Hillcrest s Behavior Insights Hillcrest Commentary Q4 2013

Transcription

1 Hillcrest s Behavior Insights Hillcrest Commentary Q Hillcrest showed again in 2013 why we are a leading innovator in Behavioral Finance. This was the first full year for our newest behavioral tool, the Management Sentiment Indicator (MSI). The companies that scored in the top 30% of our MSI score last year outperformed the Russell 2000 Value index by 887 basis points. The MSI score is based on analyzing earnings call transcripts looking for behavioral biases. We knew that managers knew about potential problems, new competitors, and sales prospects before they were announced. With the hope that they could solve the problems before they became public, company management deflected discussions about these potential complications, but left clues for the behavioralist to uncover. Our analysis and subsequent use of our Management Sentiment Indicator showed that our expectations were correct and analyzing earnings call transcripts was a profitable method of choosing stocks. The MSI indicator was part of the reason for our continued strong performance. Our Small Cap Value strategy was in the top 15% among our peers for 3 and 5 years periods, outperforming in 67% of the quarters, and EVERY rolling 3-year horizon. * Hillcrest annualized composite performance is presented gross of management fees. Returns greater than one year are annualized. Please see composite disclosure at the back of the presentation.

2 Additional news: AUM topped $111 million by year end. Rick Wilk, with over 30 years of portfolio management experience joined the investment team. Tim Muffley, also with over 30 year experience joined us as Director, Consultant Relations and Sales. We launched a Midcap strategy using our Behavioral Finance investment process. It returned 48.8% in 2013, or 15.3 percentage points ahead of the S&P MidCap 400 Index. Small Cap Stocks Continue to Look Attractive Despite the strong gains in small cap stocks, we continued to find attractively priced stocks. Looking back at the Price/Earnings to Growth, or PEG ratio, shows our ability to continue to find good investment opportunities over time. Below are year-end PEGs since inception. It shows that the only time PEG was significantly different was at the end of 2008 after the Russell 2000 Value index had fallen 29%. As of Year-End Hillcrest PEG Ratio Why look at PEG? The price/earnings to growth ratio shows the relationship between the price of a stock, the earnings generated by that stock and the growth rate of those earnings. It is important for small stocks and growth stocks since the historically trade at higher P/E ratios than large cap stocks due to their higher growth rate. Just using the P/E makes small cap stocks seem expensive but the historically higher P/Es are justified due to the higher grow of earnings in smaller companies. The Hillcrest PEG ratio has remained stable as we continue to find stocks that are priced attractively relative to their growth prospects. With great performance, a strong staff, new incoming clients in Q1 and strong financial support from our private equity backers, we are poised for significant success in the coming year. We thank everyone for their support and look forward to 2014.

3 Hillcrest Performance and Attribution: 2013 In 2013, our Small Cap Value strategy continued to outperform the Russell 2000 Value Index, gaining 42.0% versus 34.5% for the benchmark for an added value of 7.4 percentage points. This is in line with Hillcrest s consistent record of outperforming in 2/3 of all quarters and 4 or the 6 calendar years. We also continue to place very high among our small cap value peer managers, ranking in the 11 th percentile for both 3 and 5 years, and 10 th percentile since inception. For the past five years our annualized value added is 9.3 percentage points annualized. * Hillcrest annualized composite performance is presented gross of management fees. Returns greater than one year are annualized. Please see composite disclosure at the back of the presentation. We have outperformed in every 3 year period. * Hillcrest annualized composite performance is presented gross of management fees. Returns greater than one year are annualized. Data source for calculations is evestment Alliance. Please see composite disclosure at the back of the presentation.

4 Our trailing year returns are consistent with significant value added. * Hillcrest annualized composite performance is presented gross of management fees. Returns greater than one year are annualized. Please see composite disclosure at the back of the presentation. + Performance year one was calculated gross of trading costs. Please see performance disclosure in the back. Attribution Analysis How did our behavioral rankings do during 2013? Below are the returns from our rankings. The bottom line of the table shows how much you would have performed relative to the benchmark by holding an equal-weighted portfolio of the top 30% of our rankings. As you can see, our overall Buy forecast was strong as were all of the components during Over the past 5 years as the market has rebounded from 2008, valuation has worked better than growth or sentiment. The major difference is in sentiment which we believe is largely due to the implementation in 2013 of our Management Sentiment Indictor (MSI) Buy Forecast Value Sentiment Growth Top 30% vs. Benchmark +6.55% +6.79% +8.27% +4.24% 5 Years Buy Forecast Value Sentiment Growth Top 30% vs. Benchmark +5.02% +7.43% +2.39% +3.23%

5 Our fundamental analysis, which we define as the ability to pick stocks within the top rankings, added value during the third quarter. We typically get about half from each area as can be seen by the 5 year numbers below. In 2013, the model worked very well and contributed the majority of the value added. Fundamental Analysis - Estimated Value Added 0.89% Behavioral Rankings - Estimated Value Added 6.54% 2013 Performance Valued Added 7.43% When we look at the most recent 5 years we find that the value added from both parts of the process is very balanced. Fundamental Analysis - Estimated Value Added 4.31% Behavioral Rankings - Estimated Value Added 5.01% 5 Year Performance Valued Added 9.32% The first full year for our Management Sentiment Indicator (MSI) was excellent. The companies that scored in the top 30% of our MSI score outperformed the Russell 2000 Value by 887 basis points MSI Rank MSI Forecast Top 30% vs. Benchmark 8.87% The attribution below shows what contributed to our relative performance in Risk Based Performance Attribution SC Value Focus vs. Russell 2000 Value YTD through 12/31/13* * This is presented as supplemental information to the compliant presentation included herein. Please see composite disclosure at the back of the presentation.

6 Performance this quarter was again positively impacted by stock selection. Since the Hillcrest process does not have macro forecasts, this is what is expected. Below is a discussion of stocks that contributed to and detracted from value added during Detractors Ann Inc. (ANN) is a women s specialty retailer operating under the LOFT and Ann Taylor brands. The year got off to a disappointing start when the first quarter was impacted by a prolonged cold weather in the northeast and an imbalance in LOFT product mix. After LOFT posted a disappointing 1% same store sales comp in the first quarter though, the company remedied the issues with a better assortment and posted 4% and 6% comps in the second and third quarters. With expansion into Canada, ecommerce initiatives, and same store sales growth we think the company is likely to grow earnings at a strong rate. Ann is one of the better operated women s retailers, and at current valuation levels we don t think the market not giving Ann credit for its strong operations. Sirona Dental Systems, Inc. (SIRO), a leading manufacturer of dental equipment and instruments, detracted from performance as Sirona s 9% return lagged the sector s almost 48% return. The stock was one of our top performers in 2012, but underperformed in 2013 as investors focused on a negative margin impact from trade-in programs, tougher growth comparisons, and increased competition. The news hasn t been bad though as revenue beat expectations each quarter this year with double-digit top line growth, and Sirona s technology remains best in class. Though comparisons are tougher, we expect continued strong growth from its key products including CEREC, digital radiography and 3D imaging. Landec (LNDC) which develops polymer products for food, agriculture and licensed partner applications underperformed this quarter as analysts lowered growth estimate for the current year. Adverse weather caused sourcing issues for vegetables in the GreenLine and Apio businesses, as Landec had to buy produce on the open market at higher than expected prices. This hasn t impacted revenue growth which is still solid, but the disruption to profit margins has been a multi-quarter event. Investors have focused on the weather-related issues which are unpredictable and largely out of management s control, but management is working on other sourcing options to help with similar issues in the future, and we view the issue as non-recurring and expect above average earnings growth over the next several years from this fast-growing food technology company. Contributors Virtusa Corporation (VRTU), which provides IT consulting, technology implementation and application outsourcing services performed well as strong sales and earnings growth driven by broad-based demand among its clients pushed the stock price higher. Virtusa is focused on the increasingly important IT application services category where benefits to clients range from costs, to revenue, to quality control. Virtusa continues to see a growing pipeline with larger deal sizes and increasing client acceptance, and we remain attracted to its strong balance sheet and growth prospects. American Equity Investment Life Holding Company (AEL) which sells fixed index and fixed rate annuity products was another strong contributor as improving spreads and strong sales propelled earnings. We like American Equity Life as core products have grown in popularity, its market share is strong, and

7 improvement in its core fundamentals should lead to higher investment spreads, earnings growth, and returns on equity. We continue to view American Equity Life as attractively valued. Omega Protein (OME) is a nutritional ingredient company and nation s leading vertically integrated producer of omega-3 fish oil and specialty fish meal products. Omega Protein develops, produces and delivers nutritional ingredients three primary industries human nutrition, animal nutrition and plant nutrition. Driven by strong production and pricing, Omega posted better than expected earnings throughout the year leading to upwardly revised estimates and a strong stock return. We held the stock most of the year, but saw valuation was full and exited our position late in the year. Final Thoughts All of us at Hillcrest are extremely proud of our continued performance success and growth of the firm. We are continuing to prove that the application of Behavioral Finance in the management of small cap portfolios leads to investment success.

8 About Hillcrest Asset Management Brian Bruce, Doug Stark and the portfolio team craft their combined behavioral finance expertise into all portfolios. Results reflect Hillcrest s proprietary selection processes. Brian and Doug have a long history of success managing small cap stock portfolios. Hillcrest remains guided by a fundamental belief that prices vary, sometimes significantly, away from fundamentals. Also, prices are influenced by emotions and fears. Hillcrest aspires to continue to develop proprietary behavioral models to enhance its fundamental research methods. Hillcrest Contact Information: Brian Bruce Tim Muffley T. Jon Williams CEO & Chief Investment Officer Director, Consultant Relations & Sales President Hillcrest Asset Management LLC Hillcrest Asset Management LLC South Avenue Investment Partners LLC N. Dallas Pkwy, Suite N. Dallas Pkwy, Suite Yarmouth Avenue Dallas, TX Dallas, TX Encino, CA , ext bbruce@hillcrestasset.com tmuffley@hillcrestasset.com jwilliams@saipus.com

9 SMALL CAP VALUE COMPOSITE ANNUAL DISCLOSURE PRESENTATION N. Dallas Parkway, Suite 650 Dallas, Texas Fax Total Firm Composite 3 Year Annualized Ex-Post Year Assets Assets (USD) Number of % of Non- Annual Performance Results Standard Deviation Composite End (millions) (millions) Accounts Fee-Paying Composite Benchmark Composite Benchmark Dispersion % N.A N.A % N.A % % % % * Performance is presented gross of management fees. N.A. - Information is not statistically meaningful due to an insufficient number of portfolios in the composite for the entire year. N.A. 2 The three-year annualized ex-post standard deviation of the composite and/or benchmark is not presented because 36 monthly returns are not available. Small Cap Value Composite contains all fully discretionary small cap value accounts. Securities are selected from the benchmark universe using proprietary modeling which incorporates behavioral finance concepts and scores securities based on value, growth and sentiment. The top ranked securities then undergo fundamental analysis to determine the portfolio holdings. The objective is long-term capital growth and the return goal is performance of the portfolio which exceeds the benchmark, Russell 2000 Value Index, over a complete market cycle. Hillcrest Asset Management, LLC claims compliance with the Global Investment Performance Standards (GIPS ) and has prepared and presented this report in compliance with GIPS standards. Hillcrest Asset Management, LLC has been independently verified for the periods July 1, 2007 through December 31, 2011 by Ashland Partners & Company LLP. The verification report is available upon request. Verification assesses whether (1) the firm has complied with all the composite construction requirements of the GIPS standards on a firmwide basis and (2) the firm s policies and procedures are designed to calculate and present performance in compliance with the GIPS standards. Verification does not ensure the accuracy of any specific composite presentation. Hillcrest Asset Management, LLC is a registered investment adviser. The firm maintains a complete list of composite descriptions, which is available upon request. Results are based on fully discretionary accounts under management, including those accounts no longer with the firm. Past performance is not indicative of future results. The U.S. Dollar is the currency used to express performance. Returns are gross of management fees and include the reinvestment of all income. The annual composite dispersion presented is an asset-weighted standard deviation calculated for the accounts in the composite the entire year. Policies for valuating portfolios, calculating performance and preparing compliant presentations are available upon request. The investment management fee schedule for the composite is 1.00% on the first $10 million, 0.95% on the next $40 million, and 0.90% on the remainder. Actual investment advisory fees incurred by clients may vary. The Small Cap Value Composite was created January 1, 2009 Note: Returns are presented gross of management fees and include reinvestment of all income. Actual returns will be reduced by investment advisory fees and other expenses that may be incurred in the management of the account. The collection of fees produces a compounding effect on the total rate of return of net of management fees. As an example, the effect of investment management fees on the total value of a client s portfolio assuming (a) quarterly fee assessment, (b) $1,000,000 investment, (c) portfolio return of 8% a year, and (d) 1.00% annual investment advisory fee would be $10,416 in the first year, and cumulative effects of $59,816 over five years and $143,430 over 10 years.

10 MIDCAP VALUE COMPOSITE ANNUAL DISCLOSURE PRESENTATION Total Firm Composite 3 Year Annualized Ex-Post Year Assets Assets (USD) Number of % of Non- Annual Performance Results Standard Deviation Composite End (millions) (millions) Accounts Fee-Paying Composite Benchmark Composite Benchmark Dispersion % N.A. 2 N.A. * Performance is presented gross of management fees. N.A. - Information is not statistically meaningful due to an insufficient number of portfolios in the composite for the entire year. N.A. 2 The three-year annualized ex-post standard deviation of the composite and/or benchmark is not presented because 36 monthly returns are not available. Midcap Composite contains all fully discretionary midcap value accounts. Securities are selected from the benchmark universe using proprietary modeling which incorporates behavioral finance concepts and scores securities based on value, growth and sentiment. The top ranked securities then undergo fundamental analysis to determine the portfolio holdings. The portfolios typically hold approximately securities versus the benchmark which holds approximately 400. The objective is long-term capital growth and the return goal is performance of the portfolio which exceeds the benchmark, S&P Midcap 400 Index, over a complete market cycle. Hillcrest Asset Management, LLC has prepared and presented this report in compliance with the Global Investment Performance Standards (GIPS ). Hillcrest Asset Management, LLC claims compliance with the Global Investment Performance Standards (GIPS ) and has prepared and presented this report in compliance with GIPS standards. Hillcrest Asset Management, LLC has been independently verified for the periods July 1, 2007 through December 31, 2012 by Ashland Partners & Company LLP. The verification report is available upon request. Verification assesses whether (1) the firm has complied with all the composite construction requirements of the GIPS standards on a firm-wide basis and (2) the firm s policies and procedures are designed to calculate and present performance in compliance with the GIPS standards. Verification does not ensure the accuracy of any specific composite presentation. Hillcrest Asset Management, LLC is a registered investment adviser. The firm maintains a complete list of composite descriptions, which is available upon request. Results are based on fully discretionary accounts under management, including those accounts no longer with the firm. Past performance is not indicative of future results. The U.S. Dollar is the currency used to express performance. Returns are gross of management fees and include the reinvestment of all income. The annual composite dispersion presented is an asset-weighted standard deviation calculated for the accounts in the composite the entire year. Policies for valuating portfolios, calculating performance and preparing compliant presentations are available upon request. The Midcap Composite was created January 1, Note: Returns are presented gross of management fees and include reinvestment of all income. Actual returns will be reduced by investment advisory fees and other expenses that may be incurred in the management of the account. The collection of fees produces a compounding effect on the total rate of return of net of management fees. As an example, the effect of investment management fees on the total value of a client s portfolio assuming (a) quarterly fee assessment, (b) $1,000,000 investment, (c) portfolio return of 8% a year, and (d) 1.00% annual investment advisory fee would be $10,416 in the first year, and cumulative effects of $59,816 over five years and $143,430 over 10 years.