To Our Shareholders,
For the quarter ended June 30, 2020 the KEELEY Small-Mid Cap Value Fund’s net asset value (“NAV”) per Class A share rose 24.96% compared with a 20.60% gain for the Russell 2500 Value Index. For the year-to-date, the Fund is now down 25.73% compared with a 21.18% fall for the benchmark.
Commentary
Following the steep correction of the first 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 first 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 first 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 theprimary 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 value stocks sell at signi cant discounts to the overall market and that the Keeley Small-Mid Cap Value Fund is well positioned to outperform in the years ahead.
Portfolio Review
We are encouraged by the rebound in the Fund’s performance in the second quarter. Several of the stocks that contributed to the rst quarter’s disappointing results were strong contributors in the second quarter which con rms our con dence in these companies’ outlooks.
Stock election drove results this quarter. On the positive side, underweights in Financials and REITs helped results. O setting this were an underweight in Health Care, an overweight in Utilities, and the Fund’s small cash holdings.
When we look at the impact from Stock selection, we nd that the Fund gained performance in five sectors, lagged in one, and was about even in the remaining five (although more biased to the positive). The strongest sectors were Financials, Industrials, Utilities, and Real Estate, while Health Care was the only sector that meaningfully detracted from results.
- The Fund’s Financials holdings outperformed both the Russell 2500 Value Index and the Financials stocks within the benchmark. Financials generally failed to keep up with the strong market. Several stocks contributed to the strength with the best performer being BrightSphere Investment Group (BSIG). e asset management holding company bounced back with the market, but also bene tted from some takeover speculation late in the quarter.
- Industrials was another area of strength in the quarter. In this case, the outperformance was broad-based with nine of the Fund’s fourteen holdings up more than 20% in the quarter. Fortune Brands (FBHS), Chart Industries (GTLS), and Altra Industrial Motion (AIMC) were notably strong.
- The Utilities sector was the worst performing sector in the benchmark during Q2, eking out a 1% gain. e Fund’s Utilities holdings fared much better, although they still did not keep pace with the strong gain in the overall market. e Fund’s best performer in the sector was NRG Energy as its stock responded to good results. e Fund’s other three stocks in the sector all were in positive territory and all outperformed the sector.
- Real Estate was another sector which did not keep pace with the overall market, but where the Fund’s holdings performed much better than the benchmark’s sector holdings. Strong rebounds by the Fund’s health care REITs (Sabra, CareTrust) and a few REITs that are sensitive to consumer spending (Lamar Advertising, Gaming and Leisure Properties, Vici Properties) drove the solid results.
- The Fund’s shortfall in Health Care was in part due to stocks that the Fund owned such as Invacare, which declined in the quarter. e bigger impact, however, came from what the Fund did not own, namely Biotechnology and Pharmaceuticals. e Fund has generally not invested in these industries, as they are binary, and restructuring opportunities are not numerous.
During the quarter, the Fund added six new positions, eliminated one holding, and one holding was converted due to a merger (CenterState Bank merged with South State Corporation).
Let's Talk Stocks
The top three contributors in the quarter were:
Brunswick Corporation (BC, Financial) (BC - $64.01 – NYSE) is one of the leading producers of engines for recreational marine products. It also manufactures and sells recreational boats. Brunswick was helped by a sharp improvement in boating registration data in the wake of various states relaxing restrictions on boating activity. Channel inventory remains lean in the wake of a poor start to last year’s boating season followed by COVID-19 restrictions on manufacturing in 1H20. While not providing o cial EPS guidance, management was active with covering brokers in terms of conferences and non-deal roadshows and conveyed a message of sharply improving boat market fundamentals in May and June.
Nexstar Media Group (NXST, Financial) (NXST - $83.69 – NASDAQ) is the largest independent owner and operator of broadcast television stations. Due to the coronavirus, local TV stations su ered in the second quarter from signi cant revenue declines from lower advertising spending. However, shares of Nexstar, which is the nation’s largest local broadcaster, appreciated in Q2 as investors looked ahead from the current weak advertising environment, and as management guided to much stronger sequential ad placings in the third quarter. In particular, in a quadrennial presidential election year, investors found themselves enthused about more political ad spending being deployed in the year’s third and fourth quarters, especially with the pandemic limiting in-person events like political conventions and rallies. Also, Nexstar bene ted from the gradual economic reopening and investors’ expectations of rebounding non-political ad dollars, as well as from strong viewership of its station’s newscasts.
Copart, Inc. (CPRT, Financial) (CPRT - $83.27 – NASDAQ) is the global leader in online vehicle auctions. Like most rms, online auto auction provider and vehicle remarketer Copart was a ected by COVID-19, as it experienced lower processed vehicle volumes from lower car accident volumes. However, Copart shares rebounded in the second quarter, as the company posted a better-than-expected sales number for its scal quarter ending in April. Shares also rallied as North America began to reopen throughout Q2. at resulted in an increase in auto miles driven, which in turn led to greater vehicle volumes.
The three largest detractors in the quarter were:
Invacare Corporation (IVC, Financial) (IVC - $6.37 – NYSE) is a leading maker of medical products to enable disabled people to recover and to live an active life. Although Invacare showed some continued improvement during the second quarter in its e orts to enhance pro tability, the company nonetheless struggled as investors questioned the impact of COVID-19 on Invacare. Shares were pressured over the risks that Invacare faces from the potential impact of social distancing on the company’s seating and mobility businesses. Speci cally, with many clinics and healthcare facilities either closed or o ering just limited access to non-COVID-19 patients, Invacare was hampered in its ability to provide ttings and trials of its con gured products. Also, Invacare’s suppliers faced pandemic-related challenges during the second quarter that placed a ceiling on the company’s ability to supply its own customers.
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 a bank on 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.
Houghton Mifflin Harcourt Company (HMHC, Financial) (HMHC - $1.81 – NASDAQ) develops, markets and sells textbooks and other instructional material for K-12 schools. Although Houghton’s shares lost more than two-thirds of their value during the rst quarter of 2020, the stock did not participate in the second-quarter U.S. equity rebound, nishing down 3.7% in Q2. e company had posted good performance in 2019, but early in 2020 guided to disappointing billings guidance. en, in the second quarter, the pandemic wreaked havoc not just on the broader economy but also on investors’ perceptions of upcoming state education spending on instructional materials. While no major delays have been announced, the market has remained skeptical about certain states’ adoptions of textbooks as planned. Houghton Mi in Harcourt management has continued to maintain that the company is in a position to provide instructional materials to educators, whether in textbook form or virtually.
Conclusion
In conclusion, thank you for your investment in the KEELEY Small-Mid Cap Value Fund. We will continue to work hard to earn your confidence and trust.
This summary represents the views of the portfolio managers as of 6/30/2020. 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.
