Fundametrics Small Cap Equity

Transcription

1 For more on CornerCap s institutional management capabilities and past commentaries, click HERE Fundametrics Small Cap Equity 2Q 2015 Performance Summary and Observations 2Q Latest 1 Latest 3 Latest 5 Latest 7 Inception to Date (8/31/06) Fundametrics Small Cap Equity Net of Fees Returns Russell 2000 Value Total Return Russell 2000 Total Return Performance is as of 6/30/2015. All time periods over 1 year are annualized. See attached disclosure for important information regarding returns. EXECUTIVE SUMMARY: The Fundametrics Small Cap Equity strategy outperformed the Russell 2000 Value Index by 93bps, primarily due to low allocations to REITs and utilities, which lagged on rising rate concerns. The Alpha Composite, which drives stock selection, added only marginal value this quarter. The Fundametrics research system reveals that investors continue to have a narrow definition of risk control namely, avoiding stocks with high beta or high volatility. Our Financial Warnings risk overlay takes a different look at risk, based on a company s fundamental factors. This overlay has been instrumental to the strategy s long-term success, but it did not add value this quarter. The rolling one year spread between Russell 2000 Growth and Value indices is now at a noteworthy 1,156 bps. The growth index s 12.5% weighting to biotech (up 54% 1yr, 108% 2yr) is the biggest driver. Is there a biotech bubble? Most biotech stocks are excluded from the investable universe because their performance tends to tie to research and development potential, not measurable fundamentals. Historically, REITs were excluded from the investable universe. Our R&D that leverages Fundametrics to identify attractive REITs has been encouraging. Toward quarter-end, we identified an attractive entry point for REITs and started adding the highest ranked securities to the portfolio. In February, Fundametrics identified a statistically relevant signal in favor of small-caps, Tilt toward Small-Caps. This is not an absolute valuation call, but a relative signal within domestic equities. To date the Fundametrics small-cap composite outperformed the Fundametrics large composite by over 400 bps, confirming the decision.

2 2Q15 Performance Analysis For the quarter, CornerCap s Fundametrics Small Cap Equity Composite returned -0.27%, outperforming the Russell 2000 Value Index by 93 bps. Most of the outperformance this quarter came from allocation decisions while our Alpha Composite and Financial Warnings overlay were relatively neutral. The strength of allocation came from being underweight interest rate sensitive areas of the market, namely REITs and Utilities. Although REITs have historically been excluded from our investable universe, we ve been monitoring the industry with a specific industry composite. It wasn t until the very end of the quarter that REIT valuations were attractive enough to warrant including them in the portfolio (see section REITs in the Portfolio later in the report). Unlike prior quarters, stock selection, driven by the Alpha Composite, was not as impactful, with only a minor positive contribution. Selection was strongest in Healthcare, Consumer Staples, and Basic Materials; weakest in Insurance, Diversified Financials and Energy. The alpha composite did not produce the typical stair step pattern this quarter that we re accustomed to observing. Although the top ranked stocks (deciles 1 3 signified by the blue bar in Figure 1) outperformed the others, the margin was slight. The excess return of the buy group and the equally weighted investable universe was only 51 bps. Not surprising given Growth s outperformance, those uncorrelated factors classified as growth or revisions did well while valuation factors, which make up approximately 65% of the Alpha Composite were mixed (Table 1). Figure 1: Alpha Composite Performance Table 1: Top and Bottom Performing Small Cap Stock Factors Quarterly Return 6% 5% 4% 3% 2% 1% 0% Alpha Composite 1 Qtr ending 6/26/15 Buys Holds Sells Best Worst Q Sales Revisions Earnings Momentum - Current Long-Term Earning Growth Relative Price to Book Price to Operating Cash Flow Enterprise Value to Ebitda Price to Free Cash Flow Price Momentum Source: CornerCap Fundametrics Research Source: CornerCap Fundametrics Research

3 Page 3 In addition, the Financial Warnings Overlay only had a marginal benefit during the quarter. Those stocks that were Safe to Purchase outperformed those stocks with the highest risk (red bar in Figure 2 below). Although the Avoid stocks outperformed, this does not raise concerns for us. Avoids Figure 2: Risk Overlay Was Relatively Neutral Quarterly Return 7% 6% 5% 4% 3% 2% 1% 0% Alpha Composite "Buys" w/ Financial Warning Overlay 1 Qtr ending 6/26/15 "Safe" to Purchase Avoid Figure 3: 1Q Financial Warnings Overlay Sell are close enough to the Financial Warnings Sell risk level that we prefer to be conservative and look for safer opportunities. It should be noted that the Financial Warnings did show signs of improvement from last quarter (compare to Figure 3). REITs in the Portfolio Historically REITs have been excluded from the Fundametrics Small Cap investable universe. Our excluding them was based on the fact that, prior to 4Q 2014, the Alpha composite was dependent solely on universe rankings. Universe rankings will rank ALL companies relative to each other using the same model. Because REITs are capital intensive with high rates of depreciation, they have little net income and therefore would skew toward the sell rankings, in almost every case. Table 2: Current P/E s of Russell 2000 Value with and without REITs 6/30/2015 Forward P/E Russell 2000 Value w/o REITs 22.0 Russell 2000 Value REIT 40.0 Source: Bloomberg Source: CornerCap Fundametrics Research In 2013, we started a R&D project to track REITs within Fundametrics. Our process included testing both existing factors as well as creating new factors unique to REIT securities. Our objective was to determine whether CornerCap s Fundametrics process could be applied to find the best REIT stocks. Based on our observations, we have determined the project to be a success. Specifically, we have identified alpha and risk factors that can guide us in selecting the best positioned REITs for the portfolio.

4 Page 4 Fundametrics identification of attractive REITs is determined by using a sector alpha composite, which will only rank REITs against each other. We anticipate allocations ranging from 0 10% of the portfolio. The allocation weights will be determined using an approach similar to our existing Tilt methodology of identifying relative value between large, mid and small domestic equities. Our REIT Tilt identifies the relative attractiveness between small-cap REITs and small-cap equities. This signal emerged toward the end of the quarter and REITs were added to the portfolio for the first time with the initial allocation set at 5%. One prevailing thought is that REITs underperform when interest rates rise. Interestingly, through the seven periods of rising rates since 1972, REITs defined by the FTSE NAREIT US Real Estate TR Index earned a positive return and outperformed the S&P 500 in 5 out of those 7 rising rate periods. Rather than interest rates, the primary driver of REIT performance is strength in their underlying fundamentals*. This sets them up well for Fundametrics. Not all REITs will make it into the portfolio. Mortgage REITs fall into our definition of investment company and therefore will be excluded. Mortgage REITs make a profit by borrowing money using short-term debt and use the funds to buy longer-term real-estate related debt, earning the spread between the rates. Leverage is commonly used to boost their returns. We actually expect this exclusion to improve our relative REIT performance. The FTSE NAREIT All Equity REIT index has handily beaten the FTSE NAREIT Mortgage index since their 1972 inception. Table 3: REIT Returns during Rising Rate Environments 12/ /2014 Avg. Annual Return FTSE NAREIT All Equity TR Index 12.3% FTSE NAREIT Mortgage TR Index 5.1% Source: Bloomberg Market Observations and Outlook Recall from last quarter that we discussed the benefits of Fundametrics beyond stock selection at the security level. It can also help in directing asset allocation. One of those asset allocation recommendations was to tilt domestic equity portfolios toward small cap stocks which was started at the end of February. The signals remain in favor of smallcaps, but as small-caps have outperformed the signal strength has weakened. As detailed in Table 4 below, small caps have indeed outperformed large cap stocks. Table 4: Tilt Performance To-Date 2/27/15-6/30/15 Returns Fundametrics Small Composite 2.47% Fundametrics Large Composite -1.75% 4.22% Russell % S&P % 3.48% Source: CornerCap Fundametrics Research, Bloomberg Another observation we identified in prior commentaries is the prevalence of outperformance of lower beta stocks. This *Source: Interest Rates & REIT Performance East, Murphy

5 Page 5 trend continues, extending the streak to four straight quarters. Although not a factor in our Alpha or Risk Composites, it does signify investor s lack of appetite for risk. It s also an attribute that based on our years of observation, does not add significant value over the long term. CornerCap s investment process is consistently applied to the Fundametrics Small Cap Equity strategy regardless of market environment or tilt recommendation. In addition to the addition of REITs to the portfolio, the Fundametrics system has also detected value in the banks and diversified financials boosting the Financial Sector s overall weight from last quarter. Consumer Discretionary also experienced a jump with retail and consumer services leading the way. These gains came at the expense of Energy, Industrials and Consumer Staples. Within industrials, Transportation gained at the expense of capital goods.

6 Fundametrics Small-Cap Equity Disclosure Presentation June 30, 2015 Periodic Returns Composite Gross Composite Net vs. Benchmarks Russell 2000 Russell 2000 Value Fundametrics Small-Cap Equity Composite 3 Month Disclosure Presentation Average Annual to 1-year 3-year 5-year 10-year 15-year Date -0.27% 3.19% 8.30% 21.33% 21.15% n/a n/a -0.37% 2.78% 7.23% 20.19% 20.32% n/a n/a 0.42% 4.75% 6.48% 17.81% 17.08% n/a n/a -1.20% 0.76% 0.78% 15.49% 14.80% n/a n/a Annual Performance Results Composite Assets End Composite Gross Composite Net Russell 2000 Russell 2000 Value Composite Dispersion Number of Portfolios Value of Assets (millions) Total Firm Assets (millions) %* 13.10%* 9.81%* 10.09%* N.A. <= % -1.80% -1.57% -9.78% N.A. <= % % % % N.A <= % 37.55% 27.17% 20.58% N.A <= % 30.34% 26.85% 24.50% N.A. <= % 1.27% -4.18% -5.50% N.A. <= % 18.53% 16.35% 18.05% N.A. <= % 47.94% 38.82% 34.52% N.A <= % 5.70% 4.89% 4.22% N.A <= N.A. - Information is not statistically meaningful due to an insufficient number of portfolios in the composite for the entire year * Returns for 2006 are for the period 8/31/06 12/31/06 only Annualized Standard Deviation Composite Gross Russell 2000 Russell 200 Value 26.16% 24.99% 26.05% 21.32% 20.20% 19.89% 18.35% 16.45% 15.82% 14.16% 13.12% 12.79% A complete list and descriptions of composites is available. Copyright 2015 CornerCap Investment Counsel Visit our website for more information Peachtree Street, Suite 1700 Atlanta, Georgia

7 Fundametrics Small-Cap Equity Disclosure Presentation June 30, 2015 Notes To Equity Performance Presentations (1) THE FIRM For the purpose of complying with the Global Investment Performance Standards (GIPS ), the Firm is defined as CornerCap Investment Counsel, Inc. ( CornerCap ), an independent investment advisor registered under the Investment Advisers Act of 1940, specializing in equity management for mutual funds, separate clients, wrap accounts, and institutional clients. (2) GIPS PERFORMANCE STANDARDS CornerCap claims compliance with the Global Investment Performance Standards (GIPS ) and has prepared and presented this report in compliance with the GIPS standards. CornerCap has been independently verified for the periods January 1, 2002 through December 31, The verification report(s) is/are available upon request. Verification assesses whether (1) the firm has complied with all the composite construction requirements of the GIPS standards on a firm-wide basis and (2) the firm s policies and procedures are designed to calculate and present performance in compliance with the GIPS standards. Verification does not ensure the accuracy of any specific composite presentation. Policies for valuing portfolios, calculating performance, and preparing compliant presentations are available upon request. A list of composite descriptions is available upon request. (3) BASIS OF COMPOSITE PRESENTATION CornerCap includes all fee-paying, discretionary equity portfolios with a market value greater than $100,000 in its composite performance calculations. Accounts no longer under management are included in the historical composites for the periods they were under management and are excluded in the month of termination. The annual composite dispersion presented is an assetweighted standard deviation calculated for the accounts in the composite the entire year. (4) SIGNIFICANT ACCOUNTING POLICIES Performance calculations have been prepared on a monthly basis for each portfolio. The monthly returns are linked and asset weighted to calculate annual composite total returns. Valuations and returns are computed and stated in U.S. dollars. The rates of return are not indicative of future performance. The qualitative circumstances surrounding the financial securities environment should be considered. (5) FUNDAMETRICS SMALL-CAPITALIZATION EQUITY COMPOSITE The Fundametrics Small-Capitalization Equity Composite was created August 31, 2006, and contains fully discretionary accounts (excluding WRAP accounts) that invest primarily in small-cap equity securities, following a buy and sell philosophy driven by a strict adherence to the advisor's quantitative research. For comparison purposes it is measured against the Russell 2000 and the Russell 2000 Value indices. As of June 30, 2010, the Quantitative Small-Cap Composite has been renamed the Fundametrics Small-Cap Composite. (6) MANAGEMENT FEES Gross performance results for the Fundametrics Small- Capitalization Equity Composite have been calculated before management fees. Net performance results have been calculated using actual management fees. Standard Private Accounts 1.00% on the first $3,000,000 of assets under management 0.75% on the next $7,000,000 of assets under management 0.50% over $10,000,000 of assets under management (Non-Profit Fee Schedule: 0.85% on the 1 st Tier) (Sub-Advisor Fee Schedule: 0.75% on the 1 st Tier) Fundametrics Small-Cap Institutional Accounts 1.00% on the first $10,000, % on the next $10,000, % on the balance over 20,000,000 Investment Company Accounts 1.31% on Investment-Company small-cap accounts (Combined investment management fees and administrative fees) Actual investment fees incurred by clients may vary. Returns are presented gross and net of management fees and include the reinvestment of all income. A complete list and descriptions of composites is available. Copyright 2015 CornerCap Investment Counsel Visit our website for more information Peachtree Street, Suite 1700 Atlanta, Georgia