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Sydnee Gatewood
Sydnee Gatewood
Articles (3115) 

Keeley Small-Mid Cap Value Fund 3rd-Quarter Shareholder Commentary

Discussion of markets and holdings

To Our Shareholders,

For the quarter ended September 30, 2020, the Keeley Small-Mid Cap Value Fund's net asset value ("NAV") per Class A share rose 4.49% compared with a 3.54% gain for the Russell 2500 Value Index. For the year-to-date, the Fund is now down -22.39% compared with an -18.39% fall for the benchmark.


The market continued its recovery in the third quarter in tandem with the economy. It should not be a big surprise that the economy rebounded sharply given that the second quarter fall was so severe and the reason for the decline was transient. Second quarter GDP declined at a staggering 31.4% annualized rate, the worst ever. The good news is that the Atlanta Fed's latest GDPNow reading is for third quarter GDP to increase at a 35.3% seasonally adjusted annualized rate, an impressive snap-back.

We see confirmation of this recovery in a wide variety of economic statistics: e unemployment rate rose to 14.7% in April, but has since receded each month since to September's 7.9% reading. Industrial Production fell 16.5% in April, but only 7.7% in August. e ISM (Institute of Supply Management) Index plunged to 41.5 in April but bounced to 55.4 in the September report. e positive data points include Consumer Con dence, Retail Sales, Trade, and other measures. e most interesting data point is Home Sales, which are actually above pre-COVID levels. e stock market has shown an equally impressive rebound. Using the Russell 3000 Index as the benchmark, the market fell 35% between its peak on February 19 and its trough on March 23. It then staged a 54% rally to make a new high on August 21 and closed the quarter a little lower than that, but still up 53% from the lows.

The gains in the market have been driven by an increasingly narrow set of mega cap growth stocks. Because of their weight in the indices, they drive the overall performance of the Index. Most stocks, however, have been left behind. As of the end of the third quarter, 70% of the stocks in the Russell 3000 Index remained below their February highs and 45% of them were at least 20% below those levels. If we take this analysis a little further, 80% of the stocks in the Russell 2000 Value Index have not regained their February price level and 58% are down more than 20%. At the other end of the spectrum, only 37% of Russell Top 200 Growth stocks are below the February level and only 4% are down more than 20%. is has widened the valuation spread between the returns of large cap stocks and those of small cap stocks as well as between growth stocks and value stocks. rough the rst three quarters, the spread between growth and value has been a mid-twenties percentage for small caps and mid-caps and almost 38% for large caps! is valuation gap is a rare historical occurrence though the performance spread between growth and value for small caps and midcaps in 1999 was 45% and 51%, respectively.

However, given the historically wide valuation gap between value and growth, we are witnessing early stages of a rotation back to undervalued equities as evidenced by the strong performance in the quarter by industrial and cyclical stocks. As bottom up, fundamental research driven investors, we seek to purchase the ine ciently priced equities of excellent companies selling at discounts to their intrinsic value, based on their underlying asset values, earnings and cash ows. While the 2020 and 2021 macro outlooks are diminished, the longer-term prospects for many of our companies remain attractive. It is our job to research and invest in these best of breed companies selling at discounts to their intrinsic value.

Portfolio Review

The Fund's second quarter rebound continued into the third quarter as it outperformed its benchmark. While some of the Fund's sector overweight's and underweights had an impact, they netted out to very little impact. A signi cant overweight in the Industrial sector and an underweight in Real Estate helped results while an underweight in the Consumer Discretionary sector hurt results.

The impact from Stock Selection was most positive in the Industrial sector followed by Real Estate and Health Care, while holdings in the Materials and Energy sectors lagged those of the Index.

  • All of the Fund's top three contributors were in the Industrial sector: Chart Industries, Copart, and Fortune Brands Home and Security. e Fund had other winners amongst its fourteen holdings, but those three contributed all of the outperformance and are discussed individually later in this update.
  • Real Estate was a sector where the Fund was able to eke out gains despite a general decline in stocks in the sector. Casino owners VICI Properties and Gaming and Leisure Properties accounted for all of the performance as they were able to demonstrate the resilience of their business by collecting on 100% of their rents despite the impact of the COVID-19 pandemic on their tenants.
  • The Fund's holdings in the Health Care sector outpaced those of the Index on the strong gains in Ensign Group and Laboratory Corporation of America. Ensign was particularly strong as it performed well in light of the COVID-19 pandemic disruptions.
  • Holdings in the Materials sector generated the most negative contribution relative to the benchmark. is was largely due to weakness in Kaiser Aluminum. e economic slowdown took a toll on its shipments to key aerospace and automotive customers. While auto seems to be rebounding, the continued uncertainty about the timing and pace of a recovery in the airline industry and the recerti cation of the Boeing 737-Max remain overhangs.

Stock Selection in the Energy sector was a slight detractor to performance. e Fund's holdings favored Permian Basin operators. High crude inventories and choppy oil price action drove the weakness in these stocks.

During the quarter, the Fund added eight new positions and eliminated nine holdings. is is a higher level of turnover than the Fund has experienced in recent years. We sold out of some stocks where we had less conviction, they have been replaced by new holdings that are earlier in their restructuring phase and which we believe o er more potential. In addition, we have conducted some interesting research on additional types of restructuring ideas that we believe creates new opportunities for the Fund.

Let's Talk Stocks

The top three contributors in the quarter were:

Fortune Brands Home & Security (NYSE:FBHS) (FBHS - $86.52 – NYSE) is one of the leading manufacturers of products used in new home construction and repair & remodel with strong market positions in cabinets and plumbing products. Fortune Brands is a key bene ciary of the pandemic-induced dislocations as consumers shifted spending to home repair and remodel driving strong growth and pro tability in the company's agship plumbing brand Moen and composite decking Fiberon business. e improvement in new home construction should drive improvement in the cabinets segment as the value-priced o erings have performed well in this environment. e near-term outlook and underlying trends remain favorable.

Chart Industries (NASDAQ:GTLS) (GTLS - $70.27 – NASDAQ) is the leading provider of cryogenic solutions for industrial gas, energy and biomedical customers around the globe. The stock performed well due to outstanding second quarter results which bene tted from increased sales for critical care customers due to COVID-19 pandemic. Furthermore, Chart's order book broadened as stimulus packages passed in various nations accelerated funding for renewable energy projects to which Chart supplies equipment. e company also divested a non-core health care related business and announced a partnership with First Element Fuels to develop hydrogen fueling solutions for a growing number of applications.

Copart, Inc. (NASDAQ:CPRT) (CPRT - $105.16 – NASDAQ) is the global leader in online vehicle auctions. During the third quarter, Copart reported a very strong earnings release, with especially robust pro tability. Copart enjoyed record growth in average selling prices and strong vehicle sales growth overseas and also held the line on costs. In addition, the used car market was especially strong during the pandemic, as new car manufacturing ground to a halt. at sent used car prices up 12% in July. Copart's online auction platform is stronger than ever, and the company is well positioned to perform well whether there are further shutdowns or not. If there are more shutdowns, used vehicle demand should continue to be strong and more vehicles will be totaled from faster and more distracted driving. If the gradual recovery continues, miles driven should continue to rise, which means more collisions as well.

The three largest detractors in the quarter were:

Diamondback Energy (NASDAQ:FANG) (FANG - $30.12– NASDAQ) is a Texas-based exploration and production company with a large footprint in the proli c Permian Basin. Results for the second quarter were disappointing due to the rst quarter collapse in oil prices. is saw the company unable to generate free cash ow despite dramatically slowing its cadence for well completions. e company sees much lower capital spending in the second half of the year and into 2021. is should allow it to generate a healthy amount of free cash ow while keeping production at and reducing costs. FANG remains committed to its dividend, which is currently close to a 5% yield.

WEX Inc. (NYSE:WEX) (WEX - $138.97 - NYSE) is a leading provider of industry-specific payment platforms with a focus on transportation, travel, and health care. e stock fell in response to much weaker than expected second quarter earnings. While the Health Care business performed well, the travel business has been hurt signi cantly by the slowdown from the COVID-19 pandemic. e Transportation business, the company's largest, is seeing positive trends, but costs were relatively xed so the decline in second quarter revenues produced an outsized impact on earnings. In addition, the company is in the midst of a contentious lawsuit to try to terminate a merger it planned before the impact of COVID-19 appeared.

Delek US Holdings (NYSE:DK) (DK - $11.13 – NYSE) owns and operates four refineries in TX, LA and AR and 250 retail gas stations in several Southern states as well as partnership interests in several midstream pipeline projects. e quarter was extremely challenging with a collapse in oil prices having a severe impact on re ning pro tability at a time when the company was investing in its midstream projects. is had a negative impact on earnings and free cash ow. A recent announcement by the governor of California which set a 2035 deadline for essentially banning internal combustion engine vehicles also did not help sentiment for the group. In response, Delek is aggressively reducing costs and has made moves to simplify its structure.


In conclusion, thank you for your investment in the KEELEY Small-Mid Cap Value Fund. We will continue to work hard to earn your con dence and trust.

October 14, 2020

This summary represents the views of the portfolio managers as of 9/30/2020. 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.

About the author:

Sydnee Gatewood
I am the editorial director at GuruFocus. I have a BA in journalism and a MA in mass communications from Texas Tech University. I have lived in Texas most of my life, but also have roots in New Mexico and Colorado. Follow me on Twitter! @gurusydneerg

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