BUDFF - ClearBridge International Value Strategy Q2 2023 Portfolio Manager Commentary

2023-07-13 12:59:00 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 markets generated positive returns, as economic resiliency in the U.S. and Europe, demand for artificial intelligence (AI) and strong returns in Japan helped to overcome disappointment in the pace of China’s reopening.
• The Strategy outperformed its benchmark, as strong results in the consumer discretionary and industrials sectors helped to offset idiosyncratic factors in consumer staples.
• We continue to maintain our overweight to Europe, are looking for new opportunities in Japan and favor the long-term prospects of the industrials sector.

By Sean Bogda, CFA, Grace Su and Jean Yu, CFA, PhD

International Markets Rise Despite China Concerns

Market Overview

International markets generated positive returns in the second quarter, as investor demand for artificial intelligence ((AI)) related stocks in the U.S. and strong returns from the Japanese market helped to overcome disappointment in the slower-than-expected pace of China’s reopening. The benchmark MSCI All Country World ((ACWI)) Ex U.S. Index returned 2.44% for the period. Value stocks outperformed growth stocks during the quarter, with the MSCI ACWI Ex U.S. Growth Index returning 1.94% versus the 2.95% return of the MSCI ACWI Ex U.S. Value Index (Exhibit 1).

Exhibit 1: MSCI ACWI ex U.S. Value vs. Growth Performance

As of June 30, 2023. Source: FactSet.

Investors continue to be frustrated by the sluggish pace of the Chinese reopening. Entering the year, the return of China received much fanfare as the potential economic catalyst that could help stave off a global recession and spur demand for energy and commodity markets. However economic indicators in the first and second quarter have deflated hopes of a strong economic revival, instead showing a malaise as high unemployment, declining real estate prices and a lack of replacements for the outsized goods orders placed during the COVID-19 pandemic have weighed on confidence in the country’s economy and policies.

Japan proved to be a major beneficiary of the waning confidence in China and saw strong returns during the quarter as investors pivoted their attention to other Asian markets. After languishing with decades long deflation, the second quarter saw Japan register positive inflation for the first time, sparking optimism that the country could see increases in wages that could help power its domestic economy higher. With the government pursing more investor-friendly policies such as pressuring companies with lower valuations to implement initiatives to raise their share prices, investors have become more optimistic about the country due to greater transparency in corporate governance. We too are encouraged by the early progress on corporate reform, but also recognize that Japan is a market where sentiment and euphoria often exceed actual substantive change. Thus, as we are looking to add exposure to the country, we remain focused on finding high-quality businesses that have long-term competitive drivers.

In the West, signs of moderating inflation and a decline in energy prices helped to boost European markets. Despite also generating positive returns, stubborn inflation in the U.K. continued to weigh on investor perceptions of its markets, which caused it to lag its European peers. U.S. markets also benefited from signs of slowing inflation and economic resiliency and received additional tailwinds from investor enthusiasm and demand for AI-related mega cap tech stocks (whose concentrated performance among a select few companies constituted a majority of overall market returns). The strong performance by U.S. markets year-to-date has helped to further widen the relative valuation gap between U.S. and European markets, which we believe creates even stronger return potential for European companies for the foreseeable future.

The ClearBridge International Value Strategy outperformed its benchmark in the second quarter, as a combination of stock selection in consumer discretionary and industrials, as well as positive allocation effects such as our underweight to communication services helped to overcome detractors from the consumer staples and communication services sectors.

"Consumer spending in developed markets continues to be resilient and helped overcome recessionary fears."

Stock selection in the consumer discretionary sector was the largest contribution to relative performance during the period, as consumer spending continues to be resilient and helped overcome recessionary fears. Within the sector our top performing holding was Industria de Diseno Textil ( IDEXY ) (also known as Inditex), a Spanish fast fashion retailer of clothing, footwear and accessories under its Zara, Pull & Bear and other brands. Shares rallied after the company posted strong quarterly sales and net income growth, as well as positive early reviews of its new summer fashion line. The company has an excellent history of execution, as well as its continued operational investments. The company has also benefited from its geographical footprint through its locations in European vacation and travel destinations, as vacationers seek out its brands for their perceived trendy, high-fashion products. Compass Group ( CMPGF ), a U.K.-based foodservice and hospitality services company, also saw its stock price appreciate during the quarter after it raised its full year operating guidance and announced a £750 million share buyback program. The company continues to see strong performance across its business sectors, particularly in its catering division, as it rebounds from the COVID-19 pandemic and a shift towards more in-office work, and expansion into North America.

Our holdings in the industrials sector also proved beneficial to returns, as resilient economic indicators, receding recessionary fears and better than expected earnings supported results. The sector included our top individual performer for the quarter, Marubeni ( MARUY ), which engages in various business activities including manufacturing apparel, textile materials, smelting and refining of aluminum, real estate management and offers insurance, technical and logistical services, and which benefited from the rally in Japanese markets. Additionally, the announcement that Berkshire Hathaway ( BRK.A )( BRK.B ) would be increasing its investment stake in the company helped to shed further light on the company’s compelling valuation relative to its long-term opportunities.

Stock selection in the consumer staples sector was the main detractor from relative performance during the quarter, as specific idiosyncratic factors weighed on our holdings. For example, Anheuser-Busch InBev ( BUD ), a Belgian-based multination brewing company, saw its share price decline following controversy surrounding a U.S. promotion featuring a transgender social media influencer which resulted in a decline in sales and dethroning of its Bud Light brand as the top-selling global beer. We believe the market’s reaction has been drastically overblown considering the decline in Bud Light sales represents merely 1% of the company’s global volumes. We continue to have high convictions in the stock due to it having the highest margins in the industry, attractive geographic footprint and brand recognition in most of the world’s major beer markets and our belief that its market price continues to be significantly discounted from its intrinsic value.

Australian-based Treasury Wine Estates ( TSRYY ), also in the consumer staples sector, saw its share price slip during the quarter. We originally entered the position due to an exceptionally compelling entry point in 2020 after diplomatic disputes resulted in the Chinese government raising tariffs on Australian wines and Treasury losing access to the Chinese market. Treasury subsequently focused its development on its luxury, premium wine segment, but felt pressure after its first quarter earnings showed that its transition continues to face headwinds. We believe a new round of trade discussions may lift the tariffs and provide Treasury Wine with an ability to gain share in the Chinese luxury goods market.

Portfolio Positioning

We continue to have high conviction in the industrials sector, the largest overweight in the portfolio, thanks to long-term trends such as elevated infrastructure spending, electrification and the global energy transition. Additionally, we believe the growing movement towards supply chain regionalization, a marked reversal from the past two decade’s trend towards greater globalization, should provide significant industrial demand through manufacturing reshoring, nearshoring and friendshoring.

Our preference for the energy sector continues to persevere despite the downtick in energy prices during the quarter. We believe our fundamental thesis, that the industry continues to be capital constrained due to the global energy transition, will serve as a long-term tailwind to the sector and energy prices. As such, we elected to add a new position in U.K.-headquartered Noble ( NE ), a leading offshore drilling contractor for the oil and gas industry. We feel the offshore drillship market is materially tightening, the industry has undergone substantial consolidation, and the company’s free cash flow is set to rapidly rise over the next few years against the backdrop of higher competition. We believe Noble offers a compelling valuation given the underestimation of the company’s earnings potential.

We took advantage of the retreat in the Chinese market to add New Oriental Education & Technology Group ( EDU ), in the consumer discretionary sector, the dominant market leader in the for-profit education sector in China. Implementation of the Chinese government’s Double Reduction Policy to reduce educational cost pressures resulted in the stock suffering a substantial decline. While management has had to make difficult decisions resulting in the company shuttering its after school tutoring business for elementary and middle school kids and major headcount reductions, we believe the company’s current path is a positive one and will result in profitability this year. The company’s remaining assets include a high school tutoring business, which has less risk of government scrutiny, as well as non-academic tutoring (for literature and drama programs) and a livestreaming e-commerce business. We believe its current market price fails to account for these new opportunities, and its risk/reward tradeoff is particularly compelling as EDU stands to see significant appreciation as the talented management team continues its path.

We also found an opportunity to add more exposure to the Japanese market through our participation in the IPO of Rakuten Bank, one of Japan’s leading digital banks. The bank, recently spun out of its parent, ecommerce giant Rakuten Group ( RKUNY ), sources approximately two thirds of its customer accounts from the Rakuten ecosystem, a key competitive advantage that should continue to be a structural growth driver. The company demonstrates strong fundamentals despite trading below its book value, with double-digit earnings growth and a high return on equity. We believe the market does not appreciate the long-term opportunities for the new bank to be a sustainable market share gainer.

Outlook

Given that European valuations are currently near the low end of their historical range, coupled with muted short-term recession risks and an improved outlook for real income growth, we have elected to maintain our EU overweight despite having recently reduced our cyclical exposure in the region. Japan’s corporate sector continues to display stronger discipline and focus relative to the past. Many of the companies are globally competitive after years of restructuring and we continue to find opportunities there. We remain selectively optimistic towards the Chinese market and believe we are well- positioned to capitalize on further growth and a resurgence in international travel. Our oil investments align with the increase in travel within China while our focus on green metals is supported by global investments in electrification and updating power grids.

Portfolio Highlights

The ClearBridge International Value Strategy outperformed its MSCI All Country World Ex-U.S. Index benchmark during the second quarter. On an absolute basis, the Strategy had gains across six of the 10 sectors in which it was invested (out of 11 sectors total). The industrials and financials sectors were the main contributors to performance, while the consumer staples and materials sectors were the main detractors.

On a relative basis, overall sector allocation effects positively contributed to performance. Specifically, stock selection in the consumer discretionary and industrials sectors, an underweight allocation to the communication services sector, an overweight to the industrials sector and the portfolio’s cash position aided performance. Conversely, stock selection in the consumer staples and communication services sectors and an underweight to the information technology ((IT)) sector weighed on returns.

On a regional basis, stock selection in Japan and Europe Ex U.K. and an underweight allocation to emerging markets contributed to performance. Stock selection in North America and emerging markets weighed on performance.

On an individual stock basis, Marubeni, Inditex, Samsung Electronics ( SSNLF ), BNP Paribas ( BNPQF ) and Compass were the leading contributors to absolute returns during the quarter. The largest detractors were Amorepacific ( AMPCF ), Nutrien ( NTR ), Anheuser-Busch InBev, Anglo American ( AAUKF ) and Tencent ( TCEHY ).

During the quarter, in addition to the transactions mentioned above, the Strategy initiated a position in Murata Manufacturing ( MRAAY ) in the IT sector and Olympus ( OCPNF ) in the health care sector. The Strategy exited its positions in Tenaris ( TS ) in the energy sector and Volkswagen ( VWAGY ) in the consumer discretionary sector. We also elected to exit our position in Meituan ( MPNGF ), in the consumer discretionary sector, which we received as a spin-off from our holding Tencent.

Sean Bogda, CFA, Managing Director, Portfolio Manager

Grace Su, Managing Director, Portfolio Manager

Jean Yu, CFA, PhD, Managing Director, Portfolio Manager

Past performance is no guarantee of future results. Copyright © 2023 ClearBridge Investments. All opinions and data included in this commentary are as of the publication date and are subject to change. The opinions and views expressed herein are of the author and may differ from other portfolio managers or the firm as a whole, and are not intended to be a forecast of future events, a guarantee of future results or investment advice. This information should not be used as the sole basis to make any investment decision. The statistics have been obtained from sources believed to be reliable, but the accuracy and completeness of this information cannot be guaranteed. Neither ClearBridge Investments, LLC nor its information providers are responsible for any damages or losses arising from any use of this information.

Performance source: Internal. Benchmark source: Morgan Stanley Capital International. Neither ClearBridge Investments, LLC nor its information providers are responsible for any damages or losses arising from any use of this information. Performance is preliminary and subject to change. Neither MSCI nor any other party involved in or related to compiling, computing or creating the MSCI data makes any express or implied warranties or representations with respect to such data (or the results to be obtained by the use thereof), and all such parties hereby expressly disclaim all warranties of originality, accuracy, completeness, merchantability or fitness for a particular purpose with respect to any of such data. Without limiting any of the foregoing, in no event shall MSCI, any of its affiliates or any third party involved in or related to compiling, computing or creating the data have any liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits) even if notified of the possibility of such damages. No further distribution or dissemination of the MSCI data is permitted without MSCI’s express written consent. Further distribution is prohibited.

Original Post

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

For further details see: