Dear Shareholders,
FPA Queens Road Small Cap Value Fund (“Fund”) returned -3.3% in the first quarter of 2022. This compares to a -2.2% return for the Russell 2000 Value Index in the same period.
First quarter performance was negatively impacted by the Fund’s overweight position in the technology sector, which sold off sharply during the quarter, and its underweight allocation to the energy sector, which soared during the quarter (the energy holdings of the Russell 2000 Value Index were up 45% during the quarter).1 These two sector allocations detracted approximately 2.75% from the Fund’s relative performance versus the Russell 2000 Value Index for the quarter. In technology, Synaptics, one of the Fund’s best-performing holdings last year, fell precipitously during the quarter. We sold part of the position during the 4th quarter of last year and additionally trimmed shares in January. While we feel great about Synaptics’s long-term prospects, we were concerned with the company’s valuation even though operating performance has improved considerably over the last two years. At the current reduced valuation, the company appears attractive.
While China experienced an unexpected surge in COVID cases during the first quarter, trends in the U.S. were favorable. The front-page news has shifted from a focus on the pandemic to Russia’s invasion of Ukraine. The global repercussions of Putin’s war are not yet fully understood, but energy prices have soared. Increased energy prices, as well as overall price increases tied to inflation hitting 40-year highs, are putting downward pressure on global growth. The Federal Reserve announced on March 16th a 0.25% rate hike in the Federal Funds rate and signaled it will continue to raise rates throughout the year if inflation remains elevated.2 In the face of this, projections for global economic growth are dropping, prompting concerns about stagflation. The Fed’s prior predictions of inflation being ‘transitory’ have clearly not panned out.
Federal Reserve Chairman Jerome Powell said after the Federal Reserve Board of Governors’ March meeting, “The U.S. economy is very strong and well-positioned to handle tighter monetary policy.” Perhaps this prediction will prove to be more accurate than the previous assurance of “transitory” inflation; we shall see. The Fed, which had predicted U.S. GDP growth of 4% for 2022 back in December, lowered its expectation to 2.8% growth for the year.3
Trailing 12-Month Contributors and Detractors4
Contributors
- ServisFirst Bancshares (SFBS, Financial), a Birmingham, Ala.-based commercial bank, finished 2021 posting 8%quarter-over-quarter loan growth and has signaled that management expects the strong loan growth to continue throughout 2022. Loan quality remains high, and loss reserves seem more than adequate. The company recently hired a new team of bankers to help sustain continued loan growth. As one of the largest holdings in the portfolio, we remain confident in the company’s long-term prospects.5
- Synaptics (SYNA, Financial), a developer of human interface (HMI) hardware and software, has continued its strategicshift to higher-margin business, primarily Internet of Things (IoT) products. While the strategic plan has been well executed, we have trimmed the Fund’s position over the last several months due to valuation. During the first quarter, Synaptics’s stock price fell 31%.6 While increased uncertainty on global growth has tempered our near-term expectations, we believe the current valuation is attractive and remain confident in the company’s long-term prospects.
- South Jersey Industries (SJI, Financial) shares rose 40% on Feb. 24, 2022, on news that Infrastructure InvestmentFunds, a private equity fund managed by JP Morgan Investment Management, would take the company private. The deal is scheduled to close in the fourth quarter of 2022.7
- American Equity Investment Life Holding Company (AEL, Financial), a leading writer of fixed index annuities, hascontinued to transition to its AEL 2.0 business model. The plan’s main goals are to diversify the company’s assets into a broader array of investments, including private debt through strategic partnerships, and to increase its use of reinsurance to free up capital. We think this is an interesting, but somewhat aggressive plan. Thus far, the results have been impressive, but we continue to monitor the credit quality of their assets as they move toward achieving their target of having 40% of their portfolio invested in private assets, up from 15%.8
- American National Insurance (ANAT, Financial). Shares of the life insurance and annuity company’s stock rose as thecompany agreed to a buyout from Brookfield Asset Management in an all-cash deal scheduled to close during the first half of 2022.9
Detractors
- Schweitzer-Mauduit International (SWM, Financial), a product engineering and manufacturing company, fell during theyear as price increases did not keep up with inflation. The company’s margins suffered, but the company expects a normalization by mid-2022. The company made a significant acquisition during the second quarter of 2021 (Scapa Group) at what we think was a bargain price.10 However, scarcity problems and inflation negatively impacted Scapa’s initial performance. The company has aggressively raised prices and worked through many of its supply issues. The company continues to see strong demand and has projected strong financial performance for 2022.
- TreeHouse Foods, Inc. (THS, Financial), a manufacturer and distributor of private label food, announced in November2021 a plan to explore strategic alternatives. The company has been under pressure from activist investor Jana Partners (Trades, Portfolio).11 The company has resisted a sale of the entire business but continues to look for strategic divestitures. While the company appears reasonably valued, we are concerned about its long-term outlook and have reduced our holdings.
- PVH Corporation (PVH, Financial), owner of Calvin Klein and Tommy Hilfiger brands, fell during the last 12 months asthe company continues to struggle with supply chain issues resulting in delivery delays. During the first quarter, the company lowered its guidance, causing a sharp selloff in the stock. Some analysts worry that a slower-than-expected rebound in international travel may have a negative impact on the company this year (70% of sales are ex-US). Despite these concerns, management is projecting modest revenue growth and near record gross margins for 2022, and we remain confident in the company’s long-term prospects.12
- Vishay Intertechnology (VSH, Financial), a manufacturer of discrete semiconductors and passive electronics, increasedrevenues and profits last year as its share price fell. The company offers a broad range of products essential to manufacturing electronic circuits. While broadly diversified by geography, customer, and end markets, the company is sensitive to economic growth, and slower economic growth would provide a headwind. Given the current valuation, these concerns seem to be priced into the stock, and we believe the secular tailwinds outweigh the near-term uncertainty.
- Oshkosh Corporation (OSK, Financial), a specialty vehicle manufacturer, fell during the year as the company’sperformance was impacted by chassis and component shortages. Given its strong backlog and competitive position within its markets, we think the company remains an attractive opportunity.
Sincerely,
Steve Scruggs, CFA
Portfolio Manager
1 Source: FTSE Russell
2 Source: FOMC Press Release https://www.federalreserve.gov/newsevents/pressreleases/monetary20220316a.htm
3 Source: Federal Reserve Summary of Economic Projections https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20220316.pdf
4 Reflects top five contributors and top five detractors to the Fund’s performance based on contribution-to-return on a gross basis. This is not a recommendation for a specific security and these securities may not be in the Fund at the time you receive this Commentary. The information provided does not reflect all positions purchased, sold or recommended by the Fund during the trailing twelve months. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities listed. For a full list of holdings, please view the holdings report at the end of this Commentary. The portfolio holdings as of the most recent quarter-end may also be obtained at www.fpa.com.
Past performance is no guarantee, nor is it indicative, of future results.
5 Source: ServisFirst Bancshares Q1 2022 Earnings Call, April 18, 2022; https://services.choruscall.com/mediaframe/webcast.html?webcastid=2uGk9K5e
Also check out:
