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 December 31, 2019


For much of calendar year 2019, the United States engaged in a trade war with its largest global trading partner.  Near the end of the year, the House of Representatives impeached the President for just the third time in history.  US equity markets shrugged off the tumultuous political environment and the S&P 500 Index returned an impressive +31.5%; there have been only 16 calendar years since 1926 that have been better.  Small caps were slightly less heroic, as the Russell 2000 Index returned a respectable +25.5%. The economy has been supportive with real GDP modestly positive, inflation range-bound around 2%, and unemployment at a 50-year low.   

Technology was the top-performing sector by a large margin, returning more than +40% over the 12 months.  Energy was the worst-performing sector for the third year in a row, returning -7%.  All other Russell 2000 sectors returned between +15% and +30%.  Over the past 3 years, energy was the index’s worst-performing sector, returning -54% compared to the overall index return of +28%, cumulatively. The second-worst performing sector returned +7% (materials). 

For the third consecutive year, the Russell 2000 Growth Index outperformed the Russell 2000 Value Index (+28.4% vs. 22.4%).  Small cap growth outperformed small cap value in 8 of the last 10 calendar years with cumulative outperformance of more than 60% (+239% vs. +173%, or +13.0% vs. +10.6% annualized), nearly all of which occurred in the last three years.  The lopsided performance has resulted in a wider-than-normal valuation spread between growth and value. Over the past decade, the average price-to-normal earnings ratio for the Russell 2000 Growth has been 21.4x compared to 13.9x for the Russell 2000 Value, which represents an average valuation spread of 7.5x.  As of 12/31/19, the price-to-normal earnings ratio for the small cap growth and value indices were 23.0x and 13.6x, respectively, or a spread of 9.4x. This valuation gap has only been wider 1% of the time over the last decade.  

Investors’ increasing preference for low stock price volatility explains at least a portion of the valuation gap’s widening. This has caused a substantial divergence between certain industries whereby many non-cyclicals exhibit rich risk-adjusted valuations relative to their cyclical counterparts.  As an example, the forward P/E ratio for small cap utilities has more than doubled over the last decade while the forward P/E ratio for small cap banks has declined by 20%. We have nothing against utilities, consumer staples, or REITs, other than the seemingly high prices currently required to purchase them.   

While the overall equity market appears fully valued compared to history, we believe the valuation disparities across the market create an investment environment highly conducive to long-term focused active management, particularly in relative terms.  The spread between the growth and value indices is wide, suggesting a promising outlook for value.  The spread between the portfolio and the value index is also wide, suggesting a promising outlook for the portfolio.  The portfolio trades at 7.0x normal earnings (10 year average of 8.0x) compared to the Russell 2000 Value at 13.6x (10 year average of 13.9x) and the Russell 2000 Growth at 23.0x (10 year average of 21.4x). The considerable valuation advantage combined with good underlying businesses and healthy balance sheets leaves us confident about the portfolio’s prospects.    


The Hotchkis & Wiley Small Cap Value Fund underperformed the Russell 2000 Value Index in 2019.  Value lagged growth, and the portfolio exhibits valuation characteristics at a discount to the value index—this was a stylistic headwind and hurt relative performance in the year.  To illustrate the strength of this headwind, consider that Russell 2000 Value stocks that began the year with a price-to-book ratio of less than 1.0x had a negative return for the year despite the overall index return of +22%.  While heavily discounted stocks in the portfolio outperformed similar stocks in the benchmark, by a wide margin, the portfolio’s average exposure to this cohort was 26% compared to 14% for the index—an insurmountable hurdle.  The overweight position and stock selection in energy also detracted from performance. Positive stock selection in consumer discretionary, healthcare, and financials helped relative performance in the year. The underweight positions in communication services and consumer staples were modestly helpful. The largest individual detractors to relative performance were Whiting Petroleum, Embraer, C&J Energy Services, Resideo Technologies, and Global Indemnity; the largest positive contributors were Sonic Automotive, WestJet Airlines, Masonite International, KBR, and Hanger.  

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 12/31/19 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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