Commentary – 4th Quarter 2019


For the quarter ended December 31, 2019, the Small Cap Dividend Value Strategy rose 5.44% gross (5.19% net of fees) versus a 8.49% gain for the Russell 2000 Value Index. During the full-year 2019, the Strategy gained 24.04% gross (22.88% net of fees) compared with a 22.39% gain for the benchmark.

Macroeconomic Review

After limping into the end of 2018, the market bounced back in the first quarter and never looked back. As measured by the S&P 500 (or any other Index for that matter), the market rose in all four quarters, historically the market has had this outcome in almost 30% of past calendar years. The S&P 500’s full-year total return of more than 31% is its 11th best year since 1940. By these metrics, the end of the second decade of this millennium was exceptional for the stock market.

The fourth quarter helped drive these strong gains with a 9.1% total return for the S&P 500. A combination of better economic readings and progress in reaching a trade deal with China drove performance, as it did for much of the year. Growth outperformed Value, and for the first time since the second quarter of 2018, small-caps outperformed large-caps, although it was only by 10bps. Mid-caps lagged, interest-sensitive sectors like REITs and Utilities underperformed. Non-dividend paying stocks significantly outperformed dividend-paying stocks.

A year ago, the debate in the market revolved around the potential impact from the government shutdown, an escalating trade war with China, and whether the Fed had gone too far (or would go too far) in raising rates. While the government shutdown ended up being the longest on record, it did not seem to have much short-term impact on the economy and certainly did not throw the US into a recession. The trade dispute with China probably did slow economic growth, but the general perception of progress in resolving this dispute dampened the impact. Furthermore, the progress made in the fourth quarter which culminated in the announcement of a “Phase One” deal likely contributed heavily to fourth quarter gains. The question about the Fed raising interest rates was answered early in 2019 when it signaled that it would be on hold. This concern was put to rest in the middle of the year when it cut rates for the first of what would be three rate cuts.

The future course of the US economy is likely to have a big impact on the markets. After negative readings from September 2008 through June 2009, the US posted growth in the third quarter of 2009 to start the recovery/expansion. While there have been some negative quarters since, they have not been consecutive and so the economy has not fallen into the definition of a recession. This is now the longest period of expansion since the government started keeping reliable records. With unemployment near historic lows, investors have wondered how much longer the expansion can continue. We think the economy is stable and should continue to grow. While this expansion has been long in duration, the slope of it has lagged most other recoveries, there should be room for continued growth. We are not seeing some of the cost pressures that typically arise when the economy is at an advanced stage in the expansion. The most worrisome is labor costs, but growth in the labor force participation rate seems to be offsetting much of the wage pressure that generally comes from a low unemployment rate. Commodity costs are up some from a year ago, but not much changed over the last five years. Finally, economies outside the US seem to be seeing better prospects. All in all, the economy looks okay, although not robust.

Portfolio Results

The Keeley Teton Small Cap Dividend Strategy had one of its more challenging quarters and performance in the second half offset the first-half’s strong results. Part of the challenge this quarter was the make-up of the move in the market. Specifically, higher beta stocks led the move higher. That should be expected, but the degree of the move was well beyond what the definition of beta would suggest. According to Jefferies Research, the highest quintile of stocks in the Russell 2000 Value Index rose 14.7% compared with 8.49% for the Index as a whole, and 1.7% for the lowest quintile. With the Strategy’s beta at about 0.9 and few of the Strategy’s holdings in the top quintile of beta (>1.3), the risk-on environment created some performance challenges.

We also made some mistakes as the Strategy had eight stocks fell more than 10% which is too many in a quarter when the market is up more than 8%. We discuss some of these stocks below.

The Strategy outperformed in two sectors, lagged in five, and four were a push. The Strategy added value in the Consumer Discretionary and Utilities, while Technology, Real Estate Energy, Materials, and Health Care detracted from relative performance.

The Consumer Discretionary sector was the biggest contributor to relative performance. Within the sector, the Strategy’s holdings provided a wide range of outcomes as Winnebago, Marriott Vacations, and Kontoor Brands each rose more than 20% in the quarter while Jack in the Box and Culp each fell more than 10%.

The Strategy’s Utilities holdings rose modestly during the quarter while the Utility stocks in the Russell 2000 Value fell. Four out of the five stocks rose with the star being Atlantica Yield. Allete was the lone stock to decline.

While the Strategy’s Technology holdings rose nearly 10% in the quarter, they badly lagged the 21% gain for Technology stocks in the Russell 2000 Value Index. Strong gains by AVX and KBR (discussed below) were not enough to offset a steep drop in Plantronics (also discussed below) and keep up with the underlying strength in the sector.

The Strategy’s holdings in the Real Estate sector declined whereas the Real Estate stocks within the Index increased in value. Two healthcare REITs, Sabra and CareTrust, were the primary sources of weakness. They tend to be more interest-rate sensitive than many REITs and the flattening out of rates in the fourth quarter led to weakness in REITs (and Utilities as well). In addition, both stocks had done well though the first nine months as Sabra ended the year with a 41% gain and CareTrust returned 16%.

All three of the Strategy’s holdings in Energy trailed the sector’s performance within the Index. The biggest detractor was Berry Petroleum, which fell after the state of California proposed new restrictions on drilling and production operations. The Strategy’s holdings in Evolution Petroleum and Delek US also fell slightly.

The Materials sector was the third strongest in the Index on strength in steel and other metals stocks due to the perceived thawing in US/China trade relations. The Strategy did not hold any metal stocks and stocks it held that should benefit from this same trend, Olin and Mercer International, did not respond favorably yet.

While the Strategy’s holdings in Ensign and Chemed did not contribute enough to returns and we sold the Pennant shares that were spun out of Ensign too early, the bigger driver of the Strategy’s underperformance in the Health Care sector was the stocks it did not own. A little more than half the Index’s weight in the Health Care sector is in Biotechnology and Pharmaceuticals, none of which pay dividends. These sectors were up 42% and 24%, respectively and accounted for more than 80% of the sector’s contribution to the Russell 2000 Value’s performance.

The Strategy added four new holdings, liquidated four holdings, and had one holding converted on a merger.

Leading Contributors

KBR, Inc. (KBR) operates two similar but unrelated businesses; Government Solutions which provides outsourcing services to government entities (mostly the US Government), and Energy Solutions which provides engineering, construction, and maintenance services to global energy and utility companies. Shares performed well during the fourth quarter due to solid third quarter results, strong bookings in both businesses, and continued progress in completing and resolving a troubled Energy Solutions project.

Altra Industrial Motion (AIMC) is a diversified manufacturer of off-highway vehicle components and material handling parts and systems. After a sharp drop in the third quarter due to disappointing second quarter earnings, Altra’s shares rebounded in the fourth quarter. It reported better-than-expected third quarter results with improving cash flow. This should allow the company to pay off some of the debt it took on to buy Fortive’s Automation and Specialty business in late 2018. The resulting leverage reduction should improve earnings and likely give the valuation a lift.

AVX Corporation (AVX) is a leading maker of capacitors and other electronic components. Shares rose more than 35% in the quarter after majority-owner Kyocera proposed acquiring the company for $19.50/share in cash. While a final deal has not been struck, we believe that one will be completed.

Leading Detractors

Plantronics Inc. (PLT) is a leading maker of communications endpoints. Specifically, it is among the leading makers of telephony and computer headsets, audioconferencing equipment, and video conferencing equipment. The stock performed poorly in the fourth quarter after the company reported disappointing calendar third quarter earnings and lowered earnings guidance for the rest of its fiscal year. While the company has a robust new product pipeline, it appears to be struggling with product transition issues in several of its product segments. This has left it with too much inventory at its dealers which will take some time to work through which impacts sales going forward.

Granite Construction (GVA) provides construction and infrastructure solutions for the Transportation, Water, and Materials sectors.   This marks the second quarter in a row that Granite is one of our bottom contributors as its struggle with large, legacy, fixed-priced projects continued.  This was a surprise to us (and the market) given the confidence that management had expressed heading into the quarter that no additional write-downs were anticipated.  This confidence was premature as management announced on the earnings call that a write-down was required once again sending shares down 28% on the day.  Management is finally taking steps to fix this segment by changing management and strategy surrounding future project bidding including limiting project size.  While these changes are welcomed, the lack of full resolution of these troubled projects, as well as management’s inability to consistently forecast near-term business trends caused us to move on.

Covanta Holding (CVA) is a leader in sustainable waste-to-energy solutions with a global network of over 50 energy-from-waste and material processing facilities around the world. Shares were under pressure this quarter due to worries about recycled metals pricing which have been declining all year putting pressure on top-line results despite higher volumes.  Helping to offset some of these concerns is Covanta’s core energy-from-waste business which has picked up the slack on the back of record waste-tons processed and steadily increasing tip fees. The lack of landfill capacity in the northeastern US is driving consistent demand for Covanta’s services.  Additionally, Covanta’s international pipeline for constructing energy-from-waste facilities got a boost with the recent announcement that it will build a facility in China. This region offers the biggest opportunity for these types of facilities across the world.  Curbing some of this enthusiasm is investors’ concern with Covanta’s debt load standing at roughly 6x.  However, management is extremely confident that the company has the necessary liquidity to finance these projects.


Whatever the outcome of the upcoming Presidential election, 2020 promises to be an interesting year. It is also likely to be a year in which the parts of the stock market in which we traffic (small- and mid-cap value) do relatively better. We have talked in past letters about the relative attractiveness of small-caps vs. large-caps and value stocks vs. growth stocks. These comments remain applicable as the multiples for small-cap stocks relative to large-cap stocks are at the low-end of their historical ranges. This advantage did not help again in 2019, but we believe it will eventually work.

An interesting observation we have that many people do not talk about is the outperformance of value stocks in Presidential election years. In fact, since 1980, the Russell 2000 Value Index has outperformed the Russell 2000 Growth Index in all Presidential election years. In larger stocks (Russell 1000), value beat growth in eight of the ten Presidential election years. In addition, small-caps beat large caps in seven of the ten election years. While streaks are broken all the time (UNC basketball recently lost to Clemson at home after 59 consecutive wins!), the combination of relative valuation and history makes us optimistic about the year ahead, at least from a relative perspective.

In conclusion, thank you for your investment in the Small Cap Dividend Value Strategy. We will continue to work hard to justify your confidence and trust.