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Perspective

Q2 2022 Long/Short Opportunity Fund Commentary

We entered the quarter on the heels of a volatile first quarter, with markets moving quickly to price in the real and imagined effects of higher inflation and higher interest rates. As with other market corrections, declines arrived in waves with an early sell off in Consumer Discretionary companies followed by weakness in Financials and Energy. Information Technology, Industrials and Communication Services were weak throughout the quarter as high valuations normalized and supply chains remained inefficient. Over 1/4 of the Russell 3000 Value’s 12.4% decline in Q2 came from the Financials sector, where recession fears blossomed into worries of an adverse credit cycle, frozen investment banking pipelines and mortgage origination losses. Recent results from the Federal Reserve’s Comprehensive Capital Analysis and Review (CCAR) and early reads from second quarter bank earnings reports suggest that banks are healthier than their stock prices might imply.

With so many investors concerned over the “pending” recession, we note that not all recessions live up to their preceding market corrections. After what we view as two incredibly disruptive years of economic loss and growth, it would not surprise us to see a quarter or two of GDP declines. This is a natural outcome of 2021 GDP being whipsawed by 2020 losses and magnified by government stimulus spending. A recession in 2022 could be more of a rebalancing than a sea change in the direction of our still recovering economy.

We believe the impact of any recession depends on the size of an economy’s safety net. As we look at individual parts of the US economy, we see what we consider to be a healthy buffer that should soften a near-term decline in GDP. Consumer balance sheets remain much stronger versus pre-COVID levels, leverage remains low and wage growth remains solid. Forward indicators like household formation are very encouraging, suggesting that Americans are moving on with their lives after the severe chaos of COVID. Many corporate balance sheets also appear to be very healthy, debt levels are much reduced over the last two years and companies are committed to share repurchases and dividend payments.

The length and magnitude of inflationary pressures might threaten this economy’s safety net. While deeply painful, rising prices for goods and services have so far been absorbed by consumers and corporations. If, however, wage growth falls behind and unemployment rises, we would expect a swift correction in demand. Some stocks already assume a dire economic outcome, and we are focusing our work on those areas of low expectations.

We believe there are parts of the economy that are poorly positioned for slowing growth and higher interest rates. Weak balance sheets and high valuations are at risk. Highly levered companies that are dependent on the availability of cheap and easy financing are facing a new reality as spreads widen. We expect to see more headlines on restructuring at start-ups, private equity, small businesses, real estate developers and mortgage brokers. With so much debt held outside of the traditional banking system, we believe our large cap banks will avoid large losses. We expect the coming restructuring may have unexpected consequences and will be closely watching this unwind.

The current economic environment has been especially painful for companies with high valuations, as rising rates dampen the discounted value of future cash flows. This is the first market correction for growth stocks in some time, and investors in that part of the market are likely to make irrational decisions at the bottom, further extending losses.

We believe that investor behavior can have an outsized impact on stocks and markets during a sell-off. This could mean that fundamentally cheap stocks tend to get cheaper before a recovery and market bottoms are hard to call. In our experience, there are a few useful indicators of recovery as we navigate choppy markets. Option premiums on stocks and indices tell us the degree to which investors are panicked, and when and where they might be willing to buy. Insider buying and share buybacks hint at a management team’s confidence in their strategy. Earnings reports and guidance can provide a counterbalance to investor anxiety. We are carefully reading these indicators and are actively watching for new catalysts.

Attribution

In Q2, the Long/Short Opportunity Fund (SNOIX) benefitted from solid stock selection in the long portfolio and opportunistic market hedges. We saw losses in the options portfolio in reaction to lower stock prices.

In the long portfolio, we saw strong stock selection in the overweighted Energy sector as well as good results in Consumer Staples. Positions in the overweighted Consumer Discretionary and Materials sectors underperformed.

Net exposure increased through the quarter from 79% to 82%. The portfolio’s net exposure tends to rise during market sell-offs. The implied exposure of written put options rises in value as stocks decline, which has the effect of increasing our net exposure. We increased the number of short put positions and bought calls on several portfolio companies to carefully increase exposure in a rapidly moving market. We selectively trimmed market hedges as the market declined and will look to add new hedges as opportunities arise.

Contributors

Lamb Weston Holdings Inc. (LW)

Lamb Weston Inc. appreciated following a robust quarterly report, which indicated improving demand levels for the company’s potato products and a better-than-expected gross margin outlook. LW is facing an industry-wide problem of a poor potato crop, however the company has taken several initiatives to control costs and pass along price increases.

Vistra Corp (VST)

Vistra Corp. performed well during the quarter. Utilities across the board outperformed, but VST showed further relative strength as the company executed on their green energy initiatives and their shareholder-friendly capital allocation plans. After significant appreciation in the stock, we sold VST to redeploy the capital in investments with more favorable risk/reward profiles.

Suncor Energy, Inc. (SU)

Suncor Energy, Inc. is a leading Canadian integrated energy company with primary focus on the oil sands mining (80% of production). We believe that following years of underperformance due to operational issues as well as capital allocation decisions, shares are positioned to recover to prior valuation levels. In late April, activist hedge fund, Elliott Management launched a campaign against the company. Following yet another operational incident, SU announced the immediate resignation of their CEO and that it entered into an agreement with Elliott. The agreement includes the appointment of three independent directors and a strategic review of the retail business. As background, the retail business would equate to $3.6-$4.5bn— or $2.53-$3.16 per common share, based upon a multiple range of 8-10x on annualized EBITDA of $600mn. Additionally, the agreement includes the right for Elliott to nominate an additional director if certain performance criteria relative to SU’s peers are not met by December 31, 2022. At current levels, SU is trading at a discount debt-adjusted cash flow multiple of 3.3x in 2022 (vs. our global major peer group avg. of 3.9x) and at a free cash flow yield of 24% (vs. our peer group avg. of 19%). We feel the current commodity landscape as well as the corporate initiatives happening at the company, provide for an attractive investment opportunity over the near-to-medium term.

Detractors

Kohl’s Corporation (KSS)

Kohl’s (KSS) underperformed along with several Consumer Discretionary stocks as inflationary pressures, most notably rising gasoline price, weighed on consumer demand. Sentiment on Kohl’s has deteriorated after the company rejected lowball takeout bids; we believe that in a normalized environment, KSS can demonstrate improved earnings power and deliver significant shareholder returns.

 

CNO Financial Group (CNO)

CNO Financial Group (CNO) negatively impacted performance as the company lowered its earnings outlook for the year, projecting lower investment income and higher expenses from higher health care utilization, along with investments to support growth initiatives. A rising interest rate environment should support future earnings growth.

 

Freeport-McMoRan (FCX)

Freeport-McMoRan (FCX) negatively impacted performance as copper prices deteriorated during the quarter, primarily due to concerns about global economic growth. While copper prices may be volatile in the near-term, we continue to hold shares of FCX; the company is a low-cost producer with unique production growth opportunities in a supply-constrained industry. The company provides a robust shareholder return program and with an attractive valuation, trading for ~10x forward earnings.

Looking Ahead

With topline estimates in question and operating margins under pressure, we believe investors are likely to focus on valuations and balance sheets in the coming months. In our opinion, some stock valuations already reflect a severe economic downturn, while others are pricing in more rosy outcomes. Once the market’s appetite for indiscriminate selling subsides, we expect active portfolios of high quality, low valuation companies will outperform.

We remain overweight stocks in under-owned areas of the market including Energy, Materials, Consumer Discretionary and Financials. While volatility may remain elevated in the coming months, we continue to find many opportunities in the marketplace.

6/30/2022QTDYTD1-Year3-Year5-Year10-YearSince Inception
I Shares-10.11%-9.49%-6.07%8.45%6.27%8.55%5.52%
Morningstar Long/Short Equity Category-7.14%-9.65%-6.58%3.67%3.52%4.07%2.39%
70%/30% Blended Index-8.71%-9.22%-5.01%5.37%5.56%7.62%5.34%
Russell 3000 Value-12.41%-13.15%-7.46%6.81%7.01%10.39%6.75%

Performance data quoted above is historical. Past performance does not guarantee future results and current performance may be lower or higher than the performance data quoted. The investment return and principal value of an investment will fluctuate, so that shares when redeemed may be worth more or less than their original cost. Investors cannot directly invest in an index, and unmanaged index returns do not reflect any fees, expense, or sales charges. For performance information current to the most recent month-end, please call 888-814-8180.

Source: Morningstar Direct. 70%/30% Blended Index: 70% Russell 3000 Value TR and 30% ICE BofA 3 Month U.S. Treasury Bill Index. Prior to June 29, 2018, the Fund was named the Snow Capital Opportunity Fund and employed a different strategy.

The Fund’s management has contractually waived a portion of its management fees until November 5, 2023 for I, A, C and R6 Shares. The performance shown reflects the waivers without which the performance would have been lower. Total annual operating expenses before the expense reduction/reimbursement are 1.29%, 1.51%, 2.28% and 1.29% respectively; total annual operating expenses after the expense reduction/ reimbursement are 1.29%, 1.51%, 2.28% and 1.23% respectively. 5.75% is the maximum sales charge on purchases of A Shares.

The Fund’s investment adviser has contractually agreed to reduce and/or absorb expenses until at least November 5, 2023 for I, A, C and R6 Shares, to ensure that net annual operating expenses of the fund will not exceed 1.30%, 1.55%, 2.30% and 1.00%, respectively, subject to possible recoupment from the Fund in future years.

About Easterly Investment Partners

Easterly Investment Partners (EIP) is the advisor of the Easterly Long/Short Opportunity Fund. EIP is the traditional, fundamental based investment arm of Easterly Asset Management’s multiaffiliate platform. EIP’s current investment line-up spans the entire value equity market cap spectrum. Guided by a consistent contrarian investment philosophy, our value strategies are led by industry veterans and experts that have refined their craft and delivered strong performance through multiple market cycles. As of March 31 2022, EIP had approximately $2.6 billion in AUM.

Glossary

Long/Short Morningstar Category: Long-short portfolios hold sizeable stakes in both long and short positions in equities and related derivatives. Some funds that fall into this category will shift their exposure to long and short positions depending on their macro outlook or the opportunities they uncover through bottom-up research. Some funds may simply hedge long stock positions through exchange- traded funds or derivatives. At least 75% of the assets are in equity securities or derivatives.

Investors should carefully consider the investment objectives, risks, charges and expenses of the Fund. This and other information is contained in the Fund’s prospectus, which can be obtained by calling 888-814-8180 and should be read carefully before investing. Additional Fund literature may be obtained by visiting www.EasterlyFunds.com.

Past performance is not a guarantee nor a reliable indicator of future results. As with any investment, there are risks. There is no assurance that any portfolio will achieve its investment objective. Mutual funds involve risk, including possible loss of principal. The Easterly Funds are distributed by Ultimus Fund Distributors, LLC. Easterly Funds, LLC and Easterly Investment Partners, LLC are not affiliated with Ultimus Fund Distributors, LLC, member FINRA/SIPC. Certain associates of Easterly Funds, LLC are registered with FDX Capital LLC, member FINRA/SIPC.

Risks & Disclosures

Short sales involve unlimited loss potential since the market price of securities sold short may continuously increase.

Diversification does not assure a profit nor protect against loss in a declining market.

Derivatives may involve certain costs and risks such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Investing in derivatives could lose more than the amount invested.

Mutual fund investing involves risk; principal loss is possible. Investments in smaller companies involve additional risks such as limited liquidity and greater volatility. Investments in foreign securities involve greater volatility and political, economic and currency risks and differences in accounting methods. These risks are greater in emerging markets. Investments in debt securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term debt securities. The fund may invest in lower-rated and non-rated securities which present a greater risk of loss to principal and interest than higher-rated securities. The fund may invest in other investment companies, and the cost of investing in the Fund will generally be higher than the cost of investing directly in the shares of the mutual funds in which it invests. By investing in the Fund, you will indirectly bear your share of any fees and expenses charged by the underlying funds, in addition to indirectly bearing the principal risks of the funds. The fund also invests in ETFs. They are subject to additional risks that do not apply to conventional mutual funds, including the risks that the market price of an ETF’s shares may trade at a discount to its net asset value (“NAV”), an active secondary trading market may not develop or be maintained, or trading may be halted by the exchange in which they trade, which may impact the Fund’s ability to sell its shares. The Fund may use options and futures contracts which have the risks of unlimited losses of the underlying holdings due to unanticipated market movements and failure to correctly predict the direction of the securities prices, interest rates and currency exchange rates. This investment may not be suitable for all investors. Small- and Medium-capitalization companies tend to have limited liquidity and greater price volatility than large-capitalization companies. Performance over one year is annualized.

THE OPINIONS STATED HEREIN ARE THAT OF THE AUTHOR AND ARE NOT REPRESENTATIVE OF THE COMPANY. NOTHING WRITTEN IN THIS COMMENTARY OR WHITE PAPER SHOULD BE CONSTRUED AS FACT, PREDICTION OF FUTURE PERFORMANCE OR RESULTS, OR A SOLICITATION TO INVEST IN ANY SECURITY.

15382532-UFD-08132022

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