Diversified Value Fund (HWCIX)

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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 September 30, 2017

 

MARKET COMMENTARY

The S&P 500 Index returned +4.5% in the three months ended September 30, its 8th consecutive positive quarter.  Dating back to 2013, the index has generated a positive return in 18 of the last 19 calendar quarters—a feat it had not previously accomplished in its 90+ year history.  Part of the reason for this impressive run was the market’s valuation at the outset of the period.  At the beginning of 2013, the S&P 500 Index traded at 12x consensus earnings and 2x book value; the financial crisis’ mess had been largely cleaned up but valuations remained in check.  Since then, corporate earnings have been strong and the economic environment supportive.  Accordingly, we categorize most of the performance over this period as a reversion toward normal market valuations as opposed to a market that has overheated dramatically.  Based on most valuation measures, the reversion appears to have overshot historical averages but not wildly so—we are not alarmed, we are guarded. 

The Russell 1000 Growth Index outperformed the Russell 1000 Value Index by 23 percentage points dating back to 2013, including a 13 percentage point advantage year-to-date.  The FAANG stocks1 have led the market, with an average return of +160% since the beginning of 2013, and now represent more than 10% of the S&P 500 Index.  This has led to a wide valuation discrepancy between the value and growth indexes: the Russell 1000 Value trades at 17x forward earnings and 2x book value compared to the Russell 1000 Growth at 23x and 7x, respectively. 

We have continued to find value opportunities selectively, though it is more difficult today than it was 5 years ago.  Financials, technology, and energy represent the portfolio’s largest weights; REITs, consumer staples, and utilities represent the largest underweights.  The former sectors not only trade at considerable valuation discounts but also have higher earnings growth expectations over the next two years compared to the latter sectors.  We are always leery of paying high multiples for stocks, particularly when growth prospects are bleak. 

While select market segments appear richly valued, we believe others remain quite attractive.  Given this dichotomy, our portfolio’s composition and its characteristics are vastly different from the index.  The valuation discount is particularly striking; the portfolio trades at 10x normal earnings compared to 15x and 18x for the Russell 1000 Value and S&P 500, respectively.  The portfolio trades at 1.5x book value compared to 2.0x and 3.1x for the two indexes.  

ATTRIBUTION: 3Q 2017

The Hotchkis & Wiley Diversified Value Fund (Class I) outperformed the Russell 1000 Value Index in the third quarter—overall stock selection was positive.  Stock selection in industrials was particularly strong, as the portfolio’s holdings returned +8% compared to +1% for the Russell 1000 Value.  The underweight in consumer staples, the index’s worst-performing sector, helped relative performance; the overweight to technology also helped.  Stock selection in consumer discretionary, telecom, and materials detracted from performance.  The largest individual contributors to relative performance were Hewlett Packard Enterprise, Marathon Oil, Philips, Rockwell Collins, and Boeing; the largest detractors were Ericsson, Discovery Communications, AIG, Bed Bath & Beyond, and Johnson Controls. 

PORTFOLIO ACTIVITY: 3Q 2017

We increased the weight in energy by adding a new position in National Oilwell and increasing the position in Apache.  National Oilwell is a leading provider of oilfield capital equipment, consumables, and services.  Its rig systems business has been under pressure as spending on new rigs has declined amid the decline in oil prices.  While it may take time for this business to revert, its aftermarket, wellbore technology, and completion & production business segments appear to be overlooked in the marketplace.  We decreased the weight in utilities, primarily by trimming Calpine, which is in the process of being acquired.  We reduced the weight in industrials by exiting the position in Boeing due to valuation.  S&P GICS (Global Industry Classification Standard) reclassified Philips from industrials to healthcare during the quarter because the majority of its business is in medical systems/diagnostics and it is in the process of divesting its lighting business.  Much of the portfolio’s increase in the healthcare sector and decrease in the industrials sector was a result of this reclassification and not from trading.

 

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1Facebook, Apple, Amazon, Netflix, and Google

 

Mutual fund investing involves risk. Principal loss is possible. The Fund may invest in foreign securities which involve greater volatility and political, economic and currency risks and differences in accounting methods. The Fund may invest in American Depository Receipts (“ADRs”) and Global Depository Receipts (“GDRs”) which may be subject to some of the same risks as direct investment in foreign companies.

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. Certain information presented based on proprietary or third-party estimates are subject to change and cannot be guaranteed. Portfolio managers’ opinions and data included in this commentary are as of 9/30/17 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 Russell 1000 Value 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. 

Investing in value stocks presents the risk that value stocks may fall out of favor with investors and underperform other asset types during a  given periods. Equities, bonds, and other asset classes have different risk profiles, which should be considered when investing. All investments contain risk and may lose value. 

 

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