The Cambiar Small Cap Value strategy is a team managed portfolio. The portfolio employs an equal-weight portfolio construction approach. Cambiar believes this approach enables the strategy to maintain a more focused portfolio relative to peers, while also mitigating stock-specific risk via uniform position sizes.
Andrew P. Baumbusch
Jeffrey H. Susman
|Top 10 Holdings||% Weight|
|United Natural Foods||2.2|
|Ritchie Bros Auctioneers||2.2|
|% of Total||22.6|
|Attributes||Cambiar||Russell 2000V||Russell 2000|
|Market Cap Wtd Avg||2.5 B||2.0 B||2.2 B|
|Market Cap Median||2.2 B||0.7 B||0.8 B|
|Sector Weights||Cambiar||Russell 2000V||Russell 2000|
|Risk Statistics*||Cambiar||Russell 2000V||Russell 2000|
Market Review (9.30.2017)
U.S. equities (as defined by the S&P 500 Index) notched a gain of 4.5% in the third quarter. Barring a meaningful correction in the fourth quarter, the market is poised to deliver a ninth consecutive year of positive returns, and is the second-longest bull market on record in the post-WWII period (as measured from March 2009 to present). The resiliency in equities remains high, as stocks seem unfazed by increasing geopolitical tensions abroad, normalization of monetary policy in the U.S., and an absence of tax/policy reform from Washington D.C. As has been the case throughout the current bull market, any pullback in stocks during the quarter presented a buying opportunity.
Active management has had a better showing in 2017, yet asset flows remain decidedly biased towards low cost index funds (source: Morningstar). Given the rising tide environment for stocks that has been in place for the past eight years, it is hard to refute the buy-the-market at a low cost strategy. Yet this ‘free lunch’ is bound to end at some point, and given the massive flows into passive instruments, the move to the exits (should one occur) may not be an orderly process. This should not be interpreted as Cambiar calling an end to the current bull market – there are no shortage of positive data points in the market that could translate into additional upside for stocks. But at minimum, an increased awareness of valuation and selectivity should be in order.
Energy Stocks - Poised for Improved Returns?
After meaningfully lagging the market for the first six months of 2017, energy stocks rebounded in the third quarter. Is the recent recovery the start of an improving performance trend within the sector, or a short-term bounce that is not likely to be sustained? After having maintained an underweight allocation to energy stocks in 2015, Cambiar has been slowly rotating capital back into the sector. At present, our view is that the energy sector offers an attractive risk/reward – based on our outlook for a stable-to-increasing price deck for oil over the next 12 months.
Why did energy stocks struggle in the first two quarters of the year? After posting a sharp rally in the fourth quarter of 2016 on OPEC’s announced production cuts, the energy sector reversed course in January. Climbing global oil inventories led to increased negative sentiment toward the sector – given the oversupplied market conditions. Despite rebounding in September, energy stocks remain in the red on a year-to-date basis. The decoupling in stock valuations relative to oil prices thus far in 2017 borders on capitulation by investors(see the below chart).
Source: Bloomberg. WTI (West Texas Intermediate)
Frustration with the pace of the recovery in oil market vs. past cycles is sure to be weighing on investor sentiment; that said, we believe the combination of attractive valuations (in what is increasingly becoming a fully/overvalued equity market) and improving fundamentals may result in brighter days ahead for energy stocks.
As with most assets, the oil price is primarily a function of supply and demand. Global oil demand has been strong this year, with industry publications continuing to revise their demand estimates higher. On the other hand, global oil supply growth has not kept pace with demand due to OPEC production cuts as well as underinvestment in many areas of the world outside of the United States.
While the current supply/demand picture is healthy, the spike in oil in storage during the 2014-2016 timeframe resulted in a glut of oil and oil products in storage. As the below chart illustrates, U.S. oil inventories have begun to post consistent draws - which essentially means the global oil market is not just back in balance but is actually under-supplied. While there is some work to do in working down the supply bulge and reaching more normal storage levels in the U.S. (~700K barrels), the data is moving in the right direction.
A continued overhang in the bull case for energy stocks is the role of shale production in North America (N.A.); i.e., any uptick in oil prices will result in increased shale activity, thereby capping oil price gains. Yet can N.A. shale fill the potential gap that may occur from lack of new investment in conventional oilfields? Expenditures in new oil finds have been sharply curtailed since the collapse in oil prices three years ago. The big integrated and national oil companies are instead seeking to squeeze more out of their existing assets – which will succeed in providing barrels in the short-term, but at the expense of increasing decline rates. When comparing the barrels lost via a 5% decline rate vs. the incremental shale production estimates, one can create a scenario where shale is a necessary source of supply, vs. the burden tagline that it wears today.
Uncertainties regarding the pace of the recovery remain; however, Cambiar believes these concerns are reflected in the attractive valuations that exist within the sector. Cambiar’s holdings in the sector span the energy stack, including integrated oil companies, exploration and production companies and oil services companies. Many of these companies have undergone significant restructuring – such that improving top line results have the potential for a disproportionately positive impact on earnings.
Small Cap Value
The Cambiar Small Cap Value (SCV) portfolio, gross of fees, posted an in-line return vs. the strategy’s primary value index, while trailing the core benchmark by a modest margin. Gains were broad-based across most sectors of the small cap value market, with Telecom the only sector to finish in the red for the quarter. Sector leadership was mixed, with cyclical sectors having an edge over defensives. Healthcare and Industrials were notable standouts in the quarter, while real estate, consumer staples and technology were relative laggards.
Small cap stocks have participated in the continued rally in U.S. equities, and valuations within small caps are approaching historical high water marks. The one-year forward P/E for the Russell 2000 is 19x, vs. 16.5x three years ago. Small cap companies would be a direct beneficiary of corporate tax reform; however, this potential earnings bump may not be sufficient to justify current multiples. And while the timing and specifics of tax reform remain uncertain, there is no uncertainty regarding the direction of rates and general tightening of U.S. monetary policy. A rising rate environment is not necessarily a red flag for small cap stocks; on a historical basis, small cap stocks have tended to outperform their large cap counterparts during periods of rising rates. However, small cap companies typically have greater dependence on the debt markets – such that their cost of capital may increase as rates rise. The takeaway for Cambiar is to remain focused on valuations and corporate balance sheets, as selectivity in the coming quarters is likely to have a more meaningful impact on performance.
The SCV portfolio was a beneficiary of M&A activity in the quarter, as water/air purification provider Calgon Carbon Corp (basic materials) was acquired at a ~60% premium. Although the frequency of takeout activity within the SCV portfolio has declined in recent years, such events can be impactful to performance. In the case of Calgon Carbon, the contribution to performance was approximately 93 bps – making it the top performer for the quarter.
At a sector level, industrials was a bright spot for the SCV strategy in 3Q – via the portfolio’s overweight allocation as well as positive stock selection. Individual highlights included Generac, which manufactures power generation equipment for the residential and industrial markets. The stock re-rated as a clear beneficiary from an elevated hurricane season and Cambiar elected to take advantage of the near-term strength to lock in gains and sell the position during the quarter. Another notable performer was Hub Group, an asset-light transport and logistics provider. The company is well-managed, and generates solid free cashflow. The entry point was due to a challenging operating environment over the past 24 months that Cambiar views to be transitory in nature. Hub Group is poised to benefit from stronger demand trends and a tightening in truckload capacity.
In terms of portfolio detractors during the quarter, Cambiar’s performance within technology trailed the benchmark and represented the largest negative contributor to return. Tech has been a headwind for the SCV portfolio over the past year – a frustrating experience in light of historical efficacy in the sector. Similar to investing in any sector, the primary objective in researching tech stocks is to determine whether the conditions that led to the attractive valuation are transitory issues or of the terminal (i.e., value trap) variety. The answer is rarely an obvious one, and the higher beta in the names typically results in a bumpier ride. Two ‘problem children’ that Cambiar parted ways with in the quarter were Synaptics and Cardtronics. In both cases, these companies met many of Cambiar’s criteria – strong balance sheets, market leadership in their industry, experienced management teams, and reasonable valuations. Unfortunately, these attributes were not sufficient, and the investment case in both situations failed to play out. Were there opportunities to sell earlier at higher prices? In hindsight, the obvious answer is yes – but there were still enough positives to the names to warrant staying the course. The decision to liquidate arrived after another review in the quarter where the investment case could no longer be defended. Investing is a continuous learning experience – be assured that lessons learned here will be applied on a go-forward basis.
Despite elevated valuations and high correlations for much of the recent cycle in small cap stocks, price discovery has been more evident in 2017, which has presented pockets of opportunity to add value. Consequently, trading activity was elevated in Q3 – driven by both new opportunities for investment, coupled with the fact that the recent rally in small cap equities caused some of our positions to reach their desired exit price. The quarter included 8 new buys and 8 sales, which is certainly higher than recent quarters, although there was not a significant shift in the portfolio’s sector exposures. Strength in industrials presented opportunities to make trades based on valuations, where many of our current holdings made strong moves toward the higher end of their valuation range. That capital was allocated to new names in the sector, Ritchie Brothers and Forward Air, as well as two new names in the Materials sector, Orion Engineered Carbons, and Valvoline Inc.
Global equities have broadly rallied through the first nine months of 2017, with stock averages in the U.S., Japan, Europe and Emerging Markets all trading at 52-week highs. Given positive economic growth data, low volatility, strong corporate profits and lack of attractive investment alternatives, equities appear to represent the best house on the block for investors. Although Cambiar remains optimistic as it relates to our companies, we spend equal amounts of time thinking about what could impair the investment case. Complacency and investing are not a good mix.
As always, Cambiar continues to focus the core of our research on company-specific fundamentals. That said, we will also include macro variables into our analysis, to the extent the macro is relevant to our bottom-up work. One top-down segment of the market we are monitoring is central bank activity, in particular the U.S. Federal Reserve. The U.S. continues to slowly make progress on normalizing monetary policy; the key consideration is whether the markets will be able to digest higher rates and the Fed’s planned balance sheet reduction. The moves made by policymakers in the U.S. could have a ripple effect on the global markets – potentially jeopardizing what has been a synchronized growth environment. We are also closely monitoring the energy markets, given the high correlations between oil prices and stock movements within the sector.
Quarterly Top & Bottom Contributors
|Top Contributors||Avg. Weight||Contribution||Bottom Contributors||Avg. Weight||Contribution|
|Calgon Carbon||2.06||0.93||Superior Energy||1.06||-0.40|
|Array BioPharma||1.44||0.65||Diebold Nixdorf||2.00||-0.41|
A complete description of Cambiar's performance calculation methodology, including a complete list of each security that contributed to the performance of the Cambiar portfolios mentioned above are available upon request. Please contact Cambiar at 1.888.673.9950 for additional information. Past performance is no guarantee of future results.
Certain information contained in this communication constitutes “forward-looking statements”. Due to market risk and uncertainties, actual events or results, or the actual performance of Cambiar’s client accounts may differ materially from that reflected or contemplated in such forward-looking statements. All information is provided for informational purposes only and should not be deemed as a recommendation to buy the securities mentioned. There is no guarantee that the opinions expressed herein will be valid beyond the date of this presentation. There can be no assurance that the portfolio will continue to hold the same position in companies described herein, and the portfolio may change any portfolio position at any time. The specific securities identified and described do not represent all of the securities purchased, sold, or recommended by Cambiar and the reader should not assume that investments in the securities identified and discussed were or will be profitable.