Value Opportunities Fund (HWAAX)

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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 S&P 500 Index returned +3.4% in the second quarter and is now up +2.7% for the year.  Strong corporate earnings prevailed over trade war risks and geopolitical tensions.  S&P 500 earnings grew an impressive +20% year-over-year in the most recently reported quarter, with more than 81% of companies beating consensus estimates.  More than 100 of the ~500 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.  Going forward, consensus expectations are for earnings growth in the high teens, even with the looming threat of a global trade war. 

The Russell 3000 Growth Index returned +5.9% during the quarter, compared to +1.7% for the Russell 3000 Value Index.  The Russell 3000 Growth has outperformed its value counterpart in 14 of the past 20 quarters, including each of the past six.  A large part of the performance difference this quarter stems from significant variations in sector performance.  Energy, consumer discretionary, and technology were the best performing sectors, in that order. While energy is overrepresented in the value index, technology and consumer discretionary are much larger constituents in the growth index.   In addition, the financial sector, among the worst performing sectors in the quarter with a negative quarterly return, is much larger in the value index; financials represent 29.6% of the value index versus just 3.7% of the growth index.  Further, within sectors, growth outperformed value.  This was most pronounced in technology, where Russell 3000 technology Growth stocks rose +8.6% but Russell 3000 technology Value stocks fell -0.5%. 

Since the beginning of the year, we have increased the weight in industrials, consumer staples, and real estate while trimming the weight in technology.  In industrials we have identified attractive opportunities in cyclical businesses that are unrelated and have very different end markets.  Consumer staples has been the market’s worst-performer year-to-date and thus valuations have improved, particularly relative to the rest of the market.  In real estate, we have identified an eclectic mix of distinct opportunities even though we continue to find the broad sector as richly valued.  In technology, we trimmed select positions that had outperformed in lieu of valuation opportunities elsewhere. 

The 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 and that a rising interest rate environment will be especially challenging for growth stocks as they are long duration assets whose present values may be severely discounted with an interest rise.   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 the market, which is why we believe our clients should be rewarded if/when the growth/value cycle turns.  The portfolio trades at 7.8x normal earnings compared to 17.5x for the S&P 500; the price-to-book value of the portfolio is 1.3x vs. 3.2x the S&P 500.  

ATTRIBUTION: 2Q 2018

The Hotchkis & Wiley Value Opportunities Fund (Class I) outperformed the S&P 500 Index in the second quarter of 2018.  The overweight and positive security selection in energy led the outperformance in the quarter.  Positive security selection in consumer staples, real estate, and consumer discretionary also helped.  Security selection in technology along with the overweight position in financials detracted from performance.  The largest individual contributors to relative performance were Whiting Petroleum, Seritage Growth Properties, Discovery, Frank’s International, and Ericsson; the largest detractors were WestJet, Hewlett Packard Enterprise, ARRIS International, Societe Generale, and Vodafone.  

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.

Comcast is the largest cable service provider in the US and owns the NBCU media conglomerate. Comcast’s price does not reflect the growth it should produce if it continues to take share of the video and broadband markets. Comcast has the potential to grow at the expense of technologically inferior competitors and has strong record of returning cash to shareholders.

Corning is a materials sciences company that sells glass, ceramic, and advanced plastic products. Corning is priced at a modest multiple of current earnings for an outstanding business.  We believe Corning will be able to sustain a permanent margin advantage over its competition. Our conservative normal earnings estimate assumes no improvement from several new products that could each drive material earnings growth as glass use penetrates different industries. 

Mutual fund investing involves risk. Principal loss is possible.  Investing in non-diversified funds and/or smaller and/or medium-sized companies involves greater risks than those associated with investing in diversified funds and/or large company stocks, such as business risk, significant stock price fluctuations, sector concentration and illiquidity. The Fund is non-diversified, meaning it may concentrate its assets in fewer individual holdings than a diversified fund.  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. Investments in debt securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term debt securities. Investment by the Fund in lower-rated and non-rated securities presents a greater risk of loss to principal and interest than higher-rated securities. The Fund may invest in derivative securities, which derive their performance from the performance of an underlying asset, index, interest rate or currency exchange rate. Derivatives can be volatile and involve various types and degrees of risks. Depending on the characteristics of the particular derivative, it could become illiquid.

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 S&P 500 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.

 

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