International Equity – 1Q20 Review
Performance drivers and outlook for the Cambiar International Equity Portfolio.
Hello, I am Alvaro Shiraishi, co-portfolio manager of the International Equity strategy at Cambiar. Thank you for taking the time to tune into our latest podcast. We hope you all are staying safe during these unprecedented times.
There is little left to say about the negative cyclical effect of COVID 19 globally. As the World has been forced to adjust to social distancing, stay at home orders and shutdowns, the challenges that have risen to even the most basic activities, personal and professional, cannot be overstated. International financial markets and equities have reflected day to day uncertainties and changes in expectations in quite a dramatic fashion. While at the onset of the crisis the markets prosecuted the recessionary impact on the economy and stocks, the second, more severe wave has been the prosecution of liquidity at the firm and sector level, i.e. the strength of balance sheets. Overall, EPS estimates for the EAFE Index have been trimmed by 24% since the beginning of the year and we believe it is likely these numbers will prove wrong –in either direction- as we move along with the benefit of hindsight and greater perspective.
Going into the first quarter of the year, our portfolio positioning was informed by constructive expectations once a Trade truce was agreed to, allowing for normalization of economic policy and a more robust environment. As a consequence, the sudden, uncontrollable and quick deterioration of conditions as the COVID 19 contagion spread out affected our performance significantly. Dragged by our positioning in industrials, our portfolio underperformed the benchmark during the first quarter.
A material headwind to value investing, the signficant and by now long-standing outperformance of the growth style box became even more pronounced as market volatility accelerated. The EAFE growth index outperformed its value counterpart by over 10 percentage points for the quarter, a 1,000 basis points lead. The second wave of corrections (nonetheless, by handicapping financial strength expressed in balance sheet soundness) allowed for the emergence of a more selective, quality bias which we believe benefits our stock selection discipline. The sell-off provided opportunities to add high-quality names that went on sale as the market forced indiscriminate liquidation.
So, for the International Equity strategies at Cambiar, our response to the challenge has been to accept it and try to capitalize from it. We have been able to use the market extreme moves to continue executing our high quality/relative value discipline. As the market has gone “on-sale”, on and off, it has allowed us to further upgrade and balance our portfolio exposures, looking to invest not only through the cyclical downturn but past it. In doing so, we have tried to be pragmatic, acknowledging two well-known facts. First, the duration and final depth of the downturn cannot be properly handicapped with a reasonable degree of confidence. Market prognosticators trying to make “the call” are akin to wind chimes, changing their tune ever so slightly depending on the constantly changing direction of the airstream. That said, as most market participants, we understand that the unprecedented amount of monetary and fiscal support globally will soften the otherwise severe blows from the COVID crisis and should setup the economy for a healthy recovery. At Cambiar, prudence dictates not succumbing to the extreme assumption of a V-shaped, pro-cyclical bounce that leads some market participants to “all in, one-way” bets on quickly bouncing sectors.
Our approach at Cambiar has been methodical: as everyone understandably struggles to estimate the depth of the impact on businesses and balance sheets in 2020, our goal has been to look past the crisis, use our insights at the stock level to forecast normalized earnings and cash flows and set our expectations of the time it will take our portfolio companies (and pipeline ideas) to regain that earning power. Our main concern for the current year has been to assess whether a business has been temporarily damaged or structurally impacted (as well as the balance sheets). In cases where we have concluded that to be the case (unsurprisingly cyclical industrial, energy and materials exposures) we have decided to move the capital elsewhere.
This exercise has been informed by our experiences over other not dissimilar in nature while different in magnitude events, over the past 10 years, from the Global Financial Crisis to SARS and MERS but also policy induced, countercyclical corrections, the most notable, recent one at the end of 2018.
With this framework in mind, we have been able to buy names that we believe have great profitability, cash flow, and balance sheets characteristics which from a valuation perspective had been unattainable in the recent past given our risk/reward discipline. It is of critical importance to understand that our actions have not been a defensive, run for shelter exercise but an active pursuit of stocks with durable, superior investment characteristics, industry leaders, best in class operations, going on sale as the market moved down very rapidly. In doing so, we have remained very well aligned to our bottom-up, stock-picking approach. The exercise has not been a bottom fishing commitment to collect deeply discounted stocks, rather we have focused on buying what we believe to be mispriced, valuation dislocated, secularly strong performers. The opportunities have been diverse in nature and scope. During the first quarter, we added a diverse set of high-quality names within the life sciences, banking, cosmetics, alcohol/spirits, grocery chains, and electric utilities spaces. We believe the consistent attribute of all these new additions are their demonstrated history of strong profitability and low leverage.
We funded these purchases with sales of securities within the energy, insurance, pharmaceuticals, banking, aircraft leasing, and materials industries.
While we have been more active over the first part of the year than usual, the vast majority of the portfolio holdings remain in place, as the underlying companies were actively selected for their durable business characteristics, attractive prospects for future value creation, robust financial characteristics and the unique drivers of return they bring to the portfolio.
We expect to continue to be able to take advantage of market moves to continue to acquire great franchises at attractive valuations. We view the improvement of our portfolio’s balance and its quality characteristics as the means to attain strong performance through the cycle. Circumstances like the current are a challenge we accept as the means to execute that task.
At the team level, the tenure, experience, and insights of our team has allowed us to act with purpose and diligence in a very efficient manner. While adjusting to the virtual reality of telecommunicating, the process has been fluid and everyone has remained very engaged and active. Beyond the actions implemented in the quarter, our pipeline shows a wealth of good quality names that can enable us to continue to take advantage of market moves. This process has been informed through constant and diligent contact of our research organization with not only our existing holdings but prospective ones. Even remotely and accounting for time differences, the process remains very strong.
Volatile and erratic markets should allow for better performance through active stock selection. By looking to invest through and past this cyclical event, we intend to position our portfolio by enhancing even further its quality characteristics, durable profitability, superior returns, and resilient cash flows and cash positions. While such a stance could create underperformance in a “dash for trash”, V Shape scenario, our goal remains to generate sustainable performance for the long run.
Thank you for taking the time to learn more about the Cambiar International Equity portfolios. Please reach out to us if you have any questions or comments and always we appreciate your continued support of Cambiar. Take care and stay safe.
Certain information contained in this communication constitutes “forward-looking statements”, which are based on Cambiar’s beliefs, as well as certain assumptions concerning future events, using information currently available to Cambiar. Due to market risk and uncertainties, actual events, results or performance may differ materially from that reflected or contemplated in such forward-looking statements. The information provided is not intended to be, and should not be construed as, investment, legal or tax advice. Nothing contained herein should be construed as a recommendation or endorsement to buy or sell any security, investment or portfolio allocation.
Any characteristics included are for illustrative purposes and accordingly, no assumptions or comparisons should be made based upon these ratios. Statistics/charts and other information presented may be based upon third-party sources that are deemed reliable; however, Cambiar does not guarantee its accuracy or completeness. As with any investments, there are risks to be considered. Past performance is no indication of future results. All material is provided for informational purposes only and there is no guarantee that any opinions expressed herein will be valid beyond the date of this communication.