Small Cap Diversified Value Fund (HWVAX)

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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 Russell 2000 Index returned +7.8% in the second quarter and is now up +7.7% for the year.  Strong corporate earnings prevailed over trade war risks and geopolitical tensions.  Russell 2000 earnings grew an impressive +25% year-over-year in the most recently reported quarter.  Nearly 400 of the ~2,000 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. 

Unlike US large and mid cap stocks, value outperformed growth in small cap, albeit by a modest magnitude.  The Russell 2000 Value returned +8.3% during the quarter, compared to +7.2% for the Russell 2000 Growth Index.  Small growth maintains a considerable performance edge in recent years; however, having outperformed small value in 11 of the past 16 quarters.  Much of small value’s outperformance in the quarter was a sector story as energy, which comprised 7.3% of the value index and just 1.4% of the growth index, was the top-performing sector across the market by a wide margin. 

The small cap equity market’s valuation appears above average, but this is heavily influenced by the considerable overvaluation of small cap growth stocks.  Because small growth has outperformed small value to such a large extent, we believe the price of select value stocks remains attractive.  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.  An 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”, as has often been the case, is merely investors’ recognition of the wide valuation disparity across equity markets.  Whatever and whenever it may be, we are confident that the cycle will shift in favor of value once again, and our clients are well positioned to potentially benefit. 

The portfolio continued to trade at a considerable valuation discount to both the broad small cap index and the small cap value index, which is why we believe our clients should be rewarded if/when the growth/value cycle turns.  The portfolio trades at 9.8x normal earnings compared to 17.2x and 15.2x for the Russell 2000 and Russell 2000 Value, respectively.   

ATTRIBUTION: 2Q 2018

The Hotchkis & Wiley Small Cap Diversified Value Fund (Class I) outperformed the Russell 2000 Value Index in the second quarter of 2018.  Positive stock selection drove the outperformance, and was most positive in energy, consumer staples, and real estate.  The overweight exposure to energy, the small cap market’s top performing sector by a wide margin, also helped.  About 45% of the portfolio was invested in stocks with a market capitalization of less than $1 billion compared to about 25% for the index, which helped performance as this group outperformed the rest of the index.  Stock selection in healthcare was the largest detractor, followed by the underweight position in REITs.  Stock selection in materials and technology were modest detractors. 

Mutual fund investing involves risk. Principal loss is possible. 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.  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. 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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