For the third quarter, the iMGP SBH Focused Small Value portfolio underperformed its Russell 2000 Value benchmark, declining 5.45% compared to a 4.61% loss for the index. The fund’s 24.16% year-to-date decline is also behind the benchmark, which is down 21.1% over the nine-month period. Since the fund’s inception, it has generated a 6.81% annualized return compared to a 15.09% gain for the Russell 2000 Value.
Performance quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance of the funds may be lower or higher than the performance quoted. Short term performance is not a good indication of the fund’s future performance and should not be the sole basis for investing in the fund.To obtain standardized performance of the funds, and performance as of the most recently completed calendar month, please visit www.imgpfunds.com. Returns less than one year are not annualized. The Advisor has contractually agreed to limit the expenses of the fund through April 30, 2023. Without this limit the fund’s net expenses would be higher the return would be lower.
Market Overview and Strategy Performance
Early in the third quarter, the portfolio trailed the benchmark due to unusual market dynamics which included unprofitable companies meaningfully outperforming profitable companies within the benchmark and continued disruption caused by the continuation of supply chain issues, which showed few signs of improvement. The portfolio’s companies, despite their strong execution, were unable to generate much investor interest. Given the continued tightening by the Federal Reserve (Fed) and many central banks broadly, we expect economic growth to decrease in the coming few quarters which could result in earnings risk for most companies. Europe has struggled with energy insecurity and with the fallout of higher energy costs, causing demand destruction at many levels. This has exacerbated supply chain concerns for certain industries. The global economic picture is murky at best.
The three sectors that contributed most to the portfolio’s performance relative to its benchmark in the quarter were Real Estate (driven by sector allocation), Consumer Discretionary (driven by security selection), and Industrials. Consumer Discretionary holding Modine Manufacturing Company (MOD) was a top contributor on an individual stock basis. Modine designs and manufactures thermal dynamic equipment that’s used in agriculture, mining, and construction equipment. The company’s new CEO has rapidly turned over management across the organization, executing upon an 80/20 simplification strategy. When this strategy is successfully adopted by an organization, it leads to less complexity, stronger customer relationships, and a greater focus on pricing and improvements. Although Modine is still early in this process, there are already positive signs of its focus on profitability.
Another top contributor was Compass Minerals International, which produces and sells minerals globally. The company revealed further details of its lithium development strategy; although the contribution of this asset is still a couple of years away, it could be a significant value creator for the company considering the push by auto original equipment manufacturers (OEMs) into the electrical vehicle market. Within its core salt business, the company has been able to raise prices by a sizeable amount, which allowed it to recapture lost profitability as a result of last season’s higher fuel costs. While this is encouraging, we also know the company’s business is seasonal and we continue to monitor the volatility associated with this seasonality.
The sectors that detracted most from the portfolio’s performance relative to its benchmark in the quarter were Information Technology (driven by selection), Health Care (driven by allocation and selection), Consumer Staples (driven by selection), and Energy (driven mostly by selection).
Within Health Care, Orthofix Medical was among the largest detractors. The company has struggled to gain enough of a revenue growth rebound to attract investors despite its attractive valuation and underlying returns on its assets. The stock price has been punished beyond anything we would have expected. Although management’s execution and market conditions have not been great, we are patient given the company’s strong cash flow, balance sheet, and the underlying optionality of its assets.
Glatfelter Corporation was the top detractor during the quarter. Glatfelter, a manufacturer and distributor of engineered materials worldwide, has remined under substantial pressure due to its manufacturing footprint having sizeable exposure to the European Union region with many facilities in Germany. Given the natural gas and overall energy crisis that has unfolded in its core manufacturing markets along with higher-than-desired leverage during this uncertain backdrop, we lowered the position meaningfully during the quarter.
Market Outlook
While it is a truism to say every market environment is the most difficult we have faced (we have survived all previous environments, after all), the current edition must be considered well up there in the running for the title. This list of issues an investor contends with today seems endless including geopolitical dynamics, supply chain difficulties, energy issues, and central banks’ focus on taming inflation through interest-rate increases. These macro issues are far more fraught with uncertainty than what we have seen in our careers, even during the Great Financial Crisis period. During this quarter specifically, it was not clear to us why biotech, stocks with higher short interest, and loss-making companies were broadly outperforming for much of the quarter given the likelihood of a recession in coming quarters (as the Fed continues to tighten liquidity and rapidly increase the cost of capital). We have made changes to the portfolio by lowering certain positions and maintaining higher-than-usual liquidity. Our flow of new ideas is increasing although we are being very careful when evaluating companies with turnaround dynamics that are dependent on a normalizing supply chain to see improving return potential. While an economic slowdown might improve this situation, we are cognizant that a slowdown, by definition, also has demand destruction consequences. As clients know, we have always been focused on management’s ability to drive meaningfully improved returns and we cannot recall a time when these efforts were so hampered by external circumstances. Nonetheless, this is our reality, and we remain focused on working smarter, diversifying better given that risk has risen, and being patient with the macro environment to unfold. Every bear market sows the seeds of the next bull market, but the timing is unknowable.
Portfolio Breakdown as of 09/30/2022
| By Sector | Fund | Russell 2000 Value | +/- |
| Finance | 19.36% | 29.1% | -9.7% |
| Consumer Discretionary | 11.01% | 9.6% | 1.4% |
| Information Technology | 7.66% | 5.8% | 1.8% |
| Communication Services | 0.0% | 3.0% | -3.0% |
| Health Care & Pharmaceuticals | 5.57% | 12.1% | -6.5% |
| Industrials | 32.39% | 12.4% | 20.0% |
| Consumer Staples | 4.26% | 2.7% | 1.6% |
| Real Estate | 4.88% | 10.8% | -5.9% |
| Utilities | 0.0% | 5.1% | -5.1% |
| Energy | 4.81% | 5.7% | -0.9% |
| Materials | 6.87% | 3.7% | 3.1% |
| Cash | 3.18% | 0.0% | 3.2% |