Large Cap Value Fund (HWLAX)

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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, 2018

 

MARKET COMMENTARY

After a small decline in the first quarter of 2018, the S&P 500 Index returned +3.4% in the second quarter and is now up +2.7% for the year.  The positive performance from equities suggests that for the time being, investors are choosing to focus on strong corporate earnings as opposed to trade war risks and geopolitical tensions.  S&P 500 earnings grew an impressive +20% year-over-year in the most recently reported quarter, with more than 81% of companies beating consensus estimates.  More than 100 of the ~500 companies in the index reported earnings growth of more than 50% from a year ago.  Interestingly, the composition of this fastest-growing cohort was broadly distributed across sectors even though stock performance across sectors has varied significantly.  Going forward, consensus expectations are for earnings growth in the high teens, even with global trade war concerns. 

The Russell 1000 Growth Index returned +5.8% during the quarter, compared to +1.2% for the Russell 1000 Value Index.  Growth has outperformed value in 15 of the past 20 quarters, including each of the past six.  A large part of the performance difference this quarter stems from significant variations in sector performance.  Energy, consumer discretionary, and technology were the best performing sectors, in that order. While energy is overrepresented in the value index, technology and consumer discretionary are much larger constituents in the growth index.   In addition, the financial sector, among the worst performing sectors in the quarter with a negative quarterly return, is much larger in the value index; financials represent 26.6% of the value index versus just 3.5% of the growth index.  Further, within sectors, growth outperformed value.  This was most pronounced in technology, where Russell 1000 technology Growth stocks rose +8.6% but Russell 1000 technology Value stocks fell -1.0%. 

Since the beginning of the year, we have increased the weight in consumer staples and energy while trimming the weight in technology.  Consumer staples has been the market’s worst-performer year-to-date and thus valuations have improved, particularly relative to the rest of the market.  Energy has outperformed, but stock price increases have not kept pace with the rise in oil prices, which have approached equilibrium levels.  At current commodity prices, our energy holdings reflect highly compelling valuation opportunities, particularly given the broad equity market appears fully/fairly valued.  In technology, we trimmed select positions that had outperformed in lieu of valuation opportunities elsewhere. 

The equity market’s valuation appears above average, but this is heavily influenced by certain market segments that we view as considerably overvalued.  Valuation spreads are wide. In light of value’s underperformance, we are often asked what would serve as the catalyst to bring value back into vogue; unfortunately we do not have a definitive answer.  A rise in interest rates should favor value stocks, which are shorter duration instruments than growth stocks.  A global economic slowdown could favor value if the revenue/earnings projections for growth stocks fail to live up to the rosy expectations embedded in the elevated valuation multiples.  Perhaps the “catalyst”, will be investors’ eventual recognition of the wide valuation disparity across equity markets, as has often been the case.  While the timing is uncertain, we are confident that the cycle will shift in favor of value once again.

The portfolio continued to trade at a considerable valuation discount to both the broad index and the value index, which is why we believe our clients should be rewarded if/when the growth/value cycle turns.  The portfolio trades at 9.5x normal earnings compared to 17.5x and 14.6x for the S&P 500 and the Russell 1000 Value, respectively.  The price-to-book value of the portfolio is 1.6x vs. 3.2x and 2.0x for the S&P 500 and Russell 1000 Value, respectively.  

ATTRIBUTION: 2Q 2018

The Hotchkis & Wiley Large Cap Value Fund (Class I) outperformed the Russell 1000 Value Index in the second quarter of 2018.   Positive stock selection drove all of the outperformance, and was most positive in energy, healthcare, and consumer staples.  Stock selection in industrials and telecommunications, along with an underweight allocation to real estate hurt relative performance.  The largest positive contributors to relative performance were Marathon Oil, Hess, Ericsson, Apache, and Murphy; the largest detractors were Hewlett Packard Enterprise, Cummins, CNH Industrial, Vodafone, and Adient.  

LARGEST NEW PURCHASES: 2Q 2018

AXA Equitable Holdings is a large domestic life insurance company that underwrites and distributes annuities, retirement products, life insurance, and asset management services. It owns a 65% economic interest in AllianceBernstein, a full service, global asset manager that serves both retail and institutional clients. As one of the largest sellers of variable annuities in the US, annuities account for more than 50% of the company’s earnings. AXA is well capitalized and is expected to return a significant amount of its earnings to shareholders. Further, the company trades at a very low level of normalized earnings, both on an absolute basis and relative to peers.

Mutual fund investing involves risk. Principal loss is possible. The Fund may invest in foreign securities which involve greater volatility and political, economic and currency risks and differences in accounting methods.  The Fund may invest in American Depository Receipts (“ADRs”) and Global Depository Receipts (“GDRs”) which may be subject to some of the same risks as direct investment in foreign companies.

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 6/30/18 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 1000 Value Index. Securities’ absolute performance may reflect different results. The “Largest New Purchases” section includes the three largest new security positions during the quarter based on the security’s quarter-end weight adjusted for its relative return contribution; does not include any security received as a result of a corporate action; if fewer than three new security positions at quarter-end, all new security positions are included.  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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