SU:CC - ClearBridge International Growth ACWI Ex-US Strategy Q1 2024 Commentary

2024-01-20 08:09:00 ET

Summary

• ClearBridge is a leading global asset manager committed to active management. Research-based stock selection guides our investment approach, with our strategies reflecting the highest-conviction ideas of our portfolio managers.
• International growth equities outperformed as market breadth improved amid signs of softening inflation and monetary tightening reaching its peak.
• The Strategy outperformed its benchmark, supported by strong contributions from our holdings in Europe and the U.K. that continue to overcome economic pressures, as well as a bid to stocks enabling generative AI.
• We were active in the quarter, initiating five positions while closing out six names to manage risk and better position the portfolio for what we expect to be a more conducive environment for growth stocks in 2024.

By Elisa Mazen, Michael Testorf, CFA, & Pawel Wroblewski

Preparing for a More Conducive Growth Market

Market Overview

International equities rebounded in the fourth quarter, sparked by moderating inflation and plunging bond yields in the U.S. and Europe. The benchmark MSCI All Country World Ex-U.S. Index advanced 9.75% for the quarter, while the MSCI Emerging Markets Index added 7.87%.

In an indicator of improved market breadth, the MSCI ACWI Ex-U.S. Small Cap Index rose 10.20%. This followed the first three quarters of the year when small and mid-cap stocks in Europe and other regions underperformed. While narrow leadership in international markets has not merited the same attention as the dominance of the Magnificent Seven in the U.S., outperformance in the benchmark has generally been limited to large-cap companies, many with a technology bias, as well as regions like Japan benefiting from accommodative monetary policy.

A more palatable yield environment supported growth stocks, enabling the MSCI ACWI Ex-U.S. Growth Index to climb 11.12% for the quarter and outperform the MSCI ACWI Ex-U.S. Value Index by 269 basis points.

Exhibit 1: MSCI Growth vs. Value Performance

As of Dec. 31, 2023. Source: FactSet.

The ClearBridge International Growth ACWI Ex-US Strategy outperformed the benchmark for the quarter, supported by contributions in the traditional growth sectors of consumer discretionary and information technology ((IT)). Further, we believe conditions conducive to growth outperformance will be more prevalent in the year ahead, from factors such as a more benign rate environment and more challenging overall macro backdrop, with economies already slowing through 2023. Room for continued fiscal stimulus measures, which has benefited a broader group of stocks, is also more constrained than previously. We continue to maintain a diversified portfolio across sectors and regions, focusing on our valuation approach to growth and risk management, a setup that should keep us well-positioned to participate in a potential growth resurgence as financial conditions loosen.

Despite these risks, our holdings in Europe and the U.K. found their footing in the fourth quarter, with eight of the top 10 individual contributors coming from these regions. Irish building materials supplier CRH, which has demonstrated strong value creation through M&A and optimization of its portfolio assets over the last several quarters, rose strongly on positive sentiment after its investor day highlighted the company’s accelerating growth in the U.S.

Another welcome change has been the recognition of generative artificial intelligence ((AI)) opportunities for companies outside the U.S. While our IT holdings trailed their mega-cap U.S. counterparts for most of the year, semiconductor equipment maker ASML, which we consider an enabler of AI, as well as enterprise software maker SAP and IT consultant Accenture, which we see as facilitators of AI adoption in new product lines and/or enhanced business models, rose strongly in the quarter. Additional outperformers included RELX, a publisher of law and related business trade information, and Thomson Reuters, a business services conglomerate with leading positions across media and other industry verticals, which own large, proprietary data sets and stand to become key beneficiaries of the processing power of the large language models that drive generative AI. These companies are rolling out new, AI-enhanced products at higher prices which should positively impact earnings in the near term.

These gains, and the tailwinds of a period of growth outperformance, were partially offset by weakness among the Strategy’s industrial and energy holdings.

Portfolio Positioning

We were active in the quarter, initiating five positions while closing out six others. The largest addition was the opportunistic purchase of Hoya, a high-quality manufacturer of technology products and healthcare instruments based in Japan. Hoya maintains high rates of innovation and a strong focus on attractive market niches such as optical products critical for the manufacturing of semiconductors. We believe the market underestimates the durability of earnings growth of this franchise. Also in Japan, we added SMC, a secular grower in the industrials sector well-positioned for continued share gains in the growing markets of manufacturing automation for semiconductors, rechargeable batteries and others. New purchase Hexagon, in the IT sector, is a Swedish designer of a broad range of technology and scientific applications including industrial control and automation, design and cyber security solutions.

Our largest sales were Tencent (TCEHY), Kering (PPRUF) and CAE (CAE). While the business of Chinese social media, online advertising and fintech provider Tencent has recovered post-COVID, the continued regulatory uncertainty in China and weak consumer confidence have undermined the expected speed of further market improvement. Kering, a French luxury retailer with a flagship brand in Gucci, has not shown the progress we expected when we purchased the stock earlier in the year, leading us to sell the position. We took profits in Canadian aerospace and defense training provider CAE to fund better opportunities, as the post-COVID recovery in civil pilot training has already progressed well and earnings have recovered.

As part of our fundamental research on new and existing holdings, we engage our portfolio companies regularly on ESG issues germane to their business model and profitability. During the quarter, ClearBridge led an annual engagement on behalf of the Access to Medicines Index (“ATMI”) with portfolio holding Novo Nordisk. Novo provides insulin to 46,000 children in low- and middle-income countries (LMIC), making progress toward the company’s goal of 100,000 by 2030. The company needs both deeper penetration in existing countries and to add new ones to achieve its goal. In recognition of current conflicts and humanitarian challenges, Novo has also made outright donations of insulins to Ukraine and to NGOs helping the people of Gaza.

Novo would like to run its LMIC access programs as a viable and sustainable business, not solely a donation program, providing an incentive to the company and to the employees involved in its LMIC efforts. Notably, despite supply shortages of its blockbuster GLP-1 therapeutics due to production backlogs, the company explicitly prioritizes maintaining current insulin production “because of its moral obligation to do so.”

Outlook

One of the greatest headwinds to growth stock performance over the last two years, tightening liquidity due to higher yields, could abate as the new year unfolds. The ECB and BoE are expected to commence rate cuts as early as the first half of 2024 as inflation continues to normalize toward central banks’ target range and labor costs moderate. Consumers also appear well-positioned to weather a mild economic downturn, which could lead to a pickup in demand. Areas including consumer staples, health care and other long-duration growth sectors outside the U.S. did not work in 2023. In watching for a broadening of international market leadership, we are hopeful that an extended decline in rates can start to benefit these laggard areas of growth.

Exhibit 2: International Valuations Look Attractive

As of Dec. 31, 2023. Source: FactSet, MSCI, S&P.

However, equity performance improvement will also be dependent on earnings, which are expected to remain soft outside the U.S. through the first half of 2024 due to tough comparisons. Europe continues to face other challenges such as the fiscal spending required to continue to the secular transition to electric vehicles. Canada, which represents a meaningful allocation in the Strategy, is also flirting with contraction as its economy is more resource-dependent than the services-driven U.S. Successfully navigating this environment will require vigilance of consumer behavior, policy moves and focusing our research on self-funding, cash-generative businesses that can outperform through a macro transition.

We are paying particular attention to Japan, which remains an outlier among global equity markets in several ways. Among developed markets, Japan is the only one which has not raised policy rates. Inflation has been muted but is approaching the level where the Bank of Japan is likely to abandon its negative interest rate regime. Given cash rich balance sheets on the corporate side and 50% of Japanese consumer assets in cash, even a small rate rise should be beneficial.

We have discussed in past commentaries the multiple programs underway to improve profitability and encourage more equity ownership. There are several small measures coalescing and combining with the push from the government to improve capital returns to shareholders. Share buybacks are growing tremendously in Japan and are becoming a meaningful component of stock performance.

Portfolio Highlights

During the fourth quarter, the ClearBridge International Growth ACWI Ex-US Strategy outperformed its MSCI ACWI benchmark. On an absolute basis, the Strategy experienced gains across nine of the 10 sectors in which it was invested (out of 11 total) with the IT, consumer discretionary and industrials sectors the primary contributors while the energy sector was the lone detractor.

On a relative basis, overall stock selection and sector allocation contributed to performance. In particular, stock selection in the consumer discretionary, communication services, materials and health care sectors, an overweight allocation to the IT sector and an underweight to the energy sector and aided results. Conversely, stock selection in the industrials and energy sectors and an overweight to health care detracted the most from performance.

On a regional basis, stock selection in the U.K., emerging markets and Europe Ex U.K. and an underweight to emerging markets and overweight to Europe Ex U.K. supported performance while stock selection in Asia Ex Japan proved detrimental.

On an individual stock basis, the largest contributors to absolute returns in the quarter included ASML ( ASML ), SAP ( SAP ) and Taiwan Semiconductor ( TSM ) in the IT sector, Novo Nordisk ( NVO ) in the healthcare sector and London Stock Exchange Group ( LDNXF ) in the financials sector. The greatest detractors from absolute returns included positions in argenx (ARGX) and Daiichi Sankyo ( DSKYF ) in the healthcare sector, Shiseido ( SSDOY ) in the consumer staples sector, Suncor Energy ( SU ) in the energy sector and Hong Kong Exchanges and Clearing ( HKXCF ) in the financials sector.

In addition to the transactions mentioned above, we initiated positions in Ferrari in the consumer discretionary sector and Pro Medicus in the healthcare sector. We also exited positions in Sandvik (SDVKF) and MonotaRO (MONOY) in the industrials sector and Wendel in the financials sector.

Elisa Mazen, Managing Director, Head of Global Growth, Portfolio Manager

Michael Testorf, CFA, Managing Director, Portfolio Manager

Pawel Wroblewski, CFA, Managing Director, Portfolio Manager

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Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

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