Global Value

Market Commentary

Period ended March 31, 2018
 

MARKET COMMENTARY

In the first quarter of 2018, the Russell Global Developed Index declined -1.1% in US Dollar terms.  The US Dollar weakened between 2% and 3% relative to other major currencies, so in local currency terms global index declined between -3% and -4% in the quarter.  Growth stocks continued to outperform value stocks; growth’s remarkable stretch of recent outperformance is rivaled only by the internet bubble of the late 1990s.  While the broad market’s valuation today is much less extreme today, a number of popular stocks trade at valuation multiples straight out of the late 1990s.  In our view, to justify the current valuations of today’s most loved growth stocks, many things will have to go perfectly right for a very long period.  In our experience, such unbridled optimism is often met with disappointment. We believe that this poses a risk for passive investors because they are, either consciously or naively, allocating capital to excessively valued securities.  Very few people would buy a new house, car, or even a meal without regard to price, yet this discipline is sometimes forgotten when buying stocks. 

Fortunately for disciplined investors that care about price and value, some segments still offer the potential for attractive returns given the risks at hand.  Financials continue to represent the largest sector weight in the portfolio in absolute terms and relative to the benchmark.  Despite strong recent price performance, banks continue to trade at valuations well below their historical averages.  We think that competitively advantaged banks like the ones we own should be able to earn above cost-of-capital returns.  Accordingly, we view 11x normal earnings and a small premium to book value as compelling valuations, particularly considering that the excess capital on their balance sheets reduce the risk profiles dramatically. 

In recent years we have been overweight industrials in our portfolio.  We have found a number of attractively valued, well-managed companies with strong balance sheets and good prospects for growth.  These are cyclical businesses (albeit exposed to different end-markets and different cycles), but we are more than happy to “look through” the cycle and buy businesses at attractive prices relative to normalized earnings when the opportunity is presented.

We have increased our energy weight as the sector has significantly underperformed the market in recent years.  We believe oil prices have been unsustainably low and that a rise in commodity prices will be necessary to bring global supply in line with global demand growth.  Accordingly, we have positions in upstream energy companies that are positively exposed to changes in crude prices, as well as oilfield service providers who stand to benefit from increased activity levels and tightening supply-demand dynamics in their own sub-markets.  We have a strong preference for companies with good balance sheets so that we are not exposed to shareholder dilution in the event the reversion in oil prices takes longer than we anticipate. 

We remain underweight consumer staples because valuations appear a bit rich, but less so today than in the past.  For the first time in several years, we have found new opportunities for investment in the sector.  These new positions possess great brands and growing profits, driven both by margin expansion and top-line growth, particularly in the emerging markets.

Over long periods, global value has outperformed global growth, and we have no reason to believe we have entered a paradigm shift that would change this going forward.  Style shifts can occur quickly and powerfully, and we believe we are well positioned for such a reversion.  We continue to be encouraged by the portfolio’s valuation discount relative to the benchmark. The portfolio trades at 6.9x normal earnings and 1.2x book value, a notable discount to the Russell Developed Index (15.9x and 2.2x, respectively).  We remain committed to maintaining our unwavering dedication to the principals of long-term, fundamental value investing—while fads can drive short term performance fundamentals prevail in the long run.  

ATTRIBUTION: 1Q 2018

The Hotchkis & Wiley Global Value portfolio (gross and net of management fees) outperformed the Russell Developed Index in the first quarter of 2018.  The portfolio’s value approach was a considerable headwind as growth stocks outpaced value stocks globally.  This was a challenge to performance that was overcome by positive stock selection in a variety of sectors.  Positive stock selection in consumer staples, technology, and energy helped relative performance.  Stock selection in consumer discretionary and real estate, along with the overweight exposure to energy hurt.  The largest individual positive contributors to relative performance were Hewlett-Packard Enterprise, Royal Mail, Whiting Petroleum, Popular, and Danieli; the largest detractors were WestJet Airlines, Masonite International, AIG, Wells Fargo, and Vodafone. 

LARGEST NEW PURCHASES: 1Q 2018

Credito Valtellinese is the 10th largest bank in Italy with ~$25B in assets. Like many Italian banks, the Company was struggling with a high level of non-performing loans. We recently participated in a recapitalization of the bank that will enable it to fully repair its balance sheet by selling non-performing loans.  Despite these improvements to the balance sheet and outlook, Credito Valtellinese continues to trade at a low multiple of book value and normalized earnings, and in-line with local peers that have not yet addressed the problems in their own loan books.

Unilever is one of the leading suppliers of consumer goods in the food, home care, and personal care product categories.  Leveraging its brand strength, Unilever has attained #1 or #2 market share across 85% of its business. It is attractively valued and management has implemented plans to expand margins in the coming years while returning capital to shareholders. 

Heineken is the #2 brewer by volume and revenue in the world. It has dominant market share, including #1 or #2 position in 90% of its markets. The company enjoys an attractive embedded growth profile with 60% of profits coming from emerging markets and strong positions in the fast growing and profitable markets of Mexico, Vietnam and Nigeria. The brewing industry is capital intensive with high barriers to entry, as it is not economic to ship beer across long distances and brands take a long time to build. Despite these advantages, Heineken trades at a modest valuation relative to normal earnings.

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 year based on the security’s year-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 year-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.  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 March 31, 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.
 

Index definitions