Mid-Cap Value Fund (HWMIX)

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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 June 30, 2017

 

MARKET COMMENTARY

The Russell Midcap Index returned +2.7% in the second quarter.  Mid cap growth stocks outperformed mid cap value stocks in the quarter, with the Russell Midcap Growth Index returning +4.2% compared to the Russell Midcap Value Index’s return of +1.4%.  Year-to-date, the growth index has outperformed the value index by more than 6 percentage points, a reversal of value’s 13 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 75% of the Russell Midcap’s quarter return was generated by the tech and healthcare sectors. 

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.  Investors have favored sectors with stable earnings and high dividend payouts, bidding them up to levels we view as excessive; we are underweight REITs, regulated utilities, and consumer staples.  We are overweight energy, technology, and consumer discretionary, which we believe 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 7.2x normal earnings compared to 15.8x and 18.1x for the Russell Midcap Value and Russell Midcap, respectively.  The portfolio trades at 1.1x book value compared to 1.9x and 2.6x for the two indices, respectively. 

ATTRIBUTION: 2Q 2017

The Hotchkis & Wiley Mid-Cap Value Fund underperformed the Russell Midcap Value Index in the second quarter.  The overweight and stock selection in energy detracted from performance along with stock selection in consumer discretionary.  Relative to the benchmark, the portfolio benefitted from its strong selection in utilities and financials.  The largest individual contributors to relative performance were Calpine, Office Depot, CIT Group, Willis Towers Watson, and Corning; the largest detractors were Whiting Petroleum, Bed Bath & Beyond, Weatherford International, Cairn Energy, and Discovery Communications.  

PORTFOLIO ACTIVITY: 2Q 2017

We increased our energy exposure by adding new positions in C&J Energy Services and Sanchez Energy, and adding to the existing position in Superior Energy Services.  This was partially offset by trimming the position in Marathon Oil.  We reduced our technology exposure by trimming positions in Corning and CDW, which have both performed well recently. 

 

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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.

Mutual fund investing involves risk. Principal loss is possible. Investing in medium-sized companies involves greater risks than those associated with investing in large company stocks, such as business risk, significant stock price fluctuations and illiquidity. The Fund may invest in foreign securities 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. 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 6/30/17 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 MidcapValue 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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