of existing homes for sale over the past year by 18.2%. Increasing sales and declining inventories are raising home prices as reflected by several home-price indicators. For example, home prices as represented by the S&P/Case-Shiller Home Price Index rose 0.4% month-over-month in July, their six straight monthly rise. Moreover, there’s reason to think these gains should continue, given that the National Association of Homebuilders’ sentiment index, a leading indicator of residential construction, reached a six-year high in August. That said, housing still has a long way to go to reach pre-crisis levels.
And GDP?
If third-quarter consumer spending does come in at a 2.2% annualized rate, we don’t think gross domestic product (GDP), the value of all goods and services produced by the economy, will not be significantly less than 2%.
Unemployment is unexceptional
The unemployment rate decreased to 7.8% in September as total nonfarm payroll employment rose by 114,000. That said, the household survey, from which the unemployment rate is derived, showed much stronger results—an unusual gain that we think may indicate some distortions that artificially lowered the unemployment rate. Some analysts have even suggested it was intentional, designed to boost President Obama’s re-election efforts. In any case, we think we’ll see a revision.
Investment spending is weak
Three measures of investment spending—capital spending, inventory building and investment in commercial structures—all declined in the third quarter. For examples, non-defense-related capital goods orders (excluding aircraft) fell 5.2% in July following a 2.7% drop in June. That data is mirrored by the new-orders component of the Institute of Supply Management (ISM) index. Moreover, the weakness corresponds with the escalation of the sovereign debt crisis in Europe. That tells us businesses are worried about the economy and are in wait-and-see mode.
Exports have declined
Exports of goods and services fell 1.0% in July. The ISM’s new export orders index, a leading indicator of export trends, fell precipitously in June and has yet to show any meaningful recovery through August. That places the average for the quarter in recessionary territory, near levels last seen in the second quarter of 2009.
The Swiss franc is king
The situation in Europe remains precarious. In October, Spain edged closer to requesting a bailout as rumors circulate that Moody's was preparing to downgrade the country's sovereign credit rating. As evidence of just how worried investors, consider that reserves in francs at the Swiss National Bank (SNB) have soared to 79% of the country’s GDP as capital has flown in from Spain, Greece and Italy.
Falling off the cliff?
At home, policy uncertainty in Washington continues. It started with last summer's debt-ceiling debacle, and continues with the looming fiscal cliff. If those tax increases and spending cuts go into effect as scheduled, they could knock several percentage points off GDP growth and turn a lackluster recovery back into recession. We believe that much of the fiscal cliff will be postponed beyond 2013.
High-yield credit leads income
Within the fixed-income sector, the broad Barclays U.S. Aggregate Index rose 1.6% during the quarter, its tenth rise in 11 quarters. U.S. debt was led by high-yield bonds, which rose 4.5% during the quarter. Overseas, emerging-market bonds performed particularly, well, rallying at their fastest quarterly pace since the third quarter of 2010, with a 6.8% rise.
Equities rally
Improving economic data on some fronts led to a broad global rally in equities, with the MSCI All Country World Index rising 7.0% during the third quarter. International developed equities outpaced domestic equities for the first time in five quarters, with the MSCI EAFE Index returning 7.0% to the S&P 500 Index’s 6.4%. The best performers were emerging-market equities, which rose 7.9%, led by gains in India and countries highly correlated to commodities (such as Egypt and Russia).
Fed easing drives commodity gains
Central bank monetary policy accommodation and a decline in the U.S. dollar by 2.1% helped commodities in the third quarter, with the Dow Jones-UBS Commodity Index returning 9.7, its most since the fourth quarter of 2010.
Where do we go from here?
The U.S. Federal Reserve Board (Fed) ran out of patience waiting for the economic outlook to improve and responded aggressively on several fronts. These actions clearly signal that the policymakers will keep their feet on the accelerator until the recovery strengthens considerably. If the Fed’s actions work, and the economy continues to improve, risk assets would likely perform well, putting some pressure on U.S. Treasuries. That said, the financial markets have clearly improved sharply, and we’re concerned that these moves may be overdone given that the economic outlook remains precarious at best. If the economy doesn’t continue improving, severe investor anxiety may re-emerge, and risk assets would be in trouble. As always, navigate carefully.
Mark A. Grimaldi
Fund Manager
1. Organization and Significant Accounting Policies
The Sector Rotation Fund (“Fund”) is a series of the Starboard Investment Trust (“Trust”). The Trust is organized as a Delaware statutory trust and is registered under the Investment Company Act of 1940, as amended (“1940 Act”), as an open-end management investment company. The Fund is a separate non-diversified series of the Trust.
The Fund commenced operations on December 31, 2009 as a series of the World Funds Trust (“WFT”). Shareholders approved the reorganization of the Fund as a series of the Trust at a special meeting on June 22, 2011. The reorganization occurred on June 27, 2011. Effective November 29, 2010, the Fund changed its name from the Navigator Fund to the Sector Rotation Fund.
The investment objective of the Fund is to achieve capital appreciation. The Fund utilizes a sector rotation strategy which evaluates the relative strength and momentum of different sectors of the economy in order to identify short-term investment opportunities. Under normal circumstances, the Fund invests in exchange-traded funds (“ETFs”). An ETF is an open-end investment company that holds a portfolio of investments designed to track a particular market segment or underlying index.
The following is a summary of significant accounting policies consistently followed by the Fund. The policies are in conformity with accounting principles generally accepted in the United States of America (“GAAP”).
Investment Valuation
The Fund’s investments in securities are carried at fair value. Securities listed on an exchange or quoted on a national market system are valued at the last sales price as of 4:00 p.m. Eastern Time. Securities traded in the NASDAQ over-the-counter market are generally valued at the NASDAQ Official Closing Price. Other securities traded in the over-the-counter market and listed securities for which no sale was reported on that date are valued at the most recent bid price. Instruments with maturities of 60 days or less are valued at amortized cost, which approximates market value. Securities and assets for which representative market quotations are not readily available (e.g., if the exchange on which the security is principally traded closes early or if trading of the particular security is halted during the day and does not resume prior to the Fund’s net asset value calculation) or which cannot be accurately valued using the Fund’s normal pricing procedures are valued at fair value as determined in good faith under policies approved by the Trustees. A security’s “fair value” price may differ from the price next available for that security using the Fund’s normal pricing procedures.
Fair Value Measurement
The Fund has adopted ASC Topic 820, Fair Value Measurements. ASC Topic 820 defines fair value, establishes a frame work for measuring fair value and expands disclosure about fair value measurements.
Various inputs are used in determining the value of the Fund's investments. These inputs are summarized in the three broad levels listed below:
Level 1: quoted prices in active markets for identical securities
Level 2: other significant observable inputs (including quoted prices for similar securities, interest rates, credit risk, etc.)
Level 3: significant unobservable inputs (including the Fund’s own assumptions in determining fair value of investments)
The Fund has adopted FASB guidance updating ASC Topic 820 titled, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability have Significantly Decreased and Identifying Transactions that are not Orderly” which provides guidance on determining when there has been a significant decrease in the volume and level of activity for an asset or liability, when a transaction that is not orderly, and how that information must be incorporated into fair value measurement. The guidance emphasizes that even if there has been a significant decrease in volume and level of activity for an asset or liability and regardless of the valuation techniques used, the objective of a fair value measurement remains the same.
Sector Rotation Fund
Notes to Financial Statements
The inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level in the fair value hierarchy within which the fair value measurement falls in its entirety, is determined based on the lowest level input that is significant to the fair value measurement in its entirety.
The inputs or methodology used for valuing securities are not necessarily an indication of the risk associated with investing in those securities. The following tables summarize the inputs as of September 30, 2012 for the Fund’s assets and liabilities measured at fair value:
| Sector Rotation Fund | | |
| Investments in Securities | | Total | | Level 1 | | Level 2 | | Level 3 |
| Assets | | | | | | | | |
| Exchange-Traded Funds | $ | 23,033,285 | $ | 23,033,285 | $ | - | $ | - |
| Short-Term Investment | | 369,673 | | 369,673 | | | | |
| Total Assets | $ | 23,402,958 | $ | 23,402,958 | $ | - | $ | - |
| | | | | | | | | |
Investment Transactions and Investment Income
Investment transactions are accounted for as of the date purchased or sold (trade date). Dividend income is recorded on the ex-dividend date. Certain dividends from foreign securities will be recorded as soon as the Fund is informed of the dividend if such information is obtained subsequent to the ex-dividend date. Interest income is recorded on the accrual basis and includes amortization of discounts and premiums. Gains and losses are determined on the identified cost basis, which is the same basis used for federal income tax purposes.
Expenses
The Fund bears expenses incurred specifically on its behalf as well as a portion of general expenses, which are allocated according to methods reviewed annually by the Trustees.
Dividend Distributions
The Fund may declare and distribute dividends from net investment income (if any), monthly or quarterly, although the Fund currently intends to distribute these amounts on an annual basis in December of each year. Distributions from capital gains (if any) are generally declared and distributed annually. Dividends and distributions to shareholders are recorded on ex-date.
Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of increases and decreases in the net assets from operations during the reported period. Actual results could differ from those estimates.
Federal Income Taxes
No provision for income taxes is included in the accompanying financial statements, as the Fund intends to distribute to shareholders all taxable investment income and realized gains and otherwise complies with Subchapter M of the Internal Revenue Code applicable to regulated investment companies.
Sector Rotation Fund
Notes to Financial Statements
| 2. | Transactions with Affiliates & Service Providers |
Advisor
As full compensation for the investment advisory services provided to the Fund by Navigator Money Management, Inc. (the “Advisor”), the Advisor receives a monthly fee based on the Fund’s average daily net assets. The Advisor shall receive an investment advisory fee equal to an annualized rate of 1.00% of the average daily net assets of the Fund. In accordance with these terms, the Advisor earned $240,177 in advisory fees for the fiscal year ended September 30, 2012.
The Advisor has entered into an Operating Plan under which it has agreed (i) to pay the Fund’s administrator a fee based on the daily average net assets of the Fund when net assets are below $29 million; (ii) if these payments are less than a designated minimum, then the Advisor pays a fee that makes up the difference; and (iii) to assume certain expenses of the Fund outlined in the Operating Plan. These measures are intended to limit the Fund’s operating expenses to 1.65% of the average daily net assets, exclusive of brokerage fees and commissions, taxes, borrowing costs, acquired fund fees and expenses, and extraordinary expenses. The Advisor cannot recoup from the Fund any amounts paid under the Operating Plan.
Prior to June 27, 2011, the Advisor had contractually agreed to waive or limit its fees and to assume other operating expenses so that the ratio of total annual operating expenses was limited to 1.65% of the average net assets of the Fund. The limit does not apply to interest, taxes, brokerage commissions, other expenditures capitalized in accordance with GAAP or other extraordinary expenses not incurred in the ordinary course of business. The total amount of reimbursement recoverable by the Advisor is the sum of all fees previously waived or reimbursed by the Advisor to the Fund during any of the previous three (3) years, less any reimbursement previously paid by the Fund to the Advisor with respect to any waivers, reductions, and payments made with respect to the Fund. The total amount of recoverable reimbursements as of September 30, 2011 was $185,405 and expires as follows:
| Expiration Date | | Amount |
| September 30, 2013 | | $ 98,971 |
| September 30, 2014 | | 86,434 |
| Total | | $ 185,405 |
| | | |
The recovery of any amounts is limited to situations where the repayment would not cause the Fund’s expense ratio of total annual operating expenses to exceed 1.65%.
Administrator
The Nottingham Company (“Administrator”) provides the Fund with administrative, fund accounting, and compliance services pursuant to a Fund Accounting and Administration Agreement. The Administrator receives compensation from the Fund at a maximum annual rate of 0.65% and is responsible for the coordination and payment of vendor services and other Fund expenses from such compensation. The annual rate is 0.650% if the average daily net assets are under $30 million and gradually decreases to an annual rate of 0.095% if the average daily net assets are $1.795 billion or more. The fee paid to the Administrator is calculated by multiplying the average daily net assets of the Fund by the highest applicable annual rate.
Pursuant to this arrangement, the Administrator pays the following expenses: (i) compensation and expenses of any employees of the Trust and of any other persons rendering any services to the Fund; (ii) clerical and shareholder service staff salaries; (iii) office space and other office expenses; (iv) fees and expenses incurred by the Fund in connection with membership in investment company organizations; (v) fees and expenses of counsel to the Trustees who are not interested persons of the Fund and Trust; (vi) fees and expenses of counsel to the Fund and Trust engaged to assist with preparation of Fund and Trust documents and filings and provide other ordinary legal services; (vii) fees and expenses of independent public accountants to the Fund, including fees and expense for tax preparation; (viii) expenses of registering shares under federal and state securities laws; (ix) insurance expenses; (x) fees and expenses of the custodian, shareholder servicing, dividend disbursing and transfer agent, administrator, distributor, and accounting and pricing services agents of the Fund; (xi) compensation for a chief compliance officer for the Trust; (xii) expenses, including clerical expenses, of issue, sale, redemption, or
Sector Rotation Fund
Notes to Financial Statements
repurchase of shares of the Fund; (xiii) the cost of preparing and distributing reports and notices to shareholders; (xiv) the cost of printing or preparing prospectuses and statements of additional information for delivery to the Fund’s current shareholders; (xv) the cost of printing or preparing documents, statements or reports to shareholders; and (xvi) other expenses not specifically assumed by the Fund or Advisor. The Administrator cannot recoup from the Fund any Fund expenses in excess of the administration fees payable under the Fund Accounting and Administration Agreement. The Fund paid $156,115 in administration fees to the Administrator for the fiscal year ended September 31, 2012.
Compliance Services
Nottingham Compliance Services, LLC (“NCS”), a fully owned affiliate of the Administrator, provides services which assist the Trust’s Chief Compliance Officer in monitoring and testing the policies and procedures of the Trust in conjunction with requirements under Rule 38a-1 of the 1940 Act. NCS is entitled to receive compensation from the Administrator pursuant to the Administrator’s fee arrangements with the Fund.
Transfer Agent
Nottingham Shareholder Services, LLC (“Transfer Agent”) serves as transfer, dividend paying, and shareholder servicing agent for the Fund. For its services, the Transfer Agent is entitled to receive compensation from the Administrator pursuant to the Administrator’s fee arrangements with the Fund.
Distributor
Capital Investment Group, Inc. (the “Distributor”) serves as the Fund’s principal underwriter and distributor. For its services, the Distributor is entitled to receive compensation from the Administrator pursuant to the Administrator’s fee arrangements with the Fund.
Certain Trustees and officers of the Trust are also officers of the Advisor, the Distributor, or the Administrator.
| 3. | Purchases and Sales of Investment Securities |
For the fiscal year ended September 30, 2012, the aggregate cost of purchases and proceeds from sales of investment securities (excluding short-term securities) were as follows:
| Fiscal Year Ended | Purchases of Securities | Proceeds from Sales of Securities |
| September 30, 2012 | $42,819,039 | $38,635,697 |
There were no long-term purchases or sales of U.S Government Obligations during the fiscal year ended September 30, 2012.
Distributions are determined in accordance with Federal income tax regulations, which differ from generally accepted accounting principles, and, therefore, may differ significantly in amount or character from net investment income and realized gains for financial reporting purposes. Financial reporting records are adjusted for permanent book/tax differences to reflect tax character but are not adjusted for temporary differences.
Management reviewed the tax positions in the open tax years of 2009, 2010, and 2011 and determined that the implementation of ASC Topic 740 “Accounting for Uncertainty in Income Taxes” had no impact on the Fund’s net assets or results of operations. As of and during the fiscal year ended September 30, 2012, the Fund does not have a liability for uncertain tax positions. The Fund recognizes interest and penalties, if any, related to unrecognized tax benefits as income tax expense in the statement of operations. During the period, the Fund did not incur any interest or penalties.
Sector Rotation Fund
Notes to Financial Statements
Reclassifications to paid-in capital relate primarily to differing book/tax treatment of ordinary net realized gains. For the fiscal year ended September 30, 2012, the following reclassifications, which had no impact on results of operations or net assets, were recorded to reflect tax character:
| Paid-in Capital | $ (398,678) |
| Undistributed Net Realized Gain (Loss) on Investments | | 398,678 |
Distributions during the fiscal year ended were characterized for tax purposes as follows:
| | September 30, 2012 | September 30, 2011 |
| Ordinary Income | $712,133 | - |
| Long-term capital gain | 109,029 | - |
| Return of capital | 398,678 | |
At September 30, 2012, the tax-basis cost of investments and components of distributable earnings were as follows:
| Cost of Investments | $ | 20,865,943 |
| | | |
| Unrealized Appreciation | $ | 2,727,651 |
| Unrealized Depreciation | | (190,636) |
| Net Unrealized Appreciation | | 2,537,015 |
| | | |
| Undistributed Ordinary Income | | 221,043 |
| Undistributed Long-Term Gains | | 520,470 |
| | | |
| Distributable Earnings | $ | 3,278,528 |
| | | | | | |
The difference between book-basis and tax-basis net unrealized appreciation (depreciation) is attributable to the deferral of losses from wash sales.
| 5. | Reorganizational Expenses |
As outlined in Note 1, the Trustees of the Fund approved a Plan on May 4, 2011 whereby the Fund would be reorganized from WFT into a newly created series of the Trust. A special meeting of shareholders was held on June 22, 2011 resulting in approval of the Plan. The Fund assumed the costs of these reorganizational expenses which amounted to $84,797 and was amortized over twelve months.
| 6. | Commitments and Contingencies |
Under the Trust’s organizational documents, its officers and Trustees are indemnified against certain liabilities arising out of the performance of their duties to the Fund. In addition, in the normal course of business, the Trust entered into contracts with its service providers, on behalf of the Fund, and others that provide for general indemnifications. The Fund’s maximum exposure under these arrangements is unknown, as this would involve future claims that may be made against the Fund. The Fund expects risk of loss to be remote.
| 7. | New Accounting Pronouncements |
In May 2011, the FASB issued ASU No. 2011-04 “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements.” ASU No. 2011-04 amends FASB ASC Topic 820, Fair Value Measurements and Disclosures, to establish common requirements for measuring fair value and for disclosing information about fair value measurements in accordance with GAAP and International Financial Reporting Standards (“IFRS”). ASU No. 2011-04 is effective for fiscal years beginning after December 15, 2011 and for interim periods within those fiscal years.
Sector Rotation Fund
Notes to Financial Statements
The Funds have evaluated the need for disclosures and/or adjustments resulting from subsequent events through the date of issuance of these financial statements. This evaluation did not result in any subsequent events that necessitated disclosures and/or adjustments.
