We hope you and your loved ones remain safe and well, and coping as best you can in this challenging environment. At Tweedy, Browne, we feel we are truly blessed to be able to continue to work and serve our clients during this crisis. While we are acutely aware and sensitive to the fact that the lives of so many have been turned upside down by this pernicious virus, we are encouraged of late by the slow, but steadily improving economy, and the prospects for medical treatments and/or vaccines.
The performance of publicly traded equity markets of late appears to reflect this optimism. Despite a modest setback in September, global equity markets in the third quarter continued their stunning rebound from the depths of the Coronavirus-induced declines of late March. The Tweedy, Browne Funds also made financial progress during the quarter, but not enough to keep up with their respective benchmark indexes, which continue to be propelled by a small group of familiar and highly valued technology companies. Our Funds are up between 24% and 30% since their March lows, but still remain in the red year-to-date. The speed of the recovery in stock market indexes since late March, while unprecedented, has been generally quite narrow. Many, if not the vast majority, of publicly traded equities around the globe remain well below their pre-pandemic highs and in negative or flat territory for the year, particularly many of those domiciled outside of the U.S.
It has been an extraordinarily difficult stretch of time for value investors, with zero interest rates continuing to favor longer duration growth stocks, particularly the dominant large cap technology stocks in the United States. This is evident in the disparity of performance between value and growth indexes, which has rarely if ever been wider than it is today. However, green shoots for value investing may have begun to appear, as the value component of the MSCI World Index modestly outperformed its growth counterpart in the difficult month of September. Value stocks' outperformance in September was more pronounced in the U.S., where the S&P 500 Value Index declined about half as much as the S&P 500 Growth Index, as technology stocks took a beating. On the other hand, the MSCI EAFE Value Index, an international value index that is less impacted by technology companies, outperformed its growth counterpart in June and August, but not in September. The best performing segment of the global and U.S. equity market in September was the "materials" sector, made up primarily of what some market observers refer to as old economy companies in the business of the discovery and procurement of raw materials, i.e., mining, metals, packaging, chemicals, and forestry products companies. Materials stocks tend to be economically sensitive, and generally do well during periods of economic recovery and strength. A number of stocks in our Funds fall into this category and contributed materially to results in the third quarter. This included companies such as BASF (XTER:BAS, Financial), the German chemical giant; Antofagasta (LSE:ANTO, Financial), the Chilean copper mining company; Sol Spa (MIL:SOL, Financial), the Italian industrial gas company; and a number of Asian chemicals businesses, including Japanese companies ADEKA (TSE:4401, Financial), Konishi (TSE:4956, Financial), Okamoto (TSE:5122) and Zeon Corporation (TSE:4205), and Kangnam Jevisco (XKRX:000860), a South Korean manufacturer of industrial paint. While the Funds were underweighted relative to their benchmarks in the materials sector, these stocks, together with the Funds' consumer staples holdings, were among the best performing components of our Fund portfolios during the quarter.
The emerging market component of the Global Value Fund and Global Value Fund II, albeit modest in size, contributed more to returns than their developed market counterparts during the quarter, thanks to strong returns in Antofagasta (Global Value only); Chinese holdings, Wuliangye Yibin (SZSE:000858) (Global Value II only)and Baidu; and a strong rebound in their South Korean holdings.
The traditionally more defensive consumer staples sector was also a strong contributor to the Funds' returns during the quarter, but this was more about the Funds' overweight to this group rather than the performance of individual holdings, which were held back somewhat by disappointing returns in beverage stocks such as the Latin American Coca-Cola bottlers, Coca-Cola Femsa (MEX:KOFL) and Embotelladora Andina (AKO.B); Diageo (DEO), the global spirits company; and Heineken Holding (XAMS:HEIO). In contrast to poor returns produced by these beverage holdings, the Funds had strong returns from food and household products companies such as Nestlé (XSWX:NESN), Unilever (LSE:ULVR), Dongsuh Companies (XKRX:026960), and Henkel (XTER:HEN3). The communications services sector of our Fund portfolios, led by interactive media holdings, Alphabet (Google) (GOOG) and Baidu (BIDU); U.S. cable TV and internet service provider, Comcast (CMCSA); and the diversified telecommunications company, Verizon (VZ), were also solid contributors to the Funds' returns during the quarter.
Other solidly performing industry segments during the quarter included the auto components and machinery industries. As the economy reopened, people got back onto the roads, and companies such as Autoliv (ALV), the Swedish manufacturer of airbags and seatbelts; Hankook Tire (XKRX:161390), the Korean tire company; Hyundai Mobis (XKRX:012330), the Korean auto parts company; Michelin (XPAR:ML), the French premium tire manufacturer; and NGK Sparkplug (TSE:5334), the Japanese auto parts company, were all beneficiaries. As industrial production surged, so did the stock prices of machinery companies such as CNH (CNHI), the global farm equipment company; Ebara (TSE:6361), the Japanese manufacturer of pneumatic and hydraulic pumps, compressors, incinerators, and equipment for the manufacturing of semi-conductors; KSB (XTER:KSB3), the German manufacturer of pumps and valve systems; Shanghai Mechanical (SHSE:600835), the Chinese machinery and elevator company; and Trelleborg (OSTO:TREL B), the Swedish manufacturer of polymer-based industrial rubber products including seals, hoses, and anti-vibration components.
Perhaps one of the best, if not the best performing stock in terms of weight and return in our Fund portfolios (excluding Worldwide High Dividend Yield Value Fund) during the quarter, was Berkshire Hathaway (BRK.A)(BRK.B). Back in early May, Warren Buffett (Trades, Portfolio) offered up a wonderful economic and equity market history lesson for his shareholders at the Berkshire annual meeting, and encouraged his investors to "never bet against America." Berkshire's stock price was hit rather hard during the early days of the pandemic, and, as equity markets collapsed in late March, Warren and Charlie Munger (Trades, Portfolio) remained uncharacteristically silent, and somewhat inactive, leading many market observers to question whether they had lost their touch. However, after selling or reducing a number of their bank holdings including Wells Fargo (WFC), eliminating their positions in their airline stocks, announcing an agreement to purchase the natural gas transmission and storage assets of utility company Dominion Energy (D) in a deal valued at almost $10 billion, and purchasing a basket of five Japanese trading companies with high dividend yields, perhaps in an effort to help cover the yen-denominated interest expense Berkshire faces on its Japanese debt, Berkshire stock has come roaring back from its late March lows. To borrow Buffet's admonition to his investors, we would add "never bet against Warren Buffett (Trades, Portfolio)."
Concerns over the prospects for an increase in pandemic associated loan losses and rock-bottom interest rates, which constrain net interest margins, continued to haunt the Funds' bank holdings, leading to disappointing returns during the quarter in Bangkok Bank (BBK:BBL), DBS Group (SGX:D05), HSBC (HSBC), Standard Chartered (LSE:STAN), United Overseas Bank (UOB) (SGX:U11), Well Fargo, Bank of New York (BK), and US Bancorp (USB). Only National Bank of Canada (TSX:NA) enjoyed good returns. For the most part, this also held true in our insurance stocks, where core holdings such as Munich Re, SCOR, and Zurich Insurance (XSWX:ZURN) had a rough quarter. The one bright light was CNP Assurances (XPAR:CNP), our French life insurer, which produced a solid return for the quarter. Our financial holdings, where the Funds are currently overweighted, represent, in our view, some of the most undervalued companies in our Fund portfolios. If COVID recedes and the economy recovers, as we hope it will, we would expect these companies as a group to positively contribute to Fund returns. This should especially hold if the economy comes back stronger than anticipated, or if we get a surprising uptick in interest rates at some point. In the interim, in our view, the Funds' bank and insurance holdings remain financially strong as we wait patiently for value recognition in their shares.
The Funds' oil & gas holdings, which are far fewer today, also had a difficult quarter, as the pandemic weighed on overall oil demand, particularly from an important constituency, the airline industry. Market sentiment in the energy sector continues to be negative and oil prices remain quite volatile. We have rationalized the Funds' positions over the last several years in energy-related holdings, having sold or significantly reduced the Funds' positions in companies such as Halliburton (HAL), Royal Dutch (RDS.B), MRC (MRC), ConocoPhillips (COP), and Phillips 66 (PSX). The Funds' primary holding today in this industry group is Total (XPAR:FP), the French oil producer, which in our view remains undervalued and financially strong, currently pays a dividend of over 8%, and has a growing production profile.
With the exception of Johnson & Johnson (J&J) (JNJ), the Funds' pharmaceutical holdings, which served the Funds very well in the early days of the pandemic, have begun to lose some steam due to what would appear to be concerns over the pending election and the prospects for lower drug prices, regardless of who wins. Drug prices have been a political football for a decade or more, and yet the businesses of our core pharma holdings and their stock prices have thrived. We believe the diversified position the Funds have had for years in companies such as Roche (XSWX:ROG), Novartis (XSWX:NOVN), and J&J will continue over time to serve shareholders well. While fairly valued today, in our view, they bring different strengths to the Funds' portfolios, are financially strong and innovative, and have continued to compound our estimate of their underlying intrinsic values at attractive rates.
With increasing volatility in global equity markets over the last couple of years, we have been considerably more active in our investment "garden," adding a number of new portfolio holdings from both the developed and lesser developed parts of the world, while pruning securities that had either met our valuation targets or had disappointed, or whose future prospects had, in our view, become compromised. This also held true in the most recent quarter, where we established a few new positions, eliminated several, and added to or trimmed a number of others. Newly established positions during the quarter included Bank of America (BAC) (Value Fund); Carlisle Companies (CSL), Intel (INTC), and Truist (TFC) (Value and Worldwide High Dividend Yield Value Funds); AbbVie (ABBV), Astellas Pharma (TSE:4503), Jardine Matheson (LSE:JAR), and US Bancorp (Worldwide High Dividend Yield Value Fund); and Alliance Global (PHS:AGI) (Global Value, Value and Global Value Fund II). Bank of America, Truist, and US Bancorp are, in our view, three of our country's best managed and highest quality banks. We believe all three are very strong financially, enjoy franchise positions in their industry, currently pay attractive dividends, and are well positioned for growth in a recovering economy. AbbVie (U.S.) and Astellas (Japan), in our view, are attractively valued pharmaceutical companies that are particularly well positioned for growth, with an emerging portfolio of potentially highly successful new drugs. Alliance Global, the Philippines-based holding company with interests in food and beverage, real estate development and fast food restaurant businesses, Intel the U.S.- based leader in the design and manufacture of microprocessors, and Jardine Matheson, the Singapore-listed holding company with interests in auto distribution (Cycle & Carriage, Astra in Indonesia), food and retailing (Dairy Farm), property investment and development (Hongkong Land) and hotel operations (Mandarin Oriental), among other holdings, fall into the "statistical bargain" segment of our Fund portfolios. Similar to Ben Graham before us, we often utilize statistical underwriting criteria to uncover stocks that are quantitatively cheap. These stocks often trade at discounts to net current asset value, low price earnings ratios, low price to book value ratios, and/or low enterprise values in relation to EBIT, EBITA or EBITDA. More often than not, they are underleveraged and also have strong patterns of insider buying in their shares at or around the prices we are paying for our Funds. And like an insurance company that wants to issue as many policies as it can that meet its underwriting criteria to achieve a desired statistical result, we want to own a diversified group of these kinds of stocks. While these companies often have attractive qualitative characteristics as well, it is the statistical valuation pattern coupled with insider buying that tends generally to drive our decision-making in these types of stocks. Statistically-based bargains have always had a place in our Fund portfolios, less so over the last many years. However, with our equity markets sharply bifurcated today, and a significant number of securities still under water in terms of their equity prices in relation to their estimated intrinsic values, we are beginning to see an increasing number of new ideas in this area, reflected by deep quantitative discounts and material insider buying by knowledgeable insiders, i.e., CEO, CFO and the like. We also increased our holdings in a number of Fund portfolio positions, including in companies such as Babcock International (LSE:BAB), CNH, Kuraray (TSE:3405), and Coca-Cola Femsa.
In terms of sales and reductions in positions, we sold or reduced the Funds' shares in oil & gas companies such as ConocoPhillips, Phillips 66, and Royal Dutch; in copper miner Antofagasta; and in Heineken, HSBC, Mediaset, Nestlé, Novartis, Roche, Sol Spa, Zurich Insurance, Unilever, DBS, Siemens, J&J, and UOB, among others.
Taken as a whole, our Funds are currently invested across 21 different countries in more than 38 different industries, and continue to have a larger capitalization orientation, although many of the more recent additions to the portfolios are smaller and medium-sized businesses. Geographically, our two global funds (Value Fund and Worldwide High Dividend Yield Value Fund) remain significantly underweighted in U.S. equities despite an increase in new U.S. names of late, while our two international funds (Global Value Fund and Global Value Fund II) are overwhelmingly invested outside the U.S., as to be expected in funds with an international mandate. When searching out undervalued securities, our focus has largely been in developed markets and the more developed of the emerging markets. At their peak weighting in 2018, emerging market equities constituted approximately 10% of total assets of the Global Value Fund. As of quarter-end, this weighting had declined to 6.6%. In terms of country allocations, our Fund portfolios bear little to no resemblance to benchmark weightings. For example, as of September 30, the Global Value Fund had nearly double the weight of its benchmark index invested in Switzerland (18.3% versus 10.7%), and a little more than one-sixth that of the benchmark invested in Japan (4.3% versus 25.8%). With respect to sectors and industry groups, in general, the Funds continue to maintain overweighted positions vis-Ã -vis their benchmarks in consumer staples (food, beverage, household products, etc.) as well as financials (diversified financials, banks and insurance companies), pharmaceuticals and a diversified group of industrials. Our Fund portfolios are underweight in technology, materials, and consumer discretionary stocks (auto-related, distributors, hotels & leisure, and specialty retail).
As of September 30, 2020, the top twenty-five holdings in our Fund portfolios on average paid dividend yields overall of between 2.4% and 3.6%, had weighted average price/earnings ratios that ranged between 14.7 and 16.5 times 2021 estimated earnings per share, and carried cash reserves that varied between 5.5% and 9.0% of total assets. In comparison, as of September 30, 2020, the MSCI EAFE Index had a price/earnings ratio of 21.2X 2021 estimated EPS with a dividend yield of 2.7%; the MSCI World Index had a forward price/earnings ratio of 24X with a dividend yield of 2.1%; and the S&P 500 had a forward price/earnings ratio of 25.6X with a dividend yield of 1.8%. (Please note that the range of weighted average dividend yields shown above is not representative of a Fund's yield, nor does it represent a Fund's performance. The figures solely represent the range of the average weighted dividend yields of the top twenty-five common stocks held in the Funds' portfolios. Please refer to the 30-day standardized yields in the performance chart on page 1 for each of the Fund's yields.)
As mentioned earlier in this commentary, we believe the ongoing volatility in global equity markets over the last several months has spawned a significantly improved opportunity set for value investors, particularly for securities domiciled outside the U.S. We are hopeful that this valuation disparity foreshadows an improved return stream for investors like us who have maintained greater exposure to non-U.S. equities. Looking forward, we believe the stage may be in the process of being set for a rotation away from the high performing U.S. equity market to Europe, Asia and even some of the emerging markets. Over time, there has clearly been a cyclical aspect to U.S. versus non-U.S. equity returns, as evidenced by the significant outperformance of non- U.S. equities between 2000 and 2009, and the unprecedented strength of the U.S. equity market since the financial crisis in 2009 through today. In fact, a look at rolling ten-year returns for the S&P 500 and the MSCI EAFE Index going back as far as the mid-1970s reveals that it's been virtually a "toss up" as to which index outperforms, and according to the folks at Morgan Stanley, we are currently well into the strongest period of outperformance for U.S. vs. International stocks in equity market history.
What is likely to cause the teeter-totter to shift once again in favor of non-U.S. equities? Of course, that is hard to know, but we believe the periodic outperformance in non-U.S. equities in recent months may suggest we could be getting closer to such a shift. We believe equity valuations today outside the U.S. are generally more attractive than U.S. equity valuations. For example, as of September 30, the Shiller cyclically adjusted price/earnings ratio (CAPE) was 19.6X for Europe, 20.6X for Japan, and 32.1X for the U.S. Only during the dot- com bubble of 20 years ago was the U.S. Shiller CAPE ratio higher than it is today. Some market observers have contended that Asia and parts of Europe have responded more successfully to the onslaught of the virus and that their economic recoveries are likely to be quicker and more robust, off what was a deeper bottom than that reached in the U.S. This has translated into higher economic growth projections by forecasters such as the IMF for many non-U.S. economies. Whether this will hold is a subject of considerable debate as the virus continues to surge globally. The implication for many of these non-U.S. public equity markets, which tend to be more value-based and pro-cyclical in terms of their structure, particularly in Europe, is that they could perform better coming out of their respective recessions. The recent passage by the EU of an unprecedented stimulus package, where member countries came together to share the burden of the pandemic through the issuance of pan-European financed bonds, suggests a new level of cooperation in Europe, which could help to facilitate a speedier recovery there. Some market observers view this in contrast to the U.S., where economic recovery could be stymied by a resurgent virus, congressional acrimony over new stimulus proposals, rapidly rising debt levels, and upcoming U.S. elections, which are raising additional concerns about taxation, future growth rates, and implications for the performance of the U.S. equity market.
In our view, any of the factors mentioned above could serve as a spark that ignites a shift in investor sentiment towards non-U.S. equities and, potentially, better relative returns for international and global funds. Now may not be the time to let home country bias drive investment decision-making. Rather, it may indeed be the time to skate to where we believe the puck may be going.
Thank you for investing with us. Stay well.
William H. Browne, Roger R. de Bree, Frank H. Hawrylak, Jay Hill, Thomas H. Shrager, John D. Spears, Robert Q. Wyckoff, Jr.
Investment Committee
Tweedy, Browne Company LLC
October 2020
