International Value

Market Commentary

Period ended June 30, 2018


After a decline in the first quarter of 2018, the Russell Developed ex-US Index returned -0.5% in the second quarter and is now down -2.2% for the year, in US Dollar terms.  Local currency returns were higher, but US Dollar strength more than offset. The US Dollar’s relative strength over the past decade has nearly halved returns for US Dollar investors’ international portfolios.  Growth stocks once again outperformed value stocks, extending growth’s considerable performance advantage in recent years.  International growth outperformed international value by about 3 percentage points in the quarter and by about 5 percentage points since the beginning of the year.  This growth-favored cycle has served as a brisk headwind for our value-focused approach.  Fortunately, markets move in cycles, and this headwind can shift into a tailwind when value comes back into vogue.

There were large deviations in performance by sector, with energy the most notable standout returning +12% in the quarter as Brent crude prices rose +17%.  Financials were the biggest laggard, returning about -5% in the quarter with European banks declining disproportionately.  We remain overweight both of these sectors as energy continues to represent the most undervalued sector and compelling risk-adjusted opportunities in financials abound.  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% in US Dollar terms. 

The international 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 relative 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 international interest rates 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 merely be investors’ eventual recognition of the wide valuation disparity across equity markets.  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 international index, positioning us well for when the growth/value cycle turns.  The portfolio trades at 8.0x normal earnings compared to 14.0x for the Russell Developed-ex US Index.  The price-to-book value of the portfolio is 1.1x vs. 1.6x for the index.    


The Hotchkis & Wiley International Value portfolio (gross and net of management fees) underperformed the Russell Developed ex-US Index in the second quarter of 2018.  International value underperformed global growth, which served as a headwind for our value focused approach.  More than 25% of the portfolio was invested in stocks trading at a discount to book value compared to less than 15% for the index.  This was a performance detractor as this group underperformed the market considerably.  Stock selection in materials, industrials, and consumer discretionary also detracted from performance.  Positive stock selection in energy, real estate, and healthcare helped relative performance in the period, along with the overweight allocation to energy.  The largest individual detractors to relative performance were WestJet, Societe Generale, Credito Valtellinese, Barclays, and ARRIS International; the largest positive contributors were Frank’s International, Ericsson, Masonite International, Kosmos Energy, and Tesco.    


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.

Royal Dutch Shell is an integrated oil company that operates in four segments: integrated Gas, upstream, downstream, and new energies. We believe that Shell’s upstream business will see higher earnings growth as oil prices normalize. Additionally, Shell’s downstream and gas businesses are insulated from oil prices and are able to generate reasonable returns even at low crude prices. Higher earnings coupled with strong free cash flow conversion will allow Shell to return a meaningful portion of cash to shareholders.

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 International 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 ex-US 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 International Value strategy may prevent or limit investment in major stocks in the Russell Developed ex-US 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  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 as well as emerging market 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