The International Equity ADR portfolio is designed to identify compelling investment opportunities that possess the desired combination of attractive valuations and potential for multiple expansion. Cambiar’s quality and value bias will result in portfolio overweight to developed markets, subsequent underweight in emerging markets.
The strategy is constructed by Cambiar’s eight-person international investment team.
Jennifer M. Dunne, CFA
|Top 10 Holdings||% Weight|
|Sumitomo Mitsui Financial||3.0|
|British American Tobacco||3.0|
|% of Total||25.7|
|Market Cap Wtd Avg||66.0 B||60.7 B|
|Market Cap Median||42.6 B||11.3 B|
|Sector Weights||Cambiar||MSCI EAFE|
|Top 5 Countries||Cambiar||MSCI EAFE|
|Risk Statistics*||Cambiar||MSCI EAFE|
Market Review (3.31.2018)
Global equities posted mild losses during the first quarter of 2018. While there were no significant drivers behind the pullback in stocks, a lack of new upside catalysts and an increase in market volatility led investors to move to the sidelines. Talk of protectionist policy between the U.S. and China and the resulting negative impact on trade/global growth was an additional uncertainty that weighed on investor sentiment in the quarter. Throughout the current bull market, any decline in stocks has generally been a good buying opportunity, as losses were quickly erased and stocks moved on to new highs. Yet the current environment thus far in 2018 appears more cautious, with loss aversion beginning to outweigh upside potential.
Given where we are in the business/market/valuation cycle, perhaps a more circumspect posture is appropriate. While Cambiar still sees varying levels of upside in the equity markets, the Goldilocks environment is behind us and security selection/avoidance decisions will take on increased importance in 2018. The tightening of monetary policy underway in the U.S. may also spark a rotation in market leadership, as the dramatic outperformance in growth stocks appear poised to give way to their value counterparts. Higher interest rates are also beginning to offer investors an alternative to stocks, while serving as a potential headwind to companies with no earnings and/or leveraged balance sheets.
Volatility – A New Paradigm or Return to Trend?
In considering the investment climate of 2018, a look back on market conditions in 2017 is helpful. Last year was in many ways a near-perfect environment for equity investors: a synchronized global economic expansion, continued low-interest rates, favorable corporate earnings, and generally positive economic and political developments. Entering 2018, change within the market was bound to occur – and as these somewhat inevitable shifts have emerged, so too has volatility. We believe the following considerations will play a role in market behavior during 2018 (and beyond).
Positive Real Interest Rate – Monetary policy has been the primary tool to promote the global recovery over the past ten years. With U.S. inflation levels running at close to 2% and with the economy having achieved full employment, the Federal Reserve is now raising rates back to a positive real number. Assuming at least two more rate hikes in 2018, the resulting Fed Funds rate in the 2.25% range would be a positive real rate of return for the first time this decade. As the debt and equity markets have become quite comfortable with an extremely low economic cost of capital, the withdrawal of monetary stimulus is bound to exert pressure on asset prices. While many have anticipated this eventuality, it would be naïve to believe that this process after such a long duration will be a smooth one. We believe the rise in interest rates as an explanatory variable for the rise in volatility exceeds most other factors.
Source: Bloomberg. Formula: US 3 Month Bill - PCE Deflator.
Quantitative Easing (QE) Programs Outside the U.S. are Reaching Their Limits – QE remains to this day a difficult concept to explain. While it looks like money printing, it is in fact the simultaneous creation of bank reserves and the removal of risk-free instruments from the financial system. The objective is to urge financial participants out on the risk spectrum. In this regard, the QE programs of both Japan and Europe have gone further than the U.S. Federal Reserve. In Japan, the vast preponderance of positive-yielding debt has been bought by the Bank of Japan (BOJ); the BOJ has subsequently expanded their purchase activity into the corporate debt equity (via ETF) markets. In Europe, the European Central Bank (ECB) is bumping up against ownership limits for sovereign issues. The result in both cases is a shortage of risk- free bonds of various durations, an essential source of collateral for interbank liquidity. The resulting reduction in liquidity makes longer-term currency hedging prohibitively expensive for market participants such as major Japanese and European manufacturers – and thus blunts the benefit of QE. We believe Europe’s improved economic performance means that the ECB will begin exiting QE in 2018, and raising interest rates back into positive territory in 2019. Japan’s situation is uniquely complicated and we don’t expect QE to end there in 2018; however, given that the QE program is leading to illiquidity and challenges in basic capital market functions, returns appear to be diminishing.
Tariffs and Trade Wars? – President Trump has shown a clear willingness to approach negotiations through a confrontational style, including the topic of global trade. Tariffs on steel and aluminum, and possibly on select Chinese manufactures, likely represent negotiating tactics to force some kind of “deal” or reconciliation. Even so, for this to be an effective tactic, there would need to be some willingness to implement stiff tariffs in certain categories, just to prove that these are serious threats. As such, there is some risk that these tariffs “reverse” key stimulative benefits of tax reform and the general economic momentum. Global trade linkages have become deeply integrated – broadly speaking, it would take a lot of regressive tariffs to rupture these relationships. At the margin, protectionist policy is not a favorable development. That said, Chinese IP theft, forced technology transfer, and domestic market protections are difficult to defend as reciprocally reasonable trade policies to tolerate in the long term. Outside the U.S., the EU has proposed a transaction tax on internet businesses, reasoning that these are disruptive to local economies and tend to channel revenue and profits into the cloud and the most favorable tax jurisdictions. With locally sourced “profits” difficult to quantify, the EU may tax revenue. Taken in isolation, these may be reasonable responses to the negative externalities posed by online businesses. As it happens, these are mostly U.S. companies, and the largest ones in the global stock market, and they may earn less money than would otherwise have been the case.
Market Structure – Global equity market ownership is vastly different from the pre-GFC timeframe. Index funds, sector ETFs, and quantitative strategies have come to predominant markets, in some cases owning an outright majority of certain stocks and their free floats. On the other side of the markets, active managers have vastly less firepower to deploy as prices move. The consequence is that small fluctuations in market flows can lead to outsized stock price moves. Not unlike the unintended consequences of QE detailed earlier, true stock market and individual stock price liquidity (i.e., the amount of money needed to move a stock price) is lower today than in the past.
International Equity ADR
The Cambiar International Equity ADR strategy outperformed the MSCI EAFE Index by a modest margin for the first quarter. The negative return in 1Q marked the first down quarter for the strategy since the second quarter of 2016 – so perhaps some consolidation was in order. Within the index, growth stocks outperformed value, although the margin narrowed by quarter-end.
The investment team executed three new purchases and two sales in the quarter, with no material impact to aggregate sector and regional allocations. One linked trade during 1Q was a ‘swap’ of Spanish banks, as long-time holding BBVA was sold in favor of Banco Santander. BBVA had been a good performer for the portfolio, but uncertainty regarding the upcoming summer elections in Mexico could limit the upside for BBVA – given its ownership of Bancomer (which represents a meaningful portion of BBVA’s overall earnings). Santander, in our view, is a similarly high-quality Spanish bank that has a history of above-peer profitability and exposure to Latin America via their presence in Brazil. The investment case for Santander is predicated on a continued increase in profits and book value, attractive dividend yield (8%) and modest multiple expansion.
Within the developed markets, a mild sell-off occurred during the quarter – likely a combination of modest profit-taking after a strong 2017 and mixed data out of Europe that called into question the strength/durability of the economic recovery. The United Kingdom was one of the weaker performers (as measured by the FTSE 100 Index) during 1Q, as lower GDP growth and added uncertainties surrounding its pending exit from the EU have weighed on investor sentiment. Cambiar has had an underweight allocation to the UK since the June 2016 Brexit vote, and the majority of the portfolio’s UK holdings are multinationals with diverse revenue streams; examples include British American Tobacco, HSBC, and Smith & Nephew.
Sector returns within the index were fairly tight during the quarter – ranging from a +1% return for technology to a -4% return for telecom. As to be expected, returns were more disperse at the company level; thus, stock selection was the primary performance driver for the quarter. On this metric, Cambiar posted mixed results, as positive stock selection in financials, industrials and materials was offset by below-benchmark returns in consumer discretionary, energy and telecom.
As mentioned, holdings in the financial sector were a value-add during the quarter. The portfolio’s position in financial exchange Deutsche Boerse was the top individual contributor for the quarter. In addition to naming a new CEO (which had been an overhang for the stock), Deutsche Boerse also benefitted from an uptick in interest rates (thus higher float on custody assets) as well as increased trading volumes – which are positively correlated to market volatility. Representing approximately 24% of the portfolio, financials remains the largest sector allocation in the Cambiar International strategy. Although banks comprise a meaningful percentage of this allocation, companies such as Deutsche Boerse and asset manager Julius Baer that are less sensitive to rates offer good diversification within the sector.
Within industrials, aerospace company Airbus moved higher on a solid earnings report and above-consensus free cashflow (FCF). An increased in both FCF and margins have been key elements to the investment case, so progress on these fronts was encouraging. While we still see upside in Airbus, the sustainability of the current commercial aerospace cycle is an increasingly relevant conversation. One industrial position that was sold in the quarter was Komatsu, the Japanese maker of construction and mining machinery. Cambiar first initiated a position in Komatsu in Nov. 2016, and the investment has been a strong contributor to the portfolio. Yet a combination of valuation, tougher comps in '18 and better risk/reward opportunities in the pipeline led to the decision to part ways with this high-quality company.
Oil prices were generally range-bound in the low $60s during the quarter – a supportive price deck for the portfolio’s integrated and exploration/production positions. One energy position that lagged in the quarter was Canadian Natural Resources (CNQ), which was negatively impacted by a spill and subsequent closure of the Keystone Pipeline. The pipeline closure created a supply backlog for Canadian energy companies such as CNQ, as well as widening the differential between WTI and Western Canadian Select oil prices. Cambiar views the supply glut to be a transitory event for the company; a recent dividend raise, announced share buyback and valuation (stock is trading at a 10% free cashflow yield) provide additional downside support.
While only representing ~6.5% of the portfolio, Cambiar’s positions in the consumer discretionary sector were a drag on 1Q performance. Tata Motors was a notable laggard in the quarter, as the company’s Jaguar Land Rover (JLR) division posted softer sales in the midst of a model changeover. Given JLR’s significant contribution to overall Tata profits, an anticipated upturn in sales should be positively received by the market. One bright spot for Tata has been a recovery in profitability within the company’s India market; continued share gains on this front would be an additional positive for the stock.
Global equities delivered a dream year for investors in 2017 – strong returns with very low volatility. As we contemplate the outlook for equities in 2018, two key considerations are global growth and valuations. The acceleration in economic growth across most geographies is unlikely to sharply decelerate in 2018, providing a continued tailwind to corporate profits and stock prices. And while valuations in the aggregate are not inexpensive, multiples are not at the euphoric levels that often accompany the end of a bull market.
The more volatile market environment that appeared in the first quarter may be the ‘new normal’ for investors. An uptick in volatility is not necessarily a bad thing, as the corresponding increase in dispersion across sectors can be beneficial to active managers such as Cambiar. Additionally, the increase in market volatility should not be misconstrued for an imminent decline in stocks, as underlying corporate fundamentals and profits – a key driver of stock prices – continue to meet (or exceeded) market expectations. And while the low yield environment that has been supportive for equity valuations throughout the current cycle is being slowly wound down, rates still remain low on an absolute basis. Net-net – Cambiar anticipates that the overall upward trend in equities will remain intact; however, investors should prepare for a bumpier ride relative to the past 18 months.
As discussed in our 4Q commentary, Cambiar believes that security selection will take on increased importance in outperforming one’s assigned index in 2018, in contrast to the ‘set it and forget it’ approach that accompanies passive investing. While advocating active management is an admittedly self-serving recommendation, we are pleased to see that our investment strategies are off to a good start vs. their respective benchmarks – with the bulk of the excess return a function of security selection.
Quarterly Top & Bottom Contributors
|Top Contributors||Avg. Weight||Contribution||Bottom Contributors||Avg. Weight||Contribution|
|Deutsche Boerse||2.19||0.32||Canadian Natural Resources||1.84||-0.19|
|DBS Group||2.12||0.28||Royal KPN||1.74||-0.32|
|Airbus||2.11||0.28||British American Tobacco||2.96||-0.39|
|Otsuka Holdings||1.76||0.21||Tata Motors||1.83||-0.43|
A complete description of Cambiar's performance calculation methodology, including a complete list of each security that contributed to the performance of the Cambiar portfolios mentioned above are available upon request. Please contact Cambiar at 1.888.673.9950 for additional information. Past performance is no guarantee of future results.
Certain information contained in this communication constitutes “forward-looking statements”. Due to market risk and uncertainties, actual events or results, or the actual performance of Cambiar’s client accounts may differ materially from that reflected or contemplated in such forward-looking statements. All information is provided for informational purposes only and should not be deemed as a recommendation to buy the securities mentioned. There is no guarantee that the opinions expressed herein will be valid beyond the date of this presentation. There can be no assurance that the portfolio will continue to hold the same position in companies described herein, and the portfolio may change any portfolio position at any time. The specific securities identified and described do not represent all of the securities purchased, sold, or recommended by Cambiar and the reader should not assume that investments in the securities identified and discussed were or will be profitable.
DOL Disclaimer: These materials are intended for use by sophisticated parties as described in Section (c)(1) of the Department of Labor’s Fiduciary Rule, 81 Fed. Reg. 68, at 20999 (April 8, 2016). In connection with the sale of our products and services, we are not undertaking to provide impartial investment advice or to give advice in a fiduciary capacity for purposes of the Employee Retirement Income Security Act of 1974, as amended or section 4975 of the Internal Revenue Code of 1986, as amended. While we have a financial interest in the sale of our products and services because we earn revenue once we are hired, we do not receive a commission, fee or other compensation directly for the provision of investment advice (as opposed to other services) in connection with any such sale.