During the third quarter of 2021, the iMGP SBH Focused Small Value Fund lost 2.57%, outperforming its Russell 2000 Value Index benchmark, which fell 2.97%, but lagged the Morningstar Large Blend Category (down 2.06%). Since its July 2020 inception, the fund’s 36.78% annualized return trails the Russell 2000 Value’s gain of 64.72%, and the Morningstar category’s 52.45% return.
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.
Quarterly Portfolio Commentary
Portfolio Positioning/Opportunity Set
The third quarter of 2021 saw significant headwinds from continuing inflation across nearly all industries due, in part, to significant supply-chain challenges that only worsened as the third quarter progressed. We did not materially change how the portfolio was positioned as we are confident that those companies facing these headwinds have been able to raise prices effectively and have remained focused on internal self-help opportunities to offset most of these headwinds. We are assessing how long these outside forces may last and how long price increases can be accepted by the market; however, as of now, demand has remained strong enough for this to continue. While the fiscal and monetary policy changes currently being discussed in Congress and at the Federal Reserve have the potential to be a strong tailwind for many of the companies in the portfolio, they also introduce the risk of higher tax rates. We have not changed our views on the sectors we have underweighted such as financials, REITs, energy, and utilities. This positioning has been somewhat of a headwind to relative performance as financials, energy, and REITs were the best-performing sectors in the quarter.
In the current environment, managing risk and maintaining patience has not been easy. We have always said we will adhere to our investment philosophy and process throughout cycles rather than chase certain phases of the cycle. While the third quarter was relatively better compared to the first two quarters of the year, we are still not happy with the portfolio’s recent relative performance. We strive to outperform, always, but we will not do so by compromising our philosophy and discipline. This quarter was particularly frustrating as our management teams continued to largely beat expectations, offsetting the pressures from inflation, supply chain disruptions, and the inability to hire, though the market largely reacted with general apathy (which may have been partially a function of the growing impact of passive strategies on indices). The pandemic, alongside the monetary and fiscal responses, has had many effects on the global economy—most of them not good from an economic standpoint as capitalism is being ever more compromised, leading to unintended and unknown consequences. We remain focused on our management teams, which are improving operations, culture, and strategies to better capitalize on their respective niches to improve returns on capital. These turnarounds (for lack of a better word) are beneficial to all involved, including at a societal level. We are excited about how our management teams are executing, and we believe the improvements will be recognized in time.
Discussion of Performance Drivers
It is important to understand that the portfolio is built stock by stock with sector and cash weightings being residuals of the bottom-up, fundamental stock-picking. That said, we do report on the relative performance contributions of both sector weights and stock selection to help shareholders understand drivers of recent performance. It is also important to remember that the performance of a stock over a single quarter tells us nothing about whether it will be a successful position for the fund; that is only known at the point when the stock is sold.
iMGP SBH Focused Small Value Fund Attribution
| Sector Weights* | Fund | Russell 2000 Value as of 9/30/2021 |
|---|---|---|
| Communication Services | 0.0% | 4.2% |
| Consumer Discretionary | 8.7% | 8.0% |
| Consumer Staples | 7.6% | 2.8% |
| Energy | 1.6% | 7.0% |
| Finance | 15.6% | 26.2% |
| Health Care & Pharmaceuticals | 4.7% | 11.2% |
| Industrials | 33.2% | 14.9% |
| Information Technology | 14.2% | 5.5% |
| Materials | 9.1% | 4.5% |
| Real Estate | 2.2% | 11.1% |
| Utilities | 0.0% | 4.6% |
| Cash | 3.2% | 0.1% |
| 100.00% | 100.00% |
- Stock selection was the driver of relative outperformance in the quarter, while sector allocation was a mild detractor.
- The three sectors that contributed most to the portfolio’s performance relative to its Russell 2000 Value benchmark in the quarter were Communication Services (driven by allocation), Healthcare (driven by allocation and selection, equally), and Materials (driven by selection).
- Information Technology holding Belden was the top contributor on an individual stock basis. Belden continued to execute on the strong demand the company is experiencing across their end-markets such as Industrial Automation and Cyber Security. The new CEO at Belden has refocused the company to drive ROIC improvement through organic growth while driving significant margin improvement as demand has recovered through 2021. See below for more detail.
- Industrial holding Regal Rexnord was also a top contributor during the third quarter. The outperformance was due to continued strong execution during a time defined by supply chain, inflation, and labor challenges across the Industrial markets.
- The three sectors that detracted most from the portfolio’s performance relative to its benchmark in the quarter were Information Technology (driven by selection), Energy (driven by allocation) and Consumer Staples (driven by selection).
- On an individual stock basis, Consumer Staples holding Coty Inc (COTY) was the top detractor. The relative underperformance was primarily due to a large shareholder, KKR, coming to the market to sell a sizeable portion of its shares in a secondary overnight offering. Management continues to execute well, and the potential for COTY to create a global beauty and fragrance powerhouse is strong. (More on this stock below.)
- Information Technology holding NCR Inc (NCR) was also a top detractor during the third quarter. There is no obvious reason for the stock’s underperformance. Overall, the company has continued to execute on the strategy of transitioning the business to a higher ROIC and margin business model.
Top 10 Contributors as of the Quarter Ended September 30, 2021
| Company Name | Fund Weight (%) | Benchmark Weight (%) | 3-Month Return (%) | Contribution to Return (%) | Economic Sector |
|---|---|---|---|---|---|
| Regal Rexnord Corp | 3.69 | 0 | 18.38 | 0.62 | Industrials |
| Belden Inc Common Stock | 2.94 | 0.17 | 15.21 | 0.46 | Information Technology |
| REV Group Inc | 3.32 | 0.03 | 9.68 | 0.32 | Industrials |
| Lakeland Financial Corp | 1.77 | 0.1 | 16.27 | 0.3 | Financials |
| Compass Minerals International Inc | 3.69 | 0 | 9.86 | 0.3 | Materials |
| PDC Energy Inc | 1.03 | 0.29 | 22.2 | 0.28 | Energy |
| Umpqua Holdings Corp | 2.53 | 0 | 10.96 | 0.26 | Financials |
| The Hain Celestial Group Inc | 3.07 | 0 | 6.63 | 0.23 | Consumer Staples |
| ICU Medical Inc | 1.46 | 0 | 13.4 | 0.22 | Health Care |
| National Bank Holdings Corp Class A | 2.17 | 0.08 | 7.9 | 0.18 | Financials |
Top 10 Detractors as of the Quarter Ending September 30, 2021
| Company Name | Fund Weight (%) | Benchmark Weight (%) | 3-Month Return (%) | Contribution to Return (%) | Economic Sector |
|---|---|---|---|---|---|
| Coty Inc Class A | 4.53 | 0 | -15.85 | -0.72 | Consumer Staples |
| NCR Corp | 4.15 | 0.04 | -15.02 | -0.64 | Information Technology |
| Quotient Technology Inc | 1.03 | 0 | -46.16 | -0.6 | Consumer Discretionary |
| EnerSys | 2.32 | 0.24 | -23.66 | -0.55 | Industrials |
| Harley Davidson Inc | 2.16 | 0 | -20.1 | -0.48 | Consumer Discretionary |
| SPX Corp | 4.11 | 0.03 | -12.49 | -0.44 | Industrials |
| Faro Technologies Inc | 2.24 | 0.05 | -15.38 | -0.37 | Information Technology |
| Dril-Quip Inc | 0.58 | 0.07 | -27.64 | -0.33 | Energy |
| Beacon Roofing Supply Inc Class A | 2.52 | 0.05 | -10.31 | -0.26 | Industrials |
| Quanex Building Products | 1.82 | 0.06 | -13.5 | -0.26 | Industrials |
Edited Commentary from the Respective Managers on Selected Contributors
Contributors
Belden Group. The thesis for owning Belden was driven by the strategy of the new CEO and CFO to change the company’s capital allocation focus toward organic growth and margin improvement. This was a change from prior management’s focus on bolt-on acquisitions, which were dilutive to returns on invested capital (ROIC). The co-managers believe the stock’s valuation remains attractive relative to the ROIC improvements that they expect. The stock performed well as the company raised guidance in the second quarter.
REV Group. The company is an American manufacturer of specialty vehicles and was a name the co-managers identified in 2020. The thesis for owning REV Group has remained consistent: an entirely new management team has been leading the business and significantly enhancing the operational discipline. While margins have improved materially, Nicholson and Dickherber believe there is still significant opportunity to improve the company’s return on invested capital (ROIC). In their view, the stock’s valuation remains very attractive, and think it is still being discounted by investors due to the risk of supply chain headwinds.
PDC Energy. The thesis for owning PDC Energy was based on Dickherber and Nicholson’s confidence in management’s ability to optimize returns in a rising commodity environment while rapidly deleveraging the balance sheet with robust free cash flow. In their view, the valuation of the stock remains attractive.
Detractors
Coty. The thesis for owning Coty was based on SBH’s confidence that the new management team is creating significant franchise value that is not being recognized by the market. The management team is focused on paying down debt and eliminating significant costs to drive better operation leverage and ROIC over the next several years. The stock performed strongly until one of the largest shareholders, KKR, came to the market to sell a very large portion of its stake. The valuation, when viewed from the team’s ROIC vantage point, remains extremely attractive given all the internal self-help actions upon which the company is executing. Nicholson and Dickherber view Coty as one of the most exciting stories they have come across in quite some time.
Quotient. The thesis for owning Quotient was based on the view that the company has a first mover advantage in the digital marketing landscape. The SBH team expects strong margin expansion given the company’s strong increase in revenue. The stock has performed poorly as it has taken longer than expected for the margins to show sustainable improvement even as revenue and market fundamentals have improved. Going forward, the SBH team is closely monitoring management’s execution. Nicholson and Dickherber believe there are catalysts that will emerge early next year and they are maintaining a position as they monitor this position.
Dril-Quip. The decision to own Dril-Quip was based on the company’s very strong balance sheet, which includes no debt, and the potential for market share gains, which the co-managers believe will occur as spending in Dril-Quip’s market recovers. The stock performed poorly as it has taken much longer to see recovery in offshore oil market capex spend while, at the same time, cash burn started to increase. Given these dynamics and a lack of confidence regarding when an inflection might occur, the stock was sold from the portfolio.