Dear Fellow Shareholders:

For investors, the volatility of the last 18 months has been especially frustrating. Like Sisyphus endlessly pushing his boulder to the top of the hill, only to watch it tumble down again, we have seen the stock market reach a new peak three times, only to drop back sharply. Yet, looking at just the first six months of 2019, this has been a good year overall for stocks and indeed all asset classes, even bonds.

Large company stocks, as measured by the S&P 500, are up 18.5% for the first half of the year, albeit rising off a relative low at the end of 2018. Small cap stocks have also performed well, with the Russell 2000 up 17% year-to-date. May’s sell-off of 6.6% was not nearly as sharp as the 20% fourth quarter plunge in 2018, or the 10% drop earlier in that year. The drop-off in May reflected concerns over trade tensions with China; when those eased in June the market recovered to score all-time highs, just above levels seen in January 2018, September 2018 and early May 2019.

Bonds have also done well in the first half of 2019. The Federal Reserve is now expected to lower short-term interest rates in 2019, reversing course after a series of quarter-point increases which began in late 2015 and which took the Fed Funds target rate from approximately zero to the current target range of 2.25% to 2.50%. At the end of June the Barclays US Aggregate Bond Index was up 6.11% for the year. If that return holds through year end, it would rank as the best year for the major bond index since 2011.

Ten-Year Anniversaries

The current bull market was ten years old in March, and we are now also celebrating the tenth anniversary since the end of the last recession. As of this month, this current expansion is tied with 1991-2001 for the title of the longest enjoyed by the US in the last 75 years (see chart below). However, even though the current expansion will soon be the longest in recent history, the expansion lags behind most others in terms of the rate of growth, with just 2.3% annual GDP growth. This slower rate of growth may explain why we haven’t seen the types of excessive risk taking by investors typically seen at the end of a bull market.

Infographic: Current Expansion to Become the Longest, Not Strongest in History | Statista

Several factors support continuing economic growth. Most estimates for 2019 GDP growth range from 2% to 3%, in line with annual growth over the past decade. US unemployment has continued falling and is currently at a very low 3.6%, boosting consumer optimism. Despite the lowest unemployment rate since 1969, wage growth has remained subdued. There are pockets of the labor market that are seeing pay increases but overall, managers aren’t yet being forced to pay more to hire workers. We typically see wages rise over 4% year-over-year as the economy overheats late in the market cycle. June’s robust job creation figure of 224,000 further signals economic health.

Furthermore, trade issues that sparked May’s selloff have calmed for now, with a temporary trade truce in place with China as talks continue. The US is postponing tariffs on an additional $300 billion in Chinese imports.

Moreover, the Federal Reserve seems to be standing ready to support the economy with further rate cuts if it deems it necessary. Though it’s hard to understand why the Fed would lower rates if the economy were not in immediate danger of recession, one guess is that the Fed governors saw the market’s negative reaction to its December rate hike as a misstep they do not want to repeat.

chart

Factors to Watch

On the other hand, periods of economic expansion do not go on forever, and there are several factors to keep an eye on. Trade issues are not going away any time soon. It is hard to envision a permanent trade deal while China competes to overtake the US as the premier global superpower. While China relies on the US to buy its goods, there is a limit to how heavy-handed the US can be in its negotiations.

Meanwhile, manufacturing is slowing around the globe. The Purchasing Managers Index (PMI), which indicates manufacturing trends for national economies, is showing that manufacturing outputs for most major economies are now in, or approaching, the contraction zone (see chart below).

chart

In Europe, Brexit remains an ongoing puzzle with no happy resolution in sight. British officials appear to be increasingly likely not to reach a deal before the UK’s official exit from the European Union. Failure to reach a deal would mean border checks would be introduced, transport of people and goods would be disrupted, and EU tariffs would be introduced. The deadline for the official Brexit is now scheduled for October.

Meanwhile, here in the US, the micro-economics of individual companies are beginning to reveal internal pressures on margins. Top line revenue growth appears scarce for many companies due to the weaker global economy and the uncertainty created by the trade war. 2019 earnings growth will likely be meager compared to the outstanding numbers posted in 2018. Juiced by the 2017 tax cuts, S&P 500 earnings grew by more than 20% in 2018. The comparisons will be trickier in 2019. This brings into question the sustainability of indefinite rosy market expectations. One sign that stock market sentiment is still quite high is the number of high-profile IPOs of Silicon Valley “unicorns” such as Uber, Lyft and Pinterest—companies that have grown to $1 billion+ valuations. A significant earnings recession will let some of the air out of the balloon…hopefully this can be avoided.

Volatility appears set to continue. Treasury bond yields once again inverted in the second quarter, with the ten-year bond paying less interest than the three-month bill—frequently an indication of a coming economic slow-down. We live in a world where a 140-character tweet can send the market up or down by 2%. It’s easy to imagine the negative event that could push us lower—military conflict with Iran, trade interruptions with China, a terrorist act. Positive events could also surprise us, with a positive effect.

We are navigating through a challenging time for investing. We’ve faced uncertainty over the past several years and investors have been rewarded for patience. With the economy on stable footing, we’ll continue to use these short-term bouts of volatility as rebalancing opportunities to buy at lower prices or take profits on price jumps. Through these actions, we hope to be well prepared for whatever lies ahead.

Steven H. Scruggs, CFA
President, Portfolio Manager
Matt DeVries, CFA
Analyst

PORTFOLIO MANAGER’S COMMENTARY

Queens Road Value Fund

For the fiscal year ending May 31, 2019, the Queens Road Value Fund returned 6.36% versus 1.15% for the S&P 500/Citigroup Value Index.

Performance Summary: May 31, 2019

3 Months 12 Months Avg. Annual 3-Year Return* Avg. Annual 5-Year Return* Avg. Annual 10-Year Return* Avg. Annual 15-Year Return* Since Inception* Lifetime Cumulative
QRVLX -2.12% 6.36% 10.25% 7.87% 11.38% 7.09% 7.84% 259.89%
S&P 500 / Citi Value -2.72% 1.15% 8.14% 6.69% 12.17% 7.30% 7.28% 229.50%

Gross annual operating expenses 0.95%
*Performance annualized. Fund inception June 2002.

Important Performance and Expense Information
All performance information reflects past performance, is presented on a total return basis and reflects the reinvestment of distributions. Past performance is no guarantee of future results. Current performance may be higher or lower than performance quoted. Returns as of the recent month-end may be obtained by calling (888) 353‑0261.

Investment return and principal value will fluctuate, so that shares may be worth more or less than their original cost when redeemed. There can be no assurance that the fund will meet any of its objectives.

From inception to 12/31/2004 the Fund’s manager and its affiliates voluntarily absorbed certain expenses of the fund and voluntarily waived its management fee. Had the Fund’s manager not done this, returns would have been lower during that period. The Fund’s manager and its affiliates do not intend to absorb any expenses or waive its management fee in the future.

Companies That Helped Performance

  • Proctor & Gamble (PG) rose 45% during the fiscal year.  The well-known consumer products company is in the midst of a long-term strategic brand re-alignment that has begun to show positive results.  Organic revenue growth has expanded to mid-single digits after remaining relatively flat for the previous several years.  While we are pleased with management’s progress, the company’s current valuation appears to be approaching our estimate of fair value.
  • Ingersoll Rand (IR) returned 38% for the fiscal year. The global manufacturer announced during the year that it would spin-off its industrial business and focus on its climate control segment.  The climate control business has been performing above expectations as both commercial and residential construction markets remain healthy.  As we model the valuation of the remaining business after the spinoff of the industrial business, the company appears to be near fair value.
  • Merck (MRK) gained 37% for the fiscal year.  Over the last five years, this global pharmaceutical manufacturer has continued to increase spending on research and development while cutting selling expenses. This focus on science over marketing is having positive results on the company’s financial statements.  Return on invested capital continues to increase as operating margins expand.  The company has proven to be a good allocator of capital through bolt-on acquisitions and strategic partnerships.  With a strong pipeline and increasing global opportunities, we like Merck’s long-term prospects.

Companies That Hurt Performance

  • State Street Corporation (STT) fell 41% during the period. One of the oldest and largest banks in the US, STT has been recently plagued by scandals resulting from overcharging some of its commercial clients.  The company has stated that the $380 million in overcharges were accidental, but the investigation continues.  Looking at the long-term performance of its underlying businesses, things look much better.  Although they are a provider in the competitively priced custody business, the competition is spread among only a few rational companies.  Earnings continue to steadily grow and the balance sheet remains conservative.  We believe STT’s current valuation provides an opportunity for the long-term investor.
  • Lyondell Bassell Industries (LBY) declined 19% during the year.   One of the largest chemical manufacturers in the world, LBY is one of the most efficient producers of plastics.  The company has expanded through acquisitions, acquiring bolt-on and complimentary businesses as well as expanding its own manufacturing capabilities.  While the company’s valuation appears very cheap at first glance, LYB faces cyclical challenges and near-term global production growth in excess of demand growth.  These factors and its vulnerability to ethane price fluctuations have pushed down the share price.  While we are cognizant of these and other risk factors, we feel the company’s balance sheet strength and position as a low-cost producer provide a good investment opportunity.
  • Bank of New York Mellon (BK) dropped 20% for the year.  A competitor of portfolio holding State Street Corporation, BK faces the same price competition for their global custody services. In spite of this competition, the company continues to slowly but steadily increase its earnings and does so while maintaining a strong balance sheet.  BK remains one of the fund’s core holdings.

Queens Road Small Cap Value Fund

For the fiscal year ending May 31, 2019, the Queens Road Small Cap Value Fund returned -4.26% compared to -11.32% for the Russell 2000 Value Index.

Performance Summary: May 31, 2019

3 Months 12 Months Avg. Annual 3-Year Return* Avg. Annual 5-Year Return* Avg. Annual 10-Year Return* Avg. Annual 15-Year Return* Since Inception* Lifetime Cumulative
QRSVX -8.52% -4.26% 3.56% 4.46% 9.18% 6.77% 8.52% 300.55%
Russell 2000 Value Index -7.44% -11.32% 7.68% 5.00% 11.67% 7.19% 7.86% 261.11%

Gross annual operating expenses 1.18%
*Performance annualized. Fund inception June 2002.

Important Performance and Expense Information
All performance information reflects past performance, is presented on a total return basis and reflects the reinvestment of distributions. Past performance is no guarantee of future results. Current performance may be higher or lower than performance quoted. Returns as of the recent month-end may be obtained by calling (888) 353‑0261.

Investment return and principal value will fluctuate, so that shares may be worth more or less than their original cost when redeemed. There can be no assurance that the fund will meet any of its objectives.

From inception to 12/31/2004 the Fund’s manager and its affiliates voluntarily absorbed certain expenses of the fund and voluntarily waived its management fee. Had the Fund’s manager not done this, returns would have been lower during that period. The Fund’s manager and its affiliates do not intend to absorb any expenses or waive its management fee in the future.

The Queens Road Small Cap Value fund invests primarily in small-cap companies which may involve considerably more risk than investing in larger-cap stocks.

Companies That Helped Performance

  • RLI Corp (RLI) rose 34% over the last 12 months. Well-managed specialty insurer, RLI Corp. continued its 44-year dividend growth streak.  As a long-time shareholder of the company, we hold the RLI management team in very high regard as we have watched them manage their unique business model through various market environments.  However, the company’s current valuation is trading very near our estimate of fair value.
  • Deckers Outdoor, Corp. (DECK) rose 34% during the last 12 months. Best known as the makers of Ugg, Teva and Hoka One One footwear, the company has continued to perform well, posting strong earnings, and increasing guidance. In the face of a very challenging retail environment, management continues to execute its strategic plan as revenues and margins continue to grow. While the Ugg brand (80% of sales) continues to grow according to plan, the Hoka One One brand exceeds expectations. DECK remains one of our top holdings.

Companies That Hurt Performance

  • Tenneco, Inc. (TEN) dropped 77% over the last year.  Tenneco is a manufacturer and distributor of automotive parts for new vehicles and the repair/replacement market. Primarily, it makes ride suspension systems including shocks and struts, and clean air systems like catalytic converters and emission control systems. During the year, Tenneco acquired auto parts manufacturer Federal Mogul from Carl Icahn for $5.4 billion.  Prior to the transaction the company announced that they planned to split into two separate companies in a tax-free spin-off.  One company will be a pure-play ride control and after-market parts company, and the other will be a pure-play powertrain company.  The separation is scheduled to occur during the second half of 2019.  The debt load resulting from the Federal Mogul acquisition is substantial.  The separation plan the company announced makes a lot of sense and we believe the two separate companies will be worth more than the combined company.  Carl Icahn seems to agree as he has indicated he plans on holding on to his significant stake that he received in the buyout.
  • Greenbrier (GBX) fell 44% during the last 12 months.  The maker of railcars appears to be making some progress on improving production inefficiencies at its manufacturing facilities, but still faces a concerning global economic growth forecast. The company’s international and product diversification efforts combined with its substantial backlog and pristine balance sheet is reassuring and we remain cautiously optimistic.
  • Synaptics (SYNA) fell 37% during the year.  Synaptics continues to struggle as it transitions from its heavy reliance on smart phones (primarily touch screen sensors and controllers) towards a more diversified revenue mix by expanding its presence in the Internet of Things (IoT) market (touch, voice and audio sensors).  The IoT revenue is not growing quickly enough to offset declines in mobile revenue, resulting in decreasing revenues, profits and cash flow.  In the face of this poor performance, the company lost both its CEO and CFO during the year.  Our patience has been tested with this long-term holding. The company has maintained profitability and a relatively strong balance sheet, but we are closely monitoring the new CEO hire to determine our continued investment.

The thoughts expressed in this piece concerning recent market movements and future prospects for small company stocks are solely the opinion of Queens Road Funds at May 31, 2019, and, of course, historical market trends are not necessarily indicative of future market movements. Statements regarding the future prospects for particular securities held in the Funds’ portfolios and Queens Road Funds’ investment intentions with respect to those securities reflect the portfolio manager’s opinions as of May 31, 2019, and are subject to change at any time without notice. There can be no assurance that securities mentioned above will be included in any Queens Road Fund-managed portfolio in the future.

This material is not authorized for distribution unless preceded or accompanied by a current prospectus. The prospectus contains important information on the Fund’s investment objectives, risks, and charges and expenses. Please read the prospectus carefully before investing or sending money. The Fund invests primarily in small-cap stocks which may involve considerably more risk than investing in larger-cap stocks. (Please see “Primary Risks for Fund Investors” in the prospectus.)