In the third calendar quarter of 2014, the KEELEY All Cap Value Fund (KACVX) fell 4.74 percent compared to a 0.87 percent decline for the Russell 3000 Value Index. After a lengthy hiatus, volatility returned to the markets in the third quarter. The weakness was especially evident in small cap stocks, where the divergence between small and large-cap stocks was substantial. The S&P 500 Index posted a positive return in the third quarter, climbing just over 1 percent compared to the broad sell-off that occurred in small and mid-cap companies. Although the market capitalization of the portfolio has moved higher in recent years, it remains substantially below our benchmark as we continue to find attractive opportunities in small and mid-cap companies. Heightened geopolitical risks were the primary culprit for the renewed volatility, as uncertainty in foreign markets added to global growth concerns and pressured investors to shun risk. Fortunately, economic news on the domestic front was more positive. Better export growth, improving housing activity, and continued low interest rates has allowed the economy to recover from the negative effects of the harsh weather early in the year. However, subpar projections for long term GDP growth remain a signficant hurdle and puts further pressure on a fragile consumer to pick up the slack. From sector perspective the quarter was mixed, with five of ten economic sectors in the Russell 3000 Value Index producing negative returns. Stock selection within the financial and industrials sectors was the key factors in our relative underperformance during the quarter. The Fund was also negatively impacted by an overweight position to energy, which was the worst performing sector in our benchmark.
Civeo Corp. (CVEO) was the Fund's largest detractor during the quarter after shares fell sharply in September when the company announced that electing REIT status would not be preferable and simultaneously announced a rather large reduction in Canadian guidance for Q4 2014 and 2015 due to project deferrals. The reduction in earnings guidance, while never pleasant, is understandable, but the decision to not seek a REIT election was both disappointing and confusing. Frankly, we've not seen a case where the reason a company gets spun off is so quickly abandoned. Activist investors have become involved seeking, among other things, the resignation of the CEO. Nonetheless, the failure to seek a REIT election was a sufficient blow relative to our investment thesis that we elected to sell the stock.
As we mentioned earlier, stock selection in the financial sector was the primary cause of our relative underperformance during the quarter. Two of the Fund's top five detractors, Genworth (GNW) and BancorpSouth Inc. (BXS) were in the financial sector. Genworth (GNW) declined over 24 percent and cost the Fund 38 basis points of performance during the quarter. The company announced a sizeable addition to reserves for purposes of covering potential loss exposure to long-term care insurance provided to its earliest customers. This was not an unknown risk to us as we did factor this into our thinking when we established our position. However, while the reserve build was in-line with our projections, it was still a negative surprise to the street. Our view with respect to long-term care is that States will allow for premium increases, sometimes sizeable, as GNW (and others providing this insurance) are last line defenses to patients who would otherwise likely end up in Medicaid and exacerbate state budget situations. Unfortunately, a mismatch in timing occurs as claims rise first, then reserves are lifted followed by a request for premium increases. Ultimately, we feel GNW is very cheap and is in a good position to seek premium relief even as the company continues to restructure its business in both long-term care and mortgage insurance.
BancorpSouth (BXS) fell over 18 percent and cost the portfolio 31 basis points of performance. The company announced plans to delay several announced acquisitions as increased scrutiny by the Federal Reserve and the Consumer Financial Protection Bureau (CFPB) concerning BSA/AML (Bank Secrecy Act and anti-money laundering) is ongoing and the reviews will need to be completed before the acquisitions are allowed to proceed. This caused earnings reductions due to delayed deal accretion. We have seen this issue pop up at several other institutions and while it's unfortunate, we feel this is not a specific issue germane to only BXS but rather the result of increased scrutiny from Washington DC regulators concerned with money laundering. Management is complying with all policy and procedural change requests and hopes to have the matter resolved in the near future.
As we write this letter, energy is being impacted by the fears of a slowdown in the macroeconomic environment, particularly in Europe, as well as a general strengthening of the dollar which are both weighing on crude prices which drive the share prices. That said, we remain committed to our energy positions as most of our companies are undergoing some type of restructuring, remain in excellent production zones and are, by and large, producing cash flow that exceeds capital expenditures. They also have fairly conservative balance sheets with excellent liquidity. As long-term investors, our investment horizon is far greater than a quarter and we view energy as a secular growth story within a difficult market due to energy's national security implications.
Although we are admittedly concerned with the macroeconomic environment and the subsequent volatility in our space, it is difficult to ignore the activity in one of our primary investment themes, corporate spin-offs. The environment over the past few years, and especially recently, has been exceptional. According to Spin-off Advisors, approximately 62 spin-offs are likely to be completed in 2014, which would be the second highest level in close to 15 years, when 66 were completed in 2000. We believe there are a number of factors that are forcing this activity. For one, activist investors have become very prominent in recent years, especially hedge funds, and they recognize how breaking up a company can unlock significant value. Another factor is tied to the simple maturation of a number of industries, such as technology. Many tech companies are experiencing slowing growth, but have smaller divisions that are now potentially large enough to stand on their own.
eBay (EBAY) is an excellent example. Twenty years ago the stock was recognized as one of the pioneers of online retailing and although that remains a core business, PayPal is now considered a major franchise in online transactions and will most likely garner an attractive valuation. Another factor is something we would call the "unwinding" of the conglomerate phase. Years ago, especially in the growth years of the late 1990's, many companies grew substantially via acquisition only to find that little if any synergies existed. By spinning-off the ill-fitting component, it allows management to focus on their core strengths, allowing each company to thrive under their own distinct strategic initiative. Here at Keeley, we embrace this philosophy and are obviously excited about the plethora of opportunities. This is especially true in an environment that is admittedly more difficult to find attractively priced investment ideas.
Thank you for your support of the All Cap Value Fund.
