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Manager Commentary

13 Aug 2019
Reading Time: 3 minutes

Market Backdrop

Global equity markets went on a wild ride in the second quarter with equities rising in April, taking a plunge in May and then rebounding strongly in June to end the quarter on a strong footing. Hopes of accommodative central bank action early in the quarter led to equities continuing their first quarter rally but was interrupted abruptly by a falling out of the U.S.-China trade talks. An announcement that the U.S. would be ending talks and increasing tariffs on $200bn sent the markets on a tailspin as the goldilocks market environment was questioned.

Central banks around the world appeared to double down on their commitment for further monetary easing and markets began to price in rate cuts in 2019, a major change versus earlier in the year where rate hike expectations had been delayed but not expectations for rate cuts. The “central bank put” is back with the Federal Reserve, European Central Bank, Swiss Bank, and the Bank of Japan all appearing to sound the same trumpet of “whatever it takes” mentality to support economic growth and confidence over the coming year. Excess central bank liquidity has helped financial assets since the Global Financial Crisis and central banks appear to be turning on the taps once more. Global bond yields plummeted during the quarter hurting the Financials sector but helping support growth equities. Recessionary concerns continued to surface as the 3m-10y U.S. bond yield spread remained in negative territory and the New York Fed Probability of U.S. Recession measure reached over 29%, the highest reading since 2007.

In spite of rising tensions in the Middle East, oil prices fell during the quarter as increasing production from the U.S. Permian Basin combined with higher than expected global inventories and concerns over demand given weakening economic outlook led oil prices lower from their April highs. The U.S. Dollar softened a bit given increasing expectations for rate declines in the U.S. but remained elevated versus most currencies.

Large caps outperformed small and mid-caps for the quarter and year while Growth has significantly outperformed Value for the quarter and year-to-date periods. The best performing MSCI EAFE countries for the quarter were Switzerland, Australia, and Germany while the worst performing MSCI EAFE countries for the quarter were Israel, Finland, and Austria. The best performing emerging markets for the quarter were Argentina, Russia, and Greece while the worst for the quarter were Pakistan, Chile, and Hungary.

Performance and Attribution

The Timothy Plan International Fund continued its strong start of 2019 as it outperformed the MSCI EAFE index for the second quarter in a row.  Sector allocation and stock selection were both additive to alpha this quarter.  In sector allocation, an underweight to Real Estate and an overweight to Technology were positive.  Stock selection was helped by strong selection in Industrials, Financials, and Consumer Staples.  From a country standpoint, the Fund benefitted from strong stock selection in the UK, Japan, and Hong Kong.

Outlook

With subdued inflation across most developed economies, major central banks appear set to begin ultra-loose monetary policy experiment 2.0.  The added monetary stimulus should continue to support financial assets in the near term although economic conditions have worsened in major markets placing doubts about the viability of an extended economic recovery. International equities continue to provide a good investment opportunity at these valuation levels.

13 Aug 2019
Reading Time: 2 minutes

Market Backdrop

The Israeli economy remains sound and growing on a sustainable path around 3% per year.  While the Bank of Israel’s research department lowered their GDP growth expectations for 2019 to 3.1% (from 3.4%) and kept 2020 at 3.5% growth, these continue to stand out in a global context of trade wars and economic softness across advanced economies.  Inflation over the last twelve months was at the low end of the Bank of Israel’s 1-3% inflation band, allowing the central bank to continue forecasting a future path of rate increase at a gradual and cautious pace.  Given the year to date rise in the shekel exchange rate and the renewed emphasis by major central banks for more dovish monetary policy, we do not expect that Bank of Israel to continue raising rates in the near term.  The shekel has appreciated over 5% year to date on the back of increasing gas exports (Dutch disease), higher tech service exports, and persistent foreign direct investment inflows.  One area of focus recently has been the increasing fiscal deficit which reached 3.9% of GDP from a year ago level of 1.8%.  While some one-offs drove the difference as compared to the prior year, revenues have been below expectations in spite of low unemployment of 3.8% while expenditures continue to come in above the government ceiling.  We expect an emphasis on the fiscal deficit from the government over the coming year.

Prime Minister Benjamin Netanyahu was unable to form a ruling coalition after the April elections and chose instead to dissolve parliament and call for new elections which will be held on September 17th.  This will be the first time that Israel will hold two national elections in a single year. This is a risk for Netanyahu and his allies. Recent actions have seen left-leaning parties joining forces in the new election poll, placing significant pressure on the chances of a right-wing government coalition.

Performance and Attribution

The Timothy Plan Israel Common Values Fund continued its string of outperformance in the quarter bringing its year to date and last twelve months outperformance versus the TA-125 index to a wider margin. Sector allocation was positive while stock selection was a slight negative for the quarter.  An underweight to the underperforming Health Care sector helped performance while from a stock selection standpoint, good stock selection in Health Care, Financials, and Consumer Discretionary was not enough to offset bad performance in Technology for the quarter.

Outlook

The strong economy continues to support robust corporate earnings growth.  The upcoming election is a risk to markets but the most recent polls suggest a continued split vote that sees little chances of small coalition building and may mean a much broader coalition may have to be built than the right-wing coalitions of the recent past. We remain constructive Israeli equities over the long term as the innovation of Israel corporates and the strong economic growth in the country supports equity prices.

30 Jul 2019
Reading Time: 7 minutes

Macroeconomic Update

Trade tariffs and the threats of additional trade tariffs are having meaningful impacts on economic growth globally In the US, the impacts are putting the orakes on Gross Domestic Product (GDP) growth After upward revisions to the first quarter GDP expansion to 3.1%, fueled mainly by inventory building and export pre-buying ahead of the first round of tariffs, growth slowed markedly in the second quarter As of July 3, 2019 the Atlanta Federal Reserve’s GDP Now r n estimates 02 2019 growth at 15%. This growth will most likely be revised upward following a stronger than expected June employment report but will likely remain in the 15-2 0% range

On the supply side, businesses appear to have grown more cautious. Although both the June 2019 ISM Manufacturing and Non-Manufacturing (services) indices registered continuing expansion readings, botn metrics weakened as the quarter progressed The ISM Manufacturing index hit its lowest level since October 2016 and the ISM® Non-Manufacturing (services) index, which represents two-thirds of the domestic economy, fell to its lowest level in nearly two years Of concern, the New Order sub-component of the ISM Manufacturing index registered a reading of 50, which is the tipping point between expansion and contraction. This reading is the lowest level since December 2015. In contrast, on the demand side of the economy the negative impacts of tariffs are a bit more difficult to discern. While the University of Michigan Consumer Sentiment index trended down during the quarter, it remains elevated. Consumers remain on solid ground as employment gains remain at healthy levels overall. The quarterly average monthly employment gain of 170,000 during 02 2019, down from 180,000 during 01 and 233,000 in 04 of 2018, is indicative of slowing growth but wage gains and average hours worked remain generally steady It should be noted that the final round of proposed US tariffs on Chinese goods, which would have directly affected consumer products imports, has been postponed for the time being Future implementation would have a material impact on our outlook for consumer spending

While it appears that central banks in US, Europe, and China are prepared to adopt more accommodative monetary policies to support growth, the factors underlying the current slowdown, in our opinion, are not interest rate sensitive. As such, without a near-term resolution of the various trade disputes, we would expect economic activity to continue to weaken, with downside risk exceeding upside risk.

Q2 2019 Review

The markets continue to favor larger cap stocks over smaller cap names. Growth stocks are still trumping value names across all capitalizations as lower interest rates encourage investors to take another look at growth companies whose primary source of value lies out in the distant future. Financial Services stocks were strong in the mid cap growth space, while Energy names faltered as oil prices declined.

Aggressive Growth fell short of the Russell Mid Cap Growth Index by 085%, returning +4.55% versus the benchmark +54%. Sector allocation was mildly negative; the primary detraction from performance was stock selection in the Financial Services sector. Our best selection came within Health Care – here lnsulet (3 6%)7 returned +25%, Sarepta Therapeutics (1%) rose +27%, and Dentsply Sirona (12%) gained + 17.9%.

Contributors
lnsulet Corp (3 6%; +25 5%) develops, manufactures and markets the Omni Pod, an insulin infusion system for people with type 1 diabetes. There is a continued adoption of pumps and automated insulin delivery systems worldwide, particularly in the US. New patient growth in the US was mid 30% this quarter and the company is benefiting from wider Medicare and Medicaid coverage In the next few quarters, lnsulet will be providing updates on the launch of DASH, the company’s first new product in the past six years DASH offers users a new interface that allows the patient to control all settings through the patient’s smartphone device. This interface is a dramatic improvement over the current bulky controller.

HEICO (18%; +410%) is a well-run aerospace component manufacturer. It specializes in the aftermarket, offering airlines the ability to replace broken aerospace components at a sizable discount to the prices charged by the OEMs. Given that there is significant testing to receive approval by the FAA, there is a significant competitive ‘moat’ for this industry, limiting the number of competitors that HEICO faces.

Detractors

Nutanix (13%; -313%) is a leader in Hyperconverged Infrastructure (HCI), which streamlines the operations of datacenter services by combining and integrating software with hardware servers. This new technology is being rapidly adopted as more computing is being done in the cloud, which HCI is perfectly designed to address. Unfortunately, while Nutanix had a first mover advantage, it is facing intense competition from VMWare and Dell. Given the lower revenue visibility, the position has been sold from the portfolio.

Glu Mobile (13%; -34 3%) is a leading developer and publisher of freemium mobile games We were excited about the prospects of accelerating growth throughout this year, driven by WWE Universe and Disney’s Sorcerers Arena. However, we were very surprised to see that a core game, Design Homes, was facing much greater competition this year, that directly impacted bookings and revenues. And more importantly, game mechanics issues led the company to launch WWE Universe and then quickly pull the game from the market Given the poor execution from the management team, we have much lower confidence that Sorcerers Arena will be a success, and that led us to sell our position in Glu Mobile.

Market Outlook

In the second quarter, most of the “themes” in the market continued to play out in a directionally similar manner to 01 Both sides of the US/China tariff stand-off alternated between taking a hard stance and indicating that they thought a deal can get done. At the G20 meeting on the last weekend of the quarter, Trump and Xi agreed to delay pending tariff increases while negotiations continue. Many believe that it is optimistic to think that a deal will get done well before year-end The economic softness referred to in the “macro” section above has caused bond yields to take another leg down. The 10-year Treasury yield that dipped down to about 2.4% at the end of 01 went slightly below 2 0% in the 2nd quarter and finished at 2 0% on 6/30/19. The members of the Fed, for their part, had already indicated that they would be on hold for some time (sparking last quarter’s rally), but then in the June press conference they went further and hinted at a possible rate cut Chairman Powell said, “we will act as needed, including promptly if that’s appropriate” Market bulls think this return to a “Fed-put” scenario will keep at least a floor on the markets and that an eventual China deal will provide additional upside But with the market near recent highs and valuations above historical averages, arguably at least some of the positives are already discounted.

While we continue to be optimistic in our outlook, we acknowledge that there are several segments of the market that are becoming significantly overvalued. Specifically, within the Saas software universe, there are now several public companies that are trading at 10-20x forward sales, an unheard of valuation. Within the biotech sector, there are countless companies that have come public over the past year with only preclinical data, without any human clinical data to be analyzed All this reflects a market environment that perhaps has become overheated. It might be beneficial to see stocks which have had enormous returns over the past year consolidate those gains We continue to find compelling investment opportunities within the growth space and remain focused on generating alpha and producing the strongest investment results we can for you over the long run. We thank you for your continuing support and investment Please feel free to call or email us with any feedback or questions about the portfolio

The securities identified and described do not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in the securities identified was or will be profitable. The Index returns are provided to show an example of alternate return potential during the relevant time periods; however, indices may possess different investment attributes that may make comparisons difficult such as volatility, liquidity, market capitalization, and security types. The statistical data regarding the indices has been obtained from Bloomberg and the returns are calculated assuming all dividends are reinvested. The indices are not subject to any of the fees or expenses to which the portfolios are subject. This report assumes the reader has sophisticated knowledge of investing and the markets. If you require more information about the information presented, including the portfolio characteristics and risk statistics, please contact us.

Manager views expressed herein were current as of the date indicated above and are subject to change. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this commentary. A copy of the calculation methodology and the full list of recommendations made in the preceding year is available upon request. The performance data quoted represents past performance and does not guarantee future results. Performance returns quoted are gross of fees which were calculated on a time weighted basis and do not give effect to investment advisory fees, which would reduce such returns. Please see Chartwell’s Form ADV, Part II for a complete description of investment advisory fees. The following statement demonstrates the compound effect advisory fees have on investment returns: For example, if a portfolio’s annual rate of return is 15% for 5 years and the annual advisory fee for a client is 100 basis points or 1.00%, the gross cumulative 5 year return would be 101.1% and the five year return net of fees would be 92.5%. Actual fees charged to portfolios may be different due to various conditions including account size, calculation method and frequency, and the presence of a performance or incentive fee. The deduction of performance and incentive based fees will have similar, yet often larger, impacts to performance and account values than standard management fees. To receive a complete list and description of Chartwell Investment Partners’ composites, performance attribution for all securities, and/or a presentation that adheres to the GIPS® standards, please contact Lynette Treible by phone (610)407-4870, email treible@chartwellip.com, or by mail to 1205 Westlakes Drive, Suite 100, Berwyn, PA 19312.

30 Jul 2019
Reading Time: 3 minutes

Second Quarter 2019

 

Market Commentary:

Looking back, the markets remained volatile during the quarter, after one of the strongest starts to the year, as investor sentiment oscillated with each passing headline. Growth concerns were temporarily placated with the initial U.S. GDP estimate exceeding forecasts at 3.2 percent for the first quarter of 2019, though that marked the high point for expectations. Corporations reported better than expected earnings, with management teams expressing caution regarding implications from moderating growth and disruptions from the trade dispute. Optimism around a potential trade deal was crushed as negotiations collapsed, with little progress made during the quarter. Hope rested on the G-20 meeting that happened over the last weekend in June, which produced some progress towards a resolution. These headwinds culminated in pressures on interest rates as investors moved into safe-haven assets, which sent the yield on the 10-year treasury to multi-year lows below 2 percent. Inflation has remained relatively tame, further bolstering confidence in the Federal Reserve’s pivot towards easier monetary policy and the likelihood of meaningful cuts to their benchmark rate during 2019.

Looking forward to the second half of 2019, positive corporate earnings growth still remains the most likely outcome for the full year. However, growth for earnings is increasingly dependent on an acceleration into the end of the year, as the upcoming quarterly estimate has fallen and is now flat with the prior year’s earnings. Tight labor markets and a rebound in housing from lower interest rates has continued to underpin the strength in the U.S. consumer despite the market concerns. Investors are likely to be focused on company outlooks for the remainder of the year as these issues begin to show a greater impact on their earnings and cashflows. As the economic cycle continues to progress later and later, the preference for high-quality, cash-generative businesses is likely to increase as markets become increasingly concerned for those companies with more challenged models where leverage is high, or cash generation is lower. These differences, we believe, will cause further dispersion in returns between securities, while avoiding those most exposed to a key driver of investor returns. We remain vigilant in assessing absolute risk in the securities we invest in and striving to protect client capital during these times for potential volatility from the uncertainty.

Index Drivers:

Within the S&P 500 Index, every sector posted positive returns during the second quarter except Energy, which was the lone decliner. Financials, Materials, and Information Technology all rallied the most during the quarter.

Performance Drivers:

The portfolio’s relative performance was aided by strong stock selection in Health Care and Information Technology. Cable One rallied as their shift towards growing high-speed data customers continued to boost margins and drive higher cash flow. DENTSPLY SIRONA moved higher on evidence of firming in the underlying end-market demand for their dental products. STERIS saw strong execution and solid growth across their healthcare product spectrum including capital equipment. Amdocs reported better-than-expected results as investors cheered their drop in unbilled receivables, which had been a concern. Intercontinental Exchange moved higher on solid organic growth within their data segment as earnings beat expectations and sales came in towards the high end of management’s guided range.

Unfavorable stock selection in Consumer Discretionary and Real Estate weighed on relative performance. Mall owners, like Simon Property Group, continued to be pressured by store closures and bankruptcies from mall-centric retail operators. Pentair fell as earnings fell short of expectations due to unfavorable weather and high inventory levels within their aquatic systems division. Energizer Holdings reported mixed results as management pointed to volatility with their recently acquired set of battery businesses as a culprit. Genuine Parts saw strength in their U.S. auto business overwhelmed by weakness in Europe and some moderation in their industrial distribution segment. Advance Auto Parts also saw better results in their U.S. auto parts business but investor concerns over the broader light vehicle cycle and upcoming difficult comparisons weighed on shares.

Past performance is not indicative of future results. Portfolio returns reflect the reinvestment of dividend and interest income. All information provided is for informational purposes only and is not intended to be, and should not be interpreted as, an offer, solicitation, or recommendation to buy or sell or otherwise invest in any of the securities/sectors/countries that may be mentioned. A description of the methodology used to calculate the attribution analysis or a complete list of each holding’s contribution to overall performance during the measurement period may be obtained by contacting info@westwoodgroup.com. Benchmark Data Source:  © 2019 FactSet Research Systems Inc. All Rights Reserved. Russell Investment Group is the owner of the trademarks, service marks, and copyrights related to its indexes, which have been licensed for use by Westwood.

30 Jul 2019
Reading Time: 7 minutes

Macroeconomic Update

Trade tariff s, threats of additional trade tariff s, and the uncertainty regarding the ultimate resolution of the issues underlying the trade tariff s are having meaningful impacts on economic growth around the world. In the US, in the aggregate, the impacts are putting the brakes on Gross Domestic Product (GDP) growth. After upward revisions to the first quarter GDP expansion to 3.1%, fueled mainly by inventory building and export pre-buying ahead of the first round of tariff imposition, growth slowed markedly in the second quarter. As of July 3, 2019 the Atlanta Federal Reserve’s GDPNowTM (Federal Reserve Bank of Atlanta, Center for Quantitative Research) estimates second quarter 2019 growth at 1.5%. That will most likely be revised upward following a stronger than expected June employment report but will likely remain 2.0% or below following the revision. Interestingly, the tariff s are divulging a dichotomy in tariff response between business and consumer. On the supply side, businesses appear to have grown more cautious. Although both the Institute for Supply Management Manufacturing and Non-Manufacturing (services) indices (June 2019 Manufacturing ISM® Report On Business®, June 2019 Non-Manufacturing ISM® Report On Business®) registered continuing expansion readings, both weakened as the quarter progressed. The ISM Manufacturing index hit its lowest level since October 2016 and the ISM® Non-Manufacturing (services) index, which represents two-thirds of the domestic economy, fell to its lowest level in nearly two years. Of concern, the New Order sub-component of the ISM Manufacturing index registered a reading of 50, which is the tipping point between expansion and contraction. That is the lowest level since December 2015.

In contrast, on the demand side of the economy the negative impacts of tariff s are a bit more difficult to discern. While the University of Michigan Consumer Sentiment index (Survey of Consumers© The University of Michigan, 2019) trended down during the quarter, it remains elevated. Consumers remain on solid ground as employment gains, while softening, remain at healthy levels overall. The quarterly average monthly employment gain of 170,000 during the second quarter of 2019, down from 180,000 during the first quarter and 233,000 in the fourth quarter of 2018, is indicative of slowing growth but wage gains and average hours worked remain generally steady. It should be noted that the final round of proposed US tariff s on Chinese goods, which would have finally directly affected consumer products imports, have been postponed for the time being. Future implementation would have a material impact on our outlook for consumer spending.

Q2 2019 Review

The markets continue to favor larger cap growth stocks over smaller cap names and like last quarter, growth stocks are still trumping value names across all capitalizations. Technology, Consumer Discretionary and Financial Services stocks were strong, while Energy names faltered as oil prices declined. Notable this quarter, the Russell indices rebalanced at the end of June and in the Russell 1000 Growth Index, the Technology weight is now 37%, which is the highest level since the Technology bubble in the early 2000’s.

Large/Mid Growth fell short of the Russell 1000 Growth Index by 0.80%, returning +3.8% versus the benchmark +4.6%. Sector allocation was mildly negative; the primary detraction from performance was stock picks in the Consumer Discretionary sector. Lowe’s (3.4%) 1 and O’Reilly Automotive (2.0%) fell 5-7%, while the benchmark sector was up 6.6%. Our best selection came within Health Care – here Sarepta Therapeutics (0.9%) rose +27%, animal-health company Zoetis (2.3%) was up +13% and Insulet (0.7%) gained +25%.

Contributors

CDW Corp. (2.9%; +15.5%)is a technology solutions provider and reseller of equipment, operating through segments that serve corporate, small business, and public customers. The stock has performed well as the company continues to produce revenue gains greater than that of the underlying U.S. IT spend rates. This has allowed the company to consistently deliver mid to high-single-digit annual revenue growth and double-digit EPS growth. Management has aligned with faster growing emerging products/solutions, like cloud and SaaS (software as a service), and margin expansion has been driven by a higher mix of solutions sales.

Rapid7 Inc. (2.6%; +14.2%) has gained 85% this year as the company’s cloud SAAS security offerings continue to be in high demand. Enterprise customers continue to invest in Rapid7’s core market, Vulnerability Management. Rapid7 has one of the strongest software solutions to provide automated protection against intrusion for these corporate clients.

Detractors

Palo Alto Networks (1.5%; -16.0%) provides network security solutions to enterprises, services providers, and government entities. While the company beat expectations for revenue and earnings in the quarter, a miss on billings weighed on the stock. The billings miss was due to a shortening of a contract duration as well as fewer multi-year deals. This also resulted in a modest downward revision of EPS estimates for the upcoming quarter. We continue to believe that this will be a good longterm investment; network security is one of the most strategic, resilient, and rapidly growing areas of technology.

Lowe’s Companies (3.2%; -7.4%) is a big-box retailer of home-improvement products. The company had a messy quarter to say the least: a 9% EPS shortfall, gross margins down 160 basis points, inventories up 14%, and a 9% annual EPS guidance cut. Management cited cost pressures, merchandising organization transitions, and deficient pricing tools. The only positive in the quarter was a sales comparison of +4.2% in the U.S., ahead of Home Depot’s +3.0%. While we knew the company was in the midst of a turn-around, this is a setback, and we will be closely monitoring its upcoming results.

Market Outlook

In the second quarter, most of the “themes” in the market continued to play out in a directionally similar manner to Q1. Both sides of the US/China tariff stand-off alternated between taking a hard stance and indicating that they thought a deal can get done. At the G20 meeting on the last weekend of the quarter, Trump and Xi agreed to delay pending tariff increases while negotiations continue. Many believe that it is optimistic to think that a deal will get done well before year-end. The economic softness referred to in the “macro” section above has caused bond yields to take another leg down. The 10- year Treasury yield that dipped down to about 2.4% at the end of Q1 went slightly below 2.0% in the 2nd quarter and fi nished at 2.0% on 6/30/19. The members of the Fed, for their part, had already indicated that they would be on hold for some time (sparking last quarter’s rally), but then in the June press conference they went further and hinted at a possible rate cut. Chairman Powell said, “we will act as needed, including promptly if that’s appropriate.” Market bulls think this return to a “Fed-put” scenario will keep at least a floor on the markets and that an eventual China deal will provide additional upside. But with the market near recent highs and valuations above historical averages, arguably at least some of the positives are already discounted.

Portfolio positioning results primarily from bottom-up selection decisions but includes a small influence from our top-down economic outlook and sector prospects. We continue to find compelling investment opportunities within the large cap growth space and remain focused on generating alpha and producing the strongest investment results we can for you over the long run. We thank you for your continuing support and investment.

Please feel free to call or email us with any feedback or questions about the portfolio.

The securities identified and described do not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in the securities identified was or will be profitable. The Index returns are provided to show an example of alternate return potential during the relevant time periods; however, indices may possess different investment attributes that may make comparisons difficult such as volatility, liquidity, market capitalization, and security types. The statistical data regarding the indices has been obtained from Bloomberg and the returns are calculated assuming all dividends are reinvested. The indices are not subject to any of the fees or expenses to which the portfolios are subject. This report assumes the reader has sophisticated knowledge of investing and the markets. If you require more information about the information presented, including the portfolio characteristics and risk statistics, please contact us.

Manager views expressed herein were current as of the date indicated above and are subject to change. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this commentary. A copy of the calculation methodology and the full list of recommendations made in the preceding year is available upon request. The performance data quoted represents past performance and does not guarantee future results. Performance returns quoted are gross of fees which were calculated on a time weighted basis and do not give effect to investment advisory fees, which would reduce such returns. Please see Chartwell’s Form ADV, Part II for a complete description of investment advisory fees. The following statement demonstrates the compound effect advisory fees have on investment returns: For example, if a portfolio’s annual rate of return is 15% for 5 years and the annual advisory fee for a client is 100 basis points or 1.00%, the gross cumulative 5 year return would be 101.1% and the five year return net of fees would be 92.5%. Actual fees charged to portfolios may be different due to various conditions including account size, calculation method and frequency, and the presence of a performance or incentive fee. The deduction of performance and incentive based fees will have similar, yet often larger, impacts to performance and account values than standard management fees. To receive a complete list and description of Chartwell Investment Partners’ composites, performance attribution for all securities, and/or a presentation that adheres to the GIPS® standards, please contact Lynette Treible by phone (610)407-4870, email treible@chartwellip.com, or by mail to 1205 Westlakes Drive, Suite 100, Berwyn, PA 19312.

30 Jul 2019
Reading Time: 3 minutes

 

Market Commentary:

Looking back, the markets remained volatile during the quarter, after one of the strongest starts to the year, as investor sentiment oscillated with each passing headline. Growth concerns were temporarily placated with the initial U.S. GDP estimate exceeding forecasts at 3.2 percent for the first quarter of 2019, though that marked the high point for expectations. Corporations reported better than expected earnings, with management teams expressing caution regarding implications from moderating growth and disruptions from the trade dispute. Optimism around a potential trade deal was crushed as negotiations collapsed, with little progress made during the quarter. Hope rested on the G-20 meeting that happened over the last weekend in June, which produced some progress towards a resolution. These headwinds culminated in pressures on interest rates as investors moved into safe-haven assets, which sent the yield on the 10-year treasury to multi-year lows below 2 percent. Inflation has remained relatively tame, further bolstering confidence in the Federal Reserve’s pivot towards easier monetary policy and the likelihood of meaningful cuts to their benchmark rate during 2019.

Looking forward to the second half of 2019, positive corporate earnings growth still remains the most likely outcome for the full year. However, growth for earnings is increasingly dependent on an acceleration into the end of the year, as the upcoming quarterly estimate has fallen and is now flat with the prior year’s earnings. Tight labor markets and a rebound in housing from lower interest rates has continued to underpin the strength in the U.S. consumer despite the market concerns. Investors are likely to be focused on company outlooks for the remainder of the year as these issues begin to show a greater impact on their earnings and cashflows. As the economic cycle continues to progress later and later, the preference for high-quality, cash-generative businesses is likely to increase as markets become increasingly concerned for those companies with more challenged models where leverage is high, or cash generation is lower. These differences, we believe, will cause further dispersion in returns between securities, while avoiding those most exposed to a key driver of investor returns. We remain vigilant in assessing absolute risk in the securities we invest in and striving to protect client capital during these times for potential volatility from the uncertainty.

Timothy Plan Small Cap Value Fund Q2 2019 Commentary

Index Drivers:

During the first quarter, the Russell 2000 Index saw all sectors post positive returns, with Information Technology and Energy gaining the most and Consumer Staples and Financials the least.

Performance Drivers:

The portfolio’s relative performance benefitted from favorable stock selection in Materials and Utilities. ProPetro posted a strong quarter as their relationships in the shale basins, particularly the Permian, helped offset broader industry pressures. Installed Building Products gained after allaying fears regarding pricing power in the insulation installation business with tailwinds from improving housing sentiment. Innospec beat earnings handily driven by better sales and margins in their fuel specialties and oil field segments. Novanta rallied on solid organic growth and better margins as their focus on higher-growth end markets that began several years ago continues to pay dividends. Omnicell beat expectations as issues with a product transition appear to be fully resolved and execution remains good.

The portfolio’s relative performance was negatively impacted by unfavorable stock selection in Financials and an underweight to Information Technology. Penn Virginia declined after their plan to merge with another energy producer was abandoned. Columbia Banking System moved lower after missing expectations as slowing loan growth combined with higher expenses pressured their earnings. Gentherm suffered from weaker automobile volumes, leading to lower near-term guidance but management maintained their long-term guidance. Lattice Semiconductor, a recent purchase, moved modestly lower in sympathy with the market. Continental Building Products posted solid results but saw investor concerns over potential weakening in wallboard prices send shares lower as the quarter came to a close.

Past performance is not indicative of future results. Portfolio returns reflect the reinvestment of dividend and interest income. All information provided is for informational purposes only and is not intended to be, and should not be interpreted as, an offer, solicitation, or recommendation to buy or sell or otherwise invest in any of the securities/sectors/countries that may be mentioned. A description of the methodology used to calculate the attribution analysis or a complete list of each holding’s contribution to overall performance during the measurement period may be obtained by contacting info@westwoodgroup.com. Benchmark Data Source:  © 2019 FactSet Research Systems Inc. All Rights Reserved. Russell Investment Group is the owner of the trademarks, service marks, and copyrights related to its indexes, which have been licensed for use by Westwood.

16 Jul 2019
Reading Time: 8 minutes

Brandes Investment Partners Emerging Markets Equity Strategy Notes Second Quarter 2019 (April 1 – June 30, 2019)

The Timothy Plan Mutual Fund Emerging Markets returned 5.7% (gross of fees), outperforming its benchmark, the MSCI Emerging Markets Index, which increased 0.6% in the second quarter.

Positive Contributors

All of the strategy’s holdings in Russia performed well, led by food retailer X5 Retail Group and Sberbank.

X5’s shares rose on margin improvement, helped by continued food inflation in Russia. We have trimmed our position following the strong performance, maintaining a measured allocation.

Much like its peers in Russia, Argentina-based oil and gas company YPF saw its shares advance despite political risks and tightening financial conditions in Argentina.

Holdings in Brazil also lifted performance. Higher education services provider Estacio Participacoes saw enrollment increase over 12%. The company’s distance-learning segment grew over 25%, while enrollment for in-person courses remained stable even as tuition prices for that segment climbed nearly 4%. Another notable contributor among our Brazilian holdings was health care services provider Hapvida Participacoes e Investimentos. The market responded positively to Hapvida’s agreement to buy a local competitor, Grupo Sao Francisco, in a bid to expand in Sao Paulo.

Other contributors included South Korean autos Kia Motors and Hyundai Mobis.. Additionally, our underweight to China helped relative performance.

Performance Detractors

The Chinese equity market struggled amid heightened tension and complexity surrounding the U.S.-China trade dispute. While our underweight to the country aided relative returns, our holdings there weighed on absolute performance. One notable detractor was information technology services firm Chinasoft International.

Other poor performers included Turkish real estate investment trust (REIT) Emlak Konut and Mexican cement company Cemex.

Emlak’s shares fell due to disappointing 2019 results to date, specifically with regard to unit sales, operating margins and EBITDA (earnings before interest, taxes, depreciation and amortization). We maintain a measured allocation to the company knowing that its stock performance is highly dependent on the macroeconomic situation in Turkey, particularly inflation and homebuyers’ confidence, as well as the health of the construction sector.

Meanwhile, Cemex continued to face a variety of concerns. These include a sharp drop in Mexico’s construction activity this year, fears of a recession in the United States (its biggest market), and a lack of confidence in management’s capital allocation prowess. We believe these issues have been more than accounted for in Cemex’s current share price. Trading at less than 70% of book value and 9x forward earnings at quarter end, the company represents what we see as an attractive value opportunity.

Select Activity in the Quarter

The Emerging Markets Investment Committee initiated a new position in made-to-order chipmaker Taiwan Semiconductor Manufacturing Company (TSMC).

TSMC is the world’s dominant semiconductor foundry, controlling approximately 54% of this secularly growing end market.

Unlike integrated device manufacturers such as Intel and Samsung, which design, manufacture and sell semiconductors, pure-play foundries such as TSMC focus solely on manufacturing semiconductor products for their customers. With Intel’s foundry efforts struggling and GlobalFoundries (second-largest pure-play foundry after TMSC, with approximately 9%

market share) ceasing its production of leading-edge semiconductors, TSMC and Samsung will likely be the only two foundries capable of supplying leading-edge technologies.

TSMC’s smartphone segment, with clients such as Apple and Huawei, has consistently accounted for a significant portion of the firm’s revenue (over 50%) and largely driven its revenue growth over the past seven years. As the smartphone market slows down, however, management expects future revenue growth to increasingly come from its high-performance computing (HPC) business, where the development of its leading-edge technologies resides. As of 2018, HPC represented 30% of TSMC’s revenue.

While we believe TSMC is well positioned to achieve its growth objective in the HPC business, weaker demand in the smartphone market and intensifying competition in other non-leading edge segments present headwinds. Nonetheless, even after considering these challenges, our analysis shows that TSMC offers upside potential. In our view, the company is one of the most attractively valued and sustainable franchises in the global semiconductor industry, and should continue to generate appealing returns on capital and free cash flow going forward.

Year-to-Date 2019

The Timothy Plan Mutual Fund Emerging Markets returned 14.5%, outperforming the MSCI Emerging Markets Index, which gained 10.6% for the six months ended June 30, 2019.

As was the case for the second quarter, strong performance was driven by holdings in Russia, Brazil and South Korea (specifically auto companies). From an industry standpoint, holdings in oil and gas helped returns significantly. Other notable contributors included Indonesian telecom XL Axiata, Panamanian bank Banco Latinoamericano de Exportaciones y Importaciones (BLADEX) and our Mexican REIT holdings.

Our underweight to China was a leading detractor to relative returns. At the company level, Brazil-based regional jet manufacturer Embraer, Cemex, Emlak Konut, Nishat Mills and Indian electric utility Reliance Infrastructure hurt performance.

Current Positioning

Continuing the trend from the first quarter, we trimmed a number of our positions in Russia given their strong performance and ended the quarter with an approximately 8% allocation.

As of June 30, we held our largest country weights to Brazil and South Korea, while remaining materially underweight to Taiwan and China, even with the recent additions of TSMC and PetroChina. On a sector basis, our largest overweights were to real estate, consumer discretionary and communication services companies. The financial sector continued to represent a significant underweight position, due to our lower exposure to banks in China, Brazil and India. Additionally, we maintained a lower allocation to information technology than the benchmark.

Amid the constant stream of macroeconomic and geopolitical news, it is important to remember that volatility is not unusual in emerging markets investing and has often created attractive yet overlooked opportunities. We believe our investments in Russia are good examples of such opportunities. Only a few years ago, market participants seemed to view investing in Russia as a binary decision, with no regard for individual company merits or valuations. Over the past 18 months, however, shifting investor sentiment, combined with material free-cash-flow generation and strong returns on invested capital, has driven up the share prices of many of our holdings there and led us to trim our allocation.

Moreover, with the diversity of emerging market companies and their varying fundamental strengths, simply “being there” may not be the best way to access opportunities within the asset class. Rather, we believe investors can be best served by applying a selective approach that an actively managed strategy such as the Brandes Emerging Markets Equity offers.

Thank you for your continued trust.

Book Value: Assets minus liabilities. Also known as shareholders’ equity.

Forward Earnings: Sell-side analysts’ consensus earnings estimates for the next fiscal year.

Forward Price/Earnings: Price per share divided by earnings per share expected over the next 12 months.

Free Cash Flow: Total cash flow from operations less capital expenditures.

Price/Book: Price per share divided by book value per share.

Return on Capital/Return on Invested Capital: Net income minus dividends divided by total capital; used to assess a company’s efficiency at allocating the capital under its control to profitable investments.

The MSCI Emerging Markets Index with net dividends captures large and mid cap representation of emerging market countries. Data prior to 2001 is gross dividend and linked to the net dividend returns.

MSCI has not approved, reviewed or produced this report, makes no express or implied warranties or representations and is not liable whatsoever for any data in the report. You may not redistribute the MSCI data or use it as a basis for other indices or investment products.

The foregoing Quarterly Commentary reflects the thoughts and opinions of Brandes Investment Partners® exclusively and is subject to change without notice. The information provided in the commentary should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any security transactions, holdings or sectors discussed were or will be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance discussed herein. International and emerging markets investing is subject to certain risks such as currency fluctuation and social and political changes; such risks may result in greater share price volatility. There is no assurance that any securities discussed herein will remain in an account’s portfolio at the time you receive this report or that the securities sold have not been repurchased. The actual characteristics with respect to any particular account will vary based on a number of factors including but not limited to: (i) the size of the account; (ii) investment restrictions applicable to the account, if any; and (iii) market exigencies at the time of investment. Unlike bonds issued or guaranteed by the U.S. government or its agencies, stocks and other bonds are not backed by the full faith and credit of the United States. Stock and bond prices will experience market fluctuations. Please note that the value of government securities and bonds in general have an inverse relationship to interest rates. Bonds carry the risk of default, or the risk that an issuer will be unable to make income or principal payment. There is no assurance that private guarantors or insurers will meet their obligations. The credit quality of the investments in the portfolio is not a guarantee of the safety or stability of the portfolio. Investments in Asset Backed and Mortgage Backed Securities include additional risks that investors should be aware of such as credit risk, prepayment risk, possible illiquidity and default, as well as increased susceptibility to adverse economic developments. Securities of small companies generally experience more volatility than mid and large sized companies. Although the statements of fact and data in this report have been obtained from, and are based upon, sources that are believed to be reliable, we cannot guarantee their accuracy, and any such information may be incomplete or condensed. Strategies discussed are subject to change at any time by the investment manager in its discretion due to market conditions or opportunities. The Brandes investment approach tends to result in portfolios that are materially different than their benchmarks with regard to characteristics such as risk, volatility, diversification, and concentration. Please note that all indices are unmanaged and are not available for direct investment. Past performance is not a guarantee of future results. No investment strategy can assure a profit or protect against loss. Market conditions may impact performance. The performance results presented were achieved in particular market conditions which may not be repeated. Moreover, the current market volatility and uncertain regulatory environment may have a negative impact on future performance. The margin of safety for any security is defined as the discount of its market price to what the firm believes is the intrinsic value of that security. The declaration and payment of shareholder dividends are solely at the discretion of the issuer and are subject to change at any time.

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Ireland/Europe: FOR PROFESSIONAL INVESTOR USE ONLY. Issued by Brandes Investment Partners (Europe) Limited (Brandes Europe), 36 Lower Baggot Street, Dublin 2, Ireland. Registered in Ireland Number 510203. Authorised and regulated by the Central Bank of Ireland. This report is being provided for information purposes only, no representation or warranty is made, whether express or implied as to the accuracy or completeness of the information provided. To the fullest extent permitted by law Brandes Europe shall not be liable for any loss or damage suffered by any person as a result of the receipt of this report. Recipients of this report should obtain their own professional advice. The distribution of this report may be restricted by law. No action has been or will be taken by Brandes Europe to permit the possession or distribution of this report in any jurisdiction where action for that purpose may be required. Accordingly, this report may not be used in any jurisdiction except under circumstances that will result in compliance with any applicable laws and regulations. Persons to whom this report is communicated should inform themselves about and observe any such restrictions. This information is being issued only to, and/or is directed only at (i) persons who have professional experience in matters relating to investments or (ii) are persons falling within Article 49(2)(a) to (d) (“high net worth companies, unincorporated associations etc”) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 or to whom it may otherwise lawfully be communicated (all such persons together being referred to as “Relevant Persons”). This communication must not be acted on or relied on by persons who are not Relevant Persons. Any investment or investment activity to which this communication relates is available only to Relevant Persons and will be engaged in only with Relevant Persons. This report is a confidential communication to, and solely for the use of, the persons to whom it is distributed to by Brandes Europe.

8 May 2019
Reading Time: 3 minutes

Market Backdrop

Global equity markets rebounded strongly for the quarter after a major selloff in Q4 2018. While economic and earnings downgrades continued during Q1, equity markets appeared to be focused on a rebound in activity into the second half of the year. Weak first quarter data appeared to have been priced in the selloff of 2018 while an about face from the world’s two most important central banks provided a stimulus shot to the market. The Federal Reserve and the European Central Bank both retreated from signs of rising rates this year and both went a long way to fight over who was more dovish coming into the second quarter and second half of the year.

With the possibility of the start of green shoots with some data items in Europe and better China economic data arising, markets continue to need confirmation of improving conditions to maintain its current rally. Another set of possible good news could be in the U.S.-China trade negotiations as negotiators from both countries appear to be getting closer to a deal that would remove a major uncertainty for businesses. Commodities rose with oil prices following slower production in OPEC, Venezuela, and Iran and iron ore prices moving sharply higher on supply cuts in Brazil and Australia.

While the New York Federal Reserve’s recession indicator hit a 25% chance of a recession in the U.S., the highest level since the Global Financial Crisis, markets focused on the prospects of looser monetary conditions providing equity markets a boost. The dovish talk from central banks led to a sharp decline in bond yields with the German 10-year bond retreating below zero percent for the first time since 2016 and the U.S. 10-year bond plummeting below 2.5% for the first time since early 2018. The decline in the long bond and lack of a similar move in the front end of the yield curve led to an inverted yield curve at the 3m-10y level which spooked the market. A San Francisco Federal Reserve study from last year indicates an inversion at the 3m-10Y level is the best indicator of a recession one to two years out while other studies suggest the yield curve must remain inverted at least for one quarter for this indicator to work. The markets will be watching this development over the coming months. The lower yields pushed financial sector stocks down, in particular bank stocks, as lower yields and a flatter yield curve makes it much harder for them to earn reasonable rates of returns.

Large caps slightly underperformed small and mid-caps for the quarter while Growth outperformed Value for the quarter.  The best performing MSCI EAFE countries for the quarter were New Zealand, Belgium, and Hong Kong while the worst performing MSCI EAFE countries were Singapore, Japan, and Germany. The best performing emerging markets for the quarter were Colombia, China, and Egypt while the worst were Qatar, Turkey, and Poland.

Performance and Attribution

The Timothy Plan International Fund is off to a good start in 2019 as it outperformed the MSCI EAFE index for the quarter.  International equities bounced back after a rough finish to 2018 with the Fund increasing double digits for the quarter led by positive stock selection.  Stocks in the Industrials and Communications Services sectors performed best for the quarter while an overweight to the Technology sector helped as well.  From a country standpoint, Germany, Japan, and Hong Kong stocks performed best relative to the benchmark while any cash weight in a strong market and a void in Switzerland hurt relative performance.

Outlook

After a strong start to the year, we would not be surprised to see volatility rise in the 2nd half of the year as expectations have risen.  Investors have shunned European markets to start the year and are very underweight that region and we would expect a strong bounce in those markets if economic activity begins to stabilize and improve there as it appears to be doing so.  We have slightly reduced China exposure in the portfolio after a strong run in the 1st quarter as the rhetoric of US-China trade relations is likely to keep this topic in investor’s minds for some time to come.  The ECB and BoJ remain very supportive of their respective economies for the remainder of this year providing a tailwind for equity markets.

8 May 2019
Reading Time: 3 minutes

Market Backdrop

Economic activity in Israel remains on a solid footing while the Bank of Israel (BoI) continues to support the economy with fairly dovish policy.  The Composite State of the Economy Index rose in March 2019 at a similar pace of the previous 12 months as the economy continued to perform well, supporting continued corporate earnings expansion.  The BoI’s research department forecasts GDP growth of 3.2% in 2019 and 3.5% in 2020 as a result of continued solid corporate investment.  One example of the attractiveness of investment in Israel is Intel’s announcement in January that it was planning to expand its manufacturing capacity in Israel and invest over US$11bn, creating thousands of jobs in the country.  The Bank of Israel expects inflation to remain slightly above the lower band of its expectations above 1% over the coming year, clearing a path to very gradual interest rate increase.  The Monetary Committee of the BoI stated in its latest decision to keep interest rates unchanged at 0.25% that it “…assesses that the rising path of the interest rate in the future will be gradual and cautious…”.  This accommodative stance from the BoI will continue to be supportive to Israeli equity markets.

Prime minister Benjamin Netanyahu appears to have cemented his reputation as a political survivor after the April national elections showed his Likud party in the driver’s seat to form a new coalition government.  President Reuven Rivlin has tasked the Likud party days to form the new government, likely to be made up of Likud and ultra-Orthodox and right leaning parties after Netanyahu’s Likud party and his coalition members won a majority of the Knesset seats in this election.  This, in spite of the likely outcome of the prime minister to be indicted on charges of corruption later this year. A new centrist party, Blue and White, could remain a formidable challenger to the ruling coalition in the future.

Performance and Attribution

Economic activity in Israel remains on a solid footing while the Bank of Israel (BoI) continues to support the economy with fairly dovish policy.  The Composite State of the Economy Index rose in March 2019 at a similar pace of the previous 12 months as the economy continued to perform well, supporting continued corporate earnings expansion.  The BoI’s research department forecasts GDP growth of 3.2% in 2019 and 3.5% in 2020 as a result of continued solid corporate investment.  One example of the attractiveness of investment in Israel is Intel’s announcement in January that it was planning to expand its manufacturing capacity in Israel and invest over US$11bn, creating thousands of jobs in the country.  The Bank of Israel expects inflation to remain slightly above the lower band of its expectations above 1% over the coming year, clearing a path to very gradual interest rate increase.  The Monetary Committee of the BoI stated in its latest decision to keep interest rates unchanged at 0.25% that it “…assesses that the rising path of the interest rate in the future will be gradual and cautious…”.  This accommodative stance from the BoI will continue to be supportive to Israeli equity markets.

Prime minister Benjamin Netanyahu appears to have cemented his reputation as a political survivor after the April national elections showed his Likud party in the driver’s seat to form a new coalition government.  President Reuven Rivlin has tasked the Likud party days to form the new government, likely to be made up of Likud and ultra-Orthodox and right leaning parties after Netanyahu’s Likud party and his coalition members won a majority of the Knesset seats in this election.  This, in spite of the likely outcome of the prime minister to be indicted on charges of corruption later this year. A new centrist party, Blue and White, could remain a formidable challenger to the ruling coalition in the future.

Outlook

The strong economy continues to support robust corporate earnings growth.  While the recent election, fighting in Gaza, and the upcoming likely indictment of prime minister Netanyahu lead to potential distractions that could lead to added volatility for equity markets. We remain constructive Israeli equities over the long term as the innovation of Israel corporates and the strong economic growth in the country supports equity prices.

1 May 2019
Reading Time: 5 minutes

Macquarie Investment Management

US REIT • Client commentary • March 31, 2019

MARKET REVIEW

US equity markets bounced back from the dismal fourth quarter of 2018 — featuring the weakest December since 1931 — with the S&P 500® Index’s strongest first quarter since 1998. Global markets also were up, though not as much. In fact, risk assets around the globe, including bonds and commodities, were all strong in the first quarter of 2019.

The driving force behind the turnaround was the US Federal Reserve’s decision to forgo further rate hikes in 2019. In December, after raising rates for the fourth time in 2018, the Fed had stated it planned three additional hikes in 2019. Shortly before the first quarter closed, however, it backed off, saying there would be no further hikes in 2019. Additionally, the Fed said it would end its balance sheet reductions by September.

Although the decision was positive for global risk assets, it left investors to ponder just how data-dependent the central bank’s decision-making is, given that credit markets and macroeconomic indicators had been slowing throughout 2018. The Fed’s pivot was unprecedented, and many investors are now questioning the central bank’s mandate.

Nonetheless, the real estate investment trust (REIT) market clearly benefited from this course change, with the FTSE Nareit Equity REITs Index recording a 16.33% total return for the first quarter, which was higher than its cumulative return for 2016- 2018. Although fundamentals did not drastically change for the overall REIT group in the first quarter, the credit and interest rate environment improved, driving returns higher.

That raises the question: Do REITs only perform well in a declining rate environment? The answer is both yes and no. Economically sensitive sectors (apartments and industrial, for example) and stable sectors (like manufactured housing) can do well in rising markets while long-duration sectors (such as healthcare and shopping centers) may experience greater headwinds.

Data: Bloomberg.

Within the strategy

For the first quarter of 2019, the US REIT strategy (the “Strategy”) underperformed its benchmark, the FTSE Nareit Equity REITs Index.

Technology stock selection was positive as the Strategy’s weighting in cell towers outperformed. Cell towers generally have stable cash flow and are a basic oligopoly with only three major players. The Strategy owns one of them: American Tower Corp., up more than 20% for the first quarter. The company has predictable cash flow from long leases and low capital expenditures (capex) and stands to benefit as the industry transitions to 5G technology. The Strategy is underweight data centers, with Equinix Inc. as its only holding. Equinix serves the retail market and has a repeatable interconnection business that we believe is more attractive than the wholesale and hyperscale businesses of Digital Realty Trust Inc. and Cyrus One Inc. The Strategy has taken some profits in American Tower as it has become expensive, but we continue to hold Equinix.

The Strategy’s performance in the self-storage sector benefited from an underweight relative to the benchmark. The group is struggling with slowing street rates (leading to slowing rent growth) and rising expenses. Supply of self-storage facilities has risen four times over the past three years. Construction levels are at all-time highs and may peak this year. However, given that it typically takes 45 months to fully lease a new facility, the negative effect of oversupply could linger into 2020. The positive, in our view, is that this business requires low capex. Once rate deceleration stabilizes, net-operating-income (NOI) growth may improve. In addition, because expenses are higher this year due to real estate taxes, we may see better year-over-year comparisons next year. However, until we see signs of stabilization, we intend to maintain the Strategy’s underweight.

The Strategy outperformed in the specialty sector primarily due to strong stock selection, specifically Invitation Homes Inc. and EPR Properties. Both stocks rose more than 20% during the quarter. Invitation Homes benefited from the strong desire for home rentals, and we believe this should continue to drive strong internal growth. EPR Properties benefited from its exposure to long duration leases. As the bond market rallied, investors sought secure and growing income. We remain confident in these two stocks, as we feel stable income growth should be rewarded in the current market.

As was the case at the end of 2018, the Strategy’s underperformance in the first quarter was predominantly due to issues in the healthcare sector. Shares of Brookdale Senior Living Inc., the main detractor, declined for the quarter. Although the company gave guidance below analysts’ expectations, Brookdale Senior Living announced that senior housing fundamentals would bottom in the fourth quarter. We continue to believe in the company’s value proposition. The company has been an arduous holding for the Strategy, but we think 2019 will mark an inflection point. First, its real estate is undervalued by half. Second, the company has an ancillary business to which the market has assigned no value, but which we think is worth $250 million to $300 million. Given that the company’s market cap is only $1.2 billion, the market is assigning a value of just $900 million to Brookdale’s senior housing assets, grossly undervaluing the company, in our view. Yet there is a frenzy for senior housing assets as buyers expect that over the next five years, there could be strong upside from a demographic tailwind.

In the lodging sector, stock selection and an underweight allocation resulted in underperformance. The Strategy’s lack of exposure to Park Hotels & Resorts Inc., Gaming and Leisure Properties Inc., and Ryman Hospitality Properties Inc. hurt performance. We believe that although hotels have rallied with the market, from here on they will likely show minimal growth as valuations are stretched.

The diversified sector detracted from performance, as the Strategy’s lone holding in the sector, Vornado Realty Trust, rallied but lagged the broader market. The company owns a large amount of office and retail assets around Penn Station in New York City. The company’s current plans to redevelop the assets have caused near-term pressure on the stock; however, we believe the longer-term value creation will be substantial. We continue to like the Strategy’s exposure to the name.

Outlook

Since 2018’s fourth-quarter selloff, REITs have rallied strongly. With the Fed ruling out additional rate hikes this year, REITs now have the wind at their back. That may not last, however, if the market should sense that conditions are improving and that rates could rise in China, Europe, or the United States.

So far, the declining earnings growth rate for the S&P 500 Index has helped REIT shares. However, with REITs trading at a discount of just 1% to NAV and an adjusted funds from operations (AFFO) multiple of 21x, they are clearly more expensive now than they were at the end of 2018.

Given this backdrop and current valuations, we believe we are beyond the point of an “everything rally” due to the Fed’s pivot. As we await first-quarter earnings, and given the strong rally that has already taken place, the bar is now higher for companies to justify their valuations. We continue to overweight manufactured housing, apartments, and freestanding while underweighting malls, shopping centers, and data centers.

One technical aspect worth discussing is fund flows. The REIT industry is entering its fifth year of negative fund flows. This has occurred for several reasons. First, investors fled yield and gravitated toward growth when the Fed raised rates in 2017 and 2018. Second, after nearly an eight-year recovery, REITs have achieved full occupancies as rent growth has slowed in many sectors. Lastly, some of the outflow resulted from Japanese funds that were created by US REIT managers to enable retail investors in Japan to buy US REITs. The Japanese funds initially attracted $61 billion by promising yields of 25% to 30%. When the Japanese watchdog equivalent of the US Securities and Exchange Commission blew the whistle on this irresponsible promise, investors fled the funds, leaving just $30 billion. REIT investors bore the brunt of this bad behavior. Our firm never participated in this practice. We believe that an investment in our Strategy has the potential to provide a sustainable and stable dividend and steady cash flow growth. We seek to achieve 9% to 11% growth over the long term.