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
|Top 10 Holdings||% Weight|
|Orion Engineered Carbons||2.2|
|% of Total||22.3|
|Attributes||Cambiar||Russell 2000V||Russell 2000|
|Market Cap Wtd Avg||2.7 B||2.1 B||2.4 B|
|Market Cap Median||2.4 B||0.7 B||0.8 B|
|Sector Weights||Cambiar||Russell 2000V||Russell 2000|
|Risk Statistics*||Cambiar||Russell 2000V||Russell 2000|
Market Review (12.31.2017)
U.S. equities extended their year-long upward trajectory into the fourth quarter, closing out 2017 at or near all-time highs for most stock averages. The S&P 500 Index returned 6.6% in the quarter, and notched a 2017 gain of 21.8%. Smaller cap stocks (as measured by the Russell 2000 Index) gained 3.3% and 14.7%, respectively. While the details of the recently passed tax reform are still being scrutinized, small cap companies should be disproportionate beneficiaries of the reduced corporate tax rates.
2017 marked the ninth consecutive calendar year of positive returns for the S&P 500 Index, and a cumulative return of 372% from the bottom of the financial crisis in March 2009. There is little debate that we are in the later innings of the current bull market (perhaps the ninth year is a telling sign for this baseball analogy), and valuations are at elevated levels for an increasing number of market participants. That is not to say that the rally cannot continue, as corporate profitability remains robust. However, adherence to process, sensitivity to attachment points and remembering to sell will all take on increased importance in 2018.
Value vs. Growth - Cambiar's Take
The value vs. growth debate is often an either/or discussion, yet the reality is that both styles of investing have a place in the average client portfolio. By definition, growth stocks have different attributes than their value counterparts – the resulting combination thus provides broad exposure to a diverse set of equities. Given the stock market’s underlying mean reversion tendencies, the key is to have a rebalance program in place during time periods when there is material divergence in returns. After a strong run for growth stocks in 2017, now is one such time where a rebalance out of growth and into value may be appropriate.
Although 2017 produced higher equity returns across the board, growth stocks handily outperformed value for the year. As the performance tables illustrate, growth leadership extends beyond the last twelve months – this trend has been in place for much of the past ten years. While value stocks have posted periodic runs of their own (e.g., 4th quarter 2016), growth stocks have clearly had the upper hand in the current market cycle.
|2017||3 Year||5 Year||10 Year|
|Large Cap Growth - Russell 1000 Growth||30.2%||13.8%||17.3%||10.0%|
|Large Cap Value - Russell 1000 Value||13.7%||8.7%||14.0%||7.1%|
|Small Cap Growth - Russell 2000 Growth||22.2%||10.3%||15.2%||9.2%|
|Small Cap Value - Russell 2000 Value||7.8%||9.6%||13.0%||8.2%|
There is no shortage of academic studies that show value outperforms growth over the long term (with less risk). Yet why have growth stocks bested their value peers as of late, and when will value investing regain its luster? Index construction/constituents is one obvious distinction; value benchmarks have higher allocations to sectors such as energy and financials, while growth benchmarks own more technology – which has been an outperforming sector in recent years. Another reasonable explanation for the outperformance of growth stocks is the ultra-low interest rate environment that has been in place since the financial crisis. While low rates have provided a rising tide for equities regardless of style, growth stocks have been disproportionate beneficiaries of this low cost of capital environment. Low rates have also led investors to pay up via higher multiples for what they perceive to be higher growth companies. This has been especially true for the so-called FANG (Facebook, Amazon, Netflix, Google/Alphabet) stocks, whose strong momentum has contributed to widening the gap between value and growth.
What could swing the performance pendulum back to value stocks? Perceived risk/reward is a possible catalyst, given widening valuation spreads between growth and value sectors. A change in market conditions such as interest rates and inflation could also provide a lift to value stocks. Monetary policy will likely continue to normalize in 2018, and while there is no clear advantage on a style basis in a rising rate environment, the impact of rising capital costs may be a headwind to more highly leveraged companies. In contrast, traditional value companies with strong balance sheets have less reliance on capital markets to sustain their business and should therefore be less impacted by higher borrowing costs.
Cambiar’s investment approach is fairly agnostic to the underlying style tilts in the market – other than to take advantage of price dislocations that may often result from swings in market sentiment. Growth stocks have had the upper hand throughout the current cycle, and may continue to outperform value should the status quo in the markets remain. Yet should there be a flattening in earnings trends or a peak in the business cycle, the high multiples assigned to many growth stocks will likely be unsustainable – setting up an environment that is more advantageous for value stocks.
Small Cap Value
Small Cap equities rallied into the close of 2017, fueled by above-trend economic growth, encouraging corporate profits and a Christmas present in the form of a business-friendly tax reform package. The Cambiar Small Cap Value (SCV) portfolio outperformed the strategy’s primary value index in the quarter, while delivering an in-line return vs. the core index. This was the second consecutive quarter of improved relative outperformance for the SCV strategy, after a challenging first six months of 2017. Given Cambiar’s fundamental investment discipline and more focused portfolio construction approach, the portfolio’s relative performance is highly correlated to stock selection. After making several necessary adjustments to the SCV strategy during 2017, we are optimistic that we can continue the second half momentum into 2018.
Despite a fairly broad rally in stocks during 2017, there were notable divergences that persisted for much of the year. Large cap stocks outperformed small caps, and on a style basis, growth outperformed value by a wide margin. Within the small cap value market, sectors such as energy, telecom and consumer staples did not participate at all – as each of these sectors posted negative returns in 2017.
Cambiar’s outperformance in the fourth quarter was primarily driven by positive stock selection in the financial and industrial sectors; both of these sectors were also positive contributors to relative performance on a full-year basis. Cambiar’s exposure to financials is skewed to regional banks, as these companies are operating with a number of tailwinds – lower corporate tax obligations, higher rates (particularly for banks with floating-rate portfolios), and the potential for reduced regulatory oversight. Although small cap financials did not keep pace with the market in 2017 (after a very strong 2016), Cambiar anticipates a better showing in 2018 as loan growth improves and interest margins widen.
The portfolio’s outperformance in industrials has been a function of diversified holdings in the sector – some outside the more traditional machinery and equipment names. Cambiar’s industrial positions include aircraft leasing, asset-light freight/logistics operators and an auctioneer company. Air Lease, Interface and Hub Group were notable individual outperformers in 2017. While we may be in a ‘stronger for longer’ economic cycle, this optimism is largely priced in for many industrial companies. We feel our industrial positions possess unique franchises, trade at reasonable multiples on a price/book and/or free cashflow yield basis, and on the margin are less sensitive to changes in the broader economy.
In what was a recurring theme for much of 2017, Cambiar’s holdings in Technology detracted from performance in the quarter. Applying a value approach within small cap tech (particularly this late in the cycle) has been a challenging exercise, with a number of false positive outcomes. Like other areas of the small cap market, the tech sector is somewhat picked over at this point - as many quality names have appreciated beyond our targeted market cap bounds. We are certainly not deflecting blame – analytical mistakes were made, and we own these decisions. In some cases, we are continuing to stay the course with positions where we maintain conviction. One such example is Diebold Nixdorf Ltd., the ATM operator. Diebold has an approximate 35% market share in the global ATM market (a duopoly with competitor NCR) – so a clear market leader. The company has not executed well since its 2016 acquisition of Wincor Nixdorf, but with the stock now trading at 2009 levels and catalysts in the form of a new incoming CEO, anticipated replacement demand and activist involvement, we see an attractive risk/reward. Given low market expectations, even a modest amount of topline growth would be meaningful to the depressed share price.
Cambiar executed seven new purchases and six liquidations in the quarter – which is generally in line with average activity. On a year-over-year basis, it is worth highlighting sector changes within the portfolio to illustrate where the team has been finding value, vs. areas of less attractive opportunities. There was more capital allocated to financials, healthcare and materials over the course of 2017, and net selling within the industrials and consumer discretionary sectors.
Despite entering the year at fairly elevated valuations, 2017 proved to be another strong year for domestic small caps equities. As we look ahead to 2018, it is hard not to imagine more volatility, as the market has not had a correction of any magnitude since early in 2016. Cambiar remains mindful of valuation-based downside, given lofty multiples exhibited in many small cap companies, and continue our efforts to allocate capital in companies that meet our quality and valuation criteria.
U.S. equities delivered a dream year for investors in 2017 – strong returns with very low volatility. Can stocks continue their upward trajectory? While not outright practitioners of behavioral finance, we do attempt to safeguard against biases that can lead to potentially flawed decisions. For example, recency bias extrapolates recent events into the future indefinitely. As it stands today, the path of least resistance certainly appears to be higher stock prices; however, Cambiar believes an impartial assessment of risk and reward will take on heightened importance in 2018.
The acceleration in economic growth across most geographies is unlikely to sharply decelerate in the coming year, which should provide a tailwind to corporate profits and stock prices. That said, it is unlikely that 2018 will be without some degree of increased volatility along the way. Volatility is not necessarily a bad thing – the corresponding increase in dispersion across sectors is beneficial to active managers such as Cambiar.
What unforeseen shocks could derail the upward trajectory for equities? Geopolitical risk is always front of mind; changes in central bank monetary policy will be another variable worth watching. Although the three rate increases by the U.S. Federal Reserve did little to impede stocks from advancing in 2017, the ongoing normalization in policy will eventually be felt by market participants (particularly those with higher leverage ratios). In general, the mood at Cambiar is best described as constructive paranoia; while optimistic in the outlook for our companies, we spend equal time thinking about what could go wrong.
Quarterly Top & Bottom Contributors
|Top Contributors||Avg. Weight||Contribution||Bottom Contributors||Avg. Weight||Contribution|
|TCF Financial||2.11||0.44||VeriFone Systems||1.65||-0.24|
|United Natural Foods||1.59||0.42||HMS Holdings||2.09||-0.25|
|Brinker International||1.82||0.39||Travelport Worldwide||2.04||-0.38|
|Bruker Corp||2.11||0.37||Acorda Therapeutics||0.72||-0.38|
|BMC Stock||1.81||0.32||Diebold Nixdorf||1.74||-0.58|
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.