Figure 1: Small Cap Value Returns vs. Benchmarks

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1 S C H A F E R C U L L E N Small Cap Value Equity Q Commentary Market Review: U.S. small cap equities posted another quarter of modest gains in the second quarter of 2017, with the Russell 2000 Index returning 2.5% and the Russell 2500 Value Index up 0.3%. While small cap stocks continued to lag large cap, starting in June small caps benefitted more from low volatility and tightening credit spreads. Within the small cap stock universe (Russell 2000) this quarter, Telecom (+14.9%) led the move higher after being the second worst performing sector in Q Healthcare s strong performance (+8.9%) continued this quarter after being the worst-performing sector in 2016 while Technology (+4.3%) benefited from stabilizing earnings revisions. Energy (-19.5%) was the laggard for the quarter; while OPEC agreed in May to extend production cuts another nine months through February 2018, the market views the continued growth in U.S. shale production as unrestrained and oil prices retreated. In June, the Fed raised interest rates another quarter of a percentage point to between 1.0% and 1.25%. The Fed also indicated it may begin trimming its $4.5 trillion balance sheet, possibly later in This monetary tightening by the Fed is in concert with central bankers worldwide, with the European Central Bank s Mario Draghi, the bank of England s Mark Carney and others indicating they may pull back on stimulus in the coming months. In the political arena, a host of developments continued to take focus off President Trump s twin policy goals of tax and regulatory reform from the firing of FBI Director Comey, the subsequent release of his memo regarding National Security Advisor Michael Flynn, to the ongoing investigation of possible Russian interference with the November election. While House Republicans managed to pass a bill to repeal and replace the Affordable Care Act, a Senate version of the legislation appears stalled in negotiations. Meanwhile, international sentiment, particularly in Europe, improved when Emmanuel Macron won the French Presidential election in May; his election was widely viewed as a victory for free market trade and further Eurozone integration. Performance Analysis: C A P I T A L M A N A G E M E N T The Small Cap Value Equity strategy increased 0.3% in the quarter, net of fees. The Russell 2500 Value Index returned 0.3% and the Russell 2000 returned 2.5% for the second quarter of 2017 (Figure 1). Performance in the second quarter was again driven by the trends we witnessed in the first quarter; Largecapitalization, Growth and High Beta stocks outperformed Small-capitalization, Value and Low Beta stocks. The Russell 2500 Growth Index returned 4.1% in the quarter, outperforming the Russell 2500 Value Index by 380 basis points. Figure 1: Small Cap Value Returns vs. Benchmarks Q2 YTD 1 Yr 3 Yr 5 Yr 10 Yr Since Incept* Small Cap Value (gross) Small Cap Value (net) Russell 2500 Value Index Russell 2000 Index *June Performance for periods greater than 1 year is annualized. 1 of 6

2 Portfolio Attribution: Attribution Effects Small Cap Value Equity vs. Russell 2500 Value 03/31/ /30/2017 Source: SCCM/Bloomberg, 6/30/2017 The largest contributor to relative performance was our strong stock selection within Health Care and Energy. Outperformance here was led by a diverse group of attractively valued companies offering strong shareholder returns including Ensign Group, Quality Systems and Oceaneering. Our overweight allocation to Industrials and Health Care and our underweight allocation to Energy aided performance. Technology was the largest detractor to relative performance as Avnet (-14.6%) and Verint Systems (-6.2%) were impacted after providing weaker than expected earnings guidance. We retain confidence in these allocation decisions based on valuations and the long-term outlook for our portfolio companies. 2 of 6

3 Portfolio Changes: Purchases Carter s Inc Carter s sells apparel for babies and young children under its Carter s and OshKosh brands. The company markets its products primarily in the United States through its own retail stores, chains, specialty stores, department stores and online. Carter s is the market leader in the baby clothing category with over 15% share and profits from its scale relative to competitors. Despite a challenging retail environment, the company s strong brand equity and the specialized apparel category in which it competes allows the company to earn stable cash flows. Carter s is positioned to meaningfully increase its operating performance as its international expansion into key countries such as China produces strong sales and operating leverage. In addition to growing its store count domestically and abroad, the company recently announced it will be selling direct to Amazon.com, which we view as a strong catalyst for future growth. We purchased shares of Carter s at 15 times forward earnings. Mitel Networks Mitel is a provider of cloud and enterprise communications solutions used primarily by small and medium-sized businesses for their voice and data needs. The company helps customers migrate from legacy voice systems to Internet-protocol (IP) equipment. Mitel also offers software for contact centers, remote access and messaging selling direct as well as through telecom services providers, distributors and system integrators. The market is transitioning from on-premise communication systems to cloud-based services and Mitel is well positioned to take market share as it monetizes its large enterprise install base. The rapid growth in cloud should grow the addressable market from $29 billion today to $35 billion by Although Mitel primarily focuses on U.S. customers, the company is expanding to Asia and the EMEA region as management sees major cloud transformations occurring globally. We purchased shares of Mitel at 10 times forward earnings. Tahoe Resources Tahoe is a mining company that acquires, explores and develops silver and gold properties in Guatemala, Peru and Canada. The company has predominately been focused on silver mining with low-cost and longlived assets and we see meaningful upside to the stock as the company in recent years has diversified more into gold mining. Tahoe acquired the Escobal mine in Guatemala at an attractive price and the market does not appreciate its exploration upside. Moreover, Tahoe generates strong free cash flow and has ample liquidity to expand its operations in Canada and Peru. We purchased shares of Tahoe at 1.0x book value. Sales WR Berkley Corp We exited our position in WR Berkley based on valuation grounds and found a better replacement that has more attractive growth opportunities. Market Outlook: The current expansion, which began in early 2009, is now in its ninth year and the 2nd longest bull market since 1928 at 100 months in duration and up 258% from the March 2009 bottom. While financial markets have benefitted from the extraordinary low interest rate environment, the subsequent increase in debt levels has contributed to the subpar level of GDP growth in this recovery. Global debt set a new record high of $217 Trillion (over 327% of GDP), up 46% from the preceding high in Of note, the combined size of the Federal Reserve and European Central Bank, Bank of Japan, Bank of England and 3 of 6

4 Swiss National Bank balance sheets have gone from $4T to $15T from 2008 to Meanwhile U.S. companies have added $7.8T of debt since 2010 with the IMF seeing their ability to cover interest payments at its weakest since With the Fed raising rates, this presents a risk that while interest rates are rising from a low level, high debt levels make economies vulnerable to higher interest rates. The market has taken note with the yield curve (2 to 10-year) at the lowest spread since In addition, the unwinding of the Fed s balance sheet is also a headwind to liquidity and can potentially drain excess bank reserves. However, the market is optimistic that the current low inflationary and low growth market will keep the Fed from tightening too aggressively and that economic growth will be self-sustaining. A key beneficiary of the low interest rate regime has been the Technology sector as valuation multiples in the sector have dramatically expanded. Record fund flows into Technology ETFs throughout the year have led to extreme crowding and bullish sentiment in the sector. Technology is the best-performing sector through 1H, contributing 38% of the S&P 500 s 1H gains and nearly 50% before the June sell-off. FAANG (Facebook, Amazon, Apple, Netflix, Google) and other prominent technology stocks have recently been viewed as low-volatility, safe-haven securities the volatility of this group is lower than the S&P 500 index and their correlation to the defensive Consumer Staples and Utilities sectors is running at 5-year highs (Goldman Sachs, June 2017 study). Recently, FAANG free cash flow has plateaued, after doubling between 2006 and 2016, while capital expenditures have on average increased by 17%. As convergence of markets continues to accelerate, dominant technology companies must ramp up their spending to battle one another and legacy incumbents to chase the remaining growth markets that exist. The flow into passive vehicles and proliferation of ETFs continue with the total number of ETFs now at over 1,800 and assets surpassing $3T. Since 2006, cumulative flows into domestic index funds and ETFs have reached nearly $1.3T while flows out of domestic actively managed mutual funds exceed $1T. Figure 2: Cumulative Net New Cash Flow to Active and Passive Funds (12/31/ /31/2016) Source: Investment Company Institute, 12/31/ of 6

5 A number of research firms have written about the risks of passive investing, highlighting the value of active strategies which can consistently generate alpha: According to Strategas Research, approximately 1/3 of the companies in the Russell 2000 have failed to earn a profit in the past 12 months. Such figures are normally only apparent in recessions. Easy money has allowed quite a few weak hands to remain in the game, making it difficult for good companies to gain share. This is also tough on the active manager tasked with distinguishing between good and bad companies. 1 Goldman Sachs recently published a report on Active vs. Passive Management 2. The study finds that over the past 27 years: 1) Active underperforms when benchmark performance is driven by a small number of stocks, but when breadth improves, so too has excess return, 2) Active management tends to outperform (by 38bps) during market pullbacks (-2%+) while persistent bull markets have led Active to underperform by 22bps in up markets (2%+), and 3) Quantitative Easing (QE) has been a headwind for Active management, with low rates leading to low volatility and low dispersion, and therefore low alpha generation. Importantly, the study finds the best performing active managers are concentrated (high tracking error) and exhibit low turnover. With the market near all-time highs and broad-based valuations on stocks at elevated levels, we believe investors should be more mindful of risk, not less. The S&P forward price/earnings ratio is currently 18x, however the median P/E ratio is 24x, significantly higher than the long-term median average of 17x for the S&P 500. The most effective way to manage risk is to adhere to an investment discipline focused on valuation and quality, which is the core tenet of our investment approach. Relative to equity benchmarks, the valuation of our portfolio remain attractive. The strategy trades at 14x forward twelve month earnings versus 19x for the Russell 2500 Value and 25x for the Russell Best Regards, Schafer Cullen Capital Management, Inc. 1 Strategas Research, Quarterly Review in Charts Report, July 5, Goldman Sachs, An Rx for Active Management, April of 6

6 Disclosure: Schafer Cullen Capital Management (SCCM or the Adviser ) is an independent investment advisor registered under the Investment Advisers Act of This information should not be used as the primary basis for any investment decision nor should it be considered as advice to meet your particular investment needs. The portfolio securities and sector weights may change at any time at the discretion of the Adviser. It should not be assumed that any security transactions, holdings or sectors discussed were or will be profitable, or that future recommendations or decisions will be profitable or equal the investment performance discussed herein. Investing in equity securities is speculative and involves substantial risk. Past performance is no guarantee of future results. Market conditions can vary widely over time and can result in a loss of portfolio value. Individual account performance results will vary and will not match that of the composite or model. This variance depends on factors such as market conditions at the time of investment, and / or investment restrictions imposed by a client which may cause an account to either outperform or underperform the composite or model s performance. A list of all recommendations made by SCCM within the immediately preceding period of not less than one year is available upon request. The strategy depicted in this report has been managed in accordance with the investment objectives of the strategy as determined by the Adviser. The Adviser has selected benchmarks, which in their opinion closely resemble the style of the securities held in the composite or model portfolio of the strategy (e.g. large cap value, small cap value, international, etc.). The securities held in the composite or model are actively managed while the benchmark index is not. Investors should be aware that the Adviser makes no attempt to match the portfolio securities, or the security weightings of the benchmark. The composite or model s performance will be affected greater by the price movements of individual securities as the composite or model is more concentrated, generally less than 100 securities, while a comparative benchmark will generally have between 500 and 2,500 securities where individual security price movements have a lesser affect. An individual cannot invest directly in an index. In the case where this report displays model results, please be aware that such results do not represent actual trading and that results may not reflect the impact that material economic and market factors might have had on the Adviser's decision-making if the Adviser were actually managing clients' money. Model and actual results reflect the deduction of advisory fees, brokerage or other commissions, and any other expenses that a client would have paid or actually paid (Net of Fee performance) and reflect the reinvestment of dividends and other earnings. Schafer Cullen Capital Management, Inc. makes no representation that the use of this material can in and of itself be used to determine which securities to buy or sell, or when to buy or sell them; SCCM makes no representation, either directly or indirectly, that any graph, chart, formula or other device being offered herein will assist any person in making their own decisions as to which securities to buy, sell, or when to buy or sell them. All opinions expressed constitute Schafer Cullen Capital Management s judgment as of the date of this report and are subject to change without notice. 6 of 6