International High Dividend ADR Equity Strategy Q Commentary. Market and Economic Review

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1 S C H A F E R C U L L E N C A P I T A L M A N A G E M E N T International High Dividend ADR Equity Strategy Q Commentary Market and Economic Review International equity markets remained range-bound in the quarter as US equities rose following the surprise election of Donald Trump as the next President of the United States. Against this backdrop, long-term interest rates in the United States and other major developed markets continued to normalize as ultra-accommodative monetary policies are now expected to be better balanced by fiscal expansion programs led by the new US administration. In this environment, equities outperformed fixed income, the US Dollar appreciated against most currencies and cyclical companies outperformed non-cyclical companies. In the quarter, energy companies benefitted from stronger crude oil prices following OPEC s first agreement to restrict supply in eight years. By region, developed markets such as Japan and France outperformed emerging markets such as Mexico and China as market participants attempted to balance expectations for a pickup in global economic activity against perceived threats to international trade. By style class, value outperformed growth and large caps outperformed small caps. With the near-term outlook for asset markets having become more uncertain and volatile, adhering to the price disciplines of low price earnings and high dividend yield has become all the more important in providing satisfactory absolute and risk-adjusted returns. We believe that our strategy of buying shares in strong companies, at attractive valuations and holding them for the long-term (i.e. 5 years) remains attractive in this environment. Portfolio Performance We outperformed MSCI EAFE for the full year but underperformed for the latest quarter, given our overweight allocation to companies in non-cyclical sectors and our underweight allocation to companies in cyclical sectors. We remain comfortable with these allocation decisions based on valuations and the long-term outlook for our portfolio companies and continue to find new attractively valued investment opportunities across a number of geographic regions. Since Q4 YTD 1 Year 3 Year 5 Year 10 Year Incept* SCCM Intl High Div ADR (net) MSCI EAFE MSCI ACWI ex US *June 30, Performance for periods greater than 1 year is annualized Fifth Avenue New York, NY Tel Fax

2 Sector Attribution The largest contributor to relative performance was our strong stock selection in Industrials, Financials and Healthcare, where our well positioned companies with modest valuations and unique drivers for shareholder value creation outperformed, including BAE Systems, Siemens, BNP Paribas, Manulife Financial and Sanofi. Our overweight allocation to Energy and our underweight allocation to Real Estate, Information Technology and Industrials, aided performance. Cash aided performance during the quarter. The largest detractor from relative performance was our overweight allocation to non-cyclical sectors which underperformed such as Consumer Staples, Telecommunication Services and Healthcare and our underweight allocation to cyclical sectors which outperformed such as Consumer Discretionary and Materials. Much of this underperformance was driven by market participants chasing higher risk cyclical companies. Stock selection hurt us across Consumer Staples, Consumer Discretionary and Energy, where our more conservative investments underperformed. Source: Bloomberg Page 2 of 8

3 Country Attribution The largest contributor to relative performance was our overweight allocation to Canada, Norway, Germany and France and our underweight allocation to Hong Kong, Belgium and Denmark. Strong stock selection aided performance in Hong Kong, France and Germany, where a number of our financial companies, including BOC Hong Kong, BNP Paribas and Allianz, outperformed. Cash aided performance during the quarter. The largest detractor from relative performance was our inferior stock selection in the United Kingdom, Japan, Norway and Australia, where our high quality, world-leading companies with attractive, visible and growing streams of earnings and dividends underperformed riskier companies with higher levels of operating and financial leverage which outperformed. Our overweight allocation to the United Kingdom and Switzerland and our underweight allocation to Italy, Netherlands, Spain and Japan, hurt performance. Source: Bloomberg Page 3 of 8

4 Portfolio Strategy and Changes Purchases: ING Groep N.V. Netherlands Financials ING Groep N.V. (ING) is a leading global retail and commercial bank with an established position in the Benelux markets and a growing presence in Central and Eastern Europe. Following a significant restructuring program, ING is well positioned to generate higher and more stable returns on equity with a simplified business model that balances the stability of its core markets with the growth of its challenger markets. The bank is significantly geared to a macroeconomic recovery in Europe and remains defensively positioned from an asset quality and regulatory uncertainty perspective given its solid balance sheet and strong capital position. A leader in digital banking technology, ING has had a successful track record of expanding into new markets via digital channels, capturing low-cost deposits and cross selling new lending services such as credit, insurance and asset management products. The bank is committed to being at the forefront of digital innovation and is investing additional capital to create a scalable omnichannel platform that will reduce costs, improve compliance oversight and standardize banking operations across its footprint. Against the backdrop of a potential normalization of interest rates globally, a solid capital position and a management team focused on cost cutting and operational efficiency, ING s commitment to a progressive dividend growth policy is credible and should offer meaningful upside as capital requirements are clarified and earnings growth picks up momentum. Shares of ING trade at 11.8 times forward earnings, 1.0 times book value and offer a 5.3% dividend yield. MMC Norilsk Nickel Russia Materials MMC Norilsk Nickel (Norilsk Nickel) is the largest global producer of nickel and palladium, with top five positions in platinum, cobalt, rhodium, and a strong presence in copper. The company is vertically integrated, with a high-quality resource base, long-life reserve assets, and low-cost production facilities. In the aftermath of Indonesia s ban on ore exports, supply/demand dynamics are expected to normalize and may lead to a global deficit as China depletes its nickel ore stockpiles. With one of lowest production cost structures among global peers and the only large nickel producer with negative cash costs, Norilsk Nickel is best positioned to benefit from rising and expanding profit margins as prices recover. Demand for the company s main exports should be buoyed by rising sales of autos, home appliances, stainless steel applications, and smart grid technologies, among others. The company also stands to benefit from the secular trend towards tighter emissions standards globally, as platinum and palladium are used in auto catalytic converters and other pollution-control devices. Norilsk Nickel has a solid financial standing with a strong balance sheet supported by robust free cash flow. Moreover, the company has a strong track record of shareholder returns and has taken steps to improve its corporate governance profile and its environmental footprint. Norilsk management has reaffirmed its focus on capital and investment discipline, with the aim of delivering on its production, profitability, and dividend targets. Shares of Norilsk Nickel trade at 10.9 times forward earnings and offer a 8.7% dividend yield. Sales: None. Page 4 of 8

5 Outlook With monetary policy in several major developed markets likely having reached the limit of its effectiveness, market participants are increasingly expecting some form of normalization in longterm interest rates, as seen by the 100 basis points move upwards in the 10-year US government bond yield since last July. While we have seen similar rises in long-term government bond yields in the second half of five of the last six years, only for yields to subsequently decline, we are of the view that long-term interest rates will eventually normalize and that investors need to be well positioned for this eventuality. In this regard, a study 1 titled The Case For Global Dividends: Valuations And The Impact Of Rising Rates shows that during periods with +100 basis points moves upward in US long-term interest rates from 1970 to 2012 the global top decile of equities by dividend yield has outperformed the broad market by an annualized 440 basis points. Further, in a study conducted by SCCM Research, international equities have historically delivered a positive return in 75% of periods of rising interest rates and tend to outperform US equities in such periods, as shown by the graph below. Another important point is that rising bond yields tend to be associated with rising inflation expectations. In such periods, equity market multiples tend to moderate and thus it is no surprise that value equities with low price/earnings ratios and strong earnings/dividend growth outperform strongly. Given the flexibility afforded to our strategy by our focus on three key investment variables including 1) low price/earnings ratios, 2) high dividend yields and 3) strong earnings/dividend growth, we believe that we are well positioned across a number of potential interest rate environments. Source: SCCM Research; As of 12/31/2016 Page 5 of 8

6 We continue to believe that our strategy is well positioned from a long-term perspective given the strong outperformance potential from a reversal of the historically extreme multi-year underperformance of 1) international versus US equities and 2) value versus growth equities. It is prudent to note the inherently volatile nature of international and emerging market equities which have been either the best or worst performing asset class in 18 out of the last 20 years and historically the best times to invest are when short-term sentiment and performance trends are weak. Europe s earnings, which over the last forty-one years have tracked those in the United States, have lagged meaningfully in the latest market cycle and have room to surprise, though short-term political uncertainties continue to hold back investor sentiment. Within Europe, our strategy remains to invest in companies with visible long-term earnings growth drivers and/or in global multinationals which are trading at a valuation discount of 20% or greater to their US peers. In this regard, we remain focused on identifying inefficiencies in global equity markets where we are looking for leading companies introducing new and innovative products in attractive and growing industries and led by management teams with an above-average ability to allocate capital efficiently. The dividend discipline remains a key differentiator for our investment strategy over the long-term as shown by a Societe Generale study 2 covering major European equity markets from 1987 to During this period, which entails several challenging market environments, including over 20 occasions when the Euro had short-term movements of 10% or greater versus the US Dollar, the top 20% of European equities by dividend yield were up in US Dollar terms by 35-fold versus a more modest 10-fold for the broader European market. In a world where, until recently, over $10 trillion of sovereign bonds globally offered a negative yield, there is a clear need for sound investment assets that offer sustainable long-term returns, which is exactly what our strategy aims to offer. While continued accommodative monetary policies have created some pockets of froth and excess in asset markets, we believe that over the long-term, fundamentally-driven value investing should deliver meaningful outperformance relative to passive, technically-driven momentum ETFs. With equity price multiples having recovered closer to historical norms, going forward we believe that the bulk of returns will be generated via the components of dividend yield and earnings/dividend growth, which is in line with the long-term norm of equity markets globally. On both these measures we consider our portfolio to be well positioned with a higher, 4.5% dividend yield and a faster and more sustainable dividend growth profile relative to the benchmark MSCI EAFE. Despite the challenging near-term environment, this year 71% of our companies have raised their dividend payments by an average of 9.0% YoY. Strong dividend increasers include BNP Paribas, Nippon Telegraph & Telephone, Japan Tobacco, Michelin, UBS Group, Manulife Financial, Bayer, Deutsche Telekom and Imperial Brands. With strong balance sheets and continued earnings growth, we anticipate that this trend will continue in 2017 and beyond. Best Regards, Jim Cullen Portfolio Manager Rahul Sharma Portfolio Manager Pravir Singh, CFA Director of International Research Page 6 of 8

7 Appendix: Portfolio Exposure and Characteristics As Of 12/31/2016 Portfolio Exposure Sectors % Asset Regions % Asset Consumer Discretionary 6.3 Developed Asia Pacific 15.2 Consumer Staples 16.4 Continental Europe 46.8 Energy 7.9 United Kingdom 21.5 Financials 24.1 North America 7.5 Health Care 14.3 Asia Pacific Emerging 1.8 Industrials 10.3 Europe Emerging 1.5 Information Technology 0.0 Latin America 2.0 Materials 2.0 EMEA 0.0 Real Estate 0.0 Telecommunications 12.3 Developed Markets 90.9 Utilities 2.6 Emerging Markets 5.3 Cash 3.8 Cash 3.8 Total Total Top 10 Countries Top 10 Holdings United Kingdom 21.5 Siemens 3.2 Switzerland 16.0 Nestle 3.0 Germany 12.8 BNP Paribas 2.9 France 11.4 Michelin 2.9 Canada 7.5 ABB Ltd. 2.9 Japan 6.4 Novartis 2.9 Netherlands 4.8 British American Tobacco 2.9 Singapore 3.7 Total SA 2.8 Australia 3.0 Vermillion Energy Inc. 2.8 Hong Kong 2.1 HSBC Holdings PLC 2.7 Portfolio Characteristics Forward Forward Q4 16 Est. Est. Q4 16 Price / Dividend LT Debt / LT DPS LT EPS Market Earnings Yield Capital Growth Growth Cap SCCM Intl High Div ADR $72,939 MSCI EAFE Index $55,304 Source: SCCM Research, BCA Research, Bloomberg Page 7 of 8

8 Disclosure: Schafer Cullen Capital Management (SCCM or the Adviser ) is an independent investment advisor registered under the Investment Advisers Act of This information should not be used as the primary basis for any investment decision nor should it be considered as advice to meet your particular investment needs. The portfolio securities and sector weights may change at any time at the discretion of the Adviser. It should not be assumed that any security transactions, holdings or sectors discussed were or will be profitable, or that future recommendations or decisions will be profitable or equal the investment performance discussed herein. Investing in equity securities is speculative and involves substantial risk. Past performance is no guarantee of future results. Market conditions can vary widely over time and can result in a loss of portfolio value. Individual account performance results will vary and will not match that of the composite or model. This variance depends on factors such as market conditions at the time of investment, and / or investment restrictions imposed by a client which may cause an account to either outperform or underperform the composite or model s performance. A list of all recommendations made by SCCM within the immediately preceding period of not less than one year is available upon request. The strategy depicted in this report has been managed in accordance with the investment objectives of the strategy as determined by the Adviser. The Adviser has selected benchmarks, which in their opinion closely resemble the style of the securities held in the composite or model portfolio of the strategy (e.g. large cap value, small cap value, international, etc.). The securities held in the composite or model are actively managed while the benchmark index is not. Investors should be aware that the Adviser makes no attempt to match the portfolio securities, or the security weightings of the benchmark. The composite or model s performance will be affected greater by the price movements of individual securities as the composite or model is more concentrated, generally less than 100 securities, while a comparative benchmark will generally have between 500 and 2,500 securities where individual security price movements have a lesser affect. An individual cannot invest directly in an index. In the case where this report displays model results, please be aware that such results do not represent actual trading and that results may not reflect the impact that material economic and market factors might have had on the Adviser's decision-making if the Adviser were actually managing clients' money. Model and actual results reflect the deduction of advisory fees, brokerage or other commissions, and any other expenses that a client would have paid or actually paid (Net of Fee performance) and reflect the reinvestment of dividends and other earnings. Schafer Cullen Capital Management, Inc. makes no representation that the use of this material can in and of itself be used to determine which securities to buy or sell, or when to buy or sell them; SCCM makes no representation, either directly or indirectly, that any graph, chart, formula or other device being offered herein will assist any person in making their own decisions as to which securities to buy, sell, or when to buy or sell them. For comparative purposes, the adviser uses the ishares MSCI EAFE ETF. All opinions expressed constitute Schafer Cullen Capital Management s judgment as of the date of this report and are subject to change without notice. 1. The Case For Global Dividends: Valuations And The Impact Of Rising Rates By O Shaughnessy Asset Management as of August Societe Generale Quantitative Team as of December Large capitalization companies in the UK, France, Switzerland and Germany were considered for the study. The high dividend yield basket is based on trailing 12 month dividend yield rebalanced annually. Page 8 of 8