Dear Fellow Investor,
Market-moving headlines sent global equity markets lower and volatility higher in the last 12 months amid a string of concerns that have kept uncertainties afloat.
Worries over the glacial pace of world economic growth, exacerbated by a slowdown in China, continued oil-price weakness and uncertainties over the timing of an interest-rate increase by the U.S. Federal Reserve, provided fodder for market volatility.
As many market watchers expected, the Fed kept interest rates steady at its September meeting, as the direction of U.S. interest rate policy remains uncertain. Key U.S. stock indices suffered smaller declines compared to other major markets during the period, partly due to the economy’s relative strength, keeping valuations — such as the S&P 500’s price-to-book (P/B) and Shiller price-to-earnings (P/E) ratios — above their historical medians.1
European and Japanese markets fell, most significantly in the third quarter, due to fears that weakness in China and other emerging markets may weigh on exporters who rely on Chinese demand. In Japan, those same fears seemed to have overshadowed renewed optimism stemming from positive economic news that has buoyed the market in the past two years.
Emerging markets suffered the brunt of the global market decline. China’s renminbi devaluation in August, although relatively minor, raised fears of a potential spillover to other emerging countries. In Brazil, investors continued to grapple with political and economic challenges, including falling commodity prices and rising inflation. The real lost about 40% (versus the U.S. dollar), making it one of the worst-performing currencies over the last 12 months.
In this difficult environment, the net asset value of the Brandes Global Equity Fund (Class I Shares) declined 6.75% in the 12 months ended September 30, 2015. For the same period, the MSCI World Index fell 5.09%.
The Fund
The Fund’s underperformance was driven mainly by investments in emerging markets, especially Brazil, as well as in the United States. Primary detractors included holdings in oil, gas & consumable fuels, wireless telecommunications services and multi-utilities.
Share prices for the Fund’s oil & gas holdings fell due to the continued drop in oil and natural gas prices and other company-specific factors. Primary detractors included Brazil-based Petrobras (PZE, Financial), U.S.-based Chesapeake Energy, U.K.-based BP, Italy-based Eni and Russia-based Lukoil.
While the majority of our integrated oil holdings declined, we believe they continue to offer a compelling value opportunity. Based on our analysis, compared to other areas within the energy sector, integrated oil firms have stronger balance sheets, better historical returns on capital and the ability to better adapt to the lower oil price environment. Many of these companies have significantly cut capital expenditures to manage and sustain their free cash flow.
With regard to Brazil, political and economic uncertainties continued to weigh on a variety of companies. Apart from Petrobras, jet manufacturer Embraer and wireless telecommunication services provider TIM Participacoes also hurt performance. France-based utility Engie S.A. (formerly GDF Suez) was also a detractor.
The Fund benefited from holdings in financials, especially Japanese insurance firms Sompo Japan Nipponkoa Holdings, MS&AD Insurance and Tokio Marine Holdings, as well as Germany-based capital-markets operator Deutsche Boerse, Austria’s Erste Group Bank and Turkey’s Turkiye Garanti Bankasi. Other top performers included U.K.-based Imperial Tobacco and Japanese pharmaceutical firm Daiichi Sankyo.
Allocation to the materials sector boosted both absolute and relative returns. The positive contribution was driven primarily by: 1) the Fund’s lack of exposure to the metals & mining industry, which declined substantially during the period, and 2) the strong performance of Ireland-based building materials company CRH.
As always, the Fund’s allocations are a result of our bottom-up selection process and not the result of top-down views on the relative attractiveness of specific sectors, industries or regions. This approach has resulted in the Fund having a low allocation to the United States relative to the MSCI World Index. Additionally, the attractive valuations found in many emerging-market companies have led to the Fund’s increased allocation to the asset class over the past year.
We divested a number of positions, including U.S.-based pharmaceutical firm Eli Lilly, Japan-based MS&AD Insurance and Toyota Motor, U.K.-based broadcasting firm Sky and Netherlands-based Unilever.
Automaker Toyota (TM, Financial) was sold in the second quarter of 2015.We initially purchased Toyota in 2010 as the company suffered from news of unintended acceleration in some of its vehicles and the resulting recall, causing its stock to trade at a significant discount compared to its history and its peers. Toyota also faced major challenges from low automobile demand in its major markets and a strong yen, which made cars exported from Japan less competitive.
Over the past several years, Toyota has managed to address the recall issue, which led to improved investor sentiment. Additionally, the weakening yen, combined with a strong recovery in automobile demand in many markets, especially in the United States, drove up Toyota’s share price significantly over the last year. We decided to divest our position after Toyota’s shares appreciated to our estimate of the company’s long-term intrinsic value.
Volatile equity markets created potential mispricing opportunities among companies which, based on our analysis, have attractive valuations relative to their intrinsic value estimates. As a result, we made a number of purchases, including U.S.-based Emerson Electric and Leucadia National (Trades, Portfolio) Corp., South Korea’s Hyundai Motor, France-based Schneider Electric and Spain-based Repsol.
Leucadia (LUK, Financial) is a diversified holding company with interests in various businesses, ranging from investment banking, asset management, and commercial mortgage banking & servicing to beef processing and oil & gas exploration. Despite a market capitalization in excess of $5 billion, Leucadia has lacked coverage by Wall Street research analysts.
We believe Leucadia has a number of positive attributes. The company is conservatively capitalized and traded at less than its reported book value. Additionally, Leucadia has a history of being strategic and value oriented, and we appreciate that management’s significant ownership aligns its incentives with shareholder interests. These factors led us to conclude that the shares were trading at an attractive discount to our estimate of the company’s intrinsic value.
Two other additions, Schneider Electric and Emerson Electric, provide electrical products and systems covering a wide range of industrial, commercial and consumer markets. Both companies have been underappreciated, in our view, due in part to their exposure to emerging markets.
Schneider (XPAR:SU, Financial)’s key businesses include operations in low-voltage and building automation, discrete and process automation, critical power and cooling, and medium voltage and grid automation. Given that emerging markets make up nearly 45% of Schneider’s sales, some may be worried that potentially slowing economic growth in many developing countries would negatively affect the company’s businesses, especially those which are construction-driven. Additionally, the company has a penchant for mergers and acquisitions, which can carry risks of overpayment as well as integration and execution uncertainties.
We believe these risks are more than fully reflected in Schneider’s share price. Among other positive attributes, Schneider has generated high returns on incremental capital and possesses a reasonably healthy balance sheet with strong free cash flow.
Emerson Electric (EMR, Financial) is another high-quality company with a strong competitive position, conservative balance sheet and attractive long-term returns on capital. Similar to Schneider’s case, over the last few years, the market has become concerned about Emerson’s exposure to emerging markets. Investors also seem worried about the cyclicality of its process automation business, particularly its high exposure to the oil & gas end market.
Despite the negative sentiment, we believe Emerson is well positioned to continue generating value in each of its business segments, which have attractive long-term growth prospects based on our analysis. While concerns surrounding Emerson’s oil &Â gas exposure and the cyclicality of the process automation business are warranted, we feel that its shares are overly discounted at the company’s current valuation.
Outlook
The recent spike in global market volatility appeared to cause many investors to overlook fundamentals at the company level. Remaining cognizant of unfolding macroeconomic and geopolitical developments that contributed to the increased volatility, we monitor their effects on the estimated intrinsic values of our holdings. We view short-term price fluctuations and market selloffs as opportunities to search for companies that may be mispriced.
Looking ahead, we believe that company fundamentals, while seemingly obscured by recent volatility, will eventually gain investor recognition. We hold the view that selectivity — and a laser focus on margin of safety — remain paramount in any market environment, as we retain and invest in companies we believe to be worthy of inclusion in the Brandes Global Equity Fund.
As always, thank you for your business and continued trust.
Sincerely yours,
The Brandes Global Large-Cap Investment Committee
Brandes Investment Trust
Brent Fredberg, Kenneth Little, CFA, Brian Matthews, CFA, Ted Kim, CFA, James Brown, CFA
Past performance does not guarantee future results.
Because the values of the Fund’s investments will fluctuate with market conditions, so will the value of your investment in the Fund. You could lose money on your investment in the Fund, or the Fund could underperform other investments. The values of the Fund’s investments fluctuate in response to the activities of individual companies and general stock market and economic conditions. In addition, the performance of foreign securities depends on the political and economic environments and other overall economic conditions in the countries where the Fund invests. Emerging country markets involve greater risk and volatility than more developed markets. Some emerging markets countries may have fixed or managed
