CRM 3Q14 Market Commentary

Third Quarter 2014 Newsletter
Cramer Rosenthal McGlynn, LLC is a leading value-oriented
investment firm with approximately $11 billion in assets under
management. Since our firm was founded in 1973, our client
list has grown to include corporate and public pension plans,
endowments and foundations, hospitals, community and
religious organizations, Taft-Hartley and multi-employer funds
as well as individual and family trusts. Companies we buy and
hold are characterized by three attributes: change, neglect
and valuation. The hunt for these attributes provides a solid
foundation for every stage of our investment process.
Cramer Rosenthal McGlynn, LLC
520 Madison Avenue, 20th Floor
New York, NY 10022
T 212.326.5325
[email protected]
www.crmllc.com
Current News
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com, the site has an entirely new look and feel. Upgrades
include easier navigation with an integrated and intuitive flow as
well as the availability of more robust information for our clients
and consultants. We believe these changes will provide you
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Contents
Third Quarter 2014 Newsletter
Market Commentary
Current News
In describing the investment landscape, the word “divergence”
best characterizes the environment both year-to-date and in the
third quarter. In spite of generally favorable economic data,
including a positive revision to 1Q GDP and a 4.6% 2Q GDP,
bonds, and stocks which act like bonds, continue to provide
strong returns in excess of all domestic market indices. At a
time when economically sensitive stocks should be doing well,
industrial stocks were the worst performing group. How can
(Continued on page 2)
Page 1
Market Commentary
1
All Cap Value
4
Large Cap Opportunity
6
Mid Cap Value
8
Small/Mid Cap Value
10
Small Cap Value
12
Investment Philosophy & Process
14
Important Disclosures
16
PRODUCT SUMMARY
18
1
Assets Under Management
As of September 30, 2014 (In Millions)
Small Cap
Value
$1,151
Alternatives,
Other
$411
Global Opportunity,
International Opportunity
$23
All Cap Value
$1,540
Large Cap
Opportunity
$933
Small/Mid
Cap Value
$2,880
Mid Cap Value
$3,300
Assets Under Management (In Millions)
Total Assets ..................................$10,515
Representative Clients
Archer Daniels Midland Company
Arizona State Retirement System
Baptist Healthcare System
City of Phoenix Employees’ Retirement System
Cedars-Sinai Medical Center
Entergy Corporation
Indiana University
International Paper
Highmark, Inc.
Manchester Capital Management, LLC
Mississippi State University
Teachers’ Retirement System of the City of New York
United States Holocaust Memorial Museum
University of Cincinnati
CRM selected the clients listed above based on a variety of
objective criteria including the size of the account, type of
account, management style and geographic location of the client. CRM does not know whether the listed clients approve or
disapprove of CRM or the advisory services provided by CRM.
2
labor and employment statistics and auto sales be so robust, yet
cyclical stocks do so poorly? The dollar has logically strengthened
as the U.S. concludes QE3 and approaches a tightening cycle
while our developed market trading partners are mired in sluggish
growth with a need for more accommodative monetary policy.
Stronger growth accompanied by a stronger dollar would typically
be a good backdrop for smaller cap stocks. And yet, the Russell
2000 is down and trailing the Russell 1000 by over 1200 basis
points year-to-date. Most commodity prices have declined this
year (oil -12%; corn -23%; cotton -28%) providing a de facto tax
cut, and yet, consumer discretionary stocks have struggled (for
example, XRT, the SPDR S&P Retail ETF is down -2.2% year-todate).
What’s going on? The simple answer is to cite the divergence
between economic prospects in the U.S. and those of our trading
partners both in developed and emerging countries. In our view,
the most significant reversal of fortune has taken place in Europe.
After enduring a long aftermath to the Great Recession, the tone
of business in Europe began to improve in the second half of
2013. What began as comments of “it’s getting less worse” soon
became “it’s slowly improving.” As we entered 2014, there was
actually some optimism being expressed by many multinational
companies. The Russian annexation of Crimea and its support
for rebels in the Ukraine reversed this sentiment.
Optimism
has been replaced with concern and the pace of business has
deteriorated. Companies have used adjectives such as “drastic”
and “dramatic” in describing the fall-off in transactions, particularly
in Eastern Europe. The sanctions, while intended to influence
Putin, have had a “boomerang” effect on Europe which had come
to rely on Russia as an important trading partner. Uncertainty
often bruises confidence and deteriorating confidence can make
the difference between a sluggish recovery and a deflationary
recession. This deterioration in European economic prospects has
led to a remarkable rally in the bond markets of both the core and
peripheral EU members. To think that France, Italy, and Spain can
all issue ten year bonds at yields lower than the U.S. is astounding.
Notwithstanding diverging economic prospects, demographics,
energy security, and political stability, the interest rates in the
EU have had a dampening effect on U.S. Treasury rates which,
reflexively, has brought into doubt the sustainability of the U.S.
economic recovery.
If geopolitical turmoil was limited to just Russia/Ukraine, perhaps it
would not be having such a deleterious impact on global markets.
One can write chapters about Putin’s longer term intentions and
his growing disdain for what he perceives as the United States’
aggressive proselytizing on democratic values, particularly in and
among the former Soviet Union Republics. However, at this point,
Cramer Rosenthal McGlynn, Third Quarter 2014 Newsletter
his actions have gotten the attention of the western allies and the potential consequences of misjudgment
do not nearly approach those of the cold war years. Unfortunately, there are other geopolitical matters which
create a compounding effect on global growth and sentiment. China is trying to balance slower growth and
possible social unrest. China’s economy is opaque, but commodity markets are a very good barometer and
it indicates slowing. The recent events in Hong Kong are unsettling. In the United States, we tend to blend
the notion of free markets and social freedoms/democratic values. China’s leadership has a divergent view
and the result is periodic economic or social dislocation.
Other regions are also diverging. The only BRIC which seems to be experiencing an economic lift is India,
post its most recent election. Other emerging economies are facing slowing growth and higher inflation
which creates its own difficulties in managing the expectations of the populace. Add in the “war” on ISIS
and fear over the Ebola virus - it is a lot for markets to digest.
We have had a view for the past couple of years that the U.S. economy would steadily improve and our
corporations would continue to build upon their financial strength. We and others have written about all
of the tailwinds from the remarkable transformation of our domestic energy industry (the U.S. is projected
to produce nearly 10 million barrels/day next year) to the on-shoring of manufacturing to our technological
leadership. However, we live in a world which is highly interconnected and events of any consequence in
any part of the world can have an outsized influence on markets.
We experienced diverging relative investment returns this quarter. Our small and small/mid cap strategies
outperformed their respective benchmarks while our mid, large, and all cap strategies did not. Much of
this disparity can be explained by the weakness in the smaller cap indices relative to the resiliency of the
countercyclicals in the mid to larger indices. It also reflects our sector positioning which, as noted, favored
more cyclical businesses including a number of industrial companies undergoing substantial transformation.
Many of these companies have exhibited very little historical correlation to each other.
The month of September was harsh on cyclical stocks across consumer, energy, technology, and, especially,
industrials/materials. World events, the strength of the dollar, global macro fears, and the approaching
third quarter earnings season all conspired to cause this underperformance. We are not deterred. We
believe fundamentals and company specific actions (divestitures, acquisitions, spin-offs, stock buybacks,
new management, cost/productivity programs, and new products) provide strong underpinnings for our
holdings. Multiples have compressed quite quickly reflecting fear and they can and should reverse just as
quickly. While a number of companies have or will need to revise their earnings projections to reflect some
slowing in overseas markets as well as currency translation, the multiple compression has, in most cases,
been disproportionate. We will continue to seek opportunities to add to many of these existing holdings in
the coming days and weeks.
We are not “wed” to any particular sector allocation. We follow the change, neglect, and valuation. As
described above, even companies categorized in classic cyclical sectors can have very different businesses
that historically do not closely correlate with one another. Over relatively short periods of time, when fear is in
the air, these relationships do not hold. However, we know from experience, the fundamentals do win out over
time whether through public market recognition or a private equity/strategic buyer transaction. Additionally,
we have witnessed many quick reversals in recent years when global geopolitical fears fade. While it is
difficult for investors to remain patient when markets are sending contrary messages, we think patience is
essential to realizing value in these corporate transformations. Stock and fundamental underperformance
will likely be met by continued activism. We will likewise in our constructivist fashion continue to express
our views to managements and strongly advocate for our investors.
3
Investment Philosophy
& Process
Our track record, spanning over 40 years, is testament to our success in serving clients
and providing strong investment performance. Clients benefit from consistent application
of one cohesive philosophy and process, implemented by a team with diverse experience
in appraising the intrinsic value of companies.
Investment Philosophy
CRM views investment prospects on a long-term basis. Our relative value oriented
investment philosophy seeks to outperform the broad market and pertinent indices over
a full market cycle by participating in good market periods and limiting declines in poor
periods. CRM believes that successful investing is a result of recognizing and responding
to changes that may positively impact the future prospects of a business enterprise.
These changes often lead to a temporary misunderstanding or relative neglect which
reduces the risks of investing at a point in time. As relative value investors, we seek to
invest in companies which are trading at a discount to their own history and peers based
upon prospective free cash flow and earnings. In summary, our investment approach is
predicated on change, neglect and valuation.
Change
CRM seeks to identify change at an early stage that may be material to the future
operations of publicly traded companies. The financial markets are rich with change.
On a regular basis, investors are presented with acquisitions, divestitures, spin offs, cost
restructurings, geographic expansions, management changes, regulatory changes, new
products, joint ventures and capital returns to shareholders. Based on the experience of
our research team, we identify many situations where these changes lead to an attractive
investment thesis either in the company being directly impacted by the observed change
and/or in a broader set of companies which are similarly affected.
Neglect
In its earliest stages, change tends to be greeted with skepticism. The uncertainty resulting
from the change creates a period of relative neglect or lowered expectations as investors
wait for more clarity. We try to evaluate neglect by studying sell side analyst coverage,
institutional ownership, key concepts in behavioral finance such as over and under
reactions to news flow, and having a differentiated view about the future outlook for the
business.
Valuation
When change meets neglect, the intrinsic value of a company may exceed the current
stock price. We appraise the business using a number of methodologies, but most are
dependent upon our modeling of future free cash flows. We are seeking to normalize the
cash flow and earnings streams for one time or unusual items which themselves often
create neglect. As relative value investors, we are looking to invest in companies which are
trading at a discount to their own history, peers, and when appropriate, our assessment of
its value to a strategic or private equity buyer.
.
4
Cramer Rosenthal McGlynn, Third Quarter 2014 Newsletter
Investment Process
CRM generates ideas from both qualitative (approximately 75%) and quantitative
(approximately 25%) sources. Qualitative ideas emanate from: company presentations,
news services, due diligence on existing holdings, our internal research data base,
leveraging investment themes and rich text screening for specific change expressions such
as acquisition, restructuring, etc. The quantitative sources include: screening for stocks
which have underperformed the market or peer companies over certain time periods,
screening for companies which are fundamentally underperforming peers as expressed by
operating margins which are below their own history or peers and ranking stocks by sell
side or buy side sentiment. Ideas that are being actively researched are what we call “work
in process.” These names are reviewed regularly by portfolio managers and stocks are
added or deleted to focus the team’s research efforts. Part of processing an idea includes
preparing an Investment Case which documents the investment thesis. It consists of a brief
company description, a discussion of the change(s), an assessment of the relative neglect
and valuation. It also includes an assessment of the risks relevant to the thesis and our
determination of a fair price target at that point in time.
Buy Discipline
Our investment process is team oriented and collaborative. There are typically multiple
analysts/portfolio managers engaged in a review and discussion of new ideas and Investment
Cases. A financial model in sufficient detail and relevant due diligence will also be prepared
and reviewed as part of the evaluation process. If the risk/reward is deemed attractive by
the portfolio managers in the context of their overall portfolio construction, a decision will be
made by the portfolio managers to initiate a position in the stock. The portfolio managers
will modulate the position size depending upon the relative attractiveness of the idea, the
expected return and other risk considerations.
Sell Discipline
CRM’s process is focused not only on building the Investment Case, but also on understanding
how the case might deteriorate. The Firm’s sell discipline is ultimately dependent upon the
written Investment Case for the stock. A position will be sold when one or more of the following
occurs: an established price target is approaching or is attained, implying the stock has
reached our estimation of fair valuation; a factor in our initial investment thesis has deteriorated
causing us to reassess the potential for the company; or we identify a more promising
investment opportunity. After a decision to sell is made, the investment is replaced by either a
new idea or existing holdings which offer a greater risk/reward profile.
5
Product Summary
PRODUCT/INCEPTION
ASSETS
VEHICLE
MINIMUM
INVESTMENT
ANNUAL MANAGEMENT
FEE/EXPENSE RATIO1
STATUS
Separate Account
$10 Million
Open
US Concentrated
$25 Million
1.00% on the first $25m
0.75% thereafter
TBD
Mutual Fund, CRIEX (Institutional)
Mutual Fund, CRMEX (Investor)
$1 Million
$2,500
1.25% on all assets
1.50% on all assets
Open
Open
CRM US Equity Opportunities UCITS
A Shares, ISIN IE00B5ZXDG51
B Shares, ISIN IE00B3PZWY82
S Shares, ISIN IE00B43N7R95
$1,000
$100,000
$100,000
0.80% MF; 0.97% TER
1.20% MF; 1.95% TER
1.60% MF; 1.90% TER
Open
Open
Open
Separate Account
$10 Million
$1 Million
$2,500
on the first $25m
on the next $25m
on the next $50m
thereafter
on all assets
on all assets
Open
Mutual Fund, CRIGX (Institutional)
Mutual Fund, CRMGX (Investor)
0.75%
0.65%
0.55%
0.50%
0.90%
1.15%
Separate Account
$10 Million
$1 Million
$2,500
on the first $10m
on the next $15m
on the next $25m
on the next $50m
thereafter
on all assets
on all assets
Open
Mutual Fund, CRIMX (Institutional)
Mutual Fund, CRMMX (Investor)
1.00%
0.75%
0.65%
0.55%
0.50%
0.82%
1.03%
Separate Account
$10 Million
$1 Million
$2,500
on the first $25m
on the next $25m
on the next $50m
thereafter
on all assets
on all assets
Soft-Close
Mutual Fund, CRIAX (Institutional)
Mutual Fund, CRMAX (Investor)
1.00%
0.70%
0.60%
0.40%
0.88%
1.09%
9/30/2014
(In Millions)
All Cap Value
January 2002
Large Cap Opportunity
January 2005
$1,540
$933
(includes assets of
PCG Large Cap Opportunity)
Mid Cap Value
January 1998
Small/Mid Cap Value
April 1973
$3,300
$2,880
Open
Open
Open
Open
Open
Open
Small Cap Value
October 1995
$1,151
Separate Account
Mutual Fund, CRISX (Institutional)
Mutual Fund, CRMSX (Investor)
$10 Million
$1 Million
$2,500
1.00% on all assets
0.86% on all assets
1.09% on all assets
Soft-Close
Open
Open
Global Opportunity
January 2009
$5
Separate Account
$25 Million
$1 Million
$2,500
on the first $25m
on the next $75m
thereafter
on all assets
on all assets
Open
Mutual Fund, CRIWX (Institutional)
Mutual Fund, CRMWX (Investor)
0.90%
0.80%
0.70%
1.25%
1.50%
Separate Account
$25 Million
$1 Million
$2,500
on the first $25m
on the next $75m
thereafter
on all assets
on all assets
Open
Mutual Fund, CRIIX (Institutional)
Mutual Fund, CRMIX (Investor)
0.90%
0.80%
0.70%
1.25%
1.50%
Limited Partnerships & Separate Account
Limited Partnerships & Separate Account
Limited Partnerships & Separate Account
$1 Million
$1 Million
$1 Million
1.00%+20% carried interest for LP
1.00%+20% carried interest for LP
1.00%+20% carried interest for LP
Open
Open
Open
International Opportunity
January 2009
Long/Short
All Cap – February 1993
Windridge – April 2002
Global Opp. - February 2010
6
$18
$284
$77
$9
Cramer Rosenthal McGlynn, Third Quarter 2014 Newsletter
Open
Open
Open
Open
For more information regarding investing in any one of these current products please contact the CRM Marketing Team at 212.326.5325.
Shares of CRM Funds are distributed by ALPS Distributors, Inc. Please note that shares of a mutual fund may only be offered through a prospectus. Investors should carefully read a prospectus and consider the investment objectives, risks, charges and expenses before investing.
Investing in non-U.S. securities involves special risks such as, greater social, economic, regulatory, and political uncertainties, and currency
fluctuation. To request a copy of a prospectus for any CRM Mutual Fund product, please call 800.276.2883 or visit www.crmfunds.com.
1
Expense Ratio Disclosure
The net expense ratios for the CRM Small Cap Value Fund, CRM Small/Mid Cap Value, CRM Mid Cap Value Fund, CRM Large Cap Opportunity
Fund, CRM All Cap Value Fund, CRM Global Opportunity Fund and the CRM International Opportunity Fund are the ratios listed in the CRM
Funds Prospectus, dated October 28, 2013. Expense ratios will fluctuate over time. CRM has a contractual obligation to waive a portion of fees
through November 1, 2014 and to assume certain expenses. In addition, CRM has also voluntarily agreed to waive or cap certain fees for the
CRM Large Cap Opportunity Fund. This agreement may change or end at any time. Excluding the Small Cap Value, Small/Mid Cap Value and
Mid Cap Value Funds, performance would have been lower in the absence of fee waivers and expense reimbursements.
7

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