Commentary – 1st Quarter 2019


For the quarter ended March 31, 2019, the Small-Mid Cap Value Strategy increased 17.12% gross (16.98% net of fees) versus a gain of 13.12% for the Russell 2500 Value Index.

Macroeconomic Review

Major indexes have now recouped almost all of the losses sustained in the final months of 2018, when fears over a potential economic slowdown sent global markets tumbling. The two primary fears that pummeled the market in December—escalating trade disputes and steadily rising interest rates—abruptly turned around in the first quarter. First, US and Chinese officials placed a stay on the second round of tariffs while negotiating towards a solution. Second, the Federal Reserve acknowledged market concerns by signaling a hold to further interest rate hikes for the year, citing a diminished inflation outlook and slowing global growth (namely Europe). A dramatic shift post the December 20th rate hike where the outlook was still for five to six hikes in 2019. Concurrently, earnings guidance and expectations were lowered further continuing to reflect a slower Europe, slowing China and the absorption of both rounds of tariffs via pass-through pricing. With both of those exogenous threats receding, earnings expectations rebased lower, and valuations more reasonable after the storm in December, stocks posted their strongest first quarter in over a decade. The focus returned to companies that can outperform in an environment of economic growth, albeit at a moderating pace.

Much of this year’s rally was driven by relief that central banks were backing off rate hike campaigns amidst slowing growth from the Eurozone to China. Consequently, long term interest rates have declined, with three-month U.S. Treasury bills slightly higher than the yield on ten-year U.S. treasury notes. Seen from this vantage point, the market paints a portrait of stability at this moment, balancing fading exogenous impacts with moderating economic growth, forming a reasonably positive environment for small caps.

The lingering question for stocks is whether this brush with fear has led to a change in the dynamics for global economies and how much could be trade-related impairment. Taking the manufacturing PMI (purchasing managers index) for the three main global economies, the most recent figures for March show stabilized, expansionary readings above 50 for the US and China (55.3 and 50.5, respectively) while the Eurozone marks thirteen months of sequential declines, ending in recessionary readings solidly below 50 (47.5 for the Eurozone and 44.1 for Germany). This representative snapshot overlaps similar narratives supplied by companies, underscoring the relative level of support for domestic-oriented small cap companies less dependent upon exports. U.S. nonfarm payrolls rose in March by 196,000, a strong showing. Wage gains eased with the unemployment near a 49-year low, at 3.8%.

The portfolio posted solid outperformance of almost 400 basis points relative to the Russell 2500 Value Index in the first quarter and we were most pleased to mark positive relative performance in each month of the quarter. The positive contribution was primarily from strong stock selection. This outperformance was spread broadly across sectors, with more than half attributed to our Tech and Industrial holdings. Within Tech, Versum (VSM) was our top performer, up 82% in the quarter. The company initially agreed to a stock merger with Entegris, but rival Merck KGaA emerged with a much higher, all cash offer. Being a spin-off from Air Products, Versum’s takeover is an excellent example of the how the spin-off process creates pure play companies that become very attractive acquisition candidates for larger firms searching for growth, especially in this low global GDP, low interest rate environment. Five of the remaining six tech names outperformed or were in-line with the tech sector index returns. Our newest tech addition, GTY Technology Holdings (GTYH), was the only tech name down in the first quarter, though we feel this was due to non-fundamental issues (more detail below). The relative outperformance in Industrials was also broad based led by company specific factors as well as the trade and rate relief. Eight of our eleven holdings exceeded the industrial sector index returns with most up over 20% for the quarter. Financials, Communications Services, Consumer Discretionary and Real Estate made up the bulk of the remainder of the outperformance with only Utilities contributing a drag of any meaning. As the lower rates hurt the banks, our two holdings in the insurance space, AXA Equitable and Voya were both up over 20% given their equity market exposure. Nexstar Media was a top 3 performer (see details below) driving performance in Comm Services, while PVH Corp.’s announced restructuring of its Calvin Klein division plus strong results during the holiday season led to a 31% move in Consumer Discretionary. Real Estate was the 3rd best performing sector in the index due the lower rate outlook, but strong selection from our positions in the skilled nursing REITs (CareTrust and Sabra), gaming REITs, (VICI and Gaming & Leisure Properties), and Ryman Hospitality led to outperformance.

On the negative side, it was only the Utilities sector that had any meaningful underperformance. The sector lagged on the bounce after performing well in the fourth quarter, but it was our large position in NRG Energy, up only 7% in the quarter, that held back our performance. NRG is in the final stages of its business transformation and has been a very strong contributor to the Strategy for several years in a row.

Leading Contributors

Versum Materials, Inc. (VSM), a fairly recent spin-off from Air Products (APD), is a leading maker of chemicals used in the production of semiconductors and other electronics. Its stock appreciated sharply during the quarter after it received an acquisition offer from Entegris (ENTG) for cash and stock. Afterwards, competitor Merck KGaA topped that offer with a $53 cash proposal.

Nexstar Media Group, Inc. (NXST) is one of the largest owners of television broadcasting stations. Shares performed well in the quarter after falling sharply at year-end. Nexstar has been reporting solid results over the last year as it took out cost from and integrated operations acquired from Media General. In addition, political advertising was very strong in the fourth quarter and helped to drive upside. Most importantly, the company has made significant progress toward completing the conditions necessary to close its acquisition of the Tribune Media stations. The Tribune deal should be nicely accretive to earnings over time.

WEX Inc. (WEX)provides payment processing and information management services for Fleet Solutions, Travel and Corporate Solutions, and Health and Employee Benefits Solutions. In layman’s terms, WEX offers credit cards to employees of its clients simplifying and controlling their spend. In Fleet Solutions (the largest division), truck drivers are given cards instead of cash to manage spend for fuel on routes. This is safer for the driver, plus the card has to used at certain gas stations, where WEX’s scale of cardholders enables them higher discount on gas purchases. In addition, the data from the card could be better tracked for the customers information use. As a result, WEX’s stock has historically tracked gas prices and with oil’s 32% rise in the first quarter, WEX’s correlation did not disappoint. In addition, WEX’s diversification into other non-gas related businesses, Travel and Corporate Solutions and Health and Employee Benefits, are now at scale and driving solid growth.

Leading Detractors

GTY Technology Holdings, Inc. (GTYH) was a blank-check, special purpose acquisition vehicle that recently acquired six software-as-a service (SaaS) companies focused on state and local governments. The cloud and SaaS revolution are ripe for this market that does not have the expertise or manpower to implement and run all of these software functions, nor the budgets for the large upfront software license fees and hardware. State and local government can dramatically improve the digital experience for their constituents, such as enabling on-line payments (parking tickets, real estate taxes), on-line applications and quicker response times for grant applications and building permits, while also benefitting from lower IT expense, better workflow management, and population of data accessible to all agencies. GTYH was founded by William Greene, former CEO of Accenture; Joe Tucci, former CEO of EMC; and Harry You, former Chariman of DellEMC, CEO of BearingPoint and CFO of Oracle. The CEO, Stephen Rohleder, was the former Head of Accenture’s Public Services Group. The acquisitions closed in late February and with limited liquidity plus no analyst coverage as of yet, the stock has had no sponsorship leading to its underperformance in the quarter.

Valvoline Inc. (VVV) is engaged in producing, marketing, and supplying engine and automotive maintenance products worldwide, primarily engine oil and lubricants. The company has three divisions: 1) Core North America sells these products to do-it-yourself (DIY) auto retailers as well as installers who then use the product to provide the service to consumers, 2) Quick Lubes – owned and franchised service centers that use the product to perform the service on the customers vehicles, and 3) International – sells the products to retailers, JV partners and distributors. Earnings at Core North America missed due to higher retailer promotions hurting price which continued to raise the concern about losing share to private-label. The company is reducing costs and will re-emphasize its value-add in the less, competitive, premium oils. In addition, the value creation story for VVV is the growing Quick Lubes business which is now over 50% of the profitability of the entire company.

Lamb Weston Holdings, Inc. (LW) is one of the largest producers of frozen potato food products (French fries and other starchy goodness).  Through both solid demand, particularly from North American quick-service restaurants (QSRs), and steady price increases, Lamb Weston has continued to exceed consensus expectations since its spin-off from ConAgra Foods. With Lamb Weston a top 3 performer in the difficult fourth quarter, it did not participate in the rebound in the first quarter. For the first quarter, the Consumer Staples sector was the worst performing sector in the index. The underlying dynamics facing the company remain favorable with increased per capita consumption globally of potato products.  In addition, a number of U.S. QSRs, like McDonald’s reported good earnings and impressive same-store sales numbers highlighting that the strong employment levels are leading for more dining out.


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