Small Cap Value Fund Third Quarter 2017

We outperformed our index in the quarter led by stock selection in the Consumer Discretionary, Energy and Materials and Processing sectors. Optimism about tax reform pushed previously lagging small cap indexes to the lead in the quarter.  Small cap stocks pay a higher tax rate than large cap stocks on average and would be bigger beneficiaries of lower taxes. Sector performance was not a major factor in the quarter. Cheap valuations were a headwind for us in the quarter and the year to date. JP Morgan research recently said value spreads are near record levels.

Small Cap Value Fund Second Quarter 2017

We underperformed our index as a 9% decline in oil prices drove down prices of the Fund’s energy holdings. The energy impact was almost all due to our overweighting as our stock selection was benign. We trimmed our technology holdings in the quarter as they approached our price targets. Our style was not in favor versus small cap growth in the quarter as cheap valuation characteristics were a headwind. Bond surrogates outperformed as long term interest rates fell despite solid economic growth. This underweighted cohort sells at an 800 basis point Price to Earnings premium to non bond surrogate stocks despite lower earnings growth rates.

Small Cap Value Fund First Quarter 2017

The S&P 500 continued to rise and is now up 11% since the election. Meanwhile, the bond market stabilized in the quarter following a rough fourth quarter. After the strong tailwinds we received in the second half of 2016, a more nuanced environment in the quarter was not unexpected. Oil prices dropped 6 percent in the quarter causing energy to be the weakest sector in our index. Given our overweight this was a drag on performance. Our energy stock selection was a non factor.

Bond proxies slightly outperformed in the quarter after their underperformance late last year. This dramatically underweighted group still sells at a relative price to earnings ratio (p/e) premium over non bond proxies that is 36% above the long term relationship and is extremely expensive in our view. On the positive side, our stock selection in technology was strong, leading to our outperformance versus our benchmark.

Small Cap Value Fund Fourth Quarter 2016

US treasury yields ripped higher in the quarter after the election, finally moving to positive real yields. The dollar rallied to multiyear highs in response to the widest bond yield differentials versus German and Japanese yields in 30 years. Thus the reflationary sector rotation that began in the 3rd quarter accelerated in the fourth quarter, reversing years of low volatility, bond proxy leadership. This created a long lost tailwind for our deep value style. Low volatility and bond proxy stocks are still expensive, however, given the massive overvaluation that existed at midyear. Our outperformance for the year was primarily produced by energy, as energy outperformed the index for the first time in 6 years.

Small Cap Value Fund Third Quarter 2016

We outperformed our index in the quarter and the 9 month period, as some of the headwinds buffeting our deep value style over the last 5 years partially unwound. Bond proxies and low volatility stocks were weak performers in the quarter, after being bid up for several years primarily due to the bond market bubble. Radical global monetary experiments have caused over ten trillion dollars worth of bonds to have negative nominal interest rates. Large negative real rates are highly unlikely to last longer term. While we are not expecting an imminent bond market reversal, it will be positive for our style when it occurs.

Small Cap Value Fund Second Quarter 2016

We outperformed our index in the quarter despite a macro environment that was similar to the last few years; lower global long term interest rates and an equity market response bidding up defensive bondproxies and low volatility stocks, areas our deep value style rarely allows us to own. In the quarter and year to date, Utilities, Consumer Staples and Telecom were among the leading sectors of the market in its continuing reach for dividend yield and high payout ratios.  These areas, as well as Financial Services and Producer Durables were headwinds to performance.  Recently, fundamentals have only explained a portion of equity returns, as factor trading dominates.  Bond proxies trade at an unusually wide 38% P/E premium to non proxies, despite earnings growth rates that are generally lower.