For the fourth quarter of 2023, the iMGP SBH Focused Small Value Fund gained 14.02%, slightly underperforming the 15.26% gain for the Russell 2000 Value benchmark. The Fund outperformed the Morningstar Small Value category’s 12.95% return in the quarter. For the full calendar year, the Fund gained 24.74%, widely outperforming the 14.65% gain for the Russell 2000 Value index and the 16.61% return for the category.
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, 2024. Without this limit the fund’s net expenses would be higher the return would be lower.
Market Overview and Strategy Performance
Investing has never been easy but investing in today’s speculative, risk-loving fervor is a challenge for those of us that still look at the markets with risk in mind. We are pleased to say, however, that even after a more challenging relative fourth quarter, when we did not keep pace in an indiscriminately strong market, it was a satisfactory year. We were pleased to finally see some acquisition activity within the Fund where it was made abundantly clear the public markets were significantly undervaluing these businesses. Predicting an acquisition is impossible but we feel we are quite good at identifying unrecognized or underappreciated inflection points in a company’s return on invested capital (ROIC). Regardless of the market’s periodic desire to chase high short-interest, unprofitable, and in many cases high-beta stocks, we will continue to assess reward and risk, and populate the Fund with companies that we determine can meaningfully improve their returns via internal, management-driven controls, not via predicting macroeconomic events.
It’s our view that our Russell 2000 Value benchmark has gotten riskier in the last few years as the percentage of unprofitable companies has increased, making the index materially more speculative. Over the years, an increasing number of investors are opting for passive vehicles as the way to gain exposure to small-cap stocks. This approach does require one to look at the investments through a risk-adjusted lens or understand whether they are being appropriately compensated for the increasing risk that we feel is being taken. Post-COVID, we have seen a different type of market, one where we don’t always believe stocks reflect risks such as pricing in recession risk. While this environment has created less opportunity versus past cycles, we have been, and continue to work hard to uncover change agents in new management, culture shifts, and aligned incentives that can lead to improving returns on invested capital.
Contributors to Return
The three sectors that contributed most to the Fund’s performance relative to its benchmark in the quarter were Energy (driven by selection and allocation), Utilities (driven by allocation), and Consumer Discretionary (driven by selection and allocation). Within Consumer Discretionary, PVH Inc., an apparel company in the United States and internationally with brands such as Tommy Hilfiger and Calvin Klein, was a top performer in the quarter. The stock, which is not in the benchmark, gained 59.68% largely due to the market’s confidence in the newer management team’s turnaround efforts to drive ROIC higher, which is primarily focused on margin improvement. For example, management posted operating margins in the North America region of 13% in the third quarter compared to the last couple of years when operating margins were in the low- to mid-single digit range.
Within Industrials, SP Plus was the top performer. The company combines industry-leading technology and best-in-class operations to deliver mobility solutions that enable the efficient movement of people, vehicles, and personal belongings. The stock is another non-benchmark name and it gained 41.97% in the three-month period. Early in the quarter, SP Plus agreed to be acquired by a combination of strategic and private-equity sponsors for a sizeable 52% premium to the stock price. SP has been executing a technology innovation cycle within the parking-management space. This investment cycle allowed them to see strong growth and margin improvement over the last few years coming out of the Covid pandemic. In our opinion, the market was not fully appreciating the underlying ROIC improvement from these investments, and as a result we maintained a large position in the company and are happy to see this result.
Detractors from Return
The three sectors that detracted most from the Fund’s performance relative to its benchmark in the quarter were Healthcare (driven largely by selection), Information Technology (driven by selection), and Financials (driven by allocation). Information Technology holding Belden Inc. was a top detractor within the sector. The underperformance was not due to any specific execution miss or change in longer-term fundamentals. The company did suddenly see an inventory destocking phase emerge across their customer base without any clear warning signs. Belden felt this shift as they have been one of the better real-time product suppliers, allowing customers to destock their products more than normal as customers no longer need to hold much, if any, inventory.
ICU Medical was the top detractor within the Healthcare sector, losing 16.19% in the quarter. ICU is a global leader in IV therapy and has faced numerous supply chain and inflation challenges over the last couple of years. As a result, they built up their inventory to manage this volatility. However, supply chains healed faster than anticipated, and ICU will be destocking their inventory over the next 12 months, which is impacting profitability and caused declines in earnings estimates moving into 2024.
Market Outlook
As we look to 2024, we feel that risks remain elevated. That said, forecasting a recession, market crash, or the impact of higher fiscal spending is not our expertise. The market expectations today are for the Federal Reserve to cut interest rates at least 6 times this year resulting in “soft landing.” This outcome, if it comes to fruition, would be quite rare when looking at history but would likely lead to strong returns. Over the last few years, we have convinced ourselves not to be surprised by the market. Our focus, and what we pride ourselves on, is identifying positive company-specific change agents that will improve a company’s return through governance and overall influence on its employees. The number of management-team changes continues to increase, which increases our opportunity set. We believe that through our bottom-up fundamental research, we can find the right management teams making appropriate and impactful changes, improving the returns for their business. Looking ahead, the rising benchmark risk we mentioned earlier should only help us in our endeavors over time, as we believe selection will matter. Over time, our process has delivered competitive returns for our shareholders, even more so when adjusting for the risks being taken. We thank you for your interest and support.
Portfolio Breakdown as of 12/31/2023
| By Sector | Fund |
| Finance | 17.9% |
| Consumer Discretionary | 15.4% |
| Information Technology | 8.4% |
| Communication Services | 0.0% |
| Health Care & Pharmaceuticals | 1.6% |
| Industrials | 29.5% |
| Consumer Staples | 3.4% |
| Real Estate | 5.2% |
| Utilities | 0.0% |
| Energy | 7.7% |
| Materials | 12.2% |
| Cash | -1.3% |
| 100.0% |
| By Market Cap | Fund |
| Small Cap | 93.9% |
| Mid Cap | 6.1% |
| Large Cap | 0.0% |