International Equity – 2Q20 Review
Performance drivers and outlook for the Cambiar International Equity Portfolio.
Hello, I’m Alvaro Shiraishi, Co-Portfolio Manager of the Cambiar’s International Equity strategy. Thank you for your interest and continued support of our team’s efforts and for taking the time to listen to this podcast. I hope you find our views sensible and relevant and please do not hesitate to reach out to your Cambiar contacts if you wish to discuss in greater detail.
In our podcast for the first quarter of the year, we offered you that the challenge presented by the COVID-19 crisis was one we accepted and looked at as an opportunity to improve our exposures, balance and relative performance. I believe the progress made by our team has been very significant.
While from a stock performance perspective the second quarter of 2020 was a meaningful reversal from the Q1 drawdown, that recovery has been partially driven, in our view, by investors chasing the very few certainties in a still highly uncertain situation. Whether we will experience a meaningful global second wave or a plurality of localized flare-ups, the reality is that the process of reopening the global economy for business remains a hit and miss endeavor and will for the balance of this year and potentially into 2021. In this context, while equity markets have regained some sense of normalcy, volatility remains at relatively elevated levels.
This situation has resulted in: (1) very concentrated performance; (2) the widening of the growth vs value gap; (3) a flight to perceived quality (with a clear focus on sustainable growth) from a sector and geography perspectives (favoring Technology and the U.S. as key examples); (4) a parallel flight to perceived safety in bond proxies (Utilities) and businesses that benefit from COVID (Healthcare, e-commerce) or fiscal stimulus (infrastructure).
We strongly believe that the best approach to invest prudently in this market environment remains a “through and past” examination of our current and prospective holdings, looking to put capital at work in situations that: (1) will be resilient to the uneven recovery; (2) can use the opportunity to consolidate their end markets and come in a better position on a forward basis; (3) continue to enjoy robust profitability and; (4) a sound financial situation. The “swing for the fences” approach, looking to position our portfolio opportunistically for quick rebounds that require the handicapping of sector rotations and “waves” is inherently inconsistent with the Cambiar discipline.
In this context, our effort has been to continue to follow our very well defined and sound underwriting criteria to act on the opportunities that the “on and off” market might present to us. Our resolve to constantly improve the quality attributes (high profitability, strong returns, sound balance sheets, and cash flows) and improve the balance (of sources of return and volatility characteristics) of our portfolio remains firmly in place. The market has continued to give us opportunities to make great progress to that end throughout the year.
While it is a fool’s errand to try to predict with precision when the market extremes (U.S. vs World, Growth vs Value) will correct, our thought process is rooted in reasonable long term certainties that we strongly believe will work to the benefit of our investors, i.e. that quality outperforms over the long run while balance and diversification are the basis for resilient, sustainable portfolio performance.
Can International Investing Be Back in Favor?
The remarkable outperformance of U.S. equities for the past few years and in the Q2 rebound as either a safe haven or a preferred destination has presented a “why even bother” challenge to International Investors. While charts and data are very clear on the “anomaly”, a valid struggle has been to find better fundamentals elsewhere. To that end, we believe there are a number of developing trends that are supportive of better performance for ex-U.S. equities. To start, there are significant differences in the shape and composition of fiscal stimulus that offer more durable support outside the USA. European and Asian stimulus packages have significant investment components, destined for key infrastructure, healthcare, and the continued pursuit of Carbon Neutrality through renewables and now Hydrogen.
In the U.S. most of the stimulus has been directed to short term income and employment support and the agreement on larger investment budgets has remained elusive or details lacking. Another meaningful change in Europe (particularly as it refers to its previous round of accommodation post-GFC) is the fact that it allows for temporary deficit spending supported by E.U. funds. This is largely unprecedented (irrespective of amounts that are also significant) and signals a shift in priorities and stance that should benefit a prospective recovery in terms of its sustainability. The support is being directed to the countries most in need (i.e. affected by COVID) whereas after the GFC the stimulus had conditionality and observed severe fiscal restrictions.
Another factor that could lead to the correction of the marked dispersions in capital flows and performance over the past few years is the evolution of the U.S. dollar. Expectations of softness for the greenback as a result of COVID, the elevated levels of debt, and political uncertainty ahead of the November elections have started to manifest. Periods of dollar weakness are a tailwind for ex-U.S. assets.
As it relates to our portfolio, performance in the second quarter benefited from the opportunities to upgrade in quality characteristics that we referred to above. For the quarter we outperformed the MSCI EAFE benchmark with a meaningful contribution of new names and importantly, looking at the “internals” of the portfolio, our selection (alpha) was very strong with 9 of 11 sectors having a positive effect. While our bottom-up analysis of opportunities within Energy, Communication Services, and Real Estate (the last two perceived as “bond proxies”) has led us to remain on the sidelines in these areas, these decisions have continued to be additive to performance. Also encouraging is the fact that our top performers during the quarter show the diversity of exposures with stocks in Industrials, Utilities, Financials, and Consumer Discretionary making sizable contributions on the basis of company-specific developments.
The research organization at Cambiar remains very active in identifying potential attachment points from our pipeline of high quality, sustainable characteristics names. The sound base built by our activity in Q1 has continued at a more normal pace, with our adds for the quarter (one each) in Industrials, Technology, and Consumer Discretionary, all in names with what we believe to possess strong profitability history and sound capital discipline.
We appreciate your support of Cambiar, even more so in the current circumstances. Our focus remains in executing our discipline with even greater clarity and transparency in uncertain times. Thank you for your attention and again, please reach out to your Cambiar contacts with anything you may need. Be 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.
Active Profitability Exposure is defined as the relative exposure to the Profitability factor within the MSCI Barra global equity model. Profitability factor return measures the performance of companies with a high degree of profitability exposure vs. those with low exposure within the MSCI Barra global equity model. The Profitability factor is a quality metric that characterizes the efficiency of a firm’s operations and total activities. Metrics include Return on Assets, Gross Profitability, Gross Profit Margin, and Asset Turnover.
Leverage factor return measures the performance of companies with a high degree of leverage exposure vs. those with low exposure within the MSCI Barra global equity model. The Leverage factor is a quality metric that characterizes company leverage across three metrics (market leverage, book leverage, debt to assets).