In the fourth calendar quarter of 2014, the KEELEY All Cap Value Fund (KACVX, Financial) climbed 0.94 percent compared to a 5.31 percent rise for the Russell 3000 Value Index. For the year ending December 31, 2014, the Fund increased 2.91 percent compared to a 12.70 percent rise for the Russell 3000 Value Index. Although equities rebounded from a challenging third quarter, a number of the issues that facilitated much of the recent volatility continue to exist. The volatility in the price of oil garnered the majority of the attention here in the U.S. although growing concerns about the efcacy of global growth deepened toward the end of the year. Global deationary pressures have become the heart of these concerns and although the European Central Bank (ECB) has communicated their desire to consider Quantitative Easing (QE), it is difcult to project its effectiveness given the structural reforms needed at a local level. Despite the strong bounce in equities during the quarter, and especially in small caps which lagged for much of the year, broadly speaking, investors continued to rotate toward more defensive sectors. In the fourth quarter, the top performing sectors in the Russell 3000 Value Index were traditional safe havens such as utilities and consumer staples, although consumer discretionary stocks surprised as the second best performing sector in the fourth quarter. Additionally, the performance dispersion across all ten economic sectors was very high which had a signicant impact on performance amongst active managers. For example, three sectors (consumer staples, consumer discretionary, and utilities) all produced double digit returns during the quarter, while energy fell over 10 percent. Industrials and materials, which represent almost 15 percent of the benchmark, returned only 4.96 percent and -2.80 percent respectively. The Fund trailed the Russell 3000 Value Index during the quarter due in large part to negative stock selection in the energy sector. A slight overweight in the lagging energy sector also detracted, as did stock selection in the industrials sector. Energy clearly had a signicant impact on the equity markets in recent months and it also had a strong inuence on the Fund. After making a positive contribution for much of 2014, our energy holdings succumbed to the pressure from the abrupt price decline the price of oil and the long-term impact a suppressed price may have on the entire industry. Lastly, overweight positions in consumer discretionary and health care stocks made a positive impact on the Fund during the quarter.
The rapid decline in the price of oil sent shock waves across the global economy, and the volatility in the space has forced us to reassess a few of our positions in the sector. OPEC’s decision to maintain production despite the signicant decline in the price of oil surprised many investors and exacerbated the fall in the commodity. Going into the meeting our thoughts were mixed on a cut to stabilize, but OPEC’s decision indicates that they are focused more on enforcing compliance only – which implies a modest cut if any in the future. We were mixed on the OPEC production cut decision because they do have some incentive to the let the price of oil decline (maybe to the lower 80’s) due to the negative impact it would have on their international competitors, and more specically on the shale oil industry here in the U.S. We believe most of the pain will be felt by the lower end service companies that had been forecasting increasing rates and higher utilizations in the future. In response, we began to pare back our exposure to those types of service companies by selling Superior Energy Services (SPN, Financial). Bonanza Creek (BCEI, Financial) was the largest detractor in the fourth quarter after falling over 57 percent and costing the Fund 88 basis points in performance. Bonanza was also negatively impacted by the price decline in oil and is more vulnerable to lower oil prices due to the size of the company and its reliance on higher prices.
At the core, we continue to believe there are transformational changes taking place in the U.S. with respect to our ability to become energy independent. Unfortunately, the volatility of the commodity has clouded some of those prospects here in the short-term and we do realize that markets tend to overshoot on the downside while searching for equilibrium. After the trades mentioned earlier, we ended 2014 about market weight in energy versus the Russell 3000 Value Index, so we shouldn’t have a great deal of exposure to the sector moving forward on a relative basis although energy still represents around 10 percent of the index. After selling many of the more volatile, smaller cap names, the Fund’s energy exposure is focused primarily on more “stable” larger-cap names such as Haliburton (HAL, Financial), Occidental Petroleum (OXY, Financial), and Anadarko Petroleum (APC, Financial). While we do not feel it would be prudent to add at this point, we are not against adding to our energy holdings in the future if we become more comfortable with the stability in the price of oil because we continue to believe the long-term fundamentals associated with the sector remain attractive.
The financial sector also proved to be challenging during the fourth quarter and for much of 2014. Holdings in the sector were negatively impacted by our lack of interest rate sensitive positions, as REITs did exceptionally well during the quarter. Given a possible move by the Federal Reserve to raise interest rates, we were surprised by the strength in interest rate sensitive stocks in 2014. Almost all industry groups with yield performed well for the year, and areas certain areas, such as REITS, were extremely strong, boasting returns in excess of 30 percent for the year. Stock selection in nancials also had a negative impact, and our largest detractor was Genworth Financial (GNW, Financial), which fell over 33 percent and cost the Fund 41 basis points of return. The company is taking far longer than expected to turnaround its Long Term Care (LTC, Financial) business which was the root of a disappointing earnings release. We elected to sell the position due to near- and long-term uncertainty.
Going forward, we continue to expect volatility in equities until there is some stability in energy prices allowing investors to focus their attention on corporate fundamentals, where we remain optimistic. We are also enthusiastic with respect to one of our core investment themes, corporate spin-offs, which has been very fruitful of late and generated one of the most productive years ever with 60 spin-offs in 2014. This investment theme commonly produces a great amount of pricing inefciency and has historically been one of our best sources of alpha generation. We anticipate such a high level of productivity will create a strong group of investment candidates for our portfolios in 2015. Thank you for your support of the All Cap Value Fund.
Performance attribution is commonly used to measure the quality of the separate decisions that go into the management of an investment portfolio compared to a benchmark index. This analysis tries to isolate the effect and measure the return contribution of market allocation, which analyzes the positive/negative impact of a portfolio's allocation to groupings such as geographic regions or market sectors, and stock selection, which analyzes the positive/negative impact of the portfolio manager's security ownership and weighting decisions within a wider grouping. The performance attribution data in this quarterly commentary was prepared by Keeley Asset Management Corp. ("KAMCO") using the following constraints: (1) Fund portfolio holdings are as of the beginning of each day; index constituents are as of the end of the day. That means that the Fund's holdings are not included until the day after acquisition (when it is included in the portfolio as of the beginning of the next business day), and a portfolio holding that is sold is included in the analysis through the end of the day on which it is sold, and that the values at which securities are included in the analysis are the values as of the beginning of the day. For the index, securities are included at their values at the end of the day. (2) The securities’ values used in the analysis are the prices used by KAMCO in its internal records for the Fund and the prices used by the index provider for the benchmark index. If a price from either of those sources is unavailable, pricing information from FactSet is used. Pricing information from the index provider or from FactSet may differ from the pricing information used by KAMCO. (3) For the purpose of assigning portfolio security holdings to a particular sector and/or industry, KAMCO assigns the securities in accordance with the sector and industry classications of the Global Industry Classication Standard (GICS) developed by MSCI and Standard and Poor's (to the extent available) as a primary source and FactSet (to the extent available) as a secondary source for this information. In the event KAMCO securities information vendors do not classify a security's issuer to a particular sector or industry or if the published classication appears to be incorrect, KAMCO may classify the security's issuer according to its own judgment, using other securities information vendors, the company description and other publicly available information about the company's peer group. Sector and/or industry classications may change over time. The attribution information provided in this commentary includes summaries of attribution by market sector. Attribution is not precise and should be considered to be an approximation of the relative contribution of each of the sectors considered. The information on performance by sector re!ects the aggregated gross return of the Fund's securities. Contributions to the Fund's performance by sector (computed as described above) were compared against the contributions to the aggregate return of the stocks comprising the index, by sector, as reported by FactSet Databases.
