Small Cap Value (Limited Availability)

Market Commentary

Period ended September 30, 2017


The Russell 2000 Index returned +5.7% in the third quarter; the Russell 2000 Growth and Value Indexes returned +6.2% and +5.1%, respectively. The S&P 500 Index returned +4.5%, its 8th consecutive positive quarter.  Dating back to 2013, this index has generated a positive return in 18 of the last 19 calendar quarters—a feat it had not previously accomplished in its 90+ year history.  Part of the reason for this impressive run was the market’s valuation at the outset of the period.  At the beginning of 2013, for example, the Russell 2000 Value Index traded at 1.3x book value; the financial crisis’ mess had been largely cleaned up but valuations remained in check.  Since then, corporate earnings have been strong and the economic environment supportive.  Accordingly, we categorize most of the performance over this period as a reversion toward normal market valuations as opposed to a market that has overheated dramatically.  Based on most valuation measures, the reversion appears to have overshot historical averages but not wildly so—we are not alarmed, we are guarded. 

Thus far in 2017, small cap growth stocks have outperformed small cap value stocks by more than 11 percentage points.  Much of this performance difference is attributable to the growth index’s large overweight in healthcare and technology and underweight in financials and energy.  The more expensive sectors outperformed the less expensive sectors this year which has led to a wide valuation discrepancy between the value and growth indexes.  We continue to find value opportunities selectively, though it is more difficult today than it was 5 years ago.  Industrials and financials represent the portfolio’s largest weights; we have no/limited exposure in telecom, consumer staples, and utilities.  The former sectors not only trade at considerable valuation discounts but also have higher earnings growth expectations over the next two years compared to the latter sectors.  We are always leery of paying high multiples for stocks, particularly when growth prospects are minimal. 

While select market segments appear richly valued, others remain quite attractive.  Given this dichotomy, our portfolio’s composition and its characteristics are vastly different from the index.  The valuation discount is particularly striking; the portfolio trades at 9x normal earnings compared to 16x for the Russell 2000 Value.   


The Hotchkis & Wiley Small Cap Value portfolio (gross and net of management fees) outperformed the Russell 2000 Value Index in the third quarter.  Positive stock selection in technology, industrials, and real estate helped relative performance.  The overweight in industrials was also a positive contributor.  Stock selection in healthcare, materials, and financials detracted from performance in the quarter.  The largest individual contributors to relative performance were WestJet Airlines, Embraer, Rush Enterprises, Meritor, and KBR; the largest detractors were Popular, Energy XXI Gulf Coast, Office Depot, LSC Communications, and Hanger.  

Composite performance for the strategy is located on the Performance tab. Returns discussed 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. Portfolio attribution is based on a representative Small Cap Value portfolio. Certain client portfolio(s) may or may not hold the securities discussed due to each 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, is calculated using daily holding information and does not reflect management fees and other transaction costs and expenses.  Specific securities identified are the largest contributors (or detractors) to the portfolio’s performance relative to the Russell 2000 Value Index. Other securities may have been the best and worst performers on an absolute basis. Securities identified do not represent all of the securities purchased or sold 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 the 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 Literature tabs. For a list showing every holding’s contribution to the overall account’s performance and portfolio activity for a given time period, please contact H&W at  Portfolio information is 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 September 30, 2017 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. Certain information presented is based on proprietary or third-party estimates, which are subject to change and cannot be guaranteed. 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. 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. All investments contain risk and may lose value. 
Past performance is no guarantee of future results.

Index definitions