Market Overview
International markets delivered mixed performances in the first quarter of 2016. Investors grappled with a number of concerns, including China’s slowing growth and its effect on the rest of the world economy. A recent rebound in oil prices sparked some optimism, although many questioned the sustainability of the recovery.
To combat the threat of deflation and jumpstart growth, the European Central Bank announced more interest-rate cuts, bond purchases and a potential lender subsidy. In Japan, the government is expected to announce additional stimulus measures to help counter the effects of sluggish consumption and China’s economic slowdown. Despite these moves, European and Japanese equities, as measured by the MSCI Europe and Japan Indexes, respectively, declined in the quarter.
Meanwhile, emerging markets advanced, fueled in part by the U.S. dollar’s decline versus many emerging-market currencies and the stabilization in oil prices. Equities in Brazil, which continued to face political instability, were one of the biggest comebacks in the quarter, with the MSCI Brazil Index gaining more than 25% in U.S. dollar terms.
For the quarter, the Brandes International Equity Fund outperformed its benchmark, the MSCI EAFE Index, which was down 3.0%.
Positive Contributors
Significant positive contributors included U.K.-based food & staples retailers Wm. Morrison and Tesco. Tesco’s shares rose after it reported better-than-expected Christmas sales.
Holdings domiciled in emerging markets, including Korean steel company POSCO, Mexican cement company Cemex and a number of positions in Brazil, also helped performance. The Brazilian real was one of the best-performing currencies in emerging markets in the first quarter and its appreciation vs. the U.S. dollar helped the performance of the majority of our Brazilian holdings. Notable contributors included oil & gas giant Petrobras, water utility provider Companhia de Saneamento Basico do Estado de Sao Paulo (SABESP), electric utility company Eletrobras, telecommunication services providers Telefonica Brasil and TIM Participacoes, as well as bank Banco Santander Brasil.
Performance Detractors
The most significant detractors were our financial holdings, primarily banks, which were down double-digits during the quarter. The market continued to be concerned about the effect of low global interest rates and especially the increased targeting of negative interest rates by central banks in several international markets. U.K.-based Barclays (LSE:BARC, Financial) and Switzerland-based Credit Suisse (CS, Financial) weighed heavily on returns.
Barclays declined as it announced a dividend cut and a rationalization of some of its businesses in efforts to focus on its core U.K. and U.S. markets and improve its capital position. Trading at 50% of tangible book value at quarter end, Barclays offers, in our opinion, an attractive risk/reward tradeoff as we believe it should see the benefits of its restructuring over the next couple of years.
Credit Suisse saw its shares fall over 30% in the quarter as the market remained concerned about the company’s restructuring and its negative effect on financial results over the next year. Nonetheless, we continue to believe Credit Suisse has an economically attractive business model and is significantly discounted at its valuation of 0.7x tangible book value as of March 31.
Other detractors included French multi-utility Engie and Japanese auto manufacturer Honda Motor.
Select Activity in the First Quarter
The investment committee exited the strategy’s position in Dutch retailer Koninklijke Ahold and added French advertising (ad) agency Publicis Groupe during the quarter.
Publicis (XPAR:PUB, Financial) is the world’s third-largest global ad agency holding company, with many valuable brands such as Saatchi & Saatchi, Leo Burnett, Razorfish, ZenithOptimedia, and Starcom MediaVest. Publicis has historically been a well-run company with a sound balance sheet and industry-leading margins.
In our view, the business model of ad agencies has attractive economics given their variable cost structure, industry consolidation, and exposure to long-term ad spending and global gross domestic product growth. While the industry as a whole appears to be valued somewhat fully by the market, Publicis has been the recent exception due to concerns over slowing organic growth, a handful of recent account losses and its acquisition of Sapient (its largest acquisition to date), which was seen as expensive.
We believe that excessive short-term pessimism centered on these recent missteps have created an attractive entry point in Publicis’ shares for long-term focused investors. Over the long term, Publicis management has displayed, in our opinion, an admirable track record of profitability, earnings growth, operational execution and mergers & acquisitions integration. We do not view recent client losses and the potential overpayment for Sapient as evidence of permanent structural changes in the business, and we believe Publicis is well positioned to return to levels of growth in line with its peers. Given its strong free-cash-flow generation, we also expect the company will quickly de-lever its balance sheet.
Current Positioning
With the relatively light activity during the quarter, it is not surprising that the Fund’s positioning has not changed materially. As always, our allocations are driven by our bottom-up analysis of companies, not a product of a top-down evaluation of countries, sectors or industries.
The energy sector continued to represent the largest relative overweight (calculated as a percentage of the benchmark weights) at quarter end, with holdings in Russia, developed European countries and Brazil. As was the case last quarter, other key areas of exposure included U.K.-based food & staples retailers, Japanese automobile companies, and telecommunication services providers domiciled in Europe and select emerging markets. Key underweights included the banks and chemicals industries, the industrials sector, as well as allocations to Germany and Australia.
Notwithstanding periods of volatility and omnipresent clouds of uncertainty hovering over markets, we continue to believe that identifying solid companies that generate value-added goods and services, and buying them below our estimates of their true worth, is the best way to pursue attractive long-term returns. This is what Brandes has been doing for over 42 years and what we intend to keep doing going forward—to help you move closer to your long-term financial goals.
Thank you for your business and continued trust.
