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 March 31, 2017

 

MARKET COMMENTARY

The Russell Midcap Index increased +5.15% in the first quarter of 2017, continuing a nearly unbroken string of quarterly gains since the mid-2012.  The rise in equities has triggered debate about the US equity market’s current valuation.  Most traditional valuation measures are above historical averages; however, these metrics are below historical averages after adjusting for the low interest rate environment.  Our general view is that the broad mid cap market is fully valued.  Often overlooked, however, is that some market segments contain bargains while others are richly valued.  Finding such opportunities has become more difficult in recent years but we continue to observe a large valuation discrepancy between cyclical market segments and those viewed as bond surrogates.  Today’s popular stocks are those that have relatively stable earnings and high dividend payouts, like REITs, consumer staples, and regulated utilities.  While the underlying businesses are stable, these are mature, slow-growing market segments, and paying 20-25x earnings is a risky proposition in our view.  Investing in passive ETFs that track common equity indices is the other preferred strategy of the day, pouring still more investor capital into overvalued stocks and exacerbating the situation.  Meanwhile, some market segments that have been shunned trade for half the valuation levels of the more favored areas of the market, and in select circumstances, even trade at a discount to the replacement cost of the business.  

As an example, we own several banks that trade at discounts to tangible book value; it would cost more to replicate the asset base than to simply buy the company.  These businesses continue to have a stigma from the financial crisis, which is in part why current valuations remain attractive.  The fact remains, however, that these companies provide essential services to the economy (low obsolescence risk) and have capital ratios/liquidity metrics at the highest levels since the 1930s.  Regulatory uncertainty always represents a risk, but this also acts as a barrier to entry as leading franchises are difficult and costly to displace—an often overlooked benefit. Technology is another sector that offers attractive valuation opportunities for the risks at hand.  In our opinion, we own a mix of attractively-valued hardware and equipment companies with businesses that we view as more predictable than most technology companies.  These businesses have relatively sticky customers, strong balance sheets, and are prudent capital stewards. 

Because we have identified attractive pockets of opportunity within a fully valued market, the portfolio trades at a large discount to the market.  The portfolio trades at 1.2x book value and 7.1x normal earnings compared to 1.9x and 16.0x, respectively, for the Russell Midcap Value.  Compared to the Russell Midcap, the portfolio’s valuation discount is even more pronounced, as the broad index trades 2.6x book value and 18.3x normal earnings.  

ATTRIBUTION: 1Q 2017

The Hotchkis & Wiley Mid-Cap Value Fund underperformed the Russell Midcap Value Index in the first quarter of 2017.  Stock selection in Industrials and Energy detracted from performance along with an overweight position in Energy.  Relative to the benchmark, the portfolio benefitted from its strong selection in Utilities and Real Estate.  The largest individual contributors to relative performance were NRG, Goodyear, Ericsson, GEO Group, and Corning, while the largest detractors were Whiting Petroleum, ARRIS, Cobalt, Navistar and Cairn Energy.   

PORTFOLIO ACTIVITY: 1Q 2017

We added three new positions and fully exited five during the quarter, closing with 59 holdings.  We reduced the weight in utilities by trimming the position in NRG.  We modestly added to consumer discretionary and healthcare. 

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 3/31/17 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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