Steve Scruggs' FPA Queens Road Small Cap Value Fund 3rd-Quarter Letter

Dear Shareholders:

FPA Queens Road Small Cap Value Fund (“Fund”) returned -2.53% in the third quarter of 2021. This compares to a -2.98% return for the Russell 2000 Value Index in the same period. The third quarter began with equities rallying broadly as interest rates declined. As the quarter progressed, concerns about Fed tightening pushed interest rates higher, resulting in a selloff in equites during September.¹ For the quarter, large cap stocks outperformed small caps and growth shares outperformed value, a trend we have consistently seen over the last decade. However, when we look at relative valuations of large cap vs. small cap and growth vs. value, we feel confident in the prospects of small cap value.

Earnings during the quarter rebounded sharply as we’ve emerged from the worst of the COVID-19-related slowdown (hopefully). As we listened to management calls during the third quarter, we heard many of the same concerns we heard during the first half of this year. Management teams are concerned about increased input prices, wage inflation, logistics issues, and possible regulatory and tax policy changes.

Inflation continues to be a major concern. In fact, the inflation we have experienced this year has pushed real interest rates into negative territory.² Although many of the companies in our portfolio have been able to pass on price increases to counter inflation, the question remains whether this inflation is transitory or will persist. Some companies have said their price increases have been met with little resistance, which has been good for near-term profits but could be concerning. Historically, inflation has been much easier to start than it is to stop. The expectation of future price increases can be a self-fulfilling prophesy. However, in the current environment, we believe that while modest inflation across the economy is being driven by the labor situation, the sharper price increases in certain areas are more transitory and should ease as logistic bottlenecks work themselves out and inventories rebound from last year’s abrupt slow down. We remained focused on investing in high-quality, differentiated companies that have pricing power and should be less impacted by sustained inflation than lower-quality companies.³

Third Quarter Contributors and Detractors

Contributors

• Synaptics (SYNA, Financial), a developer of human interface (HMI) hardware and software, is experiencing astrategic shift to a higher-margin business, primarily Internet of Things (IoT) products, and continued its recent trend of announcing higher operating margins and providing favorable financial guidance. During the quarter, the company announced it was purchasing former portfolio holding, DSP Group, a communications chip designer.⁴ Management is executing well on this strategic shift and delivering impressive financial results.
• ServisFirst Bancshares (SFBS, Financial), a full-service commercial bank, announced during the quarter that bothdeposits and book value grew 17% from the previous year.⁵ The growth in book value is in line with its long-term average. One of the largest holdings in our portfolio, we remain confident in the company’s long-term prospects.
• American National Insurance (ANAT, Financial). Shares of thelife insurance and annuity company’sstock rallied onMay 11 when the company announced it had hired an advisor to pursue a sale of the company.⁶ On August 9, the company announced that Brookfield Asset Management Reinsurance had agreed to purchase the company in an all-cash deal for $190 per share, a 55% premium to the share price prior to the May 11 announcement.⁷ Interestingly, another portfolio holding, American Equity Life Insurance (AEL) announced an unrelated strategic partnership with Brookfield Asset Management (BAM) in October of 2020.⁸ In that deal, BAM took a 20% stake in American Equity Life, provided AEL $5 billion of reinsurance on existing liabilities and offered AEL access to BAM’s alternative asset class strategies.

• Horace Mann (HMN, Financial) shares rose as the company announced strong earnings and a strategic acquisitionof Madison National Life, a supplemental insurance provider based in the Midwest. The acquisition will allow Horace Mann agents to offer additional products to the niche market of K-12 educators.⁹
• Concentrix (CNXC, Financial), a customer experience solutions provider spun off from one of our other portfolioholdings (Synnex) in December of 2020, rose during the quarter. Boasting a broadly diversified customer base, the company offset weakness in Covid-impacted segments with strong performance in finance, e-commerce, and healthcare.

Detractors

• MasTec (MTZ, Financial) gave back some of the strong gains made during the first half of the year during the third Earlier in the year, the infrastructure construction company rallied in part due to the proposed infrastructure bill being negotiated in Congress. As the size of the bill was reduced, the stock gave back some of those gains. On a fundamental basis, the company continued its long record of consistent, profitable growth. The company remains a top 10 holding in the portfolio.
• Owens & Minor (OMI, Financial) also fell during the quarter after a sharp rally in the share price during the first halfof 2021. As a manufacturer and distributor of personal protection equipment (PPE), the company’s financial results have recently benefited from demand related to the COVID-19 pandemic. During 2020, the company brought in a new leadership team charged with reducing leverage and creating a more proactive, customer-focused culture. While the company’s interim financial results and current year guidance are favorable, we are watching closely to determine how much of the performance stems from new management versus the short-term boost from the pandemic.
• South Jersey Industries (SJI, Financial) shares fell due in part to the cancellation of the PennEast pipeline. Thepipeline, which SJI was to be a partner in, was slated to deliver 1.1 billion cubic feet per day of natural gas from the Marcellus shale region to New Jersey and Pennsylvania. While the regulatory environment in New Jersey has historically been favorable, the state’s role in preventing the PennEast pipeline’s construction is causing us to reassess the regulatory environment there.¹⁰ The company currently pays a 5.5% dividend yield and is expected to continue its long history of slow but steady normalized earnings growth.
• Oshkosh Corporation (OSK, Financial) posted increased earnings, but its shares slid during the quarter becausethe company announced significant supply chain issues and cost pressures.¹¹ Given the current valuation and long-term prospects, we think the company remains an attractive opportunity.
• Schweitzer-Mauduit (SWM, Financial) shares declined in the quarter as the company continued to integrate itssecond quarter acquisition, Scapa Plc. During the quarter the company announced earnings that missed estimates due to margin compression caused by higher input costs and supply chain challenges. While the company said it has initiated aggressive price increases throughout the year, due to timing issues they were not enough to fully offset the increase in input costs.¹² Despite this, we remain pleased with management’s overall execution.

Additions & Subtractions

During the quarter we began adding a new position in financials. We are not disclosing the investment yet because we are actively trading in the company’s shares to build our position. There were no other material changes to the portfolio.

Conclusion

We plan to write more extensive shareholder letters about the Fund and our broader market views at mid-year and at year-end. In the interim, we will continue to scout for attractively priced small cap companies that are in sound financial condition, led by strong management teams, and operating in growing industries.

Respectfully,

Steve Scruggs

Portfolio Manager

1. Source: Reuters https://www.reuters.com/business/finance/investors-look-ahead-rate-hikes-with-fed-tapering-plan-all-certain-2021-09-23/
2. Source: MarketWatch https://www.marketwatch.com/story/americans-will-have-to-get-used-to-high-inflation-at-least-until-the-end-of-2021-11632511300
3. Please see the end of the commentary for definitions of key terms.
4. Source: Synaptics Incorporated (https://www.synaptics.com/company/news/synaptics-acquire-dsp-group-expanding-leadership-low-power-AI-technology)
5. Source:ServisFirst Bancshares, Inc. (https://www.servisfirstbancshares.com/news-market-info/news/news-details/2021/ServisFirst-Bancshares-Inc.-Announces-Results-For-Fourth-Quarter-of-2020/default.aspx
6. Source: American National (https://www.americannational.com/wps/wcm/connect/americannational/e207a4f3-4415-4cae-af4e-8688d0c0de78/Homepage+Press+Release.pdf?MOD=AJPERES&CONVERT_TO=url&CACHEID=ROOTWORKSPACE.Z1 8_M2M0HJ01LG8QD0APPS6TVN3FI7-e207a4f3-4415-4cae-af4e-8688d0c0de78-nIGMIQQ)
7. Source: American National (https://www.americannational.com/wps/wcm/connect/americannational/e207a4f3-4415-4cae-af4e-8688d0c0de78/Homepage+Press+Release.pdf?MOD=AJPERES&CONVERT_TO=url&CACHEID=ROOTWORKSPACE.Z1 8_M2M0HJ01LG8QD0APPS6TVN3FI7-e207a4f3-4415-4cae-af4e-8688d0c0de78-nIGMIQQ)
8. Source: S&P Global Market Intelligence (https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/slow-to-insurance-brookfield-boosts-presence-with-american-equity-pact-60797732)
9. Source: GlobeNewswire (https://www.globenewswire.com/news-release/2021/07/14/2262758/10950/en/IHC-Announces-Agreement-to-Sell-Madison-National-Life-to-Horace-Mann-Educators-Corporation.html)
10. Source: Reuters (https://www.reuters.com/business/energy/penneast-end-development-pennsylvania-new-jersey-natgas-pipe-2021-09-27)
11. Source: Oshkosh Corporation (https://investors.oshkoshcorp.com/news/news-details/2021/Oshkosh-Corporation-Announces-Fiscal-Year-Change-and-Provides-Business-Update/default.aspx)
12. Source: Schweitzer-Mauduit International, Inc. (https://ir.swmintl.com/news-releases/news-release-details/swm-announces-second-quarter-2021-results)

The statements contained herein reflect the opinions and views of the portfolio managers as of the date written, is subject to change without notice, and may be forward-looking and/or based on current expectations, projections, and/or information currently available. Such information may not be accurate over the long-term. These views may differ from other portfolio managers and analysts of the firm as a whole, and are not intended to be a forecast of future events, a guarantee of future results or investment advice.

Portfolio composition will change due to ongoing management of the Fund. References to individual securities or sectors are for informational purposes only and should not be construed as recommendations by the Fund, the portfolio manager, the Adviser, the Sub-Adviser or the distributor. It should not be assumed that future investments will be profitable or will equal the performance of the security or sector examples discussed. The portfolio holdings as of the most recent quarter-end may be obtained at www.fpa.com.

Future events or results may vary significantly from those expressed and are subject to change at any time in response to changing circumstances and industry developments. The information and data contained herein has been prepared from sources believed reliable, but the accuracy and completeness of the information cannot be guaranteed and is not a complete summary or statement of all available data.

The information contained herein is not complete, may change, and is subject to, and is qualified in its entirety by, the more complete disclosures, risk factors, and other information contained in the Fund’s Prospectus and Statement of Additional Information. The information is furnished as of the date shown. No representation is made with respect to its completeness or timeliness. The information is not intended to be, nor shall it be construed as, investment advice or a recommendation of any kind.