2023 YEAR IN REVIEW
Market volatility creates opportunities for an investor willing to think differently. In 2022, when technology stocks sold off sharply, our team identified Workday (WDAY) as a compelling value opportunity – a very good business trading at a deep discount to what we believed it was worth. We purchased Workday in late 2022 and were quickly rewarded when the company’s share price rallied in 2023.
Not every investment works out quite that well or that fast. For instance, we initially purchased GE in 2018, early in the company’s turnaround. This turnaround was complicated by the global pandemic, which significantly disrupted GE’s aerospace business. However, we remained patient, as we saw considerable value in GE that was not reflected in the share price. Our patience paid off in 2023 when shares of GE rose significantly.
Meanwhile, energy stocks were a weak spot in the portfolio during the year, and we also experienced some pressure in healthcare, with both CVS and Elevance down modestly. We are still waiting for signs of operating improvement from underperforming businesses like Citigroup and Ericsson. Their share prices have disappointed, and while we see a lot of value in these businesses, this may not change until the companies start delivering better results.
As a result of the contributions from Workday, GE, and a number of other investments, the Hotchkis & Wiley Global Value strategy returned 28% net-of-fees in 2023. This was a strong result in a year when growth stocks meaningfully outperformed value.
Today, after a lot of movement over the past two years, we find ourselves in a market environment that looks very similar to where we were at the start of 2022. Value spreads are wider than normal.
Chart 1: Valuation Spreads – World Growth vs. World Value
This means that while some parts of the market do not look compelling (much of mega-cap tech, for example), opportunities still exist when you start to move away from the “Magnificent Seven”.
For starters, Europe trades at an unusually large discount to the US market. We think some spread is warranted but question whether the current gap is justified.
Chart 2: Price-to-Earnings Dispersion – US vs. Europe
We’ve found some interesting ideas through our bottom-up research process and have just under 32% of our portfolio in Europe (vs. 15% for the MSCI World). Notable holdings here include Siemens, an industrial conglomerate with a fast-growing but under-appreciated software business, and the advertising holding company group WPP, which is facing some short-term cyclical headwinds.
In the US, we believe there has been multiple expansion in some areas that is unsustainable. We obviously want to try and avoid these areas. Instead, we see good value in parts of health care such as insurance and medical device maker Medtronic. We also continue to maintain overweights to banks and energy. We added some high-quality regional banks in 2023 when those stocks sold off.
While value looks inexpensive relative to growth, absolute valuations for these stocks are not far out of line with historic norms. We are not afraid to lean in with big weights when the right opportunities present themselves, but when those situations grow scarcer, we adjust. We added a few names to the portfolio in 2023, growing our holdings from 51 at the start of the year to 60 at year-end. This is the highest it’s been since 2018, though still within our target range. We believe these actions have improved the diversification and resiliency of the portfolio.
Our portfolio looks very different from the market, as you can see from our high active share (93 as of 12/31/23; 5-year average = 92) and geographic / sector positioning. As a result, we have a valuation profile and long-term return opportunity that we believe is considerably more attractive than the benchmark’s.
It’s hard to predict what the market is going to do in the short term. If value outperforms, we think we’ll do well, as we have in the past. If growth further extends its advantage, this is a headwind (not insurmountable, as 2023 demonstrated). In the long term, we think security selection matters more than market cycles. We are confident that if we continue buying good assets well below their worth, we can continue to deliver good returns.