Cambiar International Equity ADR Commentary Market Review Similar to 2Q market conditions, global equities were mostly positive in the third quarter. As has been the trend throughout 2018, U.S. stocks again led the way, although there was broader participation to the upside across varying geographies. Japan was a notable outperformer, benefiting from stronger corporate profits as well as a weakening Yen. Europe was mixed in the quarter, as gains in Switzerland and France were offset by pullbacks in Italy and the United Kingdom. The weakness in these latter markets was more a function of macroeconomic concerns, vs. stock-specific fundamentals. Uncertainty regarding Brexit and the populist agenda in Italy had investors moving to the sidelines until there is more clarity on both fronts. Trade friction continues to weigh on investor sentiment, although progress with Mexico and Canada are clear steps in the right direction. Revisiting the Why International? Question After outperforming in 2017, international stocks are trailing the U.S. market by a wide margin in 2018, raising the question of why even include international equities in one s asset allocation. To be clear, international equity returns have not exactly dogged it with an annualized return of 8.3% over the trailing seven years. However, these returns pale in comparison to the S&P 500: Annualized Performance (As of 9.30.18) YTD 1 Year 3 Year 5 Year 7 Year 10 Year MSCI EAFE -1.4% 2.7% 9.2% 4.4% 8.3% 5.4% S&P 500 10.6% 17.9% 17.3% 14.0% 16.9% 12.0% Cumulative Performance (As of 9.30.18) YTD 1 Year 3 Year 5 Year 7 Year 10 Year MSCI EAFE -1.4% 2.7% 30.3% 24.1% 74.8% 68.9% S&P 500 10.6% 17.9% 61.4% 92.1% 198.5% 209.6% In Cambiar s opinion, there are three major factors leading to the current divergence between U.S. and international stock performance: 1. Better U.S. corporate earnings growth 2. An out of sync global interest rate regime leading to capital concentration in dollar-denominated assets 3. Financial pressure on Emerging Markets as a consequence of capital concentration into the dollar/capital flight out of EM As we look ahead over the next year, there are three critical macro events that may improve sentiment towards international equities potentially at the expense of U.S. stocks. 1
First, the U.S. Federal Reserve may take a pause in raising rates beyond the anticipated increase in December. Barring a sustained steepening in the yield curve, additional raises could result in a self-induced inversion. A respite in additional tightening would be cathartic for international money flows, although an inversion may at least challenge the global preference for dollars given the ominous financial signal it portends. Second, the European Central Bank (ECB) should begin the process of exiting from QE (slated for December 2018), and normalizing its interest rate regime in 2019. Success on this front would bolster the value of the Euro as well as business confidence, along with ending (or at least mitigating) the capital concentration in dollar assets. On a trade-weighted basis, the Euro (about $1.15 currently) is generally viewed as an undervalued currency, with fair value closer to the $1.25-1.30 level. But given the interest rate differentials and a difficult-to-quash what-if question about bond yields and fiscal sustainability in weaker European countries, it probably continues to trade cheap. Similar to the Federal Reserve s messaging upon exiting QE, the ECB will need to emphasize gradualism and data dependency in communicating its new rules of the road as it stops buying sovereign bonds in massive quantities. ECB President Mario Draghi will step down in late 2019 after a heroic stint, and legacy at this juncture matters. A stronger Euro as an alternative reserve currency to the dollar matters a great deal, and would partially neutralize the strong dollar tourniquet that afflicts EM financial conditions. Alongside European monetary normalization, we expect the terms of the U.K. s Brexit deal to be solidified within the next 12 months, providing closure to another key uncertainty for the markets. Third, China Finds Ways to Grow World demand depends little on Argentina or Turkey, but depends considerably on China. To date, China cut individual tax rates and has let its currency slip a little vs. the dollar, while tightening up the exits by which dollars can leak out of the country. In 2009, China enacted aggressive fiscal and monetary stimulus plans to offset the GFC-induced global recession. These measures worked in aggregate, although much of the spending was widely acknowledged as having questionable merit. Cambiar anticipates a more targeted approach to stimulus, with higher value-added industries getting priority. China s growth has slowed relative to the early 2010s; however, the country s move up the value-added curve to greater prosperity is clear on a broad basis. Beating a drum as to the merits of a true global asset allocation have become difficult, given the spectacular success of U.S. stocks since 2009. However, the virtues of asset allocation and diversification remain, despite the increased skepticism that is inevitable when returns have polarized in one direction or another. Contrary arguments suggest a this time is different conclusion, often a dangerous one to reach. The U.S. economy has more than fully recovered from the depths of the Great Recession, while other major Developed Market economies remain well below potential output. This set of factors has become all the more acute for market returns as the U.S. has normalized its monetary policy amidst full employment conditions. There are a number of reasons to believe that recoveries in international markets may gain steam in 2019-20 alongside international monetary conditions, while the ongoing success of U.S. equities may comparatively run on a bit less steam in the coming years. 2
International Equity ADR CONTRIBUTORS Top Five Avg. Weights Contribution Fast Retailing 1.93 0.28 AerCap Holdings 3.19 0.19 Roche Holding 2.05 0.18 Deutsche Post 2.11 0.17 Kubota Corporation 1.96 0.17 DETRACTORS Bottom Five Avg. Weights Contribution Canadian Natural Resources 2.22-0.19 Intesa Sanpaolo 1.81-0.20 Julius Baer Gruppe 1.83-0.28 Ctrip.com 1.72-0.44 Bayer 1.48-0.58 A complete description of Cambiar s performance calculation methodology, including a complete list of each security that contributed to the performance of the Cambiar portfolio mentioned above is available upon request. Please contact Cambiar at 1.888.673.9950 for additional information. Past performance is no guarantee of future results. YTD 1 Year 3 Year 5 Year 10 Year Since Inception ADR (gross) -0.1% -2.8% 1.4% 7.5% 4.7% 8.4% 6.6% ADR (net) -0.3% -3.2% 0.7% 6.8% 4.0% 7.6% 5.7% MSCI EAFE 1.4% -1.4% 2.7% 9.2% 4.4% 5.4% 3.7% International Equity ADR Composite Inception Date: 2.28.2006 / See Disclosure Performance After notching modest losses in the first two quarters of 2018, international equities (as measured by the MSCI EAFE Index in USD terms) recovered a bit to post a marginal gain in the third quarter. On a style basis, growth stocks again outperformed their value counterparts, although the performance spread was narrow relative to previous quarters. After representing one of the strongest equity categories in 2017, Emerging Markets have incurred a sharp pullback in 2018 which continued in the third quarter. The Cambiar International Equity ADR strategy had its share of bright spots in the quarter, but these gains were unfortunately offset by price weakness elsewhere in the portfolio. The result was a small loss for the strategy in the quarter. Although Cambiar remains constructive on the overall positioning of the portfolio, we recognize that performance is the ultimate proof statement and we are admittedly frustrated that the portfolio has been slow in delivering on this front. That said, some context about the market environment in 2018 is relevant; investor preference for growth has resulted in a challenging backdrop for value investors such as Cambiar. It is worth noting that this growth-over-value relationship appeared to have flipped in September, and the Cambiar portfolio responded accordingly. Should this trend continue (or at minimum growth stops outperforming), we believe the Cambiar portfolio is well positioned to make up some ground. Buy and sell activity was a bit more elevated in the quarter; Cambiar executed six new purchases and four liquidations, in addition to a number of trims/adds to existing positions. Given the strategy s bottom-up discipline, there were no notable themes regarding the trade activity. New holdings came from a variety of sectors, with a geography skew towards Europe. Given the de-rating in EM, a natural question is whether we are seeing more opportunities in this space. The answer is yes, although headwinds remain. We would contend that Emerging Market financial stability remains one of the largest question marks heading into 2019, as competitiveyield pressure from the U.S. and soon-to-be Europe could make matters worse within EM. At an individual stock level, Bayer AG (Healthcare) represented the largest drag on performance in the quarter. The thesis for Bayer was predicated first-and-foremost on the synergistic combination of Monsanto s seeds business with Bayer s Crop Chemicals franchise. Stable/improved performance within the company s pharmaceutical and consumer health divisions were additional catalysts that would support a re-rating in the stock. This investment case was materially altered by the August lawsuit against the company s RoundUp Ready product. Cambiar was aware of the glyphosate case; that said, the ruling was unexpected via the size of the judgment and the precedent that subsequently opened the door for potentially thousands of additional lawsuits. In light of the increased litigation risk and diversion of management focus, we deemed the situation too hard to handicap and subsequently liquidated our position in Bayer during the quarter. Unexpected developments (negative and positive) are part of the business, but a disappointing outcome nonetheless. Positive stock selection within Financials had been a consistent bright spot for the Cambiar portfolio over the past eighteen months, before posting a relatively weak performance in the third quarter. Ongoing uncertainty surrounding Brexit came back into focus during the quarter, resulting in a buyer s strike of sorts for UK equities. UK bank position Lloyds lost ground in 3Q despite the 3
company s profitability, solid cash returns to shareholders (5.1% yield), and in our view, attractive valuation. Additional situations of macro concerns trumping company specifics were the weakness in Banco Santander and Julius Baer, which were penalized in the quarter for their exposure to Emerging Markets. It is our belief, Santander s operations in Brazil are improving, while Julius Baer s growth prospects for private banking services in end markets such as Asia remain intact. Perhaps the most notable example of the macro environment setting the cadence for stocks was Intesa Sanpaolo, which pulled back in response to the current political climate in Italy more specifically, the deficit-spending plans of the populist coalition. Cambiar s view is that these types of events come and go in Italy, and current tensions will undoubtedly pass. We view Intesa to be the best bank in Italy, with one of the strongest capital levels in the European Union. Given the company s track record of profitability and attractive level of cash dividends, we remain investors in the company. In each of these cases (and investing in general), longer-term success often requires looking past the news of the day and remaining focused on the more enduring earnings drivers in a company. The International Equity ADR portfolio was also hampered by lagging returns from Schlumberger and Canadian Natural Resources (CNQ), two holdings in the Energy sector. After recovering in 2Q, CNQ was again hampered by a widening discount in Western Canada Select (WCS) oil prices. Although WCS typically trades at a discount to benchmark West Texas Intermediate (WTI) oil, a combination of high production and strained pipeline infrastructure has offset the benefit of recovering global oil prices. Upon review, the decision was made to sell the position in CNQ and deploy the proceeds into Repsol, a Spain-domiciled integrated energy company. Trading at ~10% free cashflow (FCF) yield and a 6% dividend yield at the time of purchase, Repsol is poised to benefit from the recovery in oil prices as well as a change in refining regulations that should benefit their downstream operations. Cambiar garnered positive contributions in the quarter from software company SAP (Technology), as well as via strong stock selection in Industrials as three of the portfolio s top five individual contributors in 3Q were industrial companies. As a sector, Industrials is the second-largest allocation in the portfolio (Financials is the largest). Yet the underlying companies are diverse in end market, revenue exposure and geography. Examples include a German parcel delivery company, Irish aircraft leasing firm, a Spanish construction company and a Japanese security services company. While positive global growth trends certainly provide a tailwind to many operators in the sector, Cambiar has identified a number of self help catalysts that can also unlock value in the underlying position. On a regional basis, the Cambiar portfolio remains primarily invested in developed markets, with Emerging Markets currently comprising 4% of the portfolio. The portfolio has greater exposure to EM on a revenue basis, as approximately 22% of aggregate portfolio revenues are sourced from EM jurisdictions (source: Factset). Looking Ahead As we look ahead to the final three months of 2018, there is no shortage of pending newsflow for investors to digest continued trade posturing with China, mid-term elections in the U.S., Britain s ongoing negotiations to leave the EU, Italy s fiscal budget, and turmoil in various emerging markets. And these are just the headlines we know about. Needless to say, markets are likely to remain volatile until the market gets a clearer picture of expected outcomes. Cambiar certainly considers the relevant macro inputs as part of our research process; however, the goal is to not let these events dictate buy/sell decisions, as that is a good way to whipsaw the portfolio. Market volatility is not a bad thing as it can produce price dislocations at the individual company level. At a regional level, Cambiar continues to believe that Europe offers an attractive combination of low valuations and low expectations even a modest uptick in either measure could provide a meaningful re-rating in the portfoio s European/UK holdings. We also remain constructive on Japanese equities, while recognizing that the recent rally places increased emphasis on selectivity. Within the Global portfolio, allocation to the U.S. remains at an underweight vs. the index, given more attractive valuations abroad. Above all, the focus at Cambiar remains on identifying quality companies that we believe trade at reasonable valuations, possess competitive advantages vs. their peers, and can produce through-cycle profits. We appreciate your continued confidence in Cambiar Investors. 4
Disclosure Performance: The performance information represents the respective Cambiar strategy composite and may be preliminary. Returns are presented gross and net of management fees and include the reinvestment of all income. Gross and net returns have been reduced by transaction expenses. Net returns are also reduced by actual investment advisory fees and other expenses that may be incurred in the management of the account. Gross returns for Cambiar s International Equity ADR Composite include accounts with both gross and pure gross performance. Pure gross returns, applicable to SMA portfolios, are not reduced by any expenses, which includes transaction costs, and are provided as supplemental information. Brokerage firms which sponsor SMA fee programs apply bundled fees which may include transactions costs, investment management, portfolio monitoring, consulting services, and in some cases, custodial service fees. Net returns for SMA portfolios are calculated by subtracting actual SMA fees reported by the SMA sponsor. Net of fees performance reflects a blended fee schedule of all accounts within the relevant composite. Cambiar clients and mutual fund investors may incur actual fee rates that are greater or less than the rate reflected in this performance summary. Please refer to our Form ADV Part 2A for additional information regarding our investment management fees. Results are reported in U.S. dollars. Index returns include the reinvestment of all income, and assume no management, custody, transaction or other expenses. One cannot invest directly in an index. Cambiar s past results do not necessarily indicate Cambiar s future performance and, as is the case with all investment advisors who concentrate on equity investments, Cambiar s future performance may result in a loss. The top/bottom contributors is for a representative portfolio in the strategy. A complete description of Cambiar s performance calculation methodology, including a complete list of each security that contributed to the performance of the portfolios, is available upon request. Please contact Cambiar at 1-888-673-9950 for additional information. International Equity ADR Benchmark: The MSCI EAFE Index (Europe, Australasia, Far East) is a free float-adjusted, market capitalization weighted index that is designed to measure developed market equity performance, excluding the U.S. & Canada. The index assumes no management, custody, transaction or other expenses. The MSCI EAFE Index is a broadly based index that reflects the overall market performance and Cambiar s returns may not be correlated to the index. Cambiar s performance and the performance of the MSCI EAFE Index include the reinvestment of all income. Benchmark returns are net of withholding taxes. Cambiar typically follows each custodian s treatment of tax withholding and therefore dividends may be presented as gross or net of dividend tax withholding depending on the custodian s treatment. Withholding taxes may vary according to the investor s domicile. Certain information contained in this communication constitutes forward-looking statements. Due to market risk and uncertainties, actual events or results, or the actual performance of Cambiar s client accounts may differ materially from that reflected or contemplated in such forward-looking statements. All information is provided for informational purposes only and should not be deemed as a recommendation to buy the securities mentioned. There is no guarantee that the opinions expressed herein will be valid beyond the date of this presentation. There can be no assurance that the portfolio will continue to hold the same position in companies described herein, and the portfolio may change any portfolio position at any time. The specific securities identified and described do not represent all of the securities purchased, sold, or recommended by Cambiar and the reader should not assume that investments in the securities identified and discussed were or will be profitable. Source: MSCI. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used to create indices or financial products. This report is not approved or produced by MSCI. 5