For the three months ending December 31, 2022, the iMGP International Fund gained 16.82%, underperforming the MSCI EAFE Index but outperforming MSCI ACWI ex. US Index, which returned 17.34% and 14.28%, respectively. The fund also outperformed the Morningstar Foreign Large Blend category, which notched a 16.02% gain in the quarter. For the full year, the fund fell 21.58% compared to losses of 14.45% and 15.77% for MSCI EAFE and the Morningstar Foreign Large Blend category, respectively.
Since its inception on December 1, 1997, iMGP International Fund has returned 5.85% annualized. Over the same period, it has outperformed MSCI EAFE, MSCI ACWI ex. US Index and the Morningstar Foreign Large Blend category, which have generated an annualized return of 4.52%, 4.73% and 3.73%, respectively.
Performance quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance of the funds may be lower or higher than the performance quoted. To obtain standardized performance of the funds, and performance as of the most recently completed calendar month, please visit www.imgpfunds.com. *There are contractual fee waivers in effect through 4/30/2023.
Brief Discussion of Performance Drivers for the Fourth Quarter
It is worth remembering the fund’s overall positioning is driven by the managers’ stock picking. As a result, stock selection is always the main driver behind the fund’s absolute and relative performance. Attribution analysis over a given time period may however show other factors also explain relative performance.
Both stock selection and sector allocation detracted equally during the fourth quarter relative to the MSCI EAFE Index. Selection within the financials sector was by far the biggest drag on relative performance. Selection within communication services, consumer discretionary, and consumer staples all had a positive impact on performance.
Portfolio Breakdown as of 12/31/2022
| By Sector | Fund |
| Finance | 19.43% |
| Consumer Discretionary | 14.21% |
| Information Technology | 13.60% |
| Communication Services | 8.82% |
| Health Care & Pharmaceuticals | 12.76% |
| Industrials | 12.99% |
| Consumer Staples | 6.95% |
| Real Estate | 0.00% |
| Utilities | 2.58% |
| Energy | 0.00% |
| Materials | 0.88% |
| Cash | 7.79% |
| By Region | Fund |
| Europe | 87.38% |
| North America | 6.62% |
| Asia ex-Japan | 2.28% |
| Japan | 0.00% |
| Latin America | 0.00% |
| Africa | 0.00% |
| Australia/ New Zealand | 0.00% |
| Middle East | 3.72% |
| Other Countries | 0.00% |
| *Cash is excluded from calculation |
Quarterly Market and Portfolio Commentary from Managers
David Herro, Harris Associates
Major global markets generally experienced relief in the fourth quarter after equity markets had declined meaningfully throughout the first three quarters of 2022. Conditions in markets turned more favorable as there were early signs that central bank increases in interest rates, improving supply chain conditions, and lower energy prices would lead to reductions in the level of inflation in many countries. International equities benefitted from most international currencies strengthening relative to the dollar during the quarter, though most major currencies still ended the year down 5-15% versus the dollar. Despite this, we recognize the continued challenges facing investors with the current state of financial markets. However, we believe that the lower and more widely dispersed valuations in the market today have allowed us to redeploy capital into increasingly attractive investments. As previously mentioned, over our forecast horizon (five years) we expect global economic conditions to improve and companies we own to resume growing at pre-COVID levels. At current equity price levels, we are enthusiastic about our portfolio’s mid- to long-term return potential.
We initiated a new position in Julius Baer Group during the quarter. Julius Baer Group provides a variety of services to wealthy individuals and institutional investors worldwide. We view Julius Baer Group as an attractive investment for many reasons, including its strong competitive position in faster growing emerging markets and new management improving operating efficiency. We also like that management continuously looks for ways to boost capital returns to shareholders. Also during the quarter, we lowered our intrinsic value estimate of Credit Suisse following the company’s strategic review announcement, mainly driven by the dilutive capital raise the company plans to issue. We conducted an internal review of our position in Credit Suisse and ultimately decided to exit the position due to the concentrated nature of the portfolio and to add to positions that, in our view, offer a more attractive investment on a risk-adjusted basis.
Mark Little, Lazard Asset Management
International markets rallied sharply in the fourth quarter, reducing some of the significant year-to-date drawdown. This reversal was due mainly to two factors. First, signs that peaking inflation became evident and reduced investor expectations for significant future rate hikes by central banks. Second, the end of COVID lockdowns in China raised expectations for a pickup in global growth as the China economy reopens.
The very strong returns in the quarter were led by lower quality stocks, as is normally the case in a strong absolute return period, and this extended the lead for low quality compared to high quality for the full year. Foreign currency strength added to already strong local market performance for international benchmarks as peaking inflation data drove dollar weakness. As a result, despite fears of significant macroeconomic headwinds to international markets, international benchmarks outperformed the US not only in local terms, but also in dollars for the quarter and the full year for the first time since 2017. The combination of deeply discounted valuations, a structurally higher level of interest rates, and more stable currencies could support further international market outperformance.
During the first three quarters of 2022, higher costs, exacerbated by war and resulting rate rises, drove significant macroeconomic fears. This market view rapidly changed in the fourth quarter. Many lower quality cyclicals, particularly financials, rallied significantly on signs of peaking inflation which drove expectations for a central bank policy pivot to slow the pace of raising interest rates–or stop all together. At the same time expectations increased for China to relax their long-standing no-COVID policy and reopen their economy, which fueled expectations for rising global growth. The combination of the rapid change in the market expectations created an environment ripe for a low-quality bounce within a market that was down nearly 30% at the start of the quarter. We do not believe low quality leadership is likely to continue.
While market expectations for global growth remain highly uncertain, investors have pushed valuations to decade lows. The vast majority of negative returns for 2022 came from valuation compression. At the same time, international corporate profits have remained resilient, and represent a great opportunity for stock pickers as the market expects downgrades.
In Europe, headwinds facing economies and companies are arguably more priced into stock market valuations than in other developed markets including the US. Inventories are unusually high in some sectors, particularly the industrials sector, where many companies experienced supply chain problems post COVID, leading companies to overorder. As these order books normalize, near- term growth may be negatively impacted (an issue possibly already captured by the equity market in deeply discounted valuations), but cash flows could accelerate as inventories draw down. In addition, European governments and companies have been well prepared for the winter as gas storage levels entered the season very high. Thankfully, the first few months of winter have been relatively mild enabling storage levels to remain near the top end of their five-year range. With less demand currently, the intensity of the crisis has eased, and natural gas prices have fallen and could provide margin uplift looking forward for many industrial companies who utilize gas as an input.
Investment opportunities in Asia could be increasing, particularly in China and Japan.
In Japan, near the end of the year, the Bank of Japan made the surprise move to widen their yield curve control bands, effectively signaling their willingness to increase interest rates for the first time in years. While this catalyzed a very significant move higher in banks, the most sensitive group to higher interest rates, we recognize there still remains a long way to go on this policy shift. Japan should be a beneficiary of China reopening and the weaker Yen (down 12% in 2022) could help their economic recovery.
Valuations are attractive, yet Returns on Equity (“ROEs”) in Japan remain lower than in other regions and as such, we remain vigilant in identifying those companies where corporate fundamentals are driving sustainably high or improving financial productivity.
In China, while monetary policy remains stimulative, the reopening and relaxing of the no-COVID policy after the Communist Party Congress in November has provided a catalyst for many Chinese domestic stocks, as well as global cyclicals. Despite the recent move higher, valuations remain attractive for selected companies after steep two-year share price declines. The combination of stimulative policy and the reopening of the economy should drive economic recovery in China. Additionally, the regulatory environment, which had been increasingly restrictive for much longer than expected, could be loosening now. However, we recognize that the recent positives have catalyzed a strong move in many shares and should also be balanced as US/China geopolitical tension remains high, the property market remains weak, and the recent relaxation of COVID restrictions has stretched the healthcare system significantly. As always, we focus on the relative value characteristics of each company we buy rather than focusing on the macro environment.
We continue to believe that interest rates will remain structurally higher, and we have exited the nearly decade-long period of excessively low interest rates. This could be very positive for international markets which tend to perform better during periods of sustained higher interest rates and continue to be supported by deeply discounted valuations and resilient earnings.
As global markets return to some sense of normalcy, and currency volatility abates, we continue to believe that Relative Value will lead and the extreme environments that have dominated much of the past several years (expensive growth or low-quality stocks) are unlikely to lead going forward. Stock picking and differentiation will become increasingly important in this environment and our long-tenured team is finding many ideas that we believe will be great investments over the next several years.
Todd Morris and Daniel Fields, Polen Capital
We believe a confluence of factors make international allocations more compelling than at any time since the Global Financial Crisis. Bear markets can reset asset classes from a leadership standpoint. After years of subpar returns international investors have voted with their feet. This point appears clear when looking at far lower valuations on offer ex-US than in the US. Finally, given the sharp move higher in the U.S. dollar last year we would not be surprised to see persistent dollar weakening take hold. The Portfolio continues to hold a concentrated collection of quality companies poised to grow earnings at steady rates over the coming years.
Ryanair (David Herro)
We like that Ryanair is the leading ultra-low cost carrier in Europe with a strong management team focused on minimizing costs, and its operational efficiencies allow the company to provide the lowest cost service in the region. Ryanair has strategically taken market share by flying into secondary airports with lower landing fees, undercutting flag carriers. The company’s management team continues to improve Ryanair’s competitive position while de-risking the model via high asset ownership and a strong balance sheet, which has led to strong, resilient returns and free cash flow generation.
Ryanair reported a solid set of first-half results, in our view. Fundamental performance was generally in-line with consensus expectations and management slightly increased full-year passenger guidance from 166 million to 168 million. The company operated at nearly 115% of its pre-COVID-19 capacity, despite schedules being negatively impacted by ATC Aviation Services issues and airport security delays. This compares to peers who are mostly in the 80-90% capacity range relative to pre-COVID-19 levels, which resulted in market share gains for Ryanair. A temporary ban on the practice of “use it or lose it” slot restrictions will also be coming to an end in many of its airports next year, which should provide an additional tailwind for the company to pick up additional slots.While year-over-year traffic was +143% and revenues were +207%, operating expenditures were up only 126%. This was despite a 205% increase in the cost of fuel, as higher load factors as well as incorporating Boeing 737’s into the fleet helped to improve unit level efficiency (4% more seats yet 16% less fuel). In 2023, Ryanair is expecting a recovery of Asian traffic coming to Europe while Transatlantic traffic remains strong. We continue to have confidence in the company’s management team and our investment.
CTS Eventim (Mark Little)
SAP is Europe’s largest software company and the global leader in enterprise resource planning (ERP) software. Mission critical software from SAP enables customers’ business operations to run and integrate smoothly while providing managers better awareness across the business. SAP reported a very strong quarter despite a weaker macro environment, highlighting the importance of their software to customers. SAP’s transition to a cloud-based software model over the last two years seems to have reached a tipping point in line with management’s long-term goals. The result has the potential to be a faster growing, more consistent, higher margin, and more advantaged business. As investment costs from these transition programs wane, and as the benefits of higher growth continue, we expect that earnings will grow at a mid-teens rate in the coming year onwards. SAP shares trade at just over 20x this year’s earnings, a compelling valuation for a business of this scale and quality, particularly given its accelerating profit growth.
GVS (Mark Little)
GVS provided a disappointing trading update at the end of the third quarter. Sales were a bit soft in their Health & Safety division, which have experienced a boost to sales during COVID. More significant was the miss on margin driven by higher material prices. We had expected the fading benefit from COVID related sales to eventually steer investors to focus on solid performance in the core business. We are disappointed to see the company not manage margins better at a time when debt on the balance sheet is increasing to finance acquisitions and interest cost is increasing. We exited the position during the quarter to fund new positions, which look more compelling after the weakness in the market.
Temenos (Polen Capital)
We owned Temenos because it sells what we believe to be mission critical products across both client-facing and back-end software solutions for the banking industry. Temenos is a Switzerland-based provider of digital banking, core banking, payments, fund management, and wealth management software products. The stock’s underperformance comes on the back of slowing sales cycles as customers makers are being more cautious, reconsidering projects, and freezing budgets for the time being. Several management changes were made in response to poor sales development during 2022. Beyond self-inflicted execution issues, a slowing macro backdrop could prompt digitization and modernization decisions by banks to be pushed out into the future. In the full course of time banks must address modernization needs by upgrading software but economic cycles can impede progress. Owing to our diminished confidence in management we felt it best to sell the stock out of this portfolio and allocate the proceeds to a faster-growing software company.
Worldline (David Herro)
We appreciate Worldline’s position as a leader in European payments, and believe it has a long growth runway ahead due to Europe’s lower cashless penetration and higher levels of bank payment in-sourcing when compared to the U.S. We believe the payments industry is structurally attractive with high recurring revenues, low customer churn and strong free cash flow generation. In our view, Worldline’s revenue acceleration, which is driven by e-commerce business, travel recovery and synergy opportunities, is underappreciated by the market.
Worldline’s third-quarter results showed continued strength, in our view, with 20.5% reported and 10% organic growth, which were driven by merchant services that delivered 29.6% reported and 13.6% organic growth. Management affirmed full-year guidance for 8-10% organic growth, 100-150 basis points of adjusted earnings margin improvement, and 45% conversion of adjusted earnings to free cash flow. We recently met with CEO Gilles Grapinet and CFO Gregory Lambertie and discussed implications of the macro environment on the company. Management noted that the spending environment remains broadly supportive with ongoing shifts from cash to digital payments offsetting any potential weakening in spending trends. Both Grapinet and Lambertie indicated that the market seems to be obsessed with the latest data on transaction volumes and appears nervous about an upcoming deceleration. However, management has not seen any evidence of a slowdown and noted that transactions continue to grow at healthy levels, bolstered by various government support efforts and the cash-to-digital transition. We also reviewed competitive dynamics in the financial technology field, margin evolution, and merger-and-acquisition opportunities. The company’s incremental margins have been solid with management seeing further expansion in 2023, while the merger-and-acquisition pipeline is still robust and competitive intensity has ebbed somewhat. Grapinet commented that the downsizing of technology staff in Europe has provided Worldline with the ability to upgrade its talent pool and reduced the upward pressure on labor costs while decreasing internal turnover levels, which works to drive productivity. Overall, we are pleased with management’s execution and our thesis for this company remains intact.