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Commentary iMGP SBH Focused Small Value Second Quarter 2022 Commentary

During the second quarter of 2022, the iMGP SBH Focused Small Value Fund declined 15.88%%, trailing the Russell 2000 Value Index benchmark’s 15.28% loss and the Morningstar Small Value category (down 13.35%). Since its July 2020 inception, the fund’s 10.95% annualized gain trails the Russell 2000 Value’s gain of 20.17%, and the Morningstar category’s 22.25% 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 Returns less than one year are not annualized.

Portfolio Positioning/Opportunity Set

The portfolio has remained underweight the Energy sector which was a sizeable relative headwind during the majority of the second quarter. As a result of the annual Russell index reconstitution in May, Energy as a percentage of the portfolio’s benchmark, the Russell 2000 Value Index, fell by nearly 50%. This change resulted in the portfolio being just slightly underweight this sector. The area of concern, however, is the rising weight of biotechnology stocks within the benchmark which now represents nearly 7%. Companies in the Biotech sector are difficult for us to own given their lack of profitability and the high risks often associated with operating in this sector. Therefore, if there is a significant move higher in the biotech sector it may cause relative performance headwinds. The portfolio continues to have a low turnover rate as various cross currents—from the Federal Reserve’s rate tightening, the energy shock in Europe, further supply chain challenges due to the Russia/Ukraine war, and China’s zero COVID policy—have led us to take a more patient approach to deploying new capital into both current portfolio names and potential new ideas. However, we are beginning to see more opportunities emerge as the market continues to pullback and have begun to do further due diligence on some interesting company turnarounds that could be emerging as the year progresses. 

Portfolio Breakdown as of 06/30/2022

By SectorFund Russell 2000 Value+/-
Consumer Discretionary7.1%9.6%-2.5%
Information Technology12.9%6.1%6.8%
Communication Services0.0%3.3%-3.3%
Health Care & Pharmaceuticals5.0%11.0%-6.0%
Industrials 34.4%12.7%21.6%
Consumer Staples 6.3%2.9%3.4%
Real Estate 3.2%11.9%-8.7%

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.

  • Stock selection was the driver of relative underperformance in the quarter, while sector allocation had a minor positive net impact.
  • The three sectors that contributed most to the portfolio’s performance relative to its benchmark in the quarter were Real Estate (driven by allocation and selection), Communication Services (driven by allocation) and Industrials (driven by stock selection).
  • Within Industrials top-10 holding SPX Corp. and Quanex Building Products were among the top contributors. Additional detail on both holdings is provided below.
  • The single largest individual contributor in the quarter was Modine Manufacturing, a relatively recent purchase. The stock was up 24.4% in the quarter and is discussed below.
  • The three sectors that detracted most from the portfolio’s performance relative to its benchmark in the quarter were Materials (driven by selection), Consumer Staples (driven by selection), and Health Care (driven by allocation).
  • On an individual stock basis, Materials holding Glatfelter, a global supplier of engineered materials was a top detractor for the second quarter in a row. The stock has significant European exposure and underperformed predominantly from inflation running significantly faster than the company’s ability to raise prices. The Russia-Ukraine war has only made this situation more challenging. The managers added to the position late in the quarter believing the stock is very attractively valued.
  • A key detractor in Health Care was Orthofix Medical, which fell nearly 25% in the period. Additional detail on the stock is provided below.

Commentary on Selected Contributors and Detractors

Top 10 Contributors as of the Quarter Ended June 30, 2022

HoldingPortfolio Weight %Return %Contribution %Benchmark Weight %Economic Sector
Modine Manufacturing Co2.1016.870.310.00Industrials
SPX Corp3.206.940.220.04Industrials
Quanex Building Products1.978.770.150.05Industrials
Helmerich & Payne Inc0.0912.340.100.36Energy
Southstate Corporation 0.102.870.010.45Financials
Mercury Systems1.76-
Astec Industries Inc1.31-4.89-0.060.07Industrials
Equity Commonwealth REIT2.89-2.41-0.060.22Real Estate
SP Plus Corp3.23-2.04-0.060.00Industrials
Progress Software Corp2.87-3.45-0.090.00Information Technology
Portfolio contribution for a holding represents the product of the average portfolio weight and the total return earned by the holding during the period. Past performance is no guarantee of future results. Fund holdings and/or sector allocations are subject to change at any time and are not recommendations to buy or sell any security.

The investment thesis for owning Modine Manufacturing was driven by the company’s new management team bringing in a new operating structure, helping to reduce business complexity and improve pricing. We believe the changes should result in significant improvement in Return on Invested Capital (ROIC) over time.  We also believe the current valuation is not being reflected by these changes and the overall improvement in profitability that has already started to occur. The stock performed well as the company has continued to meet or beat expectations the management team laid out.

The rationale for owning SPX Corp. was driven by the management team’s plans for margin improvement as they have divested the lowest margin businesses and redeployed capital into businesses that carry higher margins and returns. The stock performed well in the quarter, likely given its more defensive profile as much of the business is centered in North America and has sizeable recurring/replacement aspects that are regulatory driven. We believe valuation is in-line with the market if the management team does not deploy capital going forward. However, we see a long runway of capital allocation tailwinds continuing to reshape the company into a higher ROIC business.

Another top contributor was Quanex Building Products. The decision to own Quanex centered around the management team’s push toward margin improvement and an intense focus on improving ROIC. The business has continued to perform extremely well considering the headwinds of inflation and supply chain challenges. Overall, we think the stock’s valuation still does not fully reflect the sustainable profitability of the company. 

A recent addition to the portfolio, and a top contributor in the period was Helmerich & Payne, an energy drilling company.  Our thesis for owning that stock was an attractive entry point given the company’s shift in focus around measuring efficiency and the cost savings their rigs provide customers; this allows for higher pricing and better margins going forward. We believe there is a significantly long runway of customers who need to increase oil and gas production globally and the company will be a direct benefactor of this trend.

Top 10 Detractors as of the Quarter Ended June 30, 2022

HoldingPortfolio Weight %Return %Contribution %Benchmark Weight %Economic Sector
Compass Minerals International Inc3.66-43.43-1.820.00Materials
Glatfelter Corp2.12-43.30-1.090.03Materials
Six Flags Entertainment Corp1.68-50.11-1.040.00Consumer Discretionary
The Hain Celestial Group Inc2.73-30.99-0.880.00Consumer Staples
Circor International Inc1.86-38.43-0.850.00Industrials
NCR Corp3.35-22.59-0.770.00Information Technology
Orthofix Medical2.62-28.01-0.750.04Healthcare
Regal Rexnord Corp2.76-23.47-0.680.00 Industrials
ICU Medical Inc2.49-26.16-0.680.00 Healthcare
Faro Technologies Inc 1.16-39.19-0.680.03Information Technology
Portfolio contribution for a holding represents the product of the average portfolio weight and the total return earned by the holding during the period. Past performance is no guarantee of future results. Fund holdings and/or sector allocations are subject to change at any time and are not recommendations to buy or sell any security.

A top detractor in the period was Hain Celestial Group. The decision to own the stock was driven by the impressive job the management team has done managing the business and eliminating complexity over the last couple of years. However, the stock has underperformed more recently given the company’s European exposure. The management team has faced significant cost increases centered around supply chain/logistics and raw material challenges. Although the management team has raised prices over the last year to offset these costs, they have not been able to catch up given the lag in price increases. We believe valuation remains attractive at current levels; however, visibility into the abatement of headwinds remains hard to judge.

A detractor that was sold in the quarter was Faro Technologies. Our decision to sell was driven by the lack of ROIC improvement that we were expecting to see.

Orthofix, a medical device company, fell nearly 25% in the period. Our thesis for owing the company has not changed as the management team has continued to manage the external environment well considering the lack of surgery volumes due to the COVID-19 pandemic. Furthermore, company management has focused on driving more innovation, which should lead to market share gains over time. We believe the valuation is attractive at current levels; however, until more durable signs of recovery persist, we are remaining patient in adding to the position.

Another detractor in the three-month period was Under Armour. We sold the stock following the announcement that the CEO was departing. The company is shifting into a more growth-oriented company which can bring additional risks, as can an unknown incoming CEO. Therefore, the position no longer fits our thesis of self-help and margin/return improvement.  

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Mutual fund investing involves risk. Principal loss is possible. Past performance does not guarantee future results. 

Investing in small companies subjects investors to additional risks, including security price volatility and less liquidity than investing in larger companies. Though not an international fund, the fund may invest in foreign securities. Investing in foreign securities exposes investors to economic, political and market risks and fluctuations in foreign currencies. These risks are greater for investments in emerging markets. 

basis point (bps) is a value equalling one one-hundredth of a percent (1/100 of 1%)

Return on Invested Capital (ROIC) is a calculation used to assess a company’s efficiency at allocating the capital under its control to profitable investments. Return on invested capital gives a sense of how well a company is using its money to generate returns.

The Russell 2000 Value Index measures the performance of small-cap value segment of the U.S. equity universe. It includes those Russell 2000 companies with lower price-to-book ratios and lower forecasted growth values.

Each Morningstar Category Average represents a universe of Funds with similar investment objectives.

Index performance is not illustrative of fund performance.  An investment cannot be made directly in an index. 

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The iMGP Funds are Distributed by ALPS Distributors, Inc.