Small Cap Value Fund (HWSIX) - Limited Availability


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 December 31, 2018


The Russell 2000 Index was up more than +11% through the first nine months of the year before posting its worst calendar quarter in 7 years, falling -20.2% in Q4.  The end result was a -11.0% return for calendar year 2018.  In the fourth quarter, robust corporate earnings and strong economic indicators were no longer enough to fuel equity returns.  Suddenly, Fed tightening, a slight uptick in inflation, trade tensions, and a concern that tax stimulus had run its course all conspired to reverse equity gains in an abrupt risk off sell off. Small cap stocks bore the brunt of this correction due to their economic sensitivity and less defensive nature. Meanwhile, real GDP growth in the US was a healthy +3.4% in the most recent quarter and the unemployment rate remains below 4%.  The forward P/E ratio for the Russell 2000 Index declined from 20.6x at the beginning of the year to 14.3x at the end of the year.  The index’s median P/E since 1995 is 16.7x, so it went from well above average to comfortably below average over the course of the year. 

Based on historical pre-recession peak to trough returns, the typical Russell 2000 decline is about -32% with the Global Financial Crisis being the lone exception.  By way of comparison, the peak to trough decline in the Russell 2000 during 2018 was -27%.  Commodity securities were among the worst-performers of the year, with the small cap energy (-37%) and materials sectors (-26%) leading the decline.  Non-cyclical utilities performed best, returning +4% during the year—the only sector in the Russell 2000 Value with a positive return.  The performance dispersion and resulting valuation differentials among stocks that are economically sensitive compared to those that are not suggests the market has begun to price in a recession scenario.  Economic metrics do not yet verify a meaningful change from positive economic growth.  At present, while acknowledging the uncertain economic outlook, we view the valuation support of cyclical stocks as vastly superior to non-cyclicals.  We believe this valuation discrepancy provides a “margin of safety” in the long run almost irrespective of near term economic growth.

The portfolio trades at a substantial valuation discount to the index, which makes us optimistic about its prospects irrespective of market direction or temperament.  The portfolio trades at 6.1x normal earnings compared to 12.5x for the Russell 2000 Value and 14.4x for the Russell 2000.  The portfolio’s price-to-book ratio is 1.0x compared to 1.2x and 1.8x for the Russell 2000 Value and the Russell 2000, respectively.     


The Hotchkis & Wiley Small Cap Value Fund underperformed the Russell 2000 Value Index in 2018.  The portfolio’s average energy weight was about double the benchmark’s average weight (14% vs. 7%) which detracted from performance.  Energy was the worst-performing sector in the Russell 2000 Value during the year by a large margin, as crude oil prices fell 25% in the year.  The portfolio’s energy stocks held up considerably better than the index’s energy stocks, but not enough to compensate for the overweight allocation.  Stock selection in communication services and consumer discretionary also detracted from performance.  Positive stock selection in technology and healthcare, along with the underweight position in materials helped relative performance.  The largest individual detractors to relative performance were C&J Energy Services, Masonite International, WestJet Airlines, MDC Partners, and CNO Financial; the largest positive contributors were ARRIS International, Popular, Hanger, Whiting Petroleum, and Matson.

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 12/31/18 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 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 periods. 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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