Value Opportunities

Market Commentary

Period ended June 30, 2017

 

MARKET COMMENTARY

The S&P 500 Index returned +3.1% in the second quarter.  Growth stocks outperformed value stocks in the quarter, with the Russell 3000 Growth Index returning +4.7% compared to the Russell 3000 Value Index’s return of +1.3%.  Year-to-date, the growth index has outperformed the value index by more than 9 percentage points, a reversal of value’s 11 percentage point advantage in 2016.  In the last few years, investors flocked to companies with high dividend payouts (i.e. bond surrogates) because interest rates have been persistently low.  In 2017, with GDP advancing at a positive but lackluster pace, investors have flocked to stocks that have exhibited above average growth.  This has not only led to growth’s outperformance but also produced a market with narrow leadership.  More than one-third of growth’s outperformance has come from just five mega cap stocks—Apple, Amazon, Facebook, Google, and Microsoft.

Financials have represented the portfolio’s largest sector since the end of the financial crisis, and banks have comprised a meaningful portion of that exposure.  In late June, the Federal Reserve Board completed its Comprehensive Capital Analysis and Review (“CCAR”) and did not object to the capital plans of the 34 participating companies1.  In its press release, the Fed noted that the common equity capital ratio of the 34 banks “has more than doubled from 5.5 percent in the first quarter of 2009 to 12.5 percent in the first quarter of 2017”.  Of the 34 banks, 26 are public US companies.  These 26 banks were approved for returning 100% of earnings to shareholders on average, which equates to 7.5% of their equity value; i.e. a 7.5% payout yield—a handful have a payout yield of more than 10%.  We view this as a compelling dynamic for companies that have not had better balance sheets in our lifetime. 

Equity valuation multiples leave us somewhat guarded.  Valuations are above average, though a healthy corporate environment, an accommodating Federal Reserve, and a resilient consumer provide support.  Potential policy changes remain a looming uncertainty across equity markets.  In addition to the mega cap growth stocks previously mentioned, investors have favored sectors with stable earnings and high dividend payouts, bidding them up to levels we view as excessive; we are underweight consumer staples and utilities.  We are overweight financials, energy, and industrials, which exhibit compelling valuations for the risks at hand.  The portfolio trades at a considerable discount to the market, largely due to this valuation dichotomy.  The portfolio trades at 8.5x normal earnings compared to 17.3x for the S&P 500 Index and 1.2x book value compared to 3.0x for the index. 

ATTRIBUTION: 2Q 2017

The Hotchkis & Wiley Value Opportunities portfolio (gross and net of management fees) underperformed the S&P 500 Index in the second quarter.  The strategy’s value focus hurt performance relative to the S&P 500 as growth stocks outperformed value stock by a considerably margin.  The strategy outperformed the Russell 3000 Value Index.  Relative to the S&P 500, security selection in healthcare, consumer discretionary, and consumer staples detracted from performance.  This was partly offset by positive security selection in materials.  The largest individual contributors to relative performance were Oracle, Office Depot, Citigroup, Popular, and Vodafone; the largest detractors were Energy XXI Gulf Coast, Hewlett Packard Enterprise, Bed Bath & Beyond, Discovery Communications and Hanger.  
 

_______________________
1While the Fed did not object to its plan, Capital One is required to address weaknesses in its capital planning process and resubmit its plan.

Composite performance for the strategy is located on the Performance tab. Returns discussed can differ from actual portfolio returns due to intraday trades, cash flows, corporate actions, accrued/miscellaneous income, and trade price and closing price difference of any given security. Portfolio attribution is based on a representative Value Opportunities portfolio. Certain client portfolio(s) may or may not hold the securities discussed due to each account’s guideline restrictions, cash flow, tax and other relevant considerations. Equity performance attribution is an analysis of the portfolio's return relative to a selected benchmark, is calculated using daily holding information and does not reflect management fees and other transaction costs and expenses.  Specific securities identified are the largest contributors (or detractors) to the portfolio’s performance relative to the S&P 500 Index. Other securities may have been the best and worst performers on an absolute basis. Securities identified do not represent all of the securities purchased or sold for advisory clients, and are not indicative of current or future holdings or trading activity.  H&W has no obligation to disclose purchases or sales of the securities.  No assurance is made that any securities identified, or all investment decisions by H&W were or will be profitable.  Quarterly characteristics and portfolio holdings are available on the Characteristics and Literature tabs. For a list showing every holding’s contribution to the overall account’s performance and portfolio activity for a given time period, please contact H&W at hotchkisandwiley@hwcm.com.  Portfolio information is subject to the firm’s portfolio holdings disclosure policy.
 
The commentary is for information purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Portfolio managers’ opinions and data included in this commentary are as of June 30, 2017 and are subject to change without notice.  Any forecasts made cannot be guaranteed.  Information obtained from independent sources is considered reliable, but H&W cannot guarantee its accuracy or completeness. Certain information presented is based on proprietary or third-party estimates, which are subject to change and cannot be guaranteed. Equity securities may have greater risks and price volatility than U.S. Treasuries and bonds, where the price of these securities may decline due to various company, industry and market factors.  Investing in value stocks presents the risk that value stocks may fall out of favor with investors and underperform growth stocks during given periods. The strategy may be exposed to more individual stock volatility than a more diversified strategy and may also invest in smaller and/or medium-sized companies, foreign securities, and debt securities. All investments contain risk and may lose value. 
 
Past performance is no guarantee of future results.
 

Index definitions