To Our Shareholders,
For the quarter ended December 31, 2023, the Keeley Small Cap Dividend Value Fund's net asset value (“NAV”) per Class A share gained 13.2% compared with a rise of 15.3% for the Russell 2000 Value Index. For the full year, the Fund trailed its benchmark as it was up 10.0% compared with a 14.7% rise in the index.
Commentary
After a difficult 2022 and a choppy first nine months, stocks ended 2023 on a strong note. Growing investor confidence that the Fed is done raising rates for this cycle drove prices of almost all assets higher. Falling rates drove the bond market, as measured by the Bloomberg Aggregate, to its best quarterly performance since the third quarter of 1982. Its 6.2% return, however, paled in comparison to the double-digit gains produced by the equity market.
Stock markets experienced broad-based strength. Fourth quarterequity returns ranged from good to outstanding. On the good end were the 5% gains in international stocks, while US stocks appreciated more sharply with the S&P 500 up 11.7%. Small caps performed even better with the Russell 2000 up 14.0%. Style favored growth for large and mid-caps, but value for small caps.
Interest sensitive sectors performed well. Ten of the eleven sectors gainedground in the quarter with only Energy in the red. Interestingly, Real Estate and Financials were two of the better performing sectors across market cap ranges. Surprisingly, Utilities lagged the strong move in equities despite the fall in longer-term interest rates. The relative ranking of other sectors was fairly size/style specific. For example, the Magnificent Seven (Alphabet, Amazon, Apple, Microsoft, Meta, Nvidia, and Tesla) drove the technology sector to lead large cap performance, but Technology lagged in the Russell 2000 Value index.
We were particularly encouraged by the outperformance of small caps. As small- and midcap specialists, we were heartened to see that small capstocks outperformed large and mid-caps in the core and value styles and mid-caps outperformed large caps in core, value. and growth. The single best performing size/style in the quarter was the Russell 2000 Value which rose 15.3%. is was a substantial change from the first three quarters of the year when that index was down 0.5% compared with the 13% gain in the S&P 500.
Small caps remain attractive even after a quarter of outperformance. We were optimistic that a turn in relativeperformance was coming, and this may be the start of it. Even with the outperformance this quarter, small caps remain near record low valuations relative to large caps. At year-end, the forward P/E of the Russell 2000 stood at 21.9x. is is 107% of the P/E of the Russell Top 200 index. The average since 1999 has been 128% and the relative multiple has been at this wide a discount to average less than 10% of the time. Value also looks inexpensive relative to growth with the Russell 2000 Value index trading at 16.3x, 47% of the P/E of the Russell 2000 Growth index vs. a more typical 58%.
A levelling-off or a decline in rates should be good for dividend payers. The strong fourth quarter relativeperformance of the Real Estate and Financial sectors may presage further outperformance for these sectors if the Fed is done raising rates and begins to pull back on some of the tightening of monetary conditions. Utilities might also participate as they have historically done. ese sectors all have high propensities to pay dividends and are much larger weights in the value benchmarks.
As we look ahead, we are encouraged by the opportunities in our sector of the stock market. While large cap stocks trade at valuations well in excess of past averages, small and midcap stocks are much closer to average and are at historically wide discounts to the overall market. As always, we remain focused on nding stocks of companies with better than average businesses, where the future looks better than the recent past, and which trade at discounts to our assessment of intrinsic value.
Portfolio Results
The Fund lagged the very strong gains generated by the Russell 2000 Value Index. The Keeley Small CapDividend Value Fund rose 13.2% in the fourth quarter compared with the 15.3% gain in the Russell 2000 Value Index. Interestingly, most of this gain came in the last month of the quarter as the Index was up 12.4% in December. is was the sixth best monthly performance for the benchmark since it was created in 1979! About 90% of the Fund's underperformance in the quarter came during this unusually strong period.
Allocation and Selection more than offset other factor contributions in the quarter. We disaggregateperformance into three factors: Dividend vs. non-dividend, Sector Allocation, and Stock Selection. In the fourth quarter, dividends were slightly favorable, although some other factors (pro tability) hurt performance. Both Sector Allocation and Stock Selection detracted from relative performance.
- We estimate dividend-payers within the Russell 2000 Value index outperformed the overall index by a little more than 100 basis points. It is sometimes di cult to disaggregate this factor from the other two, but we did not capture this tailwind. Furthermore, much of it was offset by outperformance by the smallest market cap, higher beta, and lower profitability company stocks.
- Sector Allocation (do the sectors the Fund is overweight/underweight outperform/underperform?) detracted from relative performance slightly. The Fund's small cash holdings were the main driver of this and were partly offset by a small underweight in the Energy sector, which was the only sector declining in the quarter.
- Stock Selection (do the stocks held by the Fund outperform the sectors in which they reside?) was the main source of underperformance in the quarter. Most of the underperformance came in the Financials sector, but Technology and Health Care lagged as well. The lone bright spot in Stock Selection was the Industrials sector.
The details for those who want to dig deeper.
- Industrials – The Industrials sector is the second largest in the benchmark and performed in line with theoverall index. The Fund's holdings performed slightly better. The dispersion of returns was remarkably high with returns among the Fund's twelve holdings ranging from -3% to +97%! At the top of the list were Spirit Aerosystems and Griffon Corporation. As these were two of the Fund's best performing stocks in the quarter, they are discussed later in the “Let's Talk Stocks” section of this report.
- Financials – The Financials sector is the largest sector in the Russell 2000 Value index, and it comprisesmore than 25% of the overall weighting. Banks account for nearly two-thirds of this. is quarter, Financials were the best performing sector with a gain of nearly 24%. The Fund's stocks did not keep pace with these strong gains largely due to the performance of its holdings outside of the banking sector. The single biggest detractor was the Fund's lone insurance company stock, James River, which declined in the quarter and is discussed later in this report. In addition, holdings in asset management and nancial technology did not keep up with strong gains seen in those sectors.
- Information Technology – Technology is a mid-sized sector that surprisingly lagged the overall index bya little in the fourth quarter. The Fund's holdings lagged by more. While only Adtran was down, all four of the Fund's positions appreciated less than the Technology stocks with the benchmark.
- Health Care – The Health Care sector is another mid-sized sector within the Russell 2000 Value index.It outperformed the overall index based on the strength of shares in the Biotechnology industry. Surprisingly, biotech makes up half the sector's weight in the Russell 2000 Value index. With none of them paying dividends, the Fund had no holdings which drove the contribution from stock picking in the sector to lag. e Fund did have some bright spots as shares of Embecta Corporation and Ensign Group were both up more than 20%.
During the quarter, we bought two new stocks and completed the exit of two positions.
Let's Talk Stocks
The top three contributors in the quarter were:
Kontoor Brands (KTB, Financial) (KTB - $62.42 – NYSE) owns two well-known jeans brands: Lee and Wrangler, and marketsapparel and footwear under these banners. During the fourth quarter, Kontoor reported earnings that beat expectations. Furthermore, it provided upbeat commentary on two fronts: China and overall earnings growth in 2024. In November, Kontoor leaders told the investment community that they expected their China business to inflect positively in the fourth quarter and that in fact, they already had begun to see evidence of that. Also, management indicated an expectation of accelerated earnings growth in 2024 as Kontoor's gross margin expands due to lower input costs and better product mix. Supporting this outlook, Kontoor has reduced inventories, and the company is seeing strong demand from consumers.
Spirit AeroSystems (SPR, Financial) (SPR - $31.78 – NYSE) manufactures fuselages and aftermarket parts to support commercialand defense aircraft production, primarily for Boeing. The stock responded favorably to a CEO transition to board member Pat Shanahan, an aerospace industry veteran who moved quickly to improve the company's liquidity and cash flow. First, Spirit entered a memorandum of understanding with Boeing that will improve short-term cash generation while the production rate of the 737 MAX and the 787 ramps. A similar negotiation is ongoing with Airbus. Secondly, Spirit was able to complete a debt refinancing and an equity offering which will improve liquidity and remove an overhang on the stock. The supply chain in commercial aerospace has held together well enough recently that production ramps are more likely.
Griffon Corporation (GFF, Financial) (GFF - $60.95 – NYSE) operates prominent brands in consumer home and garden tools, closet organization, and garage doors. The company had a couple of positive developments in the quarter that drove strong stock price appreciation. First, Griffon reported earnings that surpassed expectations, primarily attributed to continued robust EBITDA margin performance in the Home and Building Products (garage doors) segment. Management put to rest worries about the potential deterioration in EBITDA margins due to the normalization of raw material costs and a heightened competitive environment by projecting a continuation of strong EBITDA margins for fiscal 2024. Second, the company has continued its commitment to enhancing shareholder value. This includes a noteworthy 20% increase in the quarterly dividend, representing the second double-digit increase this fiscal year. Additionally, the company bought back 1.9 million shares in the current quarter, bringing the fiscal year's total to approximately 7% of outstanding shares. Finally, the board increased the existing repurchase authorization by $200 million.
The three largest detractors in the quarter were:
James River Group Holdings (JRVR, Financial) (JRVR - $9.24 — NASDAQ) writes specialty insurance for middle marketcompanies. It focuses on excess and surplus lines which gives it more levers to manage risk. While overall earnings have met expectations in the last several quarters, adverse prior period loss development has been a consistent theme within results. This has made investors concerned about future losses. During the quarter, the company announced the sale of a division that recently had been the source of these concerns. While we believe the transaction is a long-term positive for James River, the price received and the negative impact on book value pressured the company's shares.
ChampionX Corporation (CHX, Financial) (CHX - $29.21 – NASDAQ) is a market leader in both chemicals used in theproduction of oil & gas and lifting systems that bring commodities to the surface for gathering in production. The company's third-quarter results fell below expectations due to slower well completion activity that occurred in September and carried on into October. This caused the company to lower its outlook. Despite a decline in commodity prices, management sees growth in its chemical business in 2024 due to an increase in o shore well completions which use more chemicals than onshore wells. Onshore customers are also increasing the intensity of chemicals per well which points to improved growth.
Atlas Energy Solutions (AESI, Financial) (AESI - $17.22 – NYSE) is a supplier of both proppants (sand) and associatedtransportation services for oil & gas well completions in the Permian Basin in west Texas. The company saw a pullback in pricing for proppant as well completions slowed in the Permian Basin during the quarter as a response to lower commodity prices. The pullback in prices is believed to be short-term in nature and the company has negotiated quarterly pricing resets with several customers as it enters 2024 with a proppant mine expansion on track. Atlas is also expected to complete its Dune Express conveyor project by the end of 2024 which will significantly reduce delivery cost of proppant and enable Atlas to mine and deliver a ton of proppant well below the mining costs of its competitors.
Conclusion
In conclusion, thank you for investing along with us in the KEELEY Small Cap Dividend Value Fund. We will continue to work hard to justify your confidence and trust.
This summary represents the views of the portfolio managers as of 12/31/23. Those views may change, and the Fund disclaims any obligation to advise investors of such changes. For the purpose of determining the Fund's holdings, securities of the same issuer are aggregated to determine the weight in the Fund. Portfolio holdings are subject to change without notice and are not intended as recommendations of individual securities.
