Fourth Quarter, 2013 Commentary In the fourth calendar quarter of 2013, the KEELEY Alternative Value Fund (KALVX) increased 5.72 percent compared to a 8.83 percent rise for th e Russell 2500 Value Index and a 10.51 percent incline for the S&P 500 Index. For the full year ending December 31, 2013, the Keeley Alternative Value Fund rose 21.47 percent co mpared to a 33.32 percent rise in the Russell 2500 Value Index, and a 32.39 percent rise in the S&P 500 Index. The fourth quarter capped off a remarkable year for equities in 2013. After strong results in 2012 and a number of concerning political and economic issues, the fo urth quarter completed an impressive climb in 2013 that seemed to surprise many investors. U.S. equities have more than doubled since the lows set in 2009 and the S&P 500 Index pr oduced its best return in 2013 in nearly fteen years. Small-cap stocks were even better, se tting record highs in 2013 as higher-beta stocks outperformed for much of the year. The long- side of the portfolio generated solid absolute and relative returns for the quarter and f or the year, outpacing the Russell 2500 Value Index over both time periods. However, Broadm ark was partially hedged for much of the year, and that proved to be a drag on performan ce for all of 2013 and was the key factor in the Fund trailing the Russell 2500 Value Index a nd the S&P 500 Index.
The Fund was 40 percent hedged coming into the 4th quarter and became more defensive with the budget and debt ceiling fears, reaching a maximum of 60 percent hedged in early October. Following the agreements in Washington the hedge was reduced and ultimately removed mid-month. Broadmark's sentiment readings r eached overly optimistic levels, which is bearish in their work, and they brought the net exposure of the portfolio down, implementing a 25 percent hedge in early November. Investor sentiment continued to move into negative range causing them to become more defensive and raising the hedge to 50 percent for the remainder of November. They reduced the hedge as conditions began to stabilize into year end. The fund finished the year with a 20 percent hedge in the Russell 2000.
Looking ahead Broadmark is watching interest rates and sentiment levels very closely. Higher interest rates at some point could be a catalyst for the deepest correction the market has seen in the last 18 months. However, for a bigger top in the market we could see a greater correction followed by new highs and larger diverge nces. This creates greater potential for a deeper correction. Additionally, the stock market a dvance has discounted a better economy. However, a better economy will prove to be a headwi nd for stock prices due to a potential rise in interest rates. Tactically Broadmark has b ecome more defensive due to excessive optimism and the potential of a sharp increase in i nterest rates. If sentiment recycles to more neutral levels and momentum divergences stabilize, they may look to become more fully invested. The long-side of the portfolio has benefited from a robust environment in their world of corporate restructuring. The last three years ha ve been the best in over a decade, with 2011 producing 47 spin-offs, 2012 posting 37, and 2013 creating another 37. We already anticipate establishing positions in some new attra ctive spin-off opportunities early in 2014 and expect this area to be a strong source of alpha in the new year. Although we remain confident in the outlook for equities and the long-s ide of the portfolio enters 2014 fully invested, Broadmark's ability to hedge some or all of the portfolio continues to be an advan- tage should downside volatility return to the markets. Thank you for your support of the Alternative Value Fund.
Performance attribution is commonly used to measure the quality of the separate decisions that go into the management of an investment portfolio compared to a benchmark index. This analysis tries to isolate th e effect and measure the return contribution of market allocatio n, which analyzes the positive/negative impact of a portfolio's allocation to groupings such as geographic regions or market sectors, and stock selection, which analy zes the positive/negative impact of the portfolio manager's security ownership and weighting decisions within a wider grouping. The performance attribution data in this quarterly commentary was prepared by Keeley Asset M anagement Corp. ("KAMCO") using the following constraints: (1 ) Fund portfolio holdings are as of the beginning o f each day; index constituents are as of the end of the day. Th at means that the Fund's holdings are not included until the day after acquisition (when it is included in the portf olio as of the beginning of the next business day), and a portfolio holding that is sold is included in the analysis th rough the end of the day on which it is sold, and t hat the values at which securities are included in the analysis are t he values as of the beginning of the day. For the i ndex, securities are included at their values at the end of the day. (2) The securities' values used in the analysis are th e prices used by KAMCO in its internal records for the Fund and the prices used by the index provider for the benchmark index. If a price from either of those sources is unavailable, pricing information from FactSet is used. Pricing i nformation from the index provider or from FactSet may differ from the pricing information used by KAMCO. (3) For the purp ose of assigning portfolio security holdings to a particul ar sector and/or industry, KAMCO assigns the securi ties in accordance with the sector and industry classicati ons of the Global Industry Classication Standard ( GICS) developed by MSCI and Standard and Poor's (to the e xtent available) as a primary source and FactSet (t o the extent available) as a secondary source for this informati on. In the event KAMCO securities information vendo rs do not classify a security's issuer to a particular sector or industry or if the published classication appe ars to be inco rect, KAMCO may classify the security's issuer according to its own judgment, using other securities informa tion vendors, the company description and other publicly availabl e information about the company's peer group. Secto r and/or industry classications may change over time. The a ttribution information provided in this commentary includes summaries of attribution by market sector. Attribut ion is not precise and should be considered to be a n approxima- tion of the relative contribution of each of the se ctors considered. The information on performance by sector reects the aggregated gross return of the Fund's securitie s. Contributions to the Fund's performance by secto r (computed as described above) were compared against the contr ibutions to the aggregate return of the stocks comp rising the index, by sector, as reported by FactSet Databases. GICS was developed by and is the exclusive propert y and a service mark of MSCI Inc. ("MSCI") and Standard & Poor's, a division of The McGraw-Hill Co mpanies, Inc. ("S&P") and is licensed for use by KA MCO. Neither MSCI, S&P nor any third party involved in m aking or compiling the GICS or any GICS classicati ons makes any express or implied warranties or representation s with respect to such standard or classication (o r the results to be obtained by the use thereof), and all such parti es hereby expressly disclaim all warranties of orig inality, accuracy, completeness, merchantability and tness for a part icular purpose with respect to any of such standard or classica- tion. Without limiting any of the foregoing, in no event shall MSCI, S&P, any of their afliates or an y third party involved in making or compiling the GICS or any GICS classi cations have any liability for any direct, indirect , special, punitive, consequential or any other damages (including lost prots) even if notied of the possibility of such damages. Data provided for performance attribution are esti mates based on unaudited portfolio results. Performance contributors and detractors were not re alized gains or losses for the Fund during the quar ter. Market performances presented soley for informational purp oses. The S&P 500 Index is designed to act as a bar ometer for the overall U.S. stock market. The index is unmanag ed, consisting of 500 stocks that are chosen on the basis of market size, liquidity, and industry grouping. The S&P 500 is a market value weighted index with each stock's weight in the index proportionate to its market value. The Russell 2000 Index measures the performance of the small-cap segment of the U.S. equity universe and is a subset of the Russell 3000® Index representing approximat ely 10% of the total market capitalization of that index. The Russell 2500 Value Index is an unmanaged index that measures the performance of those Russell 2500 companies with lo wer price-to-book ratios and lower forecasted growt h rates. The Russell 2000 Value Index measures the performan ce of small-cap value segment of the U.S. equity un iverse and includes those Russell 2000 companies with lower pr ice-to-book ratios and lower forecasted growth valu es. These Index gures do not reect any deduction for fees, expenses or taxes, and are not available for direct investment. Securities in the Fund may not match those in the i ndexes and performance of the Fund will differ. The KEELEY All Cap Value Fund, KEELEY Mid Cap Value Fund, KEELEY S mall-Mid Cap Value Fund, KEELEY Small Cap Value Fun d, KEELEY Small Cap Dividend Value Fund, KEELEY Mid Ca p Dividend Value Fund, and KEELEY Alternative Value Fund are distributed by Keeley Investment Corp. The top ten holdings of KALVX as of December 31, 2 013 include Viewpoint Financial Group, Inc. (1.30%) , Wabtec Corp. (1.29%), Generac Holdings, Inc. (1.28% ), Silvercrest Asset Management (1.26%), Tribune Co . (1.25%), Rexnord Corp. (1.25%), Protective Life Corp. (1.24% ), Terex Corp. (1.21%), Mitel Networks Corp. (1.21% ), and Fiesta Restaurant Group, Inc. (1.21%).