Small Cap Value Fund (HWSIX)

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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, 2019

 
MARKET COMMENTARY

The Russell 2000 Index returned -2.4% in the third quarter of 2019 but remains up more than +14% since the beginning of the year.  The Federal Reserve’s FOMC (Federal Open Market Committee) lowered the Fed Funds rate by 25 basis points for the second time this year, which now stands at 2.0% (upper bound).  With inflation benign and economic growth modest, albeit positive, the rate cut was widely expected and triggered little reaction from equity markets.  The price of crude oil spiked following the drone attacks on Saudi refineries, but this was short-lived and WTI (West Texas intermediate) crude finished the quarter down -8%.  Energy was the Russell 2000’s worst-performing sector, declining -21% in the quarter.  It has been the index’s worst-performing sector over the past year returning -49% (WTI has declined -27% over the past year), and has been the worst-performing sector in three of the past four calendar quarters.  Utilities +5% and real estate +5% were the best-performing small cap sectors in the quarter.  These are also the top two sectors, by far, over the past year.  The Russell 2000 is down -9% over the past 12 months but utilities and real estate are up +20% and +7%, respectively. 

Concerns about slowing economic growth and a possible recession have become increasingly pervasive amid erratic trade negotiations and geopolitical uncertainty (e.g. Brexit in the UK, potential impeachment proceedings in the US).  As a result, treasuries rallied during the quarter with the yield on the 10 year note falling below 1.5% in late August—for about a week, the 2-year treasury yield exceeded the 10-year treasury yield.  This caught investors’ attention because contemporary recessions have been preceded by similar 10-year/2-year yield curve inversions.  The time between inversion and recession has varied significantly, from several months to more than 2 years. 

The timing of the next economic slowdown and/or recession is unclear but it is certainly possible in the near to intermediate term, and we acknowledge this as a legitimate risk.  In periods leading into economic slowdowns, intuition would suggest that equity investors should gravitate toward stocks with less economic sensitivity.  For the most part, this was a winning strategy during the early 2000s recession.  During that period, richly valued internet, telecom, and media stocks cratered and many less cyclical stocks outperformed.  In today’s market, however, the richly valued stocks are the non-cyclicals, which suggests that an economic slowdown is already priced in—perhaps overly priced in.  As noted above, utilities and real estate—non-cyclical sectors—have outperformed more cyclical areas significantly.  Consequently, the valuation dispersion between certain market segments is uncommonly wide. 

The portfolio continues to trade at a large discount to the market.  The portfolio trades at 6.4x normal earnings compared to 12.6x for the Russell 2000 Value Index and 21.2x for the Russell 2000 Growth Index.  It trades at 1.1x book value compared to 1.3x and 3.8x for the value and growth indices, respectively.  This valuation discount combined with healthy balance sheets and good underlying businesses has us confident about the portfolio’s prospects as we look forward.    

ATTRIBUTION: 3Q 2019

The Hotchkis & Wiley Small Cap Value Fund underperformed the Russell 2000 Value Index in the third quarter of 2019.  The overweight position and stock selection in energy was the largest detractor to relative performance in the period, followed by the underweight position and stock selection in real estate.  Positive stock selection in healthcare, consumer discretionary, and communication services helped relative performance.  The largest individual detractors to relative performance in the period were Whiting Petroleum, Resideo Technologies, Nine Energy Services, Range Resources, and Frank’s International; the largest positive contributors were Sonic Automotive, Enstar Group, Masonite International, First Horizon National, and Quad Graphics. 

Mutual fund investing involves risk. Principal loss is possible. Investing in smaller and/or newer companies involves greater risks than those associated with investing in larger companies, such as business risk, significant stock price fluctuations and illiquidity. The Fund may invest in ETFs, which are subject to additional risks that do not apply to conventional mutual funds, including the risks that the market price of an ETF’s shares may trade at a discount to its net asset value ("NAV"), an active secondary trading market may not develop or be maintained, or trading may be halted by the exchange in which they trade, which may impact a Fund’s ability to sell its shares.  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 9/30/19 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 2000 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 period. 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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