Global Value

Market Commentary

Period ended March 31, 2019
 

MARKET COMMENTARY

After falling -13.4% in 4Q 2018, the MSCI World Index returned +12.5% in the first quarter of 2019. The swift decline and equally rapid recovery appear to have both been triggered by changes in investor sentiment as opposed to changes in underlying economic or business fundamentals.  Investor concerns emerged late in 2018 regarding trade tensions and hawkish central bank action/language; this combination created fears of impending global economic recession.  These concerns appeared to fade somewhat during the first quarter of 2019 due to positive progress on US/China trade talks and dovish central bank commentary that moved interest rates lower.  All MSCI World sectors were positive in the first quarter, with the best returning +20% (technology) and the worst returning +8% (healthcare).  The MSCI World’s forward P/E ratio increased from 14.3x at the end of 2018 to 15.7x at the end of the first quarter, which matches the index’s median valuation over the past ~20 years.  While the valuation is now about average, it is considerably lower than the 18x level where it began 2018. 

We view the overall global equity market as fairly valued, but believe that there is a large valuation disparity between certain segments of the market. Banks in our opinion remain a particularly attractive value. Banks in the MSCI World Index trade at 9.6x forward earnings.  The median multiple for this group since 2002 (earliest data available) is 11.3x, so the group currently trades at about 85% of its historical average.  Considering that banks’ balance sheets are as strong as they have been in decades, and the majority of earnings are being returned to shareholders via dividends and share repurchases, we view banks’ risk/reward tradeoff as especially compelling.  The portfolio’s banks trade at an even lower valuation (7.8x consensus earnings and 6.0x normal earnings) with a payout yield of 7% (dividends + share repurchases as a percentage of total equity).  Less attractive to us at current prices are utilities. The MSCI World’s utility sector trades at 17.2x forward earnings.  The median multiple for utilities since 2002 is 15.4x, so the group currently trades at 112% of its historical average.  Unlike banks global utilities have added financial leverage, increasing net debt to EBITDA by 25% over the past decade from 3.6x to 4.5x.  Utilities can support higher debt levels than most other businesses, but paying high multiples for slow growing businesses with increased leverage is not an attractive proposition in our view.  Reflecting these considerable valuation dispersion across sectors, the portfolio exhibits large sector deviations from the benchmark. 

The MSCI World Growth Index outperformed the MSCI World Value Index in the quarter by about 4.6 percentage points (+14.8% vs. +10.2%); since the beginning of 2017, global growth has outperformed global value by 22 percentage points (+37% vs. +15%).  Interestingly, the combination of earnings growth plus dividends paid has been similar for the underlying growth and value companies over this period.  The performance difference, therefore, is almost entirely explained by changes in price multiples.  The P/E ratio for the Value index has contracted by more than 20% while the P/E ratio for the Growth index has contracted by about 5%.  This repricing has contributed to not only the large valuation differences across sectors but also to notable spreads within sectors.  Given this backdrop, we have been able to build a portfolio that trades at a large discount to the market.  The portfolio’s forward price-to-earnings ratio is just 82% of the MSCI World Value’s P/E compared to the long term average of 88%; the portfolio’s forward price-to-earnings ratio is just 53% of the MSCI World Growth’s P/E compared to the long term average of 67%.  As active investors with a commitment to long-term fundamental valuation, we view this environment as conducive to our approach and we are optimistic about the portfolio’s prospects.  

ATTRIBUTION: 1Q 2019

The Hotchkis & Wiley Global Value portfolio (gross and net of management fees) underperformed the MSCI World Index in the quarter.  Global growth stocks outperformed value stocks by about 4.6 percentage points in the quarter, which was a significant headwind for our value focused approach; the portfolio (gross and net of management fees) outperformed the MSCI World Value Index in the quarter.  Relative to the broad benchmark, the portfolio’s overweight and stock selection in financials detracted from performance.  The outsized position in European banks hurt; the group now trades at valuation levels not seen since the financial crisis, despite dramatically improved balance sheets, improved profitability, and payout yields in the mid-to-upper single digits.  Stock selection in consumer discretionary also detracted from performance, largely due to auto and auto supplier exposure amid weak guidance from several OEMs.  While the near-term outlook for auto production is uncertain, we own a collection of well-positioned OEMs and suppliers at attractive valuations that should sustain and grow value through the cycle.  Stock selection in energy was the largest positive contributor to relative performance, driven by exploration & production exposure as crude prices rose 25%; positive stock selection in real estate also helped.  The largest individual detractors to relative performance in the quarter were Societe Generale, Royal Mail, Embraer, Vodafone, and Whiting Petroleum; the largest positive contributors were General Electric, Ophir Energy, Seritage Growth Properties, Kosmos Energy, and WestJet Airlines.  

LARGEST NEW PURCHASES: 1Q 2019

Airbus is an OEM of commercial aircraft (the majority of sales and profits), civil and military helicopters, commercial space launch vehicles, missiles, military aircraft, satellites, defense systems and defense electronics. The commercial aircraft industry is enjoying an unprecedented period of prosperity, with higher travel demand, high aircraft utilization rates, new markets/routes, strong airline profitability and record demand for new planes. Airbus also enjoys the benefits from being one of only two global suppliers of large commercial aircraft. Airbus should grow earnings and cash flow from maturing programs, operating leverage on higher rate schedules, rising efficiency, less cyclical production schedules, supplier concessions, rising aftermarket activity, and more. The sum of these factors suggests significant EPS growth in the coming few years.

Medtronic PLC is a diversified medical device company with dominant market positions in several segments. While the Company trades at a higher multiple of normal earnings than much of the portfolio, we believe that Medtronic has superior prospects for growth at high incremental returns. The small position is diversifying to the portfolio, which is meaningfully underweight the healthcare sector.

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 characteristics and attribution based on 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 MSCI World 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 during the quarter, 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 discipline used in managing accounts in the Global Value strategy may prevent or limit investment in major stocks in the MSCI World, MSCI World Value and MSCI World Growth indices and returns may not be correlated to the indexes. 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, 2019 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. 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 as a basis for other indices or any securities or financial products. This report is not approved, reviewed, or produced by MSCI. See www.hwcm.com/definitions for full disclaimer.
 
Past performance is no guarantee of future results.
 

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