Keeley Small-Mid Cap Value Fund 1st-Quarter Commentary

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Jun 30, 2022
  • For the quarter ended March 31, 2022, the Keeley Small-Mid Cap Value Fund’s net asset value per Class A share declined 4.9% compared with a 1.5% fall in the Russell 2500 Value Index.
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To Our Shareholders,

For the quarter ended March 31, 2022, the KEELEY Small-Mid Cap Value Fund’s net asset value (“NAV”) per Class A share declined 4.9% compared with a 1.5% fall in the Russell 2500 Value Index.


For the last two years, the tone of the market has been set by the evolution of the COVID-19 pandemic and the fiscal and monetary actions undertaken by the government to “bend the curve” and blunt the economic impact on its citizens. Unprecedented levels of scale and monetary stimulus first stabilized markets and then started the rebound. The announcement of successful vaccine clinical trials drove markets to new highs and the roll-out of those vaccines allowed economic activity to recover toward something approaching normal. The pandemic is not over. The United States reported more new COVID cases in the first quarter than in any previous quarter and deaths from COVID were the second highest of any quarter since the beginning. Shutdowns in some of China’s largest port cities remind us that the supply chain disruption caused by this pandemic may be with us for a while. However, concerns about the potential impact from the pandemic have now been replaced by new worries over inflation.

For the last several quarters, inflation ran ahead of the 2% rate that the Federal Reserve targets as optimal. Initially, these price increases were dismissed as “transitory”. The theory was that COVID-related supply chain constraints and the rebound in energy prices from depressed prior-year levels (“base effects”) were overstating the real inflation rate. As supply chains normalized and we anniversaried the rebound in commodity prices, the inflation rate would settle back down to the target rate. This view eroded during the early part of the quarter and the Russian invasion of Ukraine in late February made it extremely unlikely.

The personal and humanitarian impact of the invasion of Ukraine is incalculable and this episode is another reminder of our good fortune to live in the United States. The economic and geopolitical impact of this incursion is difficult to estimate, but there are some clear impacts that we can identify at this early stage. First, the price of oil and gas and other key commodities has rocketed higher and may stay there for some time. Russia is one of the largest producers and exporters of oil and natural gas. While Europe continues to buy fossil fuels from Russia, most of those countries are looking for other sources and some countries are not buying Russian oil at all. This further tightened a market with little spare capacity leading to a 34% increase in the price of oil in the first quarter. In addition, both Russia and Ukraine are important exporters of corn and wheat. Grain markets have tightened, and prices have increased. Against this backdrop, inflation is rising to concerning levels and looking less “transitory,” than before the Russians invaded Ukraine and the impact on key commodities from this conflict is likely to sustain or accelerate this trend.

The longer-term impacts may also be inflationary. In response to supply chain disruptions from COVID and from the Ukraine invasion, decision makers are acting to lower their risks. Countries in Europe are seeking other sources of energy; liquefied natural gas (LNG), nuclear, solar, and wind. These cost more than their current sources which is likely to increase energy costs for the people who live there. Companies increasingly look at bringing some production back to their home country.

This uptick in inflation has not gone unnoticed by the markets. Interest rates across the yield curve moved higher in the first quarter with the ten-year Treasury bond yield moving up 0.81% to 2.32% at quarter end. The middle of the curve moved up even more with the two-year up 1.56% to 2.29%. The result of this rise was the worst quarterly performance for the bond market since the 1980s. The Fed and its various members have signaled that they intend to continue raising rates until inflation is more contained.

The good news in the inflation story is that it is partially symptomatic of a strong economy. Energy prices were strong before the Russian invasion because demand for fuels and other petroleum-based products had recovered from the pandemic-driven downturn. Higher wages reflect a tight labor market. A strong economy is generally good for companies and good for stocks.

The bad news about inflation is twofold. First, higher inflation usually leads to higher interest rates which usually leads to lower valuation multiples. This sets up a race between rising earnings and falling multiples. In 2021, earnings rose more than valuations fell which resulted in good gains for stocks. at will be harder to achieve in 2022 and we have seen that impact on stocks so far this year, especially for stocks with higher starting valuations. Value stocks, particularly small- and midcaps, look attractive relative to growth stocks and large caps. This likely contributed to their outperformance in the first quarter across the market cap spectrum.

The other challenge arising from inflation is that policymakers will seek to contain it and the cure may not be that palatable. The Fed plans to raise interest rates with the intention of curtailing excess growth. The recent turbulence in the market likely results from investors’ concerns about whether they will be able to accomplish their goals without tipping the economy into a recession. We are probably a little more optimistic than most investors in that we believe that the economy is well-positioned to absorb a little slowdown. Unemployment is low and job openings are high. Workers furloughed may find it easier to find new jobs. We continue to build the portfolio on a bottom-up, stock-by-stock basis. We have lately been able to invest in a variety of spin-offs with several more on deck.

Portfolio Results

The Fund lagged its benchmark during the first quarter. Sector Allocation was a slight positive while Stock Selection was a negative. Within Sector Allocation, the Fund gained ground with its slight overweight in the Energy sector, but gave some back in in the Materials sector, where it was slightly underweight, and the Consumer Discretionary sector, where it was slightly overweight. The Fund benefitted from good stock selection in the Financials and Health Care sectors while disappointing performance in the Industrials, Energy, Materials, and Consumer Discretionary sectors hurt performance.

  • Financials were again the biggest relative contributor to performance in the quarter. Virtu Financial, a securities market-maker, accounted for much of the performance, but mortgage insurer Enact Holdings and several banks also generated gains while the sector within the index declined.
  • The Health Care sector also produced positive relative performance. Much of this can be attributed to what the Fund did not own, specifically biotechnology stocks. Aside from that, results in the sector were mixed, but positive on balance. A nice gain in recent Merck spin-off Organon o set losses elsewhere. The sector within the index was the second worst performing, lagging only the Consumer Discretionary sector.
  • While stock selection in the Industrials sector has generally been good over time with it adding value in six of the last nine quarters, that was not the case this quarter. Two of the Fund’s three worst performers, Fortune Brands Home & Security and Harsco (discussed later), came from this sector. Furthermore, only three of the Fund’s 17 holdings appreciated in the quarter. That is somewhat to be expected in a down market. The notable highlight in the sector was the strong performance of Nielsen after it agreed to be acquired by a team of private equity firms for cash.
  • While the Fund’s slight overweight in the Energy sector helped performance, the Fund’s holdings failed to keep pace with the strong gains in the sector overall. The Fund’s blend of companies working their way through corporate change performed well, but not as well as the index which was driven by natural gas, coal, and capital-intensive service companies like drillers.
  • The Materials sector was the second-best performing sector within the benchmark with a more than 10% gain. This was mostly due to strong gains by metals and mining companies which were driven by escalating base metals prices. We have tended to favor more differentiated companies, although the Fund’s biggest detractor in the sector was aggregates supplier Summit Materials which is under new leadership and executing a solid profitability improvement plan.
  • The Consumer Discretionary sector was the fourth sector that detracted from Fund performance during the quarter. The Fund’s Consumer Discretionary stocks performed worse than the overall sector, which itself was the worst-performing of the eleven industry sectors. Much of the disappointing performance is the result of declines in the shares of Tri Pointe Homes (discussed below) and Bath & Body Works, which reported good fourth quarter results but lowered expectations for the coming year due to cost pressures and planned technology spending.

During the quarter, we added one new position to the Fund and sold two holdings.

Let’s Talk Stocks

The top three contributors in the quarter were:

Chesapeake Energy (

CHK, Financial) (CHK - $87.00 - NASDAQ) is a natural gas-focused exploration and production company withoperations in Pennsylvania and Texas. Strong increases in commodity prices combined with a more disciplined capital allocation framework drove gains in the share prices of many energy companies in a period when not much else was working. Chesapeake announced its structure of affixed and variable dividend combined with share repurchases to return excess free cash flow. In addition, the company sold its non-core Powder River Basin acreage and announced the acquisition of a large private operator in Pennsylvania that will help improve its operational efficiency in that key market.

WEX Inc. (

WEX, Financial) (WEX - $178.45 – NYSE) is a leading provider of transaction processing services to commercial vehicle fleets, travel agencies, and health care providers. The company reported strong fourth quarter financial results during the quarter, but this time was rewarded for it. WEX had been one of the Fund’s weaker stocks in the fourth quarter, but investors seem to be coming to a better understanding of some of the financial metrics that should drive value at WEX. The stock remains well below historical valuation levels and is one of a limited number of technology companies that should continue to recover from the pandemic as the industries it serves rebound.

Virtu Financial (

VIRT, Financial) (VIRT - $37.22 — NASDAQ) is one of the largest independent electronic market-makers across awide range of securities. Virtu reported a solid fourth quarter with financial results beating consensus estimates as elevated market volatility and volumes created a good environment for the company. Profitability was strong and the company repurchased $100 million of stock in the quarter. The volatility we have seen so far in 2022 should set up the company well for continued strong results.

The three largest detractors in the quarter were:

Fortune Brands Home and Security (

FBHS, Financial) (FBHS - $74.28 - NYSE) is one of the leading manufacturers of plumbing fixtures, cabinets, doors, and security products used in home repair and remodeling as well as new home construction. The shares of Fortune Brands fell during the first quarter as sentiment turned negative on the stock due to concerns about continued input cost inflation and the impact of higher interest rates on consumers. However, the company continues to report strong results as it exceeded consensus estimates across the board. Sales growth in the quarter was solid, particularly in the Doors & Security and Cabinets segments. Management continues to navigate the inflationary environment well as the company aggressively implements price increases to offset higher costs with the expectation of price-cost parity by mid-year 2022. Finally, management conveyed confidence in the near-term outlook as it gave 2022 earnings guidance above consensus estimates.

Tri Pointe Homes (

TPH, Financial) (TPH - $20.08 - NYSE), one of the nation’s leading homebuilders, saw its stock sell off in the first quarter on growing concerns about the sustainability of growth considering deteriorating home affordability. Higher prices and rising mortgage rates are making buying a house more expensive. Nonetheless, TRI Pointe reported solid results to cap off a record year in 2021 with revenue growth of 15% in the quarter while margins improved on higher pricing and good cost controls. Management continues to anticipate solid demand across its geographies with the expectation of modest price increases as peak lumber prices runs through its income statement over the next couple quarters.

Harsco Corporation (

HSC, Financial) (HSC - $12.24 - NYSE) is a diversified manufacturer and service provider that focuses onserving the environmental remediation needs in several industries. The fourth quarter results which the company reported during the first quarter were broadly disappointing. Harsco had several issues in its usually reliable steel business as European steel production slowed due to higher power costs and the company lost a large contract to a competitor. Its Clean Earth business, which disposes of contaminated waste and provides soil remediation services, suffered from labor shortages and higher transportation costs. Finally, Harsco entered a sales process for its non-core Rail business from which the company expects to use proceeds to reduce debt. This process seems to be lagging investor expectations from a timing standpoint but should accomplish the goal.


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.

April 12, 2022

This summary represents the views of the portfolio managers as of 3/31/2022. 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.

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I/we have no positions in any stocks mentioned, and have no plans to buy any new positions in the stocks mentioned within the next 72 hours. Click for the complete disclosure
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