Value Opportunities Fund (HWAIX)

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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 S&P 500 Index returned +3.1% in the second quarter.  Growth stocks outperformed value stocks in the quarter, with the Russell 3000 Growth Index returning +4.7% compared to the Russell 3000 Value Index’s return of +1.3%.  Year-to-date, the growth index has outperformed the value index by more than 9 percentage points, a reversal of value’s 11 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 one-third of growth’s outperformance has come from just five mega cap stocks—Apple, Amazon, Facebook, Google, and Microsoft.

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.  In addition to the mega cap growth stocks previously mentioned, investors have favored sectors with stable earnings and high dividend payouts, bidding them up to levels we view as excessive; we are underweight consumer staples and utilities.  We are overweight financials, energy, and industrials, 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 8.5x normal earnings compared to 17.3x for the S&P 500 and 1.2x book value compared to 3.0x for the index. 

ATTRIBUTION: 2Q 2017

The Hotchkis & Wiley Value Opportunities Fund underperformed the S&P 500 Index in the second quarter.  The Fund’s value focus hurt performance relative to the S&P 500 as growth stocks outperformed value stock by a considerably margin.  The Value Opportunities Fund (Class I) outperformed the Russell 3000 Value Index.  Relative to the S&P 500, security selection in healthcare, consumer discretionary, and consumer staples detracted from performance.  This was partly offset by positive security selection in materials.  The largest individual contributors to relative performance were Oracle, Office Depot, Citigroup, Popular, and Vodafone; the largest detractors were Energy XXI Gulf Coast, Hewlett Packard Enterprise, Bed Bath & Beyond, Discovery Communications and Hanger. 

 

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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 non-diversified funds and/or smaller and/or medium-sized companies involves greater risks than those associated with investing in diversified funds and/or large company stocks, such as business risk, significant stock price fluctuations, sector concentration and illiquidity. The Fund is non-diversified, meaning it may concentrate its assets in fewer individual holdings than a diversified fund.  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. 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.

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.  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.

The average annual total returns for the Russell 3000 Value Index were 1.29%, 16.21%, 7.32%, 13.89%, 5.59% and 9.36% for 2Q17, one-year, three-year, five-year, ten-year and Since 12/31/02 periods ended June 30, 2017.
 

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