Global Value

Market Commentary

Period ended June 30, 2017

 

MARKET COMMENTARY

The Russell Developed Index returned +4.3% in the second quarter in US Dollar terms.  Growth stocks outperformed value stocks for the second consecutive quarter, a reversal of value’s brief but considerable advantage in 2016. With global GDP advancing at a lackluster pace since the financial crisis, investors have generally shown a preference for stocks that have exhibited above average growth. This has not only led to growth’s outperformance over this period but also more recently produced a market with narrow leadership. 

All sectors rose during the quarter except energy, which declined 6% as oil prices fell 9%. Healthcare, industrials, and financials were the top sector performers in the quarter. European equities delivered the highest US Dollar return, driven primarily by currency strength (the Euro and Pound appreciated by 7% and 4%, respectively, against the USD).  Of the top 10 developed markets represented in the index, only Canada, Australia and The Netherlands were negative in local currency terms and only Australia (-1%) in USD terms.

Financials have long represented the portfolio’s largest sector weighting, and US banks have comprised a meaningful portion of that exposure.  In late June, the Federal Reserve Board completed its Comprehensive Capital Analysis and Review (“CCAR”) and did not object to the capital plans of any of the 34 participating companies1.  In its press release, the Fed noted that the common equity capital ratio of the 34 banks “has more than doubled from 5.5 percent in the first quarter of 2009 to 12.5 percent in the first quarter of 2017”.  Of the 34 banks reviewed, 26 are public US companies.  These 26 banks were approved to return 100% of earnings to shareholders on average, which in turn equates to an average of 7.5% of their equity value.  We view this as a compelling dynamic for companies that are delivering improved profitability and have not had better balance sheets in our lifetime. 

Our views on the overall market remain unchanged. We are cautious given valuations above long-term historical averages, though see some valuation support provided by generally strong corporate profits and accommodating central banks. That said, we still see significant discrepancies across industries and individual securities, and with this comes opportunity. As we have discussed in the past, in the current low rate environment investors have favored sectors with stable earnings and high dividend payouts (sometimes referred to as “bond proxies”), bidding them up to levels we view as excessive; naturally, we are underweight consumer staples and REITs as a result. Meanwhile we continue to find value in financials, industrials, and energy. Our portfolio trades at a considerable relative discount to the broader market and at what we believe to be an absolutely attractive valuation: 7.8x normal earnings and 1.1x book value compared to 16.0x earnings and 2.2x book value for the Russell Developed Index. 

ATTRIBUTION: 2Q 2017

The Hotchkis & Wiley Global Value portfolio (gross and net of management fees) outperformed the Russell Developed Index in the second quarter.  Positive stock selection in utilities, telecommunications, and technology contributed to the outperformance.  On the negative side, energy was a significant detractor. The largest individual contributors to relative performance were Calpine, Citigroup, CNH Industrial, Office Depot, and Oracle; the largest detractors were Hewlett Packard Enterprise, Marathon Oil, Whiting Petroleum, Embraer, and Barclays.   

PORTFOLIO ACTIVITY: 2Q 2017

During the quarter we added to our holdings of Wells Fargo and Popular, two well-capitalized banks returning a lot of capital to shareholders while trading at single digit multiples of normal earnings.  We also added to our position in Seritage Growth Properties, a deeply undervalued and misunderstood US REIT.  Meanwhile, after performing well recently, we reduced our holdings of Sanofi, Danieli, BAE Systems and Koninklijke Philips in favor of other opportunities within the portfolio.    
 

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1While the Fed did not object to its plan, Capital One is required to address weaknesses in its capital planning process and resubmit its plan.

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. 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.  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, 2017 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 given periods. 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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