To Our Shareholders,
For the quarter ended June 30, 2024, the Keeley Mid Cap Dividend Value Fund's net asset value (“NAV”) per Class A share fell 4.3% compared with a 3.4% decline in the Russell Midcap Value index. e Fund remains ahead of its benchmark on a year-to-date basis with a 5.0% gain vs. the 4.5% gain in the index.
Commentary
Only two things mattered in the first half. The dominant theme during most of the first half was the ratcheting down of expectations for interest rate cuts by the Federal Reserve. The year started with investors expecting up to six rate cuts during the year and the first half ended with questions about whether there would be even one. A separate driver of performance for larger cap stocks was growing investor enthusiasm for all things related to artificial intelligence. We saw some of that last year, but even more this year, which drove the shares of Nvidia to be the best performing stock in the S&P 500 in the first half overall and the fourth best in the second quarter.
The performance difference between small caps and large caps widened in the second quarter. In the second quarter, the Russell 2000 index of small cap stocks fell 3.3% compared to a 5.7% gain in the Russell Top 200. is built on the 5.5% lead large cap stocks took in the first quarter. According to the brokerage firm Jefferies, the first half underperformance by small caps is its worst since 1973 and the sixth worst since 1929.
Driven almost entirely by the largest companies. The performance of the overall market, as measured by the Russell 3000, shows that the top decile of stocks by market cap accounted for 12.5% of the 13.6% total return. Furthermore, the top ten stocks contributed 64% of the gain (8.0 percentage points). The bottom half contributed almost nothing. It was even more extreme in the second quarter as the largest decile added 9.9 percentage points, while the Russell 3000 was up only 3.2%. The top ten accounted for 6.2 percentage points alone! Furthermore, the simple average of returns was negative for each decile, including the top one and the average stock in the bottom decile declined 9%.
Concentration in the market is at historic highs. We estimate that the top ten stocks now represent 30% of the overall index weight compared with 20% at the end of 2019. The Russell 2000, on the other hand, accounts for only 5% of the total market cap of the Russell 3000. This is a thirty-year low and is about half of what it was in 1994.
The largest stocks are the most expensive. Price appreciation in the largest cap stocks has outstripped their earnings growth so they have become more expensive. We estimate that the average (non-weighted) forward P/E ratio for companies in the top decile of the Russell 3000 is 29x next twelve months' EPS. is compares to 21x for the bottom half. The top ten trade at a 36x average P/E.
This should eventually matter. The multiple on the S&P 500 stood at 21.9x at the end of June. This is about 1.9 standard deviations above the 20-year average of 16.4x. In contrast, the S&P 400 Midcap and S&P 600 Smallcap indexes trade below their 20-year averages. While the view that the market is not cheap is not wrong given that large cap stocks represent more than 80% of it, it does not mean that there are not opportunities; potentially thousands of them in the areas we focus on!
Let's discuss dividends. We will discuss this topic more in the mid-year version of our Semi-Annual Dividend Tracker but we think it is noteworthy that two of the largest non-dividend payers, Meta and Alphabet, decided to initiate dividends and one of the fastest growing companies in the US, Nvidia, raised its dividend 150% after not changing it for more than five years. These companies generate an enormous amount of free cash flow and do not have great options to deploy it. They are large and highly profitable businesses and most businesses that they would buy are not as good as the one they have or are too small to make a large dent in the free cash flow. Finally, the rise in share prices and interest rate changes the math on the accretion potential of buybacks.
Portfolio Results
The Fund lagged its benchmark in the second quarter. The KEELEY Midcap Dividend Value Fund fell 4.3% in the quarter, slightly more than the 3.4% decline in the Russell Midcap Value index. This offset some of the outperformance generated in the first quarter, but the Fund remains ahead of its benchmark on a year-to-date basis, up 5.0% vs. up 4.6% for the index.
Relative performance was hurt equally by Sector Allocation and Stock Selection. Several factors drive relative performance for the Fund. We have previously cited Dividend vs. non-dividend, Sector Allocation, and Stock Selection. This quarter, relative market capitalization also impacted performance.
• We estimate that dividend-paying stocks in the Russell Midcap Value index outperformed the overall index by 50-75bps in the second quarter. This benefit was offset, however, by the outperformance of the largest stocks in the index, where the Fund is underweight. These stocks, which average $41 billion in market cap, fell only 2.2% compared with the 3.4% decline in the benchmark.
• Sector Allocation was a slight detractor in the quarter. A slight underweight in the Real Estate sector accounted for the largest piece of this.
• Stock Selection also detracted slightly. Selection boosted relative performance meaningfully in two sectors and detracted in two sectors. Relative performance in the remaining seven sectors was not significantly different from the benchmark but was slightly adverse in aggregate. The Fund's holdings in Financials and Health Care outperformed while the Fund lagged in Consumer Discretionary and Information Technology.
More details on performance.
• Financials – Financials is the second largest sector and performed in line with the index during the second quarter. The Fund's holdings performed better and actually appreciated slightly. Gains were led by Virtu Financial, which tends to benefit from increases in stock market volatility, and life insurers Equitable Holdings and Reinsurance Group of America which both reported strong earnings. Results in the important banking sector were mixed, an improvement from the last few quarters.
• Consumer Discretionary – The Consumer Discretionary sector is the fourth largest and generated losses that were twice as great as those of the index during the second quarter. The Fund's holdings performed worse than that low bar. Eight of the Fund's nine holdings declined in the quarter with three down more than 20%. These were led by PVH Corp. which was the Fund's largest detractor. We discuss it further in the Let's Talk Stocks section of this update.
• Information Technology – Information Technology is the fourth largest sector in the index and one of only three to post gains in the second quarter. The Fund's holdings lagged slightly and were down during the period as four of six stocks declined. We generated mixed results in this sector with both one of the three largest contributors (Gen Digital) and detractors (Jabil) residing in this sector. Both are discussed later in this report.
During the quarter, the Fund bought one new position and completed the sale of two holdings.
Let's Talk Stocks
The top three contributors in the quarter were:
NRG Energy (NRG, Financial) (NRG - $77.86 - NYSE) is one of the largest competitive energy retailers in the U.S. serving over 7.5 million residential customers in addition to commercial, industrial, and wholesale customers. It also operates generation plants that produce more than 15 GW of electricity. The company continued its streak of strong financial results, positioning NRG as one of the Fund's top contributors for the third consecutive quarter. It also completed its $950 million accelerated share repurchase in the quarter. The factor that probably gave the stock an additional boost in the quarter was growing investor recognition that growing electricity demand from artificial intelligence-focused data centers has the potential to outstrip supply growth. NRG has more exibility to supply this demand and stands to benefit.
GE Vernova (GEV, Financial) (GEV - $171.51 – NYSE) is a leading manufacturer of equipment and systems for electric power generation, transmission, and distribution. GE Vernova was spun off from GE Aerospace (GE) on April 2nd. In addition to reporting a strong inaugural quarter as an independent public company, GE Vernova benefitted from rising investor expectations for rapidly growing power demand fueled by artificial intelligence and data center growth over the next several years. GE Vernova's core products, such as natural gas-powered turbines, will likely be at the center of the needed power supply growth.
Gen Digital Inc. (GEN, Financial) (GEN - $24.98 –NASDAQ), formerly known as Norton Lifelock, is the leading provider of consumer-focused identity protection software. It has grown beyond PC-based anti-virus software to provide a suite of tools that protect users from bad actors online. After a year of digesting the Avast acquisition and seeing some attrition in its user base, GEN returned to growth in the first half of the year. Furthermore, the levelling off of interest rates and the company's ability to pay down debt should reduce pressure on earnings estimates. Overall, the outlook for earnings growth improved over the last six months.
The three largest detractors in the quarter were:
PVH Corp. (PVH, Financial) (PVH - $105.87 – NYSE) sells apparel under the Tommy Hilfiger and Calvin Klein brands. PVH reported its fourth-quarter earnings shortly after the second quarter started and introduced profit guidance for 2024 that was well below analysts' prior expectations. Macroeconomic issues in Europe and cautious orders for autumn from retailers there — particularly in the United Kingdom and Germany – drove the lower guidance. PVH is responding to this likely temporary pressure by keeping a lid on costs and holding the line on inventory. Its first-quarter earnings results, which were also reported during the second quarter, showed improvement. Based on an early read on the spring 2025 product line, that season could prove better for PVH.
Jabil Inc. (JBL, Financial) (JBL - $108.79 — NYSE) is one of the leading contract manufacturers in the world. In addition to serving the electronics industry, it has significant business manufacturing medical, industrial, and automotive components. After navigating pandemic-related supply chain disruption exceedingly well, Jabil has reported uneven results over the last few quarters. Excess inventory at some of its customers and weakness in end markets such as electric vehicle components and renewable energy have created demand softness. This led to missed targets and falling expectations. In addition, the unexpected resignation of the company's CEO after a short tenure did not help. At the same time, the sale of Jabil's Mobility division and the subsequent return of the proceeds to shareholders boosts the company's longer-term returns profile and EPS potential.
Molson Coors Beverage Company (TAP, Financial) (TAP - $50.83 – NYSE) is a prominent global beer company recognized for its iconic brands like Molson, Coors, and Miller Lite. The company reported a solid quarter, surpassing expectations across the board. However, the messaging from management was mixed, highlighting volatile April trends that resurfaced concerns about Molson Coors' ability to retain outsized market share gains and structural weaknesses in its core beer category. Despite a strong quarter, management chose not to increase full-year guidance, providing additional validity to potential growth concerns. It is likely that Molson Coors will return some market share back to Ambev (Budweiser), but the stock trades at too wide of a discount to peers after factoring in improvements in profitability and the balance sheet.
Conclusion
In conclusion, thank you for your investment in the KEELEY Mid Cap Dividend Value Fund. We will continue to work hard to justify your confidence and trust.
June 30, 2024
This summary represents the views of the portfolio managers as of 6/30/2024. 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.
