n the rst calendar quarter of 2014, the KEELEY Alternative Value Fund (KALVX, Financial) fell 2.61 percent compared to a 3.52 percent rise for the Russell 2500 Value Index and a 1.81 percent increase for the S&P 500 Index. After a strong year for equities in 2013, a more challenging environment welcomed the markets in 2014. Although the broad equity markets ended the quarter with minimal gains, that performance was masked by a quarter that experienced a great deal of volatility. Geopolitical concerns, specically regarding the Russian invasion of Crimea, added complexity to markets that were already beginning to experience some level of fatigue after two consecutive years of exceptional equity returns. Macroeconomic data painted a mixed fundamental picture. Investors attributed much of the decline in growth expectations here in the U.S. to unusually poor weather conditions. Although severe weather most likely had a negative inuence, it is uncertain as to what the full impact will be, especially with respect to corporate earnings. In the most recent quarter, companies continued to show earnings growth, but many also projected slower future gains and valuations continue to be elevated. News from abroad was of the greatest concern, where anemic economic activity in Europe and a hard landing in China are persistent worries. Lastly, notes released from the March Federal Reserve meeting indicated that they believe the economy remains on a sustainable upward trend. Those comments, coupled with an overall message that they remain supportive of a low interest rate environment, tempered investor fears and provided a much needed boost to the equity markets late in the quarter. During the rst quarter, the Fund trailed both the Russell 2500 Value Index and the S&P 500 Index. The combination of underperformance by the long-side of the portfolio with inconsistent hedging from Broadmark Asset Management resulted in a challenging quarter for the portfolio. The long-side of the portfolio was primarily impacted by negative stock selection during the quarter, although overweight positions in the lagging industrials and consumer discretionary sectors also detracted.
Broadmark's investment process begins with an assessment of the fundamental economic environment through Valuation, Monetary Policy, and Investor Sentiment. Next they validate these qualitative factors with a more quantitative assessment though their multi-factor Volume/Breadth Momentum Model. Here is a brief survey of these "Four Pillars" of their investment process:
Valuation: Continues to be ranked as slightly elevated but when adjusted for interest rates and ination, in their opinion, stocks are fairly valued on a historical basis.
Monetary Policy: Remains positive and credit spreads are tight despite comments from the Fed that the rst rate hike may come following the end of tapering.
Sentiment: Was mixed at quarter-end. Their intermediate models were still negative as the market continued to reach new highs. The short-term models had corrected to pessimistic levels (positive) following the mid-March pull back.
Momentum: Market corrections typically begin with deteriorating short-term momentum. Their short-term momentum models have turned negative and while the intermediate and long-term models are still positive, they are beginning to see deterioration. For example, the higher beta segments of the market began to underperform large-cap stocks, which can be a precursor to a troubled stock market.
The Fund was 22 percent hedged coming into 2014 as bullish sentiment rose to a three-year peak. As the geopolitical turmoil increased, so did volatility, resulting in a more cautious position. The hedge was increased to 72 percent in early February, which proved to be the most defensive position during the quarter. Momentu m improved slightly following the pull-back and Broadmark incrementally reduced the h edge on the portfolio to 0 percent on the break-out in relative strength of the Russell 2 000 Index. However, there was quick reversal in relative strength coupled with negative sentimen t and deteriorating momentum resulting in a nal hedge of 61 percent to close the quarter. Th e missing ingredient for the start of a new bear market is negative credit conditions. Therefor e, we continue to view any renewed volatility as a garden variety type short-term corr ection. Tactically, if they see further improve- ment in sentiment and momentum stabilizes, they wou ld look to further reduce their hedging activity. Although we remain condent in the outloo k for equities and the long-side of the portfolio continues to be fully invested, Broadmark 's ability to hedge some or all of the portfolio could be an advantage should the volatility that we have experienced thus far in 2014 continue. Thank you for your support of the Alterna tive 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 (excluding short exp osures, cash, money markets, and options/futures contract holdings) as of March 31, 2014 include Man itowoc, Inc. (1.27%), Superior Energy Services (1.2 7%), Legg Mason, Inc. (1.26%), Viewpoint Financial Group (1.2 5%), Fidelity National Financial (1.25%), Energen C orp. (1.24%), Generac Holdings (1.24%), Mitel Networks Corp. (1.2 2%), Silvercrest Asset Management (1.20%), and Sanc hez Energy (1.20%).
