Small Cap Value Fund (HWSIX)


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, 2019


The Russell 2000 Index returned +2.1% in the second quarter and is now up +17.0% since the beginning of the year.  An increasingly dovish tone from the US Federal Reserve contributed to positive equity markets, as Chairman Jay Powell indicated a readiness to lower interest rates for the first time in more than a decade. The Federal Funds futures market is pricing in a high likelihood of a rate cut during the Fed’s next meeting. In addition, geopolitical tensions subsided, as the US reached a deal with Mexico to halt proposed tariffs, and US-China trade talks resumed.  Small cap performance varied greatly by sector, with industrials leading the way at +8% and energy lagging at -9%.  Growth again outpaced value, further widening the valuation gap.  Over the past five years, the Russell 2000 Growth Index has outperformed the Russell 2000 Value Index by a large margin, returning +51% compared to +30%, cumulatively. 

We continue to view the overall small cap equity market as about fairly valued, perhaps slightly overvalued.  However, this is far from a normal market.  On the one hand, the market’s valuation suggests that investors have a reasonably healthy risk appetite.  On the other hand, certain attributes imply that investors are exceptionally risk averse.  A glaring example outside of US equity markets is the negative yield on some country’s government debt (e.g. German bunds), where investors are guaranteed to lose money if held to maturity.  A preference for a small, yet certain loss over a wider range of outcomes exemplifies extreme risk aversion.  This risk aversion is borne out in the US small equity market through a comparison of different sectors.  Sectors with low economic sensitivity and stable earnings streams have been flooded with capital while cyclical sectors have been shunned, irrespective of valuation.  Regulated utilities, for example, are largely insulated from economic slowdowns and exhibit more stable earnings than most other businesses.  This has appealed to risk averse equity investors, which have flooded the sector with capital.  As a result, small cap utilities’ P/E multiples are now more than 30x, an increase of 40% over the past five years.  We view this as a rich price to pay for a sector with modest prospects for growth, and do not view this as a safe investment.  While it does not represent a certain loss, we believe the long-term upside potential at these valuations are paltry at best.  Most REITs, consumer staples, and healthcare companies exhibit a similarly unappealing long-term risk-reward tradeoff. 

In many cases, banks and other financials trade at less than half the valuation of the non-cyclical markets segments.  Select small cap companies within industrials, technology, and energy also trade at substantial discounts to their intrinsic values.  These sectors have a higher correlation with economic cycles than non-cyclicals, but valuations render the long-term prospects more appealing irrespective of near-term economic growth.  Also, we have a deep-rooted preference for strong balance sheets, which we believe can provide a form of protection should the macro environment take a turn for the worse.  In our view, this combination represents a considerably less risky investment—and one with considerably more upside potential. 

The wide dichotomy between undervalued and overvalued pockets of the market has facilitated a portfolio that trades at a large valuation discount to the market, in our view, without assuming undue risk.  The portfolio trades at 6.8x normal earnings compared to 13.5x for the Russell 2000 Value Index and 20.2x for the Russell 2000 Growth Index.  It trades at less than 1.1x book value compared to 1.4x and 3.8x for the small value and mid growth indices, respectively.  This valuation discount combined with healthy balance sheets and good underlying businesses has us confident about the portfolio’s prospects as we look forward.    


The Hotchkis & Wiley Small Cap Value Fund underperformed the Russell 2000 Value Index in the second quarter of 2019.  Small cap value lagged small cap growth, which serves as a headwind for our value-focused investment process.  More than 25% of the portfolio trades at a discount to book value, compared to just 12% for the Russell 2000 Value—this was a performance detractor in the quarter.  The overweight position and stock selection in energy hurt relative performance, as energy was the market’s worst-performing sector.  Positive stock selection in communication services, consumer discretionary, and healthcare helped relative performance.  The overweight position in industrials and underweight position in consumer staples also helped returns.  The largest individual detractors to relative performance in the quarter were Office Depot, Whiting Petroleum, Tutor Perini, CommScope, and Frank’s International; the largest positive contributors were WestJet Airlines, Sonic Automotive, KBR, Matson, and Stifel Financial.

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 ETFs, which are subject to additional risks that do not apply to conventional mutual funds, including the risks that the market price of an ETF’s shares may trade at a discount to its net asset value ("NAV"), an active secondary trading market may not develop or be maintained, or trading may be halted by the exchange in which they trade, which may impact a Fund’s ability to sell its shares.  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 6/30/19 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 2000 Value Index. Securities’ absolute performance may reflect different results. 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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