Q1 2018 : Portfolio Manager Q&A

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With 2017 being one of the quietest years in decades, volatility returned to the stock market in the first quarter of 2018. How did the recent volatility affect small-cap stocks?

In the first quarter of 2018, the Russell 2000 Index of small-cap stocks was nearly flat with a return of -0.08% as compared to the Fund posting a positive return of 0.42% over the same period.

We believe investors should be focused on long-term periods rather than quarterly stock moves. We’re pleased that over the 3-, 5- and 10-year periods, the Fund outperformed the Russell 2000 Index with less risk as measured by standard deviation. In addition, the Fund was awarded Morningstar’s lowest risk rating over the 3-, 5- and 10-year periods as of the end of the first quarter.

The Fund seeks high-quality companies that have had long-term consistent growth in both stock price and earnings, preferably over a 10+ year period. We believe this selection process helps uncover companies that can perform well whether markets are calm or volatile.

With renewed market volatility, what portfolio changes were made?

The first quarter volatility gave us the opportunity to make several changes to the Fund holdings. When the small- and mid-cap market rallied in January, we sold several companies that no longer met our criteria of long-term, consistent growth in stock price and earnings.

In the small-cap segment of the market, it’s challenging to find mature, high-quality companies that meet this strict criteria. When holdings start to disappoint, we closely monitor earnings over several quarters to watch for further deterioration and will exit a position, if necessary. In fact, we sold 27 stocks this quarter, reducing the total number of holdings in the Fund to 136, with the top 20 stocks in the portfolio accounting for approximately 40% of assets, as of March 31, 2018.

Conversely, in February when the Russell 2000 Index fell nearly 4%, we added to a few smaller portfolio positions that had been consistent performers since our initial purchase.

Smaller stocks tend to be more volatile than mid and large-cap stocks. How does the Fund help mitigate this risk?

With our strict criteria to find smaller companies with a demonstrated history of growth in both earnings and stock price, many micro-cap stocks and more volatile, high-flying growth companies are eliminated. The resulting portfolio often includes small companies that possess enviable products and services, strong market share positions and a potentially lower risk profile.

Average Annual Returns as of 03/31/18

1 Yr 3 Yr 5 Yr 10 Yr
Investor - VLEOX 13.70% 9.50% 12.23% 10.06%
Institutional - VLEIX1 14.01 9.73 12.37 10.13
Russell 2000 Index 11.79 8.39 11.47 9.84
Morningstar Small Growth Category Avg. 18.07 8.77 11.88 10.28
Morningstar Category Rank (%) - VLEOX 70 37 45 54
# of Funds in Category 684 592 531 402
Morningstar Return Average Average Average
Morningstar Risk Low Low Low
VLEOX Gross / Net Expense Ratio: 1.21% / 1.21% , VLEIX Gross / Net Expense Ratio*: 1.22% / 0.96%.
Morningstar rates funds based on enhanced Morningstar risk-adjusted returns.
Morningstar rates funds based on enhanced Morningstar risk-adjusted returns. Morningstar Ratings and Rankings based on Investor class shares.
1Indicates Morningstar Extended Performance. Extended performance is an estimate based on the performance of the fund’s oldest share class, adjusted for fees. The Inception Date of (VLEIX) is November 1, 2015.

* EULAV Asset Management (the “Adviser”) and EULAV Securities LLC, the Fund’s principal underwriter (the “Distributor”), have agreed to waive certain class-specific fees and/or pay certain class-specific expenses incurred by the Institutional Class so that the Institutional Class bears its class-specific fees and expenses at the same percentage of its average daily net assets as the Investor Class’s class-specific fees and expenses (excluding 12b-1 fees and any extraordinary expenses incurred in different amounts by the classes) (the “Expense Limitation”). The Adviser and the Distributor may subsequently recover from assets attributable to the Institutional Class the reimbursed expenses and/or waived fees (within 3 years after the fiscal year end in which the waiver/reimbursement occurred) to the extent that the Institutional Class’s expense ratio is less than the Expense Limitation or, if lower, the expense limitation in effect when the waiver/reimbursement occurred. The Expense Limitation can be terminated or modified before June 30, 2019 only with the agreement of the Fund’s board. The Fund’s performance would be lower in the absence of such waivers.

As of 03/31/18, the Fund’s Top 10 Holdings were as follows: Heico Corp (3.45%), Lennox International Inc (3.31%), Teledyne Technologies Inc (3.24%), Tyler Technologies Inc (2.85%), The Toro Co (2.47%), Pool Corp (2.37%), Chemed Corp (2.11%), Rollins Inc (2.00%), WEX Inc (1.95%), ICU Medical Inc (1.89%)

There are risks associated with investing in small and mid cap stocks, which tend to be more volatile and less liquid than stocks of large companies, including the risk of price fluctuations.

The performance data quoted herein represents past performance and does not guarantee future results. Market volatility can dramatically impact the fund's short term performance. Current performance may be lower or higher than figures shown. The investment return and principal value will fluctuate so that an investor's shares, when redeemed may be worth more or less than their original cost. Past performance data through the most recent month end is available at vlfunds.com or by calling 800.243.2729.

You should carefully consider investment objectives, risks, charges and expenses of Value Line Funds before investing. This and other information can be found in the fund's prospectus and summary prospectus, which can be obtained free of charge from your investment representative, by calling 800.243.2729, or by clicking on the applicable fund at www.vlfunds.com. Please read it carefully before you invest or send money. Value Line Funds are distributed by EULAV Securities LLC. Past performance is no guarantee of future results.

Portfolio holdings are subject to change and should not be considered a recommendation to buy or sell securities. Current and future portfolio holdings are subject to risk.

The average annual returns shown above are historical and reflect changes in share price, reinvested dividends and are net of expenses. Investment results and the principal value of an investment will vary.

The Morningstar Rating™ for funds, or "star rating", is calculated for managed products (including mutual funds, variable annuity and variable life subaccounts, exchange-traded funds, closed-end funds, and separate accounts) with at least a three-year history. Exchange-traded funds and open-ended mutual funds are considered a single population for comparative purposes. It is calculated based on a Morningstar Risk-Adjusted Return measure that accounts for variation in a managed product's monthly excess performance, placing more emphasis on downward variations and rewarding consistent performance. The top 10% of products in each product category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars, and the bottom 10% receive 1 star. The Overall Morningstar Rating for a managed product is derived from a weighted average of the performance figures associated with its three-, five-, and 10-year (if applicable) Morningstar Rating metrics. The weights are: 100% three- year rating for 36-59 months of total returns, 60% five-year rating/40% three-year rating for 60-119 months of total returns, and 50% 10-year rating/30% five-year rating/20% three-year rating for 120 or more months of total returns. While the 10-year overall star rating formula seems to give the most weight to the 10-year period, the most recent three-year period actually has the greatest impact because it is included in all three rating periods. VLIFX (3 Year / 4 stars / 541 funds; 5 Year / 4 stars / 480 funds; 10 Year / 2 stars / 344 funds; ) VALLX (3 Year / 5 stars / 1265 funds; 5 Year / 4 stars / 1141 funds; 10 Year / 3 stars / 825 funds; ) VLEOX (3 Year / 3 stars / 606 funds; 5 Year / 3 stars / 534 funds; 10 Year / 3 stars / 404 funds; ) VALSX (3 Year / 4 stars / 541 funds; 5 Year / 3 stars / 480 funds; 10 Year / 3 stars / 344 funds; ) VLAAX (3 Year / 5 stars / 674 funds; 5 Year / 4 stars / 617 funds; 10 Year / 4 stars / 439 funds; ) VALIX (3 Year / 5 stars / 313 funds; 5 Year / 5 stars / 274 funds; 10 Year / 5 stars / 199 funds; ) VAGIX (3 Year / 2 stars / 878 funds; 5 Year / 2 stars / 778 funds; 10 Year / 2 stars / 563 funds; ) VLHYX (3 Year / 1 stars / 146 funds; 5 Year / 1 stars / 127 funds; 10 Year / 1 stars / 105 funds; )

Source: Morningstar Direct