Mid-Cap Value Fund (HWMAX)

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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, 2018

 
MARKET COMMENTARY

The Russell Midcap Index returned +5.0% in the third quarter and is now up +7.5% since the beginning of the year.  Failed Brexit negotiations and the threat of a global trade war have triggered short-lived bouts of equity market volatility, but positive economic data and strong corporate earnings growth has overwhelmed those concerns.  Despite Wall Street having revised estimates upward rather persistently, nearly 75% of Russell Midcap companies beat consensus earnings estimates in the most recent quarter.  The median positive surprise was 7% above consensus estimates.  In technology and healthcare, the two top-performing sectors in the quarter, more than 80% of companies reported an earnings beat. 

Mid cap growth outperformed mid cap value in the quarter, extending its considerable lead in recent years.  Some of the disparity was due to differences in sector exposures: the growth index has more exposure to technology which outperformed, and less exposure to REITs and financials which underperformed.  Sector weights aside, however, stocks with high valuations outperformed stocks with low valuations.  The Russell Midcap Growth Index has outperformed the Russell Midcap Value Index by more than 10 percentage points since the beginning of the year, after outperforming by nearly 12 percentage points in 2017.  As a result, the valuation gap between growth stocks and value stocks has widened.  Three years ago, the forward P/E for the Russell Midcap Growth was 20.5x compared to 17.5x for the Russell Midcap Value, for a difference of 3.0x (“growth premium”).  Since the year 2000, the median growth premium has been 3.3x, so three years ago spreads were modestly narrower than average.  Today, however, the forward P/E ratio for the Russell Midcap Growth has expanded to 24.4x while the Russell Midcap Value has declined to 16.5x.  The current growth premium, therefore, is 7.9x (24.4x – 16.5x), or more than double the long term average.  Earnings growth between the two indices has been comparable, thus the primary cause of the outperformance has been the repricing of growth stocks, i.e. multiple expansion.  We do not believe that this valuation gap can widen indefinitely, and consequently we are optimistic about the prospects of value relative to growth as we look forward.  

We remain overweight technology and energy compared to the Russell Midcap Value, though we have taken capital out of technology since the beginning of the year.  The sector overall, and our portfolio holdings in particular, have outperformed and so we have shifted capital to more compelling valuation opportunities.  Portfolio changes have been modest in 2018, however, with year-to-date turnover about 25% by weight and 14% by name. 

The portfolio’s valuation discount relative to the market has moved from wide to wider, which gets us excited about the portfolio going forward.  The portfolio trades at 6.9x normal earnings compared to 16.0x for the Russell Midcap Value and 18.4x for the Russell Midcap.  The portfolio’s price-to-book ratio is 1.2x compared to 2.0x and 2.7x for the Russell Midcap Value and the Russell Midcap, respectively.

ATTRIBUTION: 3Q 2018

The Hotchkis & Wiley Mid-Cap Value Fund underperformed the Russell Midcap Value Index in the third quarter of 2018.  Positive stock selection in healthcare, utilities, and financials helped relative performance.  The overweight allocation to technology and underweight allocation to materials and real estate also helped returns.  This was offset by stock selection in industrials, real estate, and consumer discretionary.  The overweight exposure to energy and underweight exposure to healthcare were also modest detractors.  The largest positive contributors to relative performance were Mallinckrodt, Office Depot, Popular, Hewlett Packard Enterprise, and NRG Energy; the largest detractors were TRI Pointe Group, Ophir Energy, Bed Bath & Beyond, Weatherford International, and Cairn Energy.

LARGEST NEW PURCHASES: 3Q 2018

Interpublic Group of Companies is the world’s fourth largest advertising agency holding company with revenues of ~$8B and close to 15% of the worldwide ad-agency market. Interpublic is an above-average business selling at a discount to the market due to misunderstood risks as the advertising industry changes.

Mutual fund investing involves risk. Principal loss is possible. Investing in medium-sized companies involves greater risks than those associated with investing in large company stocks, such as business risk, significant stock price fluctuations and illiquidity. 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 9/30/18 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 MidcapValue 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. 
 

Index definitions

Glossary of financial terms