Steven Scruggs' FPA Queens Road Small Cap Value Fund 2nd-Quarter Commentary

Dear Fellow Shareholders,

The FPA Queens Road Small Cap Value Fund (“Fund”) returned 4.20% in the second quarter of 2023. This compares to a 3.18% return for the Russell 2000 Value Index in the same period. For the first half of 2023, the Fund returned 4.93% versus the Russell 2000 Value Index at 2.50%.

While we are pleased with the Fund’s year to date results, we prefer to be measured over longer time periods. As a reminder, our goal is to outperform the Russell 2000 Value Index over the full market cycle with less risk. Consistent with our historical returns, we expect to outperform in down markets and trail somewhat in speculative markets as a result of our diligent, disciplined and patient process.

Market Commentary

We read newspapers, talk to friends and stay informed about what is going on in the markets at large. But we spend most of our time looking at small companies, one by one. It always feels a little funny writing the market commentary section. We’re not sure that it is useful to have us comment on the macro or big themes in the market. It’s not really the thrust of what we do and I’m not sure we have much original to say, but maybe we can add some perspective from where we stand in small-cap land.

Besides the issues with banks discussed in our first quarter letter, the biggest market theme in the first half of the year was the performance of mega-cap technology companies. Perhaps these companies have the most exposure to artificial intelligence, or maybe they were just too cheap after 2022’s sell-off. For the first half of 2023, the S&P 500 returned 16.88%. But 12.46%, or 74%, of that total return came from just seven high profile companies – Apple, Microsoft, Nvidia, Amazon, Meta, Google and Tesla. If you include a handful of additional large tech names, the percentage of the market’s return coming from large tech becomes even more drastic.²

From our perspective, the remaining 493 companies in the S&P 500 were up a little, roughly consistent with the small-cap indices. Most of the Fund’s companies did fine, and certainly better than the worst-case scenario suggested by rising rates and faltering consumers. Most importantly, the Fund’s big winners and losers look idiosyncratic – you can find a fuller discussion below. The Fund benefitted by being underweight banks, but possibly had one or two more big losers than usual. We will always seek to remain prudently diversified, and we firmly believe that the Fund’s attractive long-term performance is the result of our diligent, disciplined and patient process, and not from a handful of outsized bets.

Are the Small-Cap Indices Cheap?

We have seen charts from a handful of macro shops and other small-cap managers that show, on a top-down index basis, small-caps are generationally cheap relative to large-caps. We look at hundreds of small companies every year on a bottom-up basis and don’t think it is as simple as it appears. The environment is nothing like 2008, 2020 or even 2018 when there were good reasons to be fearful and a broad group of small companies were remarkably cheap. The current portfolio reflects this – while we really like the companies we own, we are having trouble finding new companies to buy. The Fund’s cash sits at approximately 10% as of June 30, 2023.

When we analyze the Fund’s benchmark, the Russell 2000 Value Index (excluding unprofitable companies), we find that almost all the relative cheapness vs. the S&P 500 stems from two sources – 1) the heavy overweight to banks (financials) and 2) a handful of sectors and subsectors such as energy, home builders (consumer durables), specialty retailers, shipping and trucking (transportation) and distributors that are materially over earning compared to 2019.³

The following table shows the sector weights and earnings yields (inverse of price to earnings (“P/E)) for the Russell 2000 Value and S&P 500 indices. As of March 31, 2023, the Russell 2000 Value trades at a 9.9% earnings yield (10.1x P/E), more than double the 4.6% earnings yield for the S&P 500 (21.6x P/E) – this is excluding companies with negative earnings. This 5% earnings pickup is optically wide. But, when we run the attribution for this large difference (the column all the way on the right in the below table), we find that Finance (banks) is responsible for about 2% of the relative cheapness. The Energy, Durables (home builders), Retail and Transportation (shipping and trucking) sectors that are materially over-earning combine for another 2% of the cheapness. Please see Appendix 1 for additional details.

We only include companies that are profitable for the previous year, representing approximately 74% of the Russell 2000 Value Index on a weighted basis. Without this constraint, the Russell 2000 Value trades at a P/E of 76.3 – significantly more expensive than the S&P 500.⁴

When doing this exercise, we, as bottom-up value investors, have a hard time resisting the urge to go company-by-company through the various Russell 2000 Value sectors to look for cheap stocks. But when we have taken a peek as to why a particular company or sub sector is cheap, it is usually because, based on our investment process, it is junky.⁵ It’s nice to know that we aren’t missing something obvious!

Quality and the Four Pillar Process

Our investment process has four pillars:

1. Balance-Sheet Strength –Seek companies with strong balance sheets. We are not comfortableowning companies that have significant liabilities (e.g., debt, legal, regulatory, pension or something inherent in the business model) that could cause insolvency concerns when there’s an economic, financial, or any other type of crisis. We want to make sure we are invested in companies that have staying power.
2. Valuation –Normalize economic earnings over full market cycles, primarily using free cash-flowdiscount valuation models. Demand a margin of safety.
3. Management – Evaluate management’s track record of laying out a long-term strategy andexecuting their stated objectives.
4. Sector and Industry Analysis –Own companies in growing industries with stable competitivedynamics and favorable economics. We avoid commoditized or overly competitive industries.

We prefer long-term compounders – i.e., high-quality franchises with strong balance sheets, proven management teams and attractive industry dynamics that we hope to own forever. Compounders don’t usually come cheap, and while we are valuation conscious, we are generally willing to pay a little bit more for higher quality. While virtually all financial assets were down in 2022, quality compounders generally held up better.⁶

So what do we mean by quality? At its most basic, we think quality means that we can have confidence that a company’s earnings and cash flows will be larger in three to five years than they are today. Different investors look at different metrics that describe quality. High returns on capital, high operating margins, organic growth, high cash conversion and low debt are all indicative of quality. But at the end of the day, we take a holistic look at our companies, seek to identify the risks, try to remain conservative and judicious, and compare the current price to our confidence in the future. Our four pillars – balance sheet strength, valuation, management, and industry analysis – guide our assessment of quality.

Historically, quality has been a large contributor to our outperformance during market downturns.⁷ Low leverage allows companies to survive and reinvest during recessions. Strong management teams can be trusted to shepherd the company through headwinds and find new opportunities. Entrenched competitive positions and industries with favorable economics and outlooks mean that the passage of time is our friend. In practice, it is never this easy. It is rare to find a company that sits cleanly atop each of the four pillars. And our view of the future is hazy at best. But when things get complicated and the future seems uncertain, the four pillars provide a framework for thinking through the next three to five years.

Simplicity and the Four Pillar Process

When we talk to clients, one of the questions we often hear is “How are you different from other small-cap value managers?” Value investing is a big tent (as they say), but there is a spectrum that runs from cheap to quality. Most investors understand that we fall towards the quality end of the spectrum, although at times we find significantly underpriced companies that are lower quality but appear to be attractive investments.

But there is another axis that runs through value investing. On the one hand is simplicity – a preference for straight-forward franchises that are inexpensive relative to the durability and growth of earnings. These franchises might also be inexpensive compared to other points in history or other companies of similar quality. On the other hand is complexity – a preference for situations that involve a number of moving parts that obscure value. This often comes with a belief that you can get an edge through insight and hard work that peels back the onion and reveals how things will play out. As in cheapness versus quality, most value investors lean one way, towards either simplicity or complexity. We lean towards simplicity.

The Four Pillar Process leads us to investments that are relatively straight-forward. Based on our experience, companies that score high across the Four Pillars tend to stay out of trouble. They don’t over-extend the balance sheet to build empires and they don’t take on contingent liabilities. Management focuses on its core business that has a long history of demonstrated results. And the core business is fundamentally sound without worrying about excessive competition, a turnaround or inflection points. Complexity can add a lot of value to a business but it can also make a mess of things. There’s an elegance and surety to well-run companies that can grow the franchise and compound.

We bring this up in an effort to help you understand how we think. The most important thing when we talk to clients or potential clients is that we’re all on the same page and there are no surprises. This is particularly hard in small-caps where even well-informed investors have probably never heard of these companies. We’ve made plenty of mistakes in the past and will make more mistakes in the future. But we want our investors to know what kind of possible mistakes they are in for. With that in mind, let’s list some things that we look for and some things that we shy away from. Of course these are tendencies, not absolutes.

What We Look For:

• Simplicity – We put a lot of effort towards ignoring the noise and highlighting the two or three most important things that make a company attractive. Often, but not always, these things are consistent profitability and balance sheet strength.
• Robustness – We stay away from false precision and the belief that we can get everything exactly right. This provides a wider margin for error and helps us make fewer and smaller mistakes. In our experience, if an investment fits within our Four Pillars, it is probably going to turn out OK.
• Durability – We look for businesses that have a long history of consistent profitability and that have staying power. These businesses have typically been around for a long time and we believe will be around for a long time.

What We Shy Away From:

• Event driven, thematic or turnaround investments that require the future to be very different than the past.
• Wide dispersions of outcomes and hit-or-miss propositions. We aim to hit singles and doubles and wait until the odds appear to be in our favor. If the downside is well protected, the upside will take care of itself. We think this leads to fewer mistakes.
• Unproven business models and companies that lack historical financials or have a limited track record.
• Aggressive or overly promotional management and aggressive business tactics.
• Shrinking or competitively challenged businesses. These tend to be statistically cheap value traps. While we are valuation disciplined, we are willing to pay a reasonable price for quality.

Many of the businesses we own have similarities with the Mittelstand companies in Germany. ⁸ The Mittelstand refers to a group of smaller German companies that share a loose collection of the following characteristics. They are in fundamental industries and have been around for many decades or longer. They are family-controlled or have large insider ownership, which allows for management continuity and independence. They are long-term oriented yet nimble, innovative and lean. And they are customer focused and collaborative with employees and other stakeholders. When we look at our large, core positions, they tend to share many of these characteristics.

We think our primary edge is temperament. Not chasing the hottest or best investment allows us to buy a diversity of quality companies trading at reasonable prices. Market volatility and a constant deluge of information/noise make this difficult to do. But when we can’t find quality companies trading at reasonable prices, we wait.

Trailing Twelve Months (TTM) Contributors

• Fabrinet (FN, Financial) is a contract manufacturer of optical communications sensors and equipment. The companyhas a niche in hard-to-replicate precision manufacturing technologies and an enviable track record of execution. The majority of sales go to the optical communications OEMs (original equipment manufacturing), but Fabrinet has been successfully diversifying into the industrial, auto and medical end markets. The company has a large data center business with growing exposure to artificial intelligence and the stock jumped when Nvidia reported blowout earnings and guidance in May 2023.¹⁰
• InterDigital (IDCC, Financial) is a research and development organization that develops and acquires wireless and videopatents across key technologies. The company has a history of strong financial performance, opportunistically buys back shares and pays a modest dividend. Shares jumped earlier this year when InterDigital announced licensing renewals with Samsung, LG and Panasonic and then reported strong fourth quarter 2022 results.¹¹
• MasTec (MTZ, Financial) is a contractor that builds and repairs infrastructure for telecoms, electric utilities, oil and gaspipelines and the clean energy industry. The Mas brothers have an impressive history of rolling up smaller players and growing earnings, most recently in the electrical and clean energy spaces.¹² The company is benefiting from strong spending for 5G in telecom and government support (including the Infrastructure Investment and Jobs Act) for clean energy and the electrical grid.¹³
• Deckers (DECK, Financial) is a footwear and apparel company that owns the UGG, Hoka, Teva, Sanuk and Koolaburra Management has done a masterful job growing and extending the UGG franchise. Now they are repeating their success with Hoka running shoes, which surpassed $1 billion in sales last year.¹⁴ At over 20 times earnings, Deckers’ is approaching our estimate of intrinsic value. We weigh this against the quality of the management team, strong brands and net cash balance sheet and are comfortable with the Fund’s current position.
• AEL (AEL, Financial) is a leading writer of fixed-index annuities. The company is undergoing an ambitioustransformation plan led by CEO Anant Bhalla to diversify into alternatives and move assets off balance sheet, creating a fee income stream and freeing up capital for buybacks (AEL 2.0). We are warily watching, but so far, results have been good. As of 23Q1, AEL had 24% of its balance sheet in private assets.¹⁵ The company has had several takeover offers over the years and on June 27, Brookfield bid $55 per share for the business.¹⁶

Trailing Twelve Months (TTM) Detractors

• ServisFirst Bank (SFBS, Financial) is a conservatively-run lending franchise helmed by Tom Broughton. Tom hires localbankers but doesn’t build branches – this allows for best-in-class efficiency metrics while maintaining a strong and conservative lending culture. Return on equity (ROE) and average earnings per share growth have been near 20% for the last 10 years through year-end 2022¹⁷ – very attractive for a conservative, vanilla commercial lender. ServisFirst was down significantly following the failure of Silicon Valley Bank and has underperformed the regional bank ETFs.¹⁸ We think investors are worried that ServisFirst is funded by uninsured commercial deposits and the stock’s premium valuation based on price to book. But we are comfortable that while the bank will raise deposit rates, the commercial relationships are sticky and ServisFirst’s high NIM and ROE will allow it to weather the storm better than competitors.
• United Natural Foods (UNFI, Financial) distributes natural and organic food. Whole Foods is a 20% customer but UNFIhas done a reasonable job diversifying its product set and customer base, with a big boost from the acquisition of SuperValu in 2018.¹⁹ The share price suffered when the January 2023 earnings report revealed a sudden margin deterioration and the company took down guidance.²⁰ The margin miss was partially due to extremely volatile food prices, partially due to high priced organic food items losing share and partially due execution mistakes at the company. The company is cheap on reduced earnings estimates and we are comfortable with our current position.
• Concentrix (CNXC, Financial) is one of the top two customer experience (CX) vendors globally. The company started offrunning call centers but has evolved into a high-tech business process outsourcer (BPO) that also designs and runs customer-facing websites and apps, integrates all the data and optimizes a client’s customer interactions. CX itself is a relatively new business and Concentrix has been rolling up smaller competitors – in March, 2023 they bought WebHelp, a leading European CX player for cash and stock.²¹

  We believe this should help consolidate an industry where Concentrix and Teleperformance are the largest players. Concentrix was spun out of TD Synnex, another of the Fund’s core holdings, and we have always been impressed with the company’s innovation and growth. The market is currently worried about the ability for artificial intelligence to disrupt Concentrix’ core call center business and the shares of all of the large CX companies have underperformed materially.²²

• Synaptics (SYNA, Financial) is a developer of human interface (HMI) hardware and software that has diversified intohigher margin internet of things (IoT) products. Synaptics was a top five contributor for the Fund in 2021 and we significantly trimmed the position due to valuation.²³ The shares were back down in 2022 with concerns about consumer technology volumes, and in May, the company missed fiscal 23Q3 earnings. We have been incrementally buying back shares at lower prices.²⁴
• UGI (UGI, Financial) owns gas utilities and pipelines in Pennsylvania and West Virginia and the largest propanedistribution businesses in the United States and Europe. This is our kind of company – despite the disparate parts, UGI grows earnings at a relatively steady high single digit rate over the long term while distributing excess cash through dividends.²⁵ Shares are down due to a collection of short-term issues – driver shortages at the US propane business, losses from fixed priced contracts at the European energy marketing business, lower propane volumes in Europe and warmer weather. We believe the company is attractive at less than 10x earnings and we have been incrementally adding.

Portfolio Positioning

The current cash allocation is approximately 10%, which is the upper limit of our cash policy. The Fund holds cash as a residual of the investment process. When we cannot find companies that meet our stringent criteria, we will allow cash to build. Over a long time horizon, we would prefer to own a diversified collection of quality companies (acquired at reasonable prices) instead of cash. But we weigh this against our reluctance to sacrifice our margin of safety and risk the permanent impairment of capital.

During the quarter we added one new position, added to seven current holdings, and reduced one holding.²⁶

As always, and as significant co-investors in the Fund, we appreciate your trust in us to be good stewards of your capital. If you would like to discuss performance or the Fund’s portfolio holdings in greater detail, please let us know.

Respectfully,

Steve Scruggs, CFA, Portfolio Manager

Ben Mellman, Senior Analyst

July 13, 2023

1 As of June 30, 2023. Source: Morningstar Direct, FPA. Data shown for the FPA Queens Road Small Cap Value Fund – Investor Class (“Fund”). Inception of the Fund was June 13, 2002. The periods referenced above reflect Russell 2000 Value drawdowns 15% or greater and are calculated from that index’s peak and trough dates, (i.e., 6/14/2002-10/9/2002, 6/5/2007-3/9/2009, 5/10/2011-10/3/2011, 6/24/2015-2/11/2016, 9/20/2018-12/24/2018, 1/16/2020-3/23/2020, 11/8/2021-9/30/22). Please see page 1 for net performance of the Fund since inception. Please also see the end of this presentation for Important Disclosures and Definitions of key terms.

2 Source: Factset

3 Source: Factset. For additional detail, please see Appendix 1.

4 Source: Factset. As of March 31, 2023. For additional details, please see Appendix 1.

5 For additional details on the Russell 2000 Value Index earnings yield, please see Appendix 1.

6 Source: FTSE Russell: JP Morgan US Quality Factor Index; December 30, 2022; https://research.ftserussell.com/Analytics/Factsheets/Home/DownloadSingleIssue?issueName=JQUA&IsManual=false

7 Please refer to the table on page 2 for performance of the Fund during 15% or greater downturns in the Russell 2000 Value Index.

8 Source: Bloomberg; Germany's Niche Companies Are a Model for Life After Globalization; April 2023; https://www.bloomberg.com/opinion/features/2023-04-11/germany-s-economic-future-depends-on-its-non-fortune-500-companies?utm_source=website&utm_medium=share&utm_campaign=copy

9 Reflects the top contributors and top detractors to the Fund’s performance based on contribution to return for the trailing twelve months (TTM). Contribution is presented gross of investment management fees, transactions costs, and Fund operating expenses, which if included, would reduce the returns presented. The information provided does not reflect all positions purchased, sold or recommended during the TTM. A copy of the methodology used and a list of every holding’s contribution to the overall Fund’s performance during the TTM is available by contacting [email protected]. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities listed. Totals may not sum due to rounding. ‘Percent of Portfolio’ reflects the average weight over the period.

10 Source: J.P. Morgan conference transcript; May 26, 2023

11 Source: Foss Patents; InterDigital announces arbitration agreement with Samsung, renewal with Panasonic, video codec license deal with LG; January 2023; http://www.fosspatents.com/2023/01/interdigital-announces-arbitration.html; Source: InterDigital; InterDigital Press Release; January 2023; https://ir.interdigital.com/news-events/press-releases/news-details/2023/InterDigital-Issues-Preliminary-Financial-Results-for-Fourth-Quarter-2022/default.aspx

12 Source: MasTec; July 2022; https://www.mastec.com/press-release/2286/mastec-to-acquire-infrastructure-and-energy-alternatives-inc-iea-a-premier; December 2021; https://www.mastec.com/press-release/2259/mastec-to-acquire-henkels-mccoy-a-premier-utility-services-provider; May 2021; https://www.mastec.com/press-release/2245/mastec-expands-electrical-distribution-operations-footprint-with-acquisition-of-i
13 Source: Factset; See discussion at the Credit Suisse Industrials Conference; Dec 1, 2022.

14 Source: Deckers; Deckers Brands Reports First Quarter Fiscal 2023 Financial Results; July 28, 2022; https://ir.deckers.com/news-events/press-releases/press-release/2022/DECKERS-BRANDS-REPORTS-FIRST-QUARTER-FISCAL-2023-FINANCIAL-

RESULTS/
15 Source: AEL 23Q1 earnings release.

16 Source: https://www.wsj.com/articles/brookfield-seeks-hard-to-get-prize-in-american-equity-deal-d8e02445

17 Source: Factset. Cumulative average growth rate is based on diluted earnings per share for year ends 2013-2022.

18 Source: Factset. 23H1 performance for SFBS vs. IAT and KRE.

19 Source: UNFI Annual Report; July 30, 2022; page 12, https://s22.q4cdn.com/589001886/files/doc_financials/2022/annual/UNFI-2022-10-K-as-filed.pdf

20 Source: UNFI fiscal 22Q2 earnings; https://ir.unfi.com/news/press-release-details/2023/United-Natural-Foods-Inc.-Reports-Second-Quarter-Fiscal-2023-Results/default.aspx

21 Source: https://ir.concentrix.com/news-releases/news-release-details/concentrix-combine-webhelp-creating-diversified-global-cx-leader.

22 Source: Concentrix fiscal 23Q2 earnings transcript; https://ir.concentrix.com/financials/quarterly-results

23 For more information, see the Q4 2021 Commentary at www.fpa.com; https://fpa.com/docs/default-source/funds/fpa-queens-road-small-cap-value-fund/literature/fpa-queens-road-small-cap-value-fund-commentary-2021-q4.pdf?sfvrsn=601e909d_4

24 Source: Synaptics fiscal 23Q3 earnings; https://investor.synaptics.com/financial-information/quarterly-results

25 Source: Company financials and Factset.

26 Portfolio composition will change due to ongoing management of the Fund.

This Commentary is for informational and discussion purposes only and does not constitute, and should not be construed as, an offer or solicitation for the purchase or sale of any securities, products or services discussed, and neither does it provide investment advice. Any such offer or solicitation shall only be made pursuant to the Fund’s Prospectus, which supersedes the information contained herein in its entirety. This Commentary does not constitute an investment management agreement or offering circular.

The statements contained herein reflect the opinions and views of the portfolio managers as of the date written, is subject to change without notice, and may be forward-looking and/or based on current expectations, projections, and/or information currently available. Such information may not be accurate over the long-term. These views may differ from other portfolio managers and analysts of the firm as a whole and are not intended to be a forecast of future events, a guarantee of future results or investment advice.

Portfolio composition will change due to ongoing management of the Fund. References to individual securities or sectors are for informational purposes only and should not be construed as recommendations by the Fund, the portfolio manager, the Adviser, the Sub-Adviser or the distributor. It should not be assumed that future investments will be profitable or will equal the performance of the security or sector examples discussed. The portfolio holdings as of the most recent quarter-end may be obtained at www.fpa.com.

Future events or results may vary significantly from those expressed and are subject to change at any time in response to changing circumstances and industry developments. The information and data contained herein has been prepared from sources believed reliable, but the accuracy and completeness of the information cannot be guaranteed and is not a complete summary or statement of all available data.

The information contained herein is not complete, may change, and is subject to, and is qualified in its entirety by, the more complete disclosures, risk factors, and other information contained in the Fund’s Prospectus and Statement of Additional Information. The information is furnished as of the date shown. No representation is made with respect to its completeness or timeliness. The information is not intended to be, nor shall it be construed as, investment advice or a recommendation of any kind.

Certain statements contained in this presentation may be forward-looking and/or based on current expectations, projections, and information currently available. Actual events or results may differ from materially those we anticipate, or the actual performance of any investments described herein may differ from those reflected or contemplated in such forward-looking statements, due to various risks and uncertainties. We cannot assure future results and disclaim any obligation to update or alter any forward-looking statements, whether as a result of new information, future events, or otherwise. Such statements may or may not be accurate over the long-term. Statistical data or references thereto were taken from sources which we deem to be reliable, but their accuracy cannot be guaranteed.

The reader is advised that the Fund’s investment strategy includes active management with corresponding changes in allocations from one period of time to the next. Therefore, any data with respect to investment allocations as of a given date is of limited use and may not be reflective of the portfolio manager’s more general views with respect to proper geographic, instrument and /or sector allocations. The data is presented for indicative purposes only and, as a result, may not be relied upon for any purposes whatsoever.

In making any investment decision, you must rely on your own examination of the Fund, including the risks involved in an investment. Investments mentioned herein may not be suitable for all recipients and in each case, potential investors are advised not to make any investment decision unless they have taken independent advice from an appropriately authorized advisor. An investment in any security mentioned herein does not guarantee a positive return as securities are subject to market risks, including the potential loss of principal. You should not construe the contents of this document as legal, tax, investment or other advice or recommendations.

Fund performance presented is calculated on a total return basis, which includes the reinvestment of all income, plus realized and unrealized gains/losses, if applicable. Unless otherwise indicated, performance results are presented on a net of fees basis and reflect the deduction of, among other things: management fees, brokerage commissions, operating and administrative expenses, and accrued performance fee/allocation, if applicable.

The information provided in this presentation is based upon data existing as of the date(s) of the report and has not been audited or reviewed. While we believe the information to be accurate, it is subject in all respects to adjustments that may be made after proper review and reconciliation.