To Our Shareholders,
For the quarter ended June 30, 2020, the KEELEY Small Cap Dividend Value Fund’s net asset value (“NAV”) per Class A share share rose 22.96% versus an 18.91% increase for the Russell 2000 Value Index. For the year-to-date, the Fund is down 21.02% compared with a 23.50% decline for the benchmark.
Commentary
Following the steep correction of the rst quarter, the market rebounded dramatically in the second quarter. At June quarter-end, the market was up almost 40% from its March 23rd low. In the rst six months of the year, the market, as measured by the S&P 500 Index, made thirteen new all-time highs after falling into bear market territory. We believe we are in the early stages of a new bull market as evidenced by the 20% market appreciation over a stunning twelve trading days. e S&P 500 Index went from a record high to the bottom of a bear market to the establishment of a new bull market in 35 trading days.
The second quarter market rebound was the mirror image of the rst quarter. As the quarter progressed, evidence mounted that an economic recovery was proceeding at a faster pace than investors had initially expected. Recent economic data points present a strong case for a V-shaped recovery. In the May employment report, jobs grew by 2.5 million compared with consensus expectations for an 8 million decline. is is a sharp reversal from the 20.7 million tumble in April and this has been accompanied by a steady stream of better than expected economic reports:
- May Retail Sales grew a record 17.7% in April, more than double the expectation.
- Surveys from the New York Fed and the Philadelphia Fed both exceeded consensus forecasts.
- The ISM Manufacturing and non-Manufacturing surveys both beat forecasts and exceeded 50, which generally signi es economic expansion.
- June Private non-Farm payrolls grew 4.8 million, double the consensus expectation and the unemployment rate declined to 11.1% from 12.5% in May.
Toward the end of the quarter, new COVID-19 case numbers started to rise. is has driven governors to restrict activity and investors fear a repeat of the March market correction, should economic activity stall. We believe that any new restrictions are likely to be more surgical than those imposed earlier this year and will have less economic impact. At greatest risk are companies in verticals such as travel, leisure, and restaurants.
From a macro viewpoint, the policy response, both scal and monetary, has been unprecedented and extraordinary. e government has now passed three rounds of scal stimulus aggregating several trillion dollars. is has included direct payments, enhanced unemployment bene ts, low-cost forgivable loans to small businesses, and large loans to companies in heavily impacted industries. Another round of stimulus and infrastructure spending is under consideration by the White House and Congress.
At its June meeting, the Federal Reserve Board pronounced that it would maintain a zero Fed funds rate through 2022 and reiterated the Central Bank will increase its holdings of treasury securities and other asset purchases for an extended period. e Fed also said that it will begin buying individual corporate bonds under its Secondary Market Corporate Credit Facility, an emergency lending program.
Against this backdrop, leading indicators look to show a bottom and there appears to be a clear path forward for recovery in the economy. However, the resurgence of COVID-19 is tearing through the U.S., in places like Arizona, Texas, California and Florida, and forcing businesses to postpone reopening. Until a vaccine or more effective therapeutics are developed, social distancing, masks, handwashing, and other personal actions will be the primary means to control the virus spread. While states are slowing reopening and reinstituting restrictions, others continue to lift controls.
It is our belief that the extraordinary policy accommodation by the Fed, coupled with trillions in scal stimulus appropriated by Congress, should put a oor under both the economy and stock market. We believe that small-and mid-cap dividend-paying value stocks sell at signi cant discounts to the overall market and that the Keeley Small Cap Dividend Value Fund is well positioned to outperform in the years ahead.
Portfolio Results
The Fund had a very good quarter. Not only did it outperform in a strong market, it outperformed during a time when dividend-paying small-caps lagged their non-dividend-paying peers. We calculate that dividend-paying stocks within the Russell 2000 appreciated only about 15% compared with a 34% gain for non-dividend-paying stocks. Within the Russell 2000 Value Index the di erence was almost as wide, 12.5% vs. 29.2%.
As is the case in most quarters for the Fund, the impact on the portfolio from Stock Selection dominated returns. Sector Allocation was a slight drag as the Fund’s cash holdings held back performance in a strong market. Aside from this, a slight overweight in the strong Consumer Discretionary sector (+64% in the quarter) helped, while a slight overweight in Utilities and a slight underweight in Health Care detracted slightly.
The Stock selection impact added value in six sectors, detracted in four, and was not meaningful in one. Stock Selection added the most value in Financials, however, Real Estate, Communication Services, and Utilities were also large contributors. The Health Care and Materials sectors detracted most.
- A Q2 rebound in banks, asset managers, and business development companies drove strong gains in the Fund’s Financials holdings, whereas Financials were slower to rebound in the Russell 2000 Value Index. e Fund had eight stocks that rose more than 30% in the quarter and another three that were up more than 20%. BrightSphere Investment Group was up more than 90% and was one of the Fund’s best performers for the quarter.
- Real Estate was another sector where the Fund’s holdings far outstripped the lackluster returns within the index. As with Financials, the strength was broad-based with four of the Fund’s nine holdings up more than 30% and only one stock down during the quarter.
- In the Communications Services sector, the Fund held only two stocks in the quarter. One of them, however, was Nexstar Media Group, a large operator of broadcast television stations. Its shares were up more than 45% in the quarter.
- The Utilities sector was the only sector in the index to generate a negative return during the quarter, but the Fund’s holdings handily outpaced this result and appreciated. is was mostly due to the more than 30% rise in the shares of Atlantica Yield, a developer and operator of renewable energy generation facilities. Its shares fell in Q1 with the rest of the market, but its heavily contracted sales of electricity with investment-grade counterparties actually become more valuable in a lower interest-rate environment. e market seemed to recognize this in the second quarter.
- Health Care was the sector in which the Fund lagged the benchmark the most in the quarter. For most of the last several years, the Fund has held only two healthcare stocks, Ensign Group and Chemed. is has served the Fund well over time as these stocks have been winners. is quarter, however, Health Care was driven more by biotechnology, which surprisingly represents about 40% of the Russell 2000 Value’s allocation to Health Care. None of these stocks pay dividends and they were up 55% as a group in Q2.
Let’s Talk Stocks
The top three contributors in the quarter were:
Winnebago Industries, Inc. (WGO, Financial) (WGO - $66.62 - NYSE) a leading RV manufacturer, has seen a resurgence of the “RV lifestyle” driven by pandemic-related shutdowns and fears. As dealers started to reopen, Winnebago experienced an acceleration in sales. Winnebago continues to bene t from market share gains for its towable segment Grand Designs which posted strong growth in backlog and the motorhome segment is bene tting from its recent acquisition of Newmar and its addition of a luxury component to the lineup.
BrightSphere Investment Group, Inc. (BSIG, Financial) (BSIG - $12.46 – NYSE) is a global diversi ed asset management company with over $160 billion in assets under management (AUM). e company posted a very good quarter with better-than-expected revenues and earnings while reporting positive in ows in a very di cult environment. Toward the end of the quarter the stock received another boost as BrightSphere was rumored to be a potential acquisition target.
KB Home (KBH, Financial) (KBH - $30.68 – NYSE) is one of the nation’s leading homebuilders. e stock has recovered from the large decline last quarter driven by pandemic-related shutdowns halting the strong underlying fundamentals prior to COVID. Demand drivers are expected to accelerate beyond the rst-time home buyer as pandemic-related lockdowns could entice urban dwellers to look for more space in suburbs. Additionally, the current “work-from-home” dynamic has introduced an aspect of mobility that could further accelerate housing trends with additional support from record low mortgage rates.
The three largest detractors in the quarter were:
Cadence Bancorporation (CADE, Financial) (CADE - $8.86 - NYSE) is a mid-sized commercial bank operating in the Gulf South region of the US. Credit quality has been a concern at Cadence for the last year as it saw some early problems in some of its loan portfolios. Investors expect these to accelerate due to the economic weakness brought on by the COVID pandemic. Cadence built reserves signi cantly with its rst quarter earnings report, but also wrote down most of its acquisition goodwill and cut its dividend signi cantly.
ALLETE, Inc. (ALE, Financial) (ALE - $54.61– NYSE) is a small cap utility headquartered in Duluth, MN. Two thirds of its power sales are to industrial companies which include taconite miners (iron-ore used for steel). As a result, ALLETE is one of the more economically sensitive utilities. ere are concerns about the current economic environment which is putting pressure on shares as investors worry about the company selling excess power into the depressed wholesale power market. ese concerns overshadow the company’s very attractive renewable asset portfolio that is expected to generate about 50% of power produced by 2021.
CenterState Bank Corporation/South State Bank (SSB, Financial) (SSB - $47.66 - NASDAQ) is one of the leading community banks in the Southeastern United States. e merger of CenterState Bank of Florida into South State Bank of South Carolina brings together two banks with a good record of building solid deposit growth and disciplined credit management. Stocks of banks undergoing mergers of equals often lag their peers until the merger is completed and that did not occur for this bank until very late in the quarter.
Conclusion
In conclusion, thank you for your investment in the KEELEY Small Cap Dividend Value Fund. We will continue to work hard to justify your confidence and trust.
This summary represents the views of the portfolio managers as of 6/30/20. Those views may change, and the Fund disclaims any obligation to advise investors of such changes. For the purpose of determining the Fund’s holdings, securities of the same issuer are aggregated to determine the weight in the Fund. Portfolio holdings are subject to change without notice and are not intended as recommendations of individual securities.
