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, 2013
U.S. equity investors enjoyed strong gains in 2013 as the S&P 500 Index produced an impressive +32.39% total return for the year. Although companies have yet to report fourth quarter results, 2013 earnings appear to have grown in the high teens compared with 2012. And, with balance sheets strengthened, corporations returned considerable cash to shareholders. The strong earnings growth was accompanied by even stronger stock price appreciation, which has led to more extended equity market valuations. The valuation expansion was supported by scores of positive economic developments in housing, employment, manufacturing, and consumer confidence. Also, with balance sheets strengthened, corporations returned considerable cash to shareholders.
Taking a closer look at the equity market, valuation discrepancies have narrowed during the year. At the beginning of the year, cyclical sectors traded at a considerable valuation discount to non-cyclical sectors, which is no longer the case. Moreover, the "yield trade", in which investors sought out securities that were perceived as bond substitutes (e.g. REITs "real estate investment trust", telecom), began to unwind in 2013. Given these changes, we have shifted the portfolio moderately to favor broader diversification and quality franchises, without having to pay a significant premium.
The U.S. political landscape remained contentious throughout the year. The prolonged budgetary stalemate, government shutdown, and enactment of the so-called "nuclear option1" exemplified Congress' inability to compromise. At long last, Congress demonstrated encouraging signs of bipartisanship by passing a budget deal in December. It also appears primed to confirm Janet Yellen as the next Federal Reserve Chairwoman, which should result in the continuation of the central bank's dovish monetary stance. Whether this cooperation can be sustained, however, remains uncertain.
The unprecedented shift from equities into bonds began to reverse in 2013 as plan sponsors balked at the paltry yields. Persistently low yields combined with the threat of both rising interest rates and rising inflation provide support for the equity market by way of positive fund flows. Nevertheless, many of the exceptional valuation opportunities have been at least partially expended, so we have dialed down the risk/return profile of the portfolio to an extent. The portfolio has continued to trade at a considerable discount to the overall equity market (S&P 500 Index), however, and we remain optimistic regarding the risk-adjusted potential of the current portfolio.
The Hotchkis & Wiley Large Cap Value Fund (Class I) (HWLIX) outperformed the Russell 1000 Value Index in 2013. Positive stock selection drove more than 85% of the outperformance for the year. Stock selection was particularly strong in financials, technology, and telecommunications. Within financials, we held several strong-performing insurers that traded near or less than tangible book value despite substantial/excess reserves. Five technology stocks in three different industries (hardware, software, and equipment) each returned more than 40% over the year. The sole telecom holding (Vodafone 3.3%*), which had exhibited a considerably depressed valuation, quintupled the benchmark's telecom return during the year as the company agreed to sell its interest in Verizon Wireless (0.0%)*. The largest individual performance contributors over the year were Hewlett-Packard (3.3%)*, Vodafone (3.3%)*, and Unum (1.7%)*. An overweight and stock selection in utilities detracted from performance. The portfolio's modest cash position, which averaged less than 3% throughout the year, was also a relative detractor due to the strong positive market. The largest individual performance detractors for the year were Exelon (2.6%)*, J.C. Penney (0.0%)*, and Royal Dutch Shell (3.9%)*.
FUND ACTIVITY: 2013
Over the year, the largest sector increase was in healthcare, where the added exposure to managed care companies more than offset the trim in pharmaceuticals. UnitedHealth Group (2.9%)* and Humana (1.0%)* were new purchases during the year; we believe both are attractively valued due to excessive concerns regarding healthcare reform and its impact on profitability. We also increased the weight in technology despite trimming several strong performers. We took a new position in IBM (1.5%)*, which we believe is a well-positioned, diversified technology company with a strong balance sheet, prudent capital allocation, and an attractive valuation. The largest sector decrease was in financials where we exited/trimmed several strong performing insurers. We also lowered the consumer discretionary weight by exiting the positions in H&R Block (0.0%)* (it approached our valuation target) and J.C. Penney (0.0%)* (increased risk profile).
1The nuclear option replaces the 60-vote requirement for all Presidential appointees with a simple majority requirement (51 votes).
*% of total portfolio as of December 31, 2013. Mutual fund investing involves risk. Principal loss is possible. The Fund may invest in foreign securities which involve greater volatility and political, economic and currency risks and differences in accounting methods. The Fund may invest in American Depository Receipts ("ADRs") and Global Depository Receipts ("GDRs") which may be subject to some of the same risks as direct investment in foreign companies.
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. The opinions expressed are those of the portfolio managers as of 12/31/13 and may not be accurate reflections of their opinions after that date. There is no guarantee that any forecasts made will come to pass. The Fund may not continue to hold the securities mentioned and the Advisor has no obligation to disclose purchases or sales of these securities. 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.