In the second calendar quarter of 2015, the KEELEY Small Cap Value Fund (KSCVX, Financial) declined 2.63 percent compared to a 0.42 percent rise for the Russell 2000 Index and a 1.20 percent decline for the Russell 2000 Value Index. The equity markets continued to focus primarily on global uncertainty which weighed on the markets’ ability to move forward. The developments in Greece have garnered the majority of the headlines and left investors wondering what the broader impact could be of a potentially messy default. Volatility in China has also been abnormally high and the possible deterioration of their bull market in equities has added to this global uncertainty. Despite those concerns, news here in the U.S. has been better, with continued gains in employment and optimism that we will see a recovery in the second half of the year despite the tempered growth in GDP during the first half of 2015. Corporate earnings were generally positive during the quarter, but stock buybacks, and more recently mergers and acquisitions, continue to be the first use of capital in lieu of long-term investment and expansion. While that has boosted earnings and has been a tailwind for equities for a number of years, the lid on capital spending is a concern with respect to the economy’s ability to produce sustainable long-term growth. The Federal Reserve took a backseat to the global worries during the quarter, and despite those concerns and the potential impact it might have here in the U.S., the Fed continued to indicate that an interest rate hike is imminent toward the end of the year.
The Keeley Small Cap Value Fund trailed both the Russell 2000 Index and Russell 2000 Value Index during the quarter. Both our sector allocation and stock selection proved to detract during this period. Dispersion amongst sectors continued to be very high, and the majority of our allocation challenges were tied to healthcare, which easily outpaced all other sectors during the quarter after climbing 5.78 percent. Conversely, six sectors produced a negative return, with technology and healthcare effectively producing all of the positive performance in the Index. This shines light on how narrow the market has been recently. However, we remain underweight healthcare; especially biotech stocks which have been exceptionally strong for a number of years. We have never viewed the biotech industry as an area of emphasis for our firm, primarily due to their lack of earnings, cash flow, and transparency. Strength in this industry has often been a headwind for our process. We remain comfortable with this, especially in light of what we believe are excessive valuations for these companies. The industrials sector was the largest detractor from our results during the quarter, and stock selection proved to have the most significant impact. Finally, our lack of exposure to interest rate sensitive names contributed to our results as rates increased, and stock selection in financials made a positive contribution during the quarter.
The industrial sector, typically an area of strength for our process, proved to be a headwind during the quarter. Stock selection was the primary issue and accounted for almost half of our relative underperformance. The largest detractor in the sector was long-time holding L.B. Foster Company (FSTR, Financial) which declined over 27 percent and cost the Fund 31 basis points of performance. Despite growth across the majority of their business segments and earnings that exceeded expectations, the company continues to be hampered by their exposure to the energy market as well as a lawsuit recently filed by client Union Pacific. L.B. Foster plans to fight the suit and we anticipate the stock may endure a slight overhang until the issue is resolved.
Despite positive stock selection in the materials sector, the largest detractor in the quarter was Kapstone Paper and Packaging Corp. (KS, Financial) which fell over 29 percent and cost the portfolio 37 basis points in performance. The maker of specialty paper and containerboard completed the acquisition of Victory Packaging for $615 million in cash in June. Although the acquisition is expected to generate cost savings and be immediately accretive, the stock declined during the quarter after hitting an all-time high in February. After strong growth for a number of years, a disappointing first quarter due to weather, the west coast port strikes, and an IRS ruling making the paper and packaging industry ineligible to convert to an MLP structure, caused analysts to downgrade the industry. We view the recent decline as temporary and continue to have a favorable opinion on the company over the long-term.
The best performing stock during the quarter came from the financial sector. LegacyTexas Financial Group (LTXB, Financial) climbed over 32 percent and added 35 basis points of performance to the Fund. In January of 2015, our original holding, Viewpoint Financial Group acquired LegacyTexas Bank and took on the latter’s name. A primary goal of the merger was to make the transition to a full-service commercial bank and not be as dependent on the oil and gas market. The company is about half way through this transition and the market is beginning to realize the benefits of the company’s diversification. Prior to the performance this quarter, the company had been hindered due to its perceived reliance on the energy market and shares were under pressure as oil declined.
Overall, we realize that a number of uncertainties remain, especially globally, but here in the U.S. we believe the market is well-positioned for moderate growth. Similar to 2014, the disappointing first quarter is expected to hamper annual growth in 2015. However, strength in the labor market, positive developments in consumer spending and continued momentum in housing should fuel faster growth in the second half of the year. In our world of small cap investing, we have some concerns with respect to valuations but are encouraged about the upcoming earnings season as expectations have been lowered after the weaker first quarter. In general, earnings have been mixed recently, but with lower energy and international exposure, we expect small cap stocks to have an advantage over larger cap companies. We continue to be overweight the consumer discretionary sector, which we believe will benefit from lower energy prices as well as an acceleration in consumer spending. Additionally, despite some challenges with respect to CAPEX spending, we believe our holdings in industrials have strong growth prospects and are attractively priced on a relative basis. We feel many of our positions in these sectors and others have been ignored due to the emphasis on low quality stocks as well as smaller stocks with respect to size (i.e. micro cap). Low quality stocks have been stronger than ever primarily due to an emphasis on biotech and we believe this is simply not sustainable over the long-term. The performance of biotech stocks has been well-documented in our commentary and their extraordinary performance has been a challenge for a number of active managers, including us. However, we continue to stay the course with our positions and this quarter consisted primarily of a few “trims” and “adds”. The restructuring stories and investment theses behind our names remain intact and we are confident that the upside in these situations will be reflected in share prices over our longer-term time horizon. Although macroeconomic events have dominated the headlines year-to-date, we believe the equity markets are flush with the type of change we seek that can benefit stock pickers like ourselves. M&A activity is picking up and activist involvement is as robust as ever. These types of trends have historically been a positive catalyst for our approach and we look forward to identifying the best opportunities for our Funds. Thank you for your support of the Small Cap Value Fund.
KEELEY Small Cap Value Fund Standardized Performance Information
The performance reflected herein is for the Class A shares without load. "Without load" does not reflect the deduction of the maximum 4.50% sales fee (load), which reduces the performance quoted. Past performance does not guarantee future results. The performance data quoted represents past performance and current returns may be lower or higher. The investment return and principal will fluctuate so that an investor's shares, when redeemed, may be worth more or less than the original cost. Most current performance data may be obtained at www.KeeleyFunds.com.
The Fund's adviser has contractually agreed to waive a portion of its management fee or reimburse the Fund if total ordinary operating expenses during the current fiscal year as a percentage of the Fund's average net assets exceed 1.39% for Class A Shares and 1.14% for Class I Shares. The waiver excludes expenses related to taxes, interest charges, dividend expenses incurred on securities that a Fund sells short, litigation and other extraordinary expenses, brokerage commissions and other charges relating to the purchase and sale of portfolio securities. The waiver is in effect through January 31, 2016.
This summary represents the views of the portfolio managers as of 06/30/15. 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.
Risks: Smaller and medium-sized company stocks are more volatile and less liquid than larger, more established company securities.
Prior to investing, investors should carefully consider the Fund's investment objective, risks, charges and expenses as detailed in the prospectus and summary prospectus. To obtain a prospectus or a summary prospectus, call us at 800.533.5344 or visit www.keeleyfunds.com. The prospectus/summary prospectus should be read carefully before investing.
Performance attribution is commonly used to measure the quality of the separate decisions that go into the management of an investment portfolio compared to a benchmark index. This analysis tries to isolate the effect and measure the return contribution of market allocation, which analyzes the positive/negative impact of a portfolio's allocation to groupings such as geographic regions or market sectors, and stock selection, which analyzes the positive/negative impact of the portfolio manager's security ownership and weighting decisions within a wider grouping. The performance attribution data in this quarterly commentary was prepared by Keeley Asset Management Corp. ("KAMCO") using the following constraints: (1) Fund portfolio holdings are as of the beginning of each day; index constituents are as of the end of the day. That means that the Fund's holdings are not included until the day after acquisition (when it is included in the portfolio as of the beginning of the next business day), and a portfolio holding that is sold is included in the analysis through the end of the day on which it is sold, and that the values at which securities are included in the analysis are the values as of the beginning of the day. For the index, securities are included at their values at the end of the day. (2) The securities values used in the analysis are the prices used by KAMCO in its internal records for the Fund and the prices used by the index provider for the benchmark index. If a price from either of those sources is unavailable, pricing information from FactSet is used. Pricing information from the index provider or from FactSet may differ from the pricing information used by KAMCO. (3) For the purpose of assigning portfolio security holdings to a particular sector and/or industry, KAMCO assigns the securities in accordance with the sector and industry classifications of the Global Industry Classification Standard (GICS) developed by MSCI and Standard and Poor's (to the extent available) as a primary source and FactSet (to the extent available) as a secondary source for this information. In the event KAMCO securities information vendors do not classify a security's issuer to a particular sector or industry or if the published classification appears to be incorrect, KAMCO may classify the security's issuer according to its own judgment, using other securities information vendors, the company description and other publicly available information about the company's peer group. Sector and/or industry classifications may change over time. The attribution information provided in this commentary includes summaries of attribution by market sector. Attribution is not precise and should be considered to be an approximation of the relative contribution of each of the sectors considered. The information on performance by sector reflects the aggregated gross return of the Fund's securities. Contributions to the Fund's performance by sector (computed as described above) were compared against the contributions to the aggregate return of the stocks comprising the index, by sector, as reported by FactSet Databases.
The Global Industry Classification Standard ("GICS") was developed by and is the exclusive property and a service mark of MSCI Inc. ("MSCI") and Standard & Poor's, a division of The McGraw-Hill Companies, Inc. ("S&P") and is licensed for use by KAMCO. Neither MSCI, S&P nor any third party involved in making or compiling the GICS or any GICS classifications makes any express or implied warranties or representations with respect to such standard or classification (or the results to be obtained by the use thereof), and all such parties hereby expressly disclaim all warranties of originality, accuracy, completeness, merchantability and fitness for a particular purpose with respect to any of such standard or classification. Without limiting any of the foregoing, in no event shall MSCI, S&P, any of their affiliates or any third party involved in making or compiling the GICS or any GICS classifications have any liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits) even if notified of the possibility of such damages.
Data provided for performance attribution are estimates based on unaudited portfolio results. Performance contributors and detractors were not realized gains or losses for the Fund during the quarter. Market performance presented solely for informational purposes. The S&P 500 Index is designed to act as a barometer for the overall U.S. stock market. The index is unmanaged, consisting of 500 stocks that are chosen on the basis of market size, liquidity, and industry grouping. The S&P 500 is a market value weighted index with each stock’s weight in the index proportionate to its market value. The Russell Midcap Value Index measures the performance of the mid-cap value segment of the U.S. equity universe. The Russell 2000 Value Index measures the performance of small-cap value segment of the U.S. equity universe. The Russell 2500 Value Index measures the performance of small to mid-cap value segment of the U.S. equity universe. The MSCI World ex USA Small Cap Index captures small cap representation across Developed Market countries excluding the United States. The index is based on the MSCI Global Investable Market Indices (GIMI) Methodology – a comprehensive and consistent approach to index construction that allows for meaningful global views and cross regional comparisons across all market capitalization size, sector and style segments and combinations. These Index figures do not reflect any deduction for fees, expenses or taxes, and are not available for direct investment. Securities in the Fund may not match those in the indexes and performance of the Fund will differ. The KEELEY All Cap Value Fund, KEELEY Mid Cap Value Fund, KEELEY Small-Mid Cap Value Fund, KEELEY Small Cap Value Fund, KEELEY Small Cap Dividend Value Fund, and KEELEY Mid Cap Dividend Value are distributed by Keeley Investment Corp.
The top ten holdings of KSCVX as of June 30, 2015 include LegacyTexas Financial Group, Inc. (1.41%), Texas Capital Bancshares, Inc. (1.38%), UMB Financial Corp. (1.27%), Wintrust Financial Corp. (1.25%), Iberiabank Corp. (1.24%), Hanover Insurance Group, Inc. (1.24%), BancorpSouth, Inc. (1.23%), American Equity Investment Life Holding Co. (1.23%), Synovus Financial Corp. (1.23%), Provident Financial Services, Inc. (1.22%).
