In the third calendar quarter of 2015, the KEELEY Mid Cap Dividend Value Fund (KMDVX, Financial) fell 8.71 percent compared to an 8.04 percent decrease for the Russell Mid Cap Value Index. Equity markets proved to be very volatile in the third quarter and U.S. stocks produced some of their worst returns since 2011. The macroeconomic environment, led by concerns of an interest rate hike by the U.S. Federal Reserve and concerns of a slowdown in China, were the primary factors in investors’ decision to become more defensive as high quality and traditional safe havens performed best during the quarter. We look forward to the day when markets return their attention to individual company fundamentals, but we are well aware that volatility will most likely remain while investors place their attention on concerns about global growth and central bank policies. Fortunately, valuations measures have become much more reasonable and a number of areas of the economy continue to show strength. The Keeley Mid Cap Dividend Value Fund was not immune from the broad equity market volatility that occurred during the third quarter and slightly underperformed the Russell Mid Cap Value Index. For the quarter, nine of ten economic sectors were negative for the Russell Mid Cap Value Index but with significant dispersion. Returns ranged from +5.2% (utilities) to -24.1% (energy). Overall, stock selection was the primary factor in our underperformance, as sector allocation had a positive impact. Strong stock selection as well as an underweight position in the lagging energy was the most significant contributor to our results during the quarter. Although valuations in the sector are becoming more attractive, the price of the commodity remains very speculative at the moment and we plan on being very patient and selective with respect to any potential additions in the sector. Over the quarter, our average energy weight was 6.1 percent versus the benchmark’s average weight of 9.7 percent. Stock selection was the key driver in our relative performance during the quarter, and challenges in both the financial and utilities sectors were the primary factors.
The top performing position during the quarter was Broadridge Financial Solutions (BR, Financial) which climbed over 11 percent and added 26 basis points of performance to the Fund. The financial processing company has experienced strong new sales over the past year and projected continued momentum into 2016.
The second best performer was American Water Works Co. (AWK, Financial) which climbed over 13 percent and added 23 basis points of performance to the Fund. The stock was clearly helped by being in the right sector, as all investors flocked toward defensive names during the quarter. American Water Works was specifically helped by a slightly better than expected earnings announcement buoyed by better cost controls and margin improvement.
The largest detractor during the quarter was FMC Corporation (FMC, Financial) which declined over 35 percent and cost the Fund 63 basis points of performance. The company reported a disappointing Q2 earnings release due to large part to foreign currency (FX, Financial) challenges as well as weak South American demand for agricultural chemicals.
The second largest detractor was Superior Energy Services (SPN, Financial) which fell over 39 percent and cost the fund 51 basis points of performance. The stock was largely impacted by the broad weakness in energy names, driven by the continued downdraft in oil prices which has produced a fragile and unclear outlook.
The ensuing overview follows the same framework we have used from a number of years, evaluating the market on the following four areas: Economy, Valuation, Interest Rates, and Sentiment. Our current outlook is more positive than we have given in a while. We said at the beginning of the year that we thought the market would be up or down 5% this year and that small and large would perform pretty similarly. We may be wrong about small and large performing in line with each other, but we still think we have a pretty good shot at being right about the market (at least the low-end of our expectation). That implies we get a rally in the fourth quarter. Supporting that idea are more attractive valuations, more cautious sentiment, and seasonality. On the other side of the ledger, rates seem more likely to rise and the economy looks less robust.
Economy – neutral last quarter, still neutral – The economic news has been pretty uneven for the last few months. Much of the data in the US has been pretty good, but not spectacular. Europe also seems to be growing, but is certainly not robust either. On the other side, Japan seems to have stalled again and China’s growth continues to slow. With as much aggressive monetary policy as we have seen, we would have expected more growth. Emerging markets also seem to have slowed significantly. At this point, the benefit of lower gasoline prices should be felt, but it does not seem to be adding much. We expect more of the same. The trend in the economy is probably neither an emerging headwind nor an emerging tailwind for earnings.
Interest Rates – neutral last quarter, still neutral – The Fed keeps talking about raising interest rates this year, but has not done anything about it. We are guessing they will do so before the end of the year. We do not think that this will be the beginning of a long string of increases because this increase will be more designed to try to move toward a more neutral policy, not a policy designed to slow the rate of growth. We think the Fed will be careful not to raise too much because it does not want to make the dollar even stronger. More strength in the dollar will further hurt US exporters as well as emerging market economies.
Valuation –negative last quarter, now neutral – The decline in the market and relative stability in forward estimates has made the market cheaper. At the end of September, the S&P 500’s multiple on forward 12 months earnings was 14.8x, a slight discount to its average since 1999. With the S&P Small Cap now at 16.6x, this puts the relative P/E at 1.12x, in-line with its average since 1999. Mid Cap still looks a little expensive on a relative basis. The most interesting thing is value relative to growth. While the Russell 2000 Value outperformed the Russell 2000 Growth by more than 200 bps in Q3, it is still trailing by about 450bps YTD (-10.06% vs. -5.47%). It is behind by about 350bps/year over the last three years. This has driven the relative P/E (Value/Growth) down to very attractive levels.
Sentiment – negative last quarter, now positive – A bit of a drubbing in the market tends to cure excessive bullishness and we saw that come through in Q3. Both individual investors and newsletter writers became much less optimistic over the last three months. These measures of sentiment, and others such as the put/call ratio, have historically been associated with good returns in subsequent periods.
To recap, the economy, interest rates, and valuation all look neutral and sentiment looks positive (because it is too negative). This comes at a point where seasonal trends are in our favor, so we could get a bounce. We see it as more of a trade rather than the setup for a new bull market. A month or so ago, we said that we thought we were in the midst of a garden variety correction. Unless something very negative develops in the near-term, we think that is still the case. Thank you for your support of the Mid Cap Dividend Value Fund.
KEELEY Mid Cap Dividend 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 09/30/15. 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. Additionally, dividend paying investments may not experience the same price appreciation as non-dividend paying investments. Portfolio companies may also choose not to pay a dividend or it may be less than anticipated.
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 KMDVX as of September 30, 2015 include Broadridge Financial Solutions, Inc. (2.69%), Vulcan Materials Co. (2.50%), CIGNA Corp. (2.38%), American Water Works Company, Inc. (2.16%), Total Systems Services, Inc. (2.12), CIT Group, Inc. (1.96%), ITT Corp. (1.89%), Reinsurance Group of America, Inc. (1.87%), Iron Mountain, Inc. (1.81%) and Autoliv, Inc. (1.77%).
