Capital Income Fund (HWIIX)


The performance data quoted represents past performance and does not guarantee future results. Current performance may be lower or higher. Investment return and principal value of the fund will fluctuate, and shares may be worth more or less than their original cost when redeemed. Click quarter-end or month-end to obtain the most recent fund performance.

Manager Commentary
Period ended March 31, 2018



The Hotchkis & Wiley Capital Income Fund invests in both value equity securities and high yielding fixed income securities with an emphasis on income generation.  The long-term allocation target between value equities and high yielding fixed income securities is 50/50.  The portfolio has two benchmarks, the S&P 500 Index (“the equity benchmark”) and the ICE BofAML US Corporate, Government & Mortgage Index (“the fixed income benchmark”).  These benchmarks are averaged, using the portfolio’s long-term allocation targets, to produce a “50/50 blended benchmark” to help assess performance.


In the first quarter of 2018, the S&P 500 Index fell -0.8% and the ICE BofAML US High Yield Index fell -0.9%, each ending impressive streaks of positive quarterly performance. 

In equities, growth outperformed value.  The Russell 1000 Growth Index returned +1.4% while the Russell 1000 Value Index fell -2.8%, extending growth’s recent performance advantage.  Over the last 10 years, the value index has returned +111% cumulatively compared to +193% for the growth index (+7.8% and +11.3% annualized, respectively).  The only other period that favored growth to such an extent was the internet bubble of the late 1990s.  While the broad market’s valuation today is much less extreme than it was in 1999, a number of popular stocks exhibit exorbitant valuation multiples akin to internet bubble levels.  We believe this poses risks for passive investors because they are, either consciously or naively, allocating capital to excessively valued securities.  Very few people would buy a new house, car, or even a meal without regard to price, but this frame of mind seems to breakdown at times when buying stocks.  In our view, to justify the current valuations of today’s most richly valued stocks, many things have to go perfectly right for a very long period.  In our experience, such unbridled optimism rarely materializes.

Fortunately for active investors, we believe some segments of the equity market offer attractive valuations for the risks at hand.  Financials continue to represent the largest sector weight in the portfolio and largest overweight relative to the S&P 500 Index.  Despite healthy stock price appreciation in recent years, banks continued to trade at valuations well below their historical averages.  Critics argue that lower valuations are justified because banks will be unable to earn the same returns on capital they have earned in the past due to more stringent capital requirements.  We agree, but competitively advantaged banks like the ones we own should be able to earn above cost-of-capital returns.  Accordingly, we view 11x normal earnings and a small premium to book value as compelling valuations, particularly considering that the excess capital on their balance sheets reduce the risk profiles dramatically.  We have also been partial to industrials.  Our focus has been on attractively valued, well-managed companies with strong balance sheets and good prospects for growth.  The sector is composed of mostly cyclical businesses but with different end markets.  Different industries experience cyclical troughs at different times and therefore exhibit compelling valuation opportunities at different times.  Thus, we have been overweight industrials for an extended period but our investment mix has changed through time. 

At the end of the quarter, yield-to-worst for the ICE BofAML US High Yield Index stood at 6.35%, a 0.51% increase from the beginning of the year.  The high yield market’s spread over treasuries widened by 9 basis points, refusing to absorb the increase in interest rates.  Interestingly, the lowest rated credits (CCC & below) posted a slightly positive return in the quarter while higher rated credits declined the most.  More often than not, lower rated credits underperform when the high yield market falls and outperform when it rises.  Exceptions tend to occur when the market’s decline is due to the increase in interest rates, which transpired this quarter, because higher rated credits are more rate sensitive than lower rated credits. 

All 18 high yield sectors declined in the quarter but the worst-performer declined a rather modest -2.6% (banking).  In last two calendar years, the best-performing sector outperformed the worst-performing sector by 11 and 34 percentage points, respectively, so this quarter’s sector dispersion was quite narrow.  Small and mid cap credits outperformed large cap credits, which tends to be (and was) conducive to our bottom-up credit picking approach.  While the market is tighter than average, fundamentals are reasonable and we have invested in credits that our research indicates have strong/quality asset coverage.  We continue to adhere to our core competency of focusing on credits of all sizes as well as fallen angels, which are often overlooked by other investors.  


The Hotchkis & Wiley Capital Income Fund (Class I) outperformed, by declining less than, the 50/50 blended benchmark in the first quarter of 2018.  The average equity weight was 56% and the average high yield bond weight was 44% over the course of the quarter.  The equity overweight had little effect as both asset classes performed similarly in the period. 

The equity portion of the portfolio underperformed the S&P 500 Index during the quarter.  Growth stocks outperformed value stocks, which is a headwind for our value investment approach.  Stock selection in consumer discretionary along with the overweight position in energy and underweight position in technology hurt relative performance.  Positive stock selection in technology, consumer staples, industrials, and healthcare helped relative performance.  The largest individual detractors to relative performance in the quarter were Office Depot, Energy XXI, WestJet Airlines, Ophir Energy, and AIG; the largest positive contributors were Hewlett-Packard Enterprise, Whiting Petroleum, Royal Mail, Popular, and Danieli. 

The high yield bond portion of the portfolio outperformed the ICE BofAML US Corporate, Government & Mortgage Index as high yield bonds outperformed investment grade bonds.  The portfolio also outperformed the ICE BofAML US High Yield Index due to positive credit selection.  Credit selection was positive or neutral in 15 of the 18 BofAML sectors, and was particularly positive in basic industry, energy, and retail credits.  Credit selection in services was a modest detractor.    

Mutual fund investing involves risk. Principal loss is possible. Investments in debt securities typically decrease in value when interest rates rise.  This risk is usually greater for longer-term debt securities.  Investment by the fund in lower-rated and non-rated securities presents a greater risk of loss to principal and interest than higher-rated securities.  The Fund may invest in derivative securities, which derive their performance from the performance of an underlying asset, index, interest rate or currency exchange rate.  Derivatives can be volatile and involve various types and degrees of risks.  Depending on the characteristics of the particular derivative, it could become illiquid.  Investment in Asset Backed and Mortgage Backed Securities include additional risks that investors should be aware of such as credit risk, prepayment risk, possible illiquidity and default, as well as increased susceptibility to adverse economic developments. The Fund may invest in foreign as well as emerging markets which involve greater volatility and political, economic and currency risks and differences in accounting methods.

Fund holdings and/or sector allocations are subject to change and are not buy/sell recommendations. Current and future portfolio holdings are subject to risk. Value stocks may underperform other asset types during a given period. Portfolio managers’ opinions and data included in this commentary are as of 3/31/18 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. Specific securities identified are the largest contributors (or detractors) on a relative basis to the S&P 500 Index. Securities’ absolute performance may reflect different results. The Fund may not continue to hold the securities mentioned and the Advisor has no obligation to disclose purchases or sales of these securities. Attribution is an analysis of the portfolio's return relative to a selected benchmark, is calculated using daily holding information and does not reflect the payment of transaction costs, fees and expenses of the Fund. Past performance is no guarantee of future results. Diversification does not assure a profit nor protect against loss in a declining market.

Credit Quality weights by rating were derived from the highest bond rating as determined by S&P, Moody's or Fitch. Bond ratings are grades given to bonds that indicate their credit quality as determined by private independent rating services such as Standard & Poor's, Moody's and Fitch. These firms evaluate a bond issuer's financial strength, or its ability to pay a bond's principal and interest in a timely fashion. Ratings are expressed as letters ranging from 'AAA', which is the highest grade, to 'D', which is the lowest grade. In limited situations when none of the three rating agencies have issued a formal rating, the Advisor will classify the security as nonrated.

Investing in high yield securities is subject to certain risks, including market, credit, liquidity, issuer, interest-rate, inflation, and derivatives risks.  Lower-rated and non-rated securities involve greater risk than higher-rated securities.  Equities, bonds and other asset classes have different risk-return profiles, which should be considered when investing.  All investments contain risk and may lose value. 

The average annual total returns for the ICE BofAML US High Yield Index were -0.91%, 3.69%, 5.18%, 5.01%, and 6.56% for 1Q18, one-year, three-year, five-year and Since 12/31/10 periods ended March 31, 2018, respectively.

Index definitions

Glossary of financial terms