Third Quarter 2019 Market Commentary

Third Quarter 2019 Market Commentary

Cramer Rosenthal McGlynn, LLC is a leading value-oriented investment firm with approximately $4 billion in assets under management. Since the 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. The intellectual coherence of our investment philosophy is a genuine strength. 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.

Current News

We are very excited to announce the completion of the management buyout agreement to repurchase the entire ownership stake of Cramer Rosenthal McGlynn from M&T Bank. With the closing of this transaction, CRM has once again become 100% employee owned.

This agreement, as we've mentioned previously, was reached with CRM employees investing in themselves without the assistance of third-party debt or capital. With the finalization of this deal, the employees of CRM have completed a longheld goal of repurchasing the firm in order to better align our interests with those of our clients and stakeholders.

As you know, CRM has always had a strong entrepreneurial mindset and this transaction will further enhance our unique culture with a focus on differentiated, concentrated investing. The enhancements we have made to our investment process

Cramer Rosenthal McGlynn, LLC 520 Madison Avenue, 20th Floor New York, NY 10022 T 212.326.5325 info@

Contents Third Quarter 2019 Commentary

Current News

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Market Commentary

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Investment Philosophy & Process

4

PRODUCT SUMMARY

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Assets Under Management As of September 30, 2019 (In Millions)

Alternatives $569

Small Cap Value $892

All Cap Value $582

Mid Cap Value $669

and portfolio construction over the past few years position us well to continue to generate alpha for our clients, well into the future. We feel these changes put us in a good position to separate ourselves from other active managers and take advantage of the change and evolution of the marketplace.

Market Commentary

Interest rate volatility spiked this quarter as economic data pointed to slower growth and the cold war tariff discussions with China stoked uncertainty. The global central banks continued to soften the impact with additional accommodative actions. These dovish movements coupled with steady U.S. employment and hope for a trade resolution have allowed the markets to shrug off an attack on Saudi oil facilities, repo market rate volatility, and the announcement by Nancy Pelosi of a formal impeachment inquiry of President Trump this quarter.

Small/Mid Cap Value

$1,014

Assets Under Management (In Millions)

Total Assets..................................$3,726

Despite this macro noise, we believe the environment remains productive for our strategies, which are focused on investing in companies undergoing change. Since the global financial crisis, we have seen a significant increase in the number of management changes, restructurings, and shareholder activism. This pool of change events continues to support our new idea generation engine.

The equity markets were generally flat point-to-point this quarter but there was a lot of churning below the surface. The escalation of tariff tensions between the U.S. and China, which is deflationary and reduces corporate profits, confidence, and investment, was partially responsible for the selloff in August. The market recouped most of its losses in September as economic data was more balanced and the trade discussions were less confrontational. However, earnings outlook for the market continued to be revised downward throughout the year given slower global demand and weak capital expenditure activity. As a result, the vast majority of the market return this year has been due to P/E multiple expansion as opposed to earnings growth.

Large cap stocks outpaced small cap stocks again this quarter with the S&P 500 index up 1.7% while the Russell 2000 index declined -2.4%. Over the past 12 months, the S&P 500 index has outperformed the Russell 2000 index by more than 1200 basis points. This is partially due to the weaker earnings outlook

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Cramer Rosenthal McGlynn, Third Quarter 2019 Newsletter

for small caps versus large caps, coupled with a risk averse market sentiment this year.

For the quarter, defensive sectors (Utilities, Real Estate, and Staples) outperformed the more cyclical sectors (Energy, Materials, and Discretionary). The Healthcare sector continues to be challenged by policy uncertainty including Medicare for All and prescription drug pricing. The cyclical sectors did get a bounce in the month of September as recession fears from August subsided and risk seeking was in vogue.

Global central banks continued their dovish actions. The Federal Reserve lowered its fed funds target rate by 25 basis points at its July 31 and September 18 meetings. The European Central Bank also announced a new round of stimulus aimed at preventing the Eurozone from entering a recession at its meeting in September. Interest rate volatility increased meaningfully this quarter given the seesaw of economic data and tariff discussions. The yield on the 10-year Treasury Note declined from approximately 2% at the end of June to less than 1.5% by early September. Rates reversed quickly to top out at nearly 1.9% by mid-September only to decline again to nearly 1.5% in early October. The thirst for yield and risk aversion has led to nearly $15 trillion of negative yielding sovereign debt, up from approximately $7 trillion at the beginning of the year.

Not unlike last quarter, tariff negotiations between the U.S. and China have been precarious. In mid-July, President Trump threatened tariffs on $325 billion of Chinese goods. By August 1, the U.S. declared China a currency manipulator. China responded by suspending new U.S. agricultural purchases. The equity markets reacted negatively in August to the stepped-up trade tension. In early September, tariff escalations halted and trade talks restarted. As of early October, the U.S. and China appear to have reached a trade d?tente. But, as we have learned over the past year, a final comprehensive resolution will likely not be reached for some time.

Trade tensions have hit the U.S. industrial sector particularly hard, but the U.S. consumer remains resilient. The U.S. ISM Manufacturing PMI Index for September slipped below 50, signaling contraction. The last time the ISM Manufacturing Index was below 50 was during the energy selloff in early 2016 and the Brexit announcement in mid-2016. On the positive side, the ISM Non-Manufacturing PMI Index (the service sector of the economy) remained above 50, signaling expansion. Consensus forecasts fourth quarter 2019 and full year 2020 GDP of approximately 2%, a deceleration from earlier in the year.

Our outlook remains balanced given the accommodative position of the Federal Reserve and other global central banks. The potential positive resolution/d?tente to the tariff negotiations could be offset by slower global economic growth and heightened geopolitical tension around the world. As always, we remain active on new idea generation given the rich levels of corporate change in the marketplace (spinoffs, restructurings, new management, new products, and divestitures) and continue to add to existing holdings where we believe value has not yet been recognized by investors.

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Investment Philosophy & Process

Our track record, spanning over 45 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 is designed 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 successful investing is a result of recognizing and responding to changes that may positively impact the future prospects of a business enterprise. Often times, investors misunderstand the potential benefits of these changes, resulting in relative neglect, which reduces the risks of investing at a point in time. We believe this results in investing in companies that are under earning both their potential and consensus expectations. As relative value investors, we seek to invest in companies that 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 present a multitude of change opportunities. On a regular basis, investors are presented with management changes, spin-offs, cost restructurings, capital returns to shareholders, acquisitions, joint ventures, divestitures, regulatory changes, new products, and activist investors.

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. CRM seeks to evaluate neglect by studying sell-side analyst coverage and recommendations, 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. CRM appraises the business using a number of methodologies, but most are dependent upon our modeling of future free cash flows. CRM looks to normalize the cash flow and earnings streams for one time or unusual items, which themselves often create neglect. In many cases, reported GAAP earnings understate or distort a company's underlying free cash flow. 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.

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Cramer Rosenthal McGlynn, Third Quarter 2019 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 database, leveraging investment themes, and rich text screening for specific change expressions such as "acquisition," "restructuring," etc. The quantitative sources include screening for stocks that have underperformed the market or peer companies over certain time periods, screening for companies fundamentally underperforming and demonstrating operating margins below their own history or peers, and ranking stocks by sell-side or buy-side sentiment. Ideas actively being researched are what we call "work in process." Analysts and portfolio managers discuss these ideas collectively and strategize additional due diligence. Analysts build a detailed financial model and continuously provide feedback to portfolio managers. As part of this process, analysts develop an "Investment Case," which documents the investment thesis. It consists of a brief company description, a discussion of the change(s), and assessment of the relative neglect and valuation. The Investment Case also includes an assessment of the risks relevant to the thesis, relevant ESG considerations, and establishes upside and downside price targets.

Buy Discipline

Our investment process is very team oriented and collaborative. There are typically multiple analysts/portfolio managers engaged in a review and discussion of new ideas and Investment Cases. If the risk/reward ratio 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. A position will generally 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 that offer a greater risk/reward profile.

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