Large Cap Fundamental Value

Market Commentary

Period ended March 31, 2014

The S&P 500 Index finished the first quarter of 2014 with a +1.8% return but experienced some turbulence along the way.  In early February, the S&P was down nearly 6% for the year, fueled by developments in several of the largest emerging market economies.  Chinese manufacturing slowed and the country’s banking regulator signaled increased credit scrutiny.  Also, Argentina devalued its peso triggering a selloff in several other emerging market currencies, revealing that contagion is alive and well.  This rattled US equity investors, sending the VIX Index from 14 at the beginning of the year to 21 in early February.

Earnings season progressed convincingly, however, and U.S. equities began to recover.  More than 73% of S&P 500 Index companies met or exceeded consensus earnings estimates even though these estimates have risen consistently in recent years.  Harsh winter weather across much of the country affected certain segments of the market (e.g. retail, housing) but should not pose lasting effects.  Consumer confidence climbed to a six-year high in March, an important factor considering personal consumption comprises roughly two-thirds of U.S. GDP.

Performance dispersion by sector was sizeable during the quarter, and largely a reverse of calendar year 2013.  Consumer discretionary went from first-to-worst, and was one of only two S&P sectors with a negative return during the quarter (Telecom was the other).  Utilities went from second worst-to-first, returning +10% during the quarter.  In general, non-cyclical stocks outperformed cyclical stocks, which is a more common occurrence when equity markets are negative.

The housing market has improved, the labor market has improved, corporate earnings have been robust, and balance sheets are strong.  Also, the yield curve is normal-to-steep, which has been a constructive signal for economic growth historically.  Understandably, these factors have served as a springboard for equity markets which have posted astounding returns over the past five years.  This has extended broad equity valuations and tempered our outlook accordingly.  We continue to find interesting opportunities selectively, though the valuation opportunities available several years ago have been at least partly exhausted.  Nevertheless, we remain optimistic about the risk/return prospects of the portfolio.  At 11.3x normal earnings, the portfolio trades at an 18% discount to the Russell 1000 Value Index and a 28% discount to the S&P 500 Index.

ATTRIBUTION: 1Q 2014

The Hotchkis & Wiley Large Cap Fundamental Value portfolio (gross and net of management fees) outperformed the Russell 1000 Value Index during the quarter.  Two-thirds of the outperformance was due to positive stock selection, which was particularly strong in technology, industrials, energy, and utilities.  Within technology, Corning, Hewlett-Packard, and Microsoft each returned more than +10%.  The largest two individual contributors were both utilities, as Public Service Enterprise Group and Exelon each returned more than +20% for the quarter.  Stock selection in telecommunications and financials detracted from performance over the quarter.  The largest individual detractors were Vodafone, Citigroup, and Target.

 

Composite performance for the strategy is located on the Performance tab. Portfolio attribution is based on a representative Large Cap Fundamental Value portfolio. Certain client portfolio(s) may or may not hold the securities discussed due to the account’s guideline restrictions, cash flow, tax and other relevant considerations. Equity performance attribution is an analysis of the portfolio's return relative to a selected benchmark and is calculated using daily holding information.  Returns calculated using this buy-and-hold methodology can differ from actual portfolio returns due to intraday trades, cash flows, corporate actions, accrued/miscellaneous income, and trade price and closing price difference of any given security. 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. Securities identified do not represent all of the securities purchased, sold, or recommended for advisory clients, and are not indicative of current or future holdings or trading activity.  H&W has no obligation to disclose purchases or sales of these securities.  No assurance is made that any securities identified, or all investment decisions by H&W were, or will be profitable. Quarterly characteristics and portfolio holdings are available on the Characteristics and Communications tabs (subject to the firm’s portfolio holdings disclosure policy).
 
The commentary is for information purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Portfolio managers’ opinions and data included in this commentary are as of March 31, 2014 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.  Equity securities may have greater risks and price volatility than U.S. Treasuries and bonds, where the price of these securities may decline due to various company, industry and market factors.  Investing in value stocks presents the risk that value stocks may fall out of favor with investors and underperform growth stocks during given periods. All investments contain risk and may lose value.
 
Past performance is no guarantee of future results.
 

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