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

Transcription

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 continued to moderate in 2018 after their strong gains last year given rising uncertainties on the trade front with the likely near-term introduction of trade barriers and tariffs, which would be harmful to the global economy. A key consideration here is whether these tariffs represent short-term posturing by governments or a long-term structural change in the world order. Against this backdrop of uncertainty, fixed income outperformed equities in most developed countries, long-term interest rates fell and the US Dollar reversed its losses from last year to appreciate against most currencies. In the quarter, Energy, along with non-cyclical sectors such as Healthcare, Utilities and Consumer Staples, outperformed whereas cyclical sectors such as Financials, Consumer Discretionary and Industrials underperformed. By region, Western Europe outperformed Developed Asia and Developed Markets outperformed Emerging Markets. By country, Australia, Canada, Netherlands, United Kingdom and France outperformed, whereas Brazil, South Korea, Italy and Denmark underperformed. By style class, growth outperformed value and large caps outperformed small caps. With momentum-based strategies having led markets higher on a multi-year basis, 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. This is especially in light of the meaningful underperformance over several years of international value equities relative to other asset classes, which could now begin to normalize as international earnings and dividend growth accelerates. Portfolio Performance We underperformed in the quarter as value investments remained out of favor, with MSCI EAFE Value underperforming MSCI EAFE Growth by nearly 300 basis points. Furthermore, Emerging Markets gave up a portion of their strong gains from last year and this impacted some of our direct Emerging Market investments. We continue to believe that our strategy is well positioned to generate alpha and outperform over a full market cycle while taking on less risk as measured by beta, standard deviation and/or down-market capture. Since Q2 YTD 1 Year 3 Year 5 Year 10 Year Incept* SCCM Intl High Div ADR (gross) SCCM Intl High Div ADR (net) MSCI EAFE MSCI ACWI ex US *June 30, Performance for periods greater than 1 year is annualized. 645 Fifth Avenue New York, NY Tel Fax

2 Sector Attribution The largest contributor to relative performance was our overweight allocation to Energy, Healthcare and Consumer Staples and our underweight allocation to Consumer Discretionary and Industrials. We made these allocation decisions based onn the visibility and sustainability of future dividend streams while looking to avoid companies withh high levelss of financial and/or operating leverage. Stock selection aidedd us in Industrials where BAE Systems and Smiths Group outperformed. Cash aided performance during the quarter.. The largest detractor from relative performance was our stock selection in Consumer Discretionary, Information Technology, Telecommunication Services and Healthcare. In many cases our portfolio companies in these sectors were held back by negative short-term factors though we see limited, if any, meaningful impact to the long-term earnings power of these companies. Our overweight allocation to Telecommunication Servicess and Financials and our underweight allocation to Materials and Information Technology hurt performance. We retain confidence in these allocation decisions based on valuations and the long-term outlook for our portfolio companies. Source: Bloomberg, 06/ /30/2018 Page 2 of 8

3 Country Attribution The largest contributor to relative performance was our overweight allocation to the United Kingdom, Netherlands and Ireland and our underweight allocation to Japan, South Korea, Denmark and Spain. Stock selection aided our performance in China, Singapore and Hong Kong. Cash aided performance during the quarter. The largest detractor from relative performance was ourr stock selection acrosss several European countries including Germany, France, Netherlands and Switzerland. In these markets our holdings in cyclicall sectors, including financials, consumer discretionary and industrials, underperformed as market participants appeared to overreact to negative headlines regarding European politics and the prospect of a prolonged global trade war. Our overweight allocation to Singapore, Switzerland, Germany and Brazil and our underweight allocation to Australia and France hurt performance. Source: Bloomberg, 06/ /30/2018 Page 3 of 8

4 Purchases: None. Sales: Japan Tobacco Japan Consumer Staples We exited our position in Japan Tobacco given the company s lackluster recent capital allocation decisions in the form of high priced acquisitions which we believe are destroying shareholder value and its weaker positioning in next generation products. When engaging with management on these issues we found that they did not embrace our point of view. We have used proceeds from this sale to add to our position in Imperial Brands given attractive valuations and have retained our position in British American Tobacco. Page 4 of 8

5 Outlook 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. In this regard, as seen below, international equities currently have the lowest weight in the MSCI World Index in 40 years, at 39.1% versus their long-term by a narrow group of US-domiciled large capitalization growth average weight off 51.7%, as the performance of world equities is being dominatedd stocks. Thus, many investors who look to simply match the exposure of broad global indices are currently underweight international equities despite their meaningfully more attractive valuations at a time when the profitability of international companies has room to rise and international currencies, which are oversold and cheap on a purchasing powerr parity basis, have room to normalize. Further, value as a style remains the most out of favor since the Tech Bubble, following which MSCI World Value returned 75% over the next 7 years (March 2000 Feb 2007) while MSCI World Growth posted negative returns. Thus, in a world of increasingly full asset prices, our international value strategy offers the patient long-term investor with the unique and valuable ability to benefit from the normalization of two major discounts of meaningful proportion, all the while collecting an attractive 4.9% dividend payment. Global Ex-US Equities are Meaningfully Out of Favor Source: BCA Research; As Of 6/30/2018 Over the last five years, certain areas of the international equity landscape, such as Japanese equities (+60%), international small caps (+74%) and international Information Technology companies (+105%) have all meaningfully outperformed MSCI EAFE (+41%) and MSCI ACWI ex US (+37%). While having limited exposure to them due to valuation considerations has hurt our relative Page 5 of 8

6 performance, we believe that these areas of the market offer less compelling investment opportunities going forward. Japanese equities offer the lowest dividend yields globally and have poor corporate governance; international small caps trade at a +20% valuation premium to large caps and tend to outperform earlier in an economic cycle; and Information Technology companies, after outperforming for six straight years in a row, appear fully valued. Given our focus on investing with a price discipline and a long-term outlook, we will continue to avoid overvalued parts of the market, even at the expense of some short-term underperformance and we ask that our clients do the same. Relative performance has also been impacted by the returns of higher dividend-paying equities globally, which have underperformed against the backdrop of rising interest rates in the United States, a phenomenon that has been short-lived historically and typically reverses as fundamentals begin to re-exert themselves. As the study below shows, higher-yielding sectors of the MSCI World index have meaningfully underperformed lower- and non-yielding sectors of the market on both a trailing 12-month and year-to-date basis. Going forward, we would expect that fundamentals, in the form of well-managed companies with high-quality earnings and a disciplined approach to dividends and dividend growth, will come back into favor, driven by upward trends in corporate profitability and inflation. Yield Sectors Weight in MSCI 12 Month YTD Performance World Index Performance (USD) (USD) Source: SCCM Research; As of 6/30/2018 Global asset markets currently are being pulled in several different directions based on a mixed set of signals. On the one hand, current global economic growth is strong, corporate profitability is healthy, companies are growing dividends at the fastest pace in several years, credit spreads remain narrow and inflation, though rising somewhat, largely remains benign. On the other hand, assets markets are trying to price in the impact of a possible prolonged trade war, US short-term interest rates are rising, which tends to depress price/earnings multiples, corporate and sovereign leverage in select cases is high and equity market leadership is becoming increasingly narrow with, for example, only ten stocks accounting for over 200% of the MSCI World return for the first two quarters of this year. Thus, after a prolonged multi-year bull market in global equities, purely beta maximizing and/or momentum-driven strategies no longer make as much sense and risk and reward must be carefully weighted to ensure that satisfactory risk-adjusted results may be achieved. Markets dislike uncertainty and thus the recent sell-off on the back of negative news headlines regarding tariffs and trade wars is understandable. Across our portfolio holdings, we remain underweight investments which would be most adversely impacted in such a scenario, including the manufacturers and retailers of industrial and consumer goods which need to travel across borders. For now, the initial steps from politicians on trade in various countries has been limited in nature and thus the hope remains that these moves mostly represent short-term posturing. Further, the global order in its current form, with some countries running continued large trade surpluses and others running continued large trade deficits, is likely unsustainable. Thus, an attempt at some form of successful restructuring of the current trade paradigm, if done in a rational and rules-based approach, appears reasonable and, if successful, would be a major positive for future sustainable economic growth. The opportunity for cooler heads to prevail and for a positive surprise here, in Page 6 of 8

7 much the same way that political developments surprised positively last year across most major regions of the world, should not be ruled out. While low interest-rates and general investor complacency have driven up overall valuations, we continue to find new and exciting investment opportunities as international markets tend to be more inefficient and the universe of international dividend-paying companies is nearly four times as large as in the United States. Currently, we are actively looking through a broad prospect list of new investment ideas across both cyclical and non-cyclical sectors while gradually looking to prune some existing positions which have performed well and are no longer as attractively valued. In addition, thus far in 2018, 82% of our portfolio companies which have declared dividends have raised their dividend payments by an average of 9.4% YoY. These strong dividend actions come despite near-term equity market volatility, which indicates the confidence our companies have in their long-term earnings outlook. In this regard, strong dividend increasers include Sinopec, Lloyds Banking, British American Tobacco, Telefonica Brasil, United Overseas Bank, Daimler, BNP Paribas, BOC Hong Kong, Unilever, Smurfit Kappa and Imperial Brands. With strong balance sheets and continued earnings growth, we anticipate that this trend will continue in 2018 and beyond. Best Regards, Jim Cullen Portfolio Manager Rahul Sharma Portfolio Manager Pravir Singh, CFA Director of International Research 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. All opinions expressed constitute Schafer Cullen Capital Management s judgment as of the date of this report and are subject to change without notice. Page 7 of 8

8 Appendix: Portfolio Exposure and Characteristics as of 06/30/2018 Portfolio Exposure Sectors % Asset Regions % Asset Consumer Discretionary 6.2 Developed Asia Pacific 12.0 Consumer Staples 12.0 Continental Europe 44.0 Energy 9.9 United Kingdom 23.3 Financials 24.3 North America 5.2 Health Care 13.0 Asia Pacific Emerging 5.0 Industrials 10.3 Latin America 2.0 Information Technology 2.3 EMEA 1.8 Materials 4.5 Real Estate 0.0 Telecommunications 8.6 Developed Markets 84.4 Utilities 2.2 Emerging Markets 8.8 Cash 6.8 Cash 6.8 Total Total Top 10 Countries Top 10 Holdings United Kingdom 23.3 Novartis 3.1 Switzerland 14.5 United Overseas Bank 2.9 Germany 11.2 China Petroleum (SINOPEC) 2.9 France 8.5 Smurfit Kappa 2.9 Netherlands 7.0 Imperial Brands 2.9 Canada 5.2 Nestle 2.9 Hong Kong 3.4 Siemens 2.9 Singapore 3.3 BAE Systems 2.9 Japan 2.8 HSBC Holdings 2.8 China 2.7 Allianz 2.8 Portfolio Characteristics Forward Forward Q2 18 Est. Est. Q2 18 Price / Dividend LT Debt / LT DPS LT EPS Market Earnings Yield Capital Growth Growth Cap SCCM Intl High Div ADR MSCI EAFE Index Source: SCCM Research, BCA Research, Bloomberg Page 8 of 8