Mid-Cap Value Fund (HWMAX)

I SHARES    A SHARES    C SHARES    R SHARES   

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 Russell Midcap Index returned +2.8% in the second quarter and is now up +2.3% 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.  Russell Midcap earnings grew an impressive +25% year-over-year in the most recently reported quarter, with more than 75% of companies beating consensus estimates.  More than 175 of the ~800 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. 

The Russell Midcap Growth Index returned +3.2% during the quarter, compared to +2.4% for the Russell Midcap Value Index.  Mid cap growth has outperformed value in 11 of the past 15 quarters, including each of the past six.  Energy was the top-performing sector, and because it is a larger weight in the value index, this helped value’s relative performance.  This was offset by value’s larger exposure to financials which was among the market’s worst-performing sectors, and value’s smaller exposure to technology which outperformed the market.  Within sectors growth outperformed value.  This was most pronounced in the consumer discretionary sector, where Russell Midcap Growth stocks rose +7.1% but Russell Midcap Value stocks rose just +0.8%. 

Since the beginning of the year, we have increased the weight in real estate and industrials modestly while trimming the weight in energy.  In real estate, we have identified an eclectic mix of distinct opportunities even though we continue to find the broad sector richly valued.  In industrials we have identified attractive opportunities in cyclical businesses that are unrelated and have very different end markets.  While we are still partial to opportunities in energy, we trimmed our overweight position as the stocks have outperformed. 

The mid cap equity market’s valuation appears above average, but this is heavily influenced by certain market segments that we view as considerably overvalued.  Excluding these segments, market valuations appear more reasonable.  Also, because growth has outperformed value to such a large extent, we believe the price of select value stocks remains attractive.  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 across 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 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 6.9x normal earnings compared to 17.9x and 15.6x for the Russell Midcap and Russell Midcap Value, respectively.  The price-to-book value of the portfolio is 1.1x vs. 2.6x and 1.9x for the Russell Midcap and Russell Midcap Value, respectively.    

ATTRIBUTION: 2Q 2018

The Hotchkis & Wiley Mid-Cap Value Fund (Class I) outperformed the Russell Midcap Value Index in the second quarter of 2018.  Positive stock selection drove the outperformance, and was particularly positive in real estate, healthcare, and financials. The overweight and outperformance in energy, a high returning sector, also helped performance.  Stock selection in technology and utilities, combined with an underweight allocation to REITs detracted from performance.  The largest individual contributors to relative performance were Whiting Petroleum, Kosmos Energy, GEO Group, Ericsson, and Discovery; the largest detractors were Hewlett Packard Enterprise, ARRIS International, Goodyear Tire, CNO Financial, and Ophir Energy.    

LARGEST NEW PURCHASES: 2Q 2018

Amerco, through its primary subsidiary U-Haul, offers truck, trailer, and self-storage rentals across its 22,000 locations in the US and Canada.  U-Haul is over 10x larger than its next largest competitor and has more locations than all US rental car companies combined.  In addition, the company has significant optionality in its self-storage business and real estate assets. We believe these advantages, combined with Amerco’s attractive valuation, make the stock compelling.

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 than 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.

CBS is a mass media company that operates in four segments: Entertainment (National CBS network, ~50% of EBIT-Earnings Before Interest & Taxes), Cable Networks (mostly Showtime, ~30% of EBIT), Local TV Broadcasting, and Publishing (Simon & Schuster). CBS’s multiple is depressed relative to other media companies even though it does not face any material risk from disruptions to Pay TV and will take share of distribution fees for many years. A fundamental change in TV’s share of ad spend appears unlikely. Thus, as ad spend in the US recovers and vertical integration to TV production continues, CBS should enjoy increasing revenue with high conversion to EBIT and higher margins on syndication revenue.

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 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 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