The second quarter of 2010 unfolded in a stark contrast from the previous four quarters. The positive outlook and investor confidence in a global recovery were quickly replaced with growing fears about the European sovereign debt crisis and state of the Chinese economy.  The shift from optimism to pessimism resulted in a sizable retracement in stock prices, sending indices around the world back to their lowest levels in months.

 

In Europe, the Icelandic volcano eruption that occurred in April might have foreshadowed the events to come for the region.  The clouds of volcanic smoke paralleled the clouds of doubt hanging over the PIIGS nations (Portugal, Ireland, Italy, Greece, and Spain) and their ability to meet their debt obligations.  Although a massive bailout package was successful in removing worst-case scenarios off the table, investor concerns remain elevated.

 

Across the globe, efforts by the Chinese central government to cool the property market and contain inflation left investors fearful that the economy would slow too much.  The potential for a hard landing contributed to a broad selloff in China-related equities – in particular the commodity markets and companies that are particularly reliant on China as their primary export destination.

 

For the quarter, it was evident that investors were actively removing the ‘risk on’ trade, and crowding into “safety haven” assets such as U.S. treasuries, German Bunds, the Japanese Yen and gold.  The divergent moves in stocks versus bonds has caused the equity risk premium (ERP) to rise from a seemingly normal level in the early spring to a level that is consistent with historically high risk aversion and market stress. 

 

While it is impossible to exclude the macro from our investment thinking, the Cambiar investment team remains focused on closely watching our current holdings, while always seeking new opportunities.  Given the recent sell-off, we are finding no shortage of attractive investment candidates. 

 

The Cambiar International Equity Fund posted a return of -12.0% for the quarter, vs. a -14.0% return for the MSCI EAFE Index.   

 

For the quarter, financials was the leading contributor to Cambiar’s performance relative to the EAFE. As many European banks were dragged down by the Eurozone sovereign default crisis, Cambiar’s low exposure here was a strong positive.  The Fund’s holdings within the sector (insurance companies, fee-based financial services positions, Asian banks) also held up better than the index.

 

The Fund’s industrials allocation, which represents the largest sector weighting in the portfolio, was another positive contributor to performance in the quarter.  Reflecting Cambiar’s bottom-up stock selection process in which portfolios are constructed on a stock by stock basis, the Fund’s outperformance came from an array of businesses ranging from robotic automation to restroom fixtures. 

 

Energy was the top detractor within the benchmark for the quarter.  Although the Fund did own British Petroleum, the quick response to liquidate this position early on in the Horizon spill event protected the Fund from a material capital loss. In aggregate, the Fund’s energy positions produced a small positive impact on performance vs. the EAFE Index in 2Q.

 

Although Cambiar had sufficient exposure to the defensive-minded consumer staples and healthcare sectors, the Fund’s aggregate holdings in these sectors were performance detractors in the quarter.  The underperformance was primarily sustained by two positions – Teva Pharmaceutical and Lonza Group.  Although disappointed by these companies’ performance in the short-term, we remain constructive on the earnings trajectory for these positions over the next 12-24 months.

 

At the country level, the U.K. was the largest contributor.  Performance was not limited in scope, as the investment team was able to garner strong numbers from various industries ranging from media to electronic interdealer brokers. Japan continues to be the largest overweight as our diversified holdings continue to trade near historical lows and signs of domestic recovery remain strong. 

 

The instability in Europe and slowing of momentum in Asia had many fearing a double-dip recession was right around the corner.  Despite the uptick in macro consternations, attractive investment opportunities do exist…they just might be less obvious.  For example, one fallout of the Eurozone sovereign debt issue was a weaker euro.  From an investing vantage point, companies with Euro-expenses and non-Euro revenues should see an uptick in earnings.  While company-specific fundamentals remain paramount in Cambiar’s buy/sell decision, the additional currency tailwind should bode well for holdings such as Adidas, Unilever and EADS.

 

Another silver lining that resulted from the recent sell-off is a broader reset of valuations; the recent pullback in stock prices has opened the doors for the Cambiar investment team to initiate positions in a number of durable franchises whose current prices offer a compelling risk/reward profile. 

 

While the immediate forecast for equities might not be appear to be terribly intriguing, at some point market consolidation phases conclude and further advances can occur - sometimes rather quickly.  Just as the ultimate market low in 2009 was exceedingly difficult to forecast or to invest around, we would expect a similar market inflection to be difficult to pinpoint.

 

As always, we appreciate your continued confidence in Cambiar Investors.