Performance was very strong again in the third quarter with a near double-digit gain (see below). Kestrel results were especially strong compared to our benchmark Russell 2000®Value Index which was only slightly positive for the quarter. The R2V Index has continued to underperform, trailing the NASDAQ® index by an astonishing 46 percentage points year-to-date (-21.5% vs +24.5%). However, we are believers that this extreme differential will reverse soon, especially if there are more indications of further economic recovery by 2022. From an investment standpoint, the key question is determining what the “new normal” will look like.

We have put considerable thought into this question from our rather unique perspective as a negative screener. For example, airlines dependent on high load factors, full fare business travelers, and government subsidies are discarded from consideration. Hotels with significant convention business are treated similarly. With increased office space vacancies, threats of rent strikes, and stretched municipal finances, firms lending money collateralized by metropolitan commercial and residential real estate are another area of concern. We don’t believe flight to suburbs and exurbs is a passing theme, as working from home becomes a more accepted alternative. Education seems like another danger area, with the traditional college economic model under pressure – risk areas would include student loan defaults and college town economies. However, as confirmed contrarians, we will potentially revisit these groups if we believe that their stock prices more than reflect their diminished fundamental outlook (and get the appropriate management signals), but we’re not there yet.

Following this strategy, we are unlikely to be the fastest out of the gate the day an approved vaccine is announced and the riskier stocks elevate. However, the companies we are selecting should participate in a long-term cyclical recovery. A recent addition is a lessor of shipping containers that is now benefitting from an improvement in world trade. In this age of extreme political differences, one of the few areas of agreement is the need for additional fiscal stimulus (politicians are always good at spending other people’s money). We have several holdings in the portfolio that will benefit from increased infrastructure spending. We also have significant holdings in relatively stable companies which will do well in a less than robust environment.

Opinions differ widely as to the shape of the recovery, a veritable alphabet soup that includes “V”, “L”, “K”, and “W”. This divergence of potential outcomes suggests we should put less faith than usual in management signals, at least when economically sensitive companies are involved. Overly optimistic management teams are more likely to initiate repurchases or make insider purchases. However, when we overlay our risk controls, we have confidence in our portfolio regardless of the ultimate letter that describes the economic recovery.

                                                                                                                                                 Abbott J. Keller, CFA

                                                                                                                                            Chief Investment Officer