Investment Strategies ■ Small Cap Value ■ Performance Commentary
1st Quarter 2013 Small Cap Value Equity Commentary
Market Commentary
Last year’s rally accelerated into 2013, with equity indices posting first quarter returns in excess of most full-year showings. Whereas economically sensitive issues dominated 2012 results, traditionally defensive names have driven markets more recently. Against this backdrop, small cap value equities lagged both mid cap value and large cap value stocks, owing primarily to less impressive results in areas of perceived safety: Consumer Staples, Healthcare and Utilities.
Portfolio Performance & Developments
Unexcitingly, the Cooke & Bieler Small Cap Value portfolio performed in line with its benchmark as we rebalanced existing holdings, added new names and eliminated others. While the strategy’s equity holdings actually outperformed the Russell 2000 Value Index benchmark for the quarter, this outperformance was offset by a larger than usual frictional cash position. As effective managers should, particularly following a period of meaningful outperformance, we trimmed the strategy’s winners aggressively in the fourth quarter of 2012 and continued to do so this quarter. We trimmed these winners even in the absence of immediate replacements, resulting in a cash position that averaged 9% over the past three months and presented a nearly 1% headwind to performance. However, thanks in part to the addition of two new stocks, that cash position has again moved closer to normal levels.
On the opposite side of the Cooke & Bieler Small Cap Value portfolio’s trade ledger, we eliminated two holdings. The first was a strong performer in 2012 and reached our estimate of fair value. In the second case, we lost confidence in our initial thesis. In particular, we lost confidence in the management team’s capital allocation strategy. After the company completed a multi-year capex program in their attractive military distribution business, we expected free cash flow to make its way back to shareholders. Unfortunately, management unexpectedly shifted focus to growing their less attractive retail grocery business, borrowing debt to fund a 50% growth in store count. With increased debt on the balance sheet and a capital allocation strategy that left us scratching our heads, we sold the stock in January.
Ironically, this quarter’s tremendous market performance hints at an investor base motivated by fear – and more specifically a fear of missing out. In short, it is unusual for defensive groups, as they have recently, to lead a market advance. While we may not yet be in the midst of the “great rotation,” the risk-off rally we’ve seen since January does seem to suggest an influx of fixed income investors seeking bond-like equities and/or halfhearted profit takers keeping a toe in the water.
Market Outlook
Most bottom-up practitioners will freely admit that the fat pitches of 2009, 2010 and 2011 are anything but obvious these days. That said, our idea pipeline is promising, albeit less thematic than it was 18 months ago. We remain active in the Cooke & Bieler Small Cap Value portfolio, shoring it up, revisiting our investment theses and seeking out enduring franchises at a discount.
Sources: Bloomberg, FactSet, Russell
The material presented represents the manager's assessment of the Small Cap Value institutional portfolio and market environment at a specific point in time and should not be relied upon by the reader as research or investment advice regarding any stock.
