Global Value

Market Commentary

Period ended June 30, 2018
 

MARKET COMMENTARY

After a small decline in the first quarter of 2018, the Russell Developed Index returned +2.1% in the second quarter and is now up +1.0% for the year, in US Dollar terms.  Local currency returns were higher (both US and ex-US developed markets returned between 3 and 4%) but were offset by a strengthening US Dollar. The positive performance from global equities suggests that for the time being, investors are choosing to focus on strong corporate earnings as opposed to trade war risks and geopolitical tensions.  Global earnings grew more than +30% year-over-year in the most recently reported quarter, with more than 1,000 companies in the ~7,000 stock index reporting earnings growth of more than 50% from a year ago.  Interestingly, the composition of this fastest-growing cohort was broadly distributed across sectors even though stock performance across sectors has varied significantly. 

There were large deviations in performance by sector, with energy as the most notable standout returning more than +13% in the quarter with Brent crude prices rising +17%.  Financials were the biggest laggard, returning about -4% in the quarter with European banks declining disproportionately.  We remain overweight both of these sectors, though we trimmed some of the strongest performers in energy and added/increased exposure to two European banks and a large Japanese insurer that represent compelling valuation opportunities.  We have found few opportunities in emerging markets with attractive valuations for the risks at hand; this quarter, emerging markets returned about -4% in local currency and about -8% for a US Dollar investor. 

Growth stocks continued to outperform value stocks globally.  Growth outperformed value by about 4 percentage points in the quarter, by about 8 percentage points year-to-date, and by more than 10 percentage points over the past 12 months.  While we do not like to underperform our benchmark, which is core rather than value, we are generally pleased to have lagged by a modest magnitude over the past year considering the brisk headwind our value approach has faced.  Fortunately, markets move in cycles, and this headwind can shift into a tailwind when value comes back into vogue.

The global equity market’s valuation appears above average, but this is heavily influenced by certain market segments that we view as considerably overvalued. Valuation spreads are wide. In light of value’s underperformance, we are often asked what would serve as the catalyst to bring value back into vogue; unfortunately we do not have a definitive answer.  A rise in interest rates across the globe should favor value stocks, which are shorter duration instruments than growth stocks.  A global economic slowdown could favor value if the revenue/earnings projections for growth stocks fail to live up the rosy expectations embedded in the elevated valuation multiples.  Perhaps the “catalyst”, will be investors’ eventual recognition of the wide valuation disparity across equity markets, as has often been the case.  While the timing is uncertain, we are confident that the cycle will shift in favor of value once again.

The portfolio continues to trade at a considerable valuation discount the global index, positioning us well for when the growth/value cycle turns.  The portfolio trades at 7.6x normal earnings compared to 16.0x for the Russell Developed Index.  The price-to-book value of the portfolio is 1.1x vs. 2.2x for the index.  

ATTRIBUTION: 2Q 2018

The Hotchkis & Wiley Global Value portfolio (gross and net of management fees) outperformed the Russell Developed Index in the second quarter of 2018.  Positive stock selection trumped the value headwind in the quarter as energy, consumer staples, and real estate led the way.  The overweight exposure to energy also helped, as this was the top-performing sector for both the portfolio and the index. As noted above, global value underperformed global growth, which served as a headwind for our value focused approach.  The largest individual contributors to relative performance were Whiting Petroleum, Ericsson, Discovery, Kosmos Energy, and Frank’s International. The largest detractors were WestJet, Societe Generale, Hewlett Packard Enterprise, Barclays, and Credito Valtellinese.  

LARGEST NEW PURCHASES: 2Q 2018

Tokio Marine is a property-casualty insurer domiciled in Japan. The company is the 3rd largest P&C insurer in its home market, as measured by net written premiums. It also has a sizeable presence in North America resulting from several acquisitions completed over the past decade. We are attracted to the sustainable earnings power of Tokio Marine’s diverse insurance operations, the excess capital on the balance sheet, and the improving governance and financial performance. Stable margins and a focus on capital efficiency should drive an expansion in return on equity and deliver better-than-expected growth in earnings and book value per share. Despite these attractive attributes, Tokio Marine shares trade at less than 0.75x book value and a single-digit multiple of normal earnings.

ING is the largest Dutch bank, providing retail and wholesale banking services to private clients, small businesses, large corporations, financial institutions, and governments. The Netherlands and Belgium account for 50% of revenue with the majority of the remaining revenue from elsewhere within Europe. ING is healthy: asset quality is good, the Company’s capital position is strong, and operations are profitable. ING trades at low multiples of current and normal earnings, and pays out more than 50% of its earnings.

Amerco, through its primary subsidiary U-Haul, offers truck, trailer, and self-storage rentals across its 22,000 locations in the US and Canada.  U-Haul, with more locations than all US rental car companies combined (10x larger than its next largest competitor), is the unrivaled US leader in “DIY” moving and storage.  In addition, the Company has significant optionality in its self-storage business and real estate assets.  These advantages, combined with Amerco’s attractive valuation, make the stock compelling.

Composite performance for the strategy is located on the Performance tab. Returns discussed can differ from actual portfolio returns due to intraday trades, cash flows, corporate actions, accrued/miscellaneous income, and trade price and closing price difference of any given security. Portfolio attribution is based on a representative Global Value portfolio. Certain client portfolio(s) may or may not hold the securities discussed due to each account’s guideline restrictions, cash flow, tax and other relevant considerations. Equity performance attribution is an analysis of the portfolio's return relative to a selected benchmark, is calculated using daily holding information and does not reflect management fees and other transaction costs and expenses.  Specific securities identified are the largest contributors (or detractors) to the portfolio’s performance relative to the Russell Developed Index. Other securities may have been the best and worst performers on an absolute basis.  The “Largest New Purchases” section includes the three largest new security positions during the quarter based on the security’s quarter-end weight adjusted for its relative return contribution; does not include any security received as a result of a corporate action; if fewer than three new security positions at quarter-end, all new security positions are included.  Securities identified do not represent all of the securities purchased or sold for advisory clients, and are not indicative of current or future holdings or trading activity.  H&W has no obligation to disclose purchases or sales of the securities.  No assurance is made that any securities identified, or all investment decisions by H&W were or will be profitable. The value disciplines used in managing accounts in the Global Value strategy may prevent or limit investment in major stocks in the Russell Developed Index and returns may not be correlated to the index. Quarterly characteristics and portfolio holdings are available on the Characteristics and Literature tabs. For a list showing every holding’s contribution to the overall account’s performance and portfolio activity for a given time period, please contact H&W at hotchkisandwiley@hwcm.com.  Portfolio information is subject to the firm’s portfolio holdings disclosure policy.
 
The commentary is for information purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Portfolio managers’ opinions and data included in this commentary are as of June 30, 2018 and are subject to change without notice.  Any forecasts made cannot be guaranteed.  Information obtained from independent sources is considered reliable, but H&W cannot guarantee its accuracy or completeness. Certain information presented is based on proprietary or third-party estimates, which are subject to change and cannot be guaranteed. Equity securities may have greater risks and price volatility than U.S. Treasuries and bonds, where the price of these securities may decline due to various company, industry and market factors.  Investing in value stocks presents the risk that value stocks may fall out of favor with investors and underperform growth stocks during a given period. The strategy invests in foreign securities which involve greater volatility and political, economic and currency risks and differences in accounting methods. All investments contain risk and may lose value. 
 
Past performance is no guarantee of future results.
 

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