1st Quarter 2013 Commentary - ASTON/Barings International Fund
1st Quarter 2013
It was a good quarter for international equity markets as the Fund’s MSCI EAFE Index benchmark rose just more than 5%. Japan was the best performing region in gaining 11.6%, followed by Pacific Ex-Japan. Both the United Kingdom (UK) and Europe Ex-UK regions posted tepid gains in underperforming the benchmark, while Emerging Markets fell 1.6%. Healthcare was the best performing sector in the benchmark, rising 12% during the quarter, followed closely by Consumer Staples. The Materials sector was the worst performing sector, and along with Energy and Utilities posted losses for the period. Those three sectors were the only ones not to outperform the overall index during the quarter.
The Fund sharply underperformed its benchmark during the quarter owing mainly to stock selection, though asset allocation didn’t help either. An overweight position in Emerging Markets and an underweight to Consumer Staples, combined with stock selection in both areas, were the primary factors behind the relative underperformance. Holdings in Emerging Markets telecom stocks underperformed, though the biggest individual detractor during the quarter was Chinese search engine Baidu. Golden Agri-Resources was the notable laggard within Staples. Elsewhere, stock selection within Healthcare, Financials, and the Pacific Ex-Japan also trailed the benchmark, with China Pacific Insurance and Roche among the detractors.
Stock selection in the Consumer Discretionary sector and in the Europe Ex-UK region boosted relative performance during the quarter. Within Consumer Discretionary, Internet mall operator Rakuten and auto-parts maker Denso in Japan helped returns, while a new position in Adidas in Europe added to results there.
Buys and Sells
The purchase of Adidas was one of many changes to the portfolio during the quarter. We believe the German running shoe manufacturer should be able to grow earnings through margin improvements. Other purchases for the Fund included Russian bank Sberbank and
Russian mobile operator Mobile Telesystems. We expect Mobile Telesystems to be able to grow earnings as the availability of low-cost smartphones increases in Russia in the coming years. Another new position was established in UK household products company Reckitt Benckiser. We feel the market is underestimating the earnings power of the company, especially their key pharmaceutical product Suboxone.
We sold seven stocks from the portfolio during the quarter, three after solid recoveries in their stock price, three on analyst downgrades, and one after a buyout bid. A strong rebound in performance led to the sale of salmon producer Marine Harvest, Korean telecom company KT Corp., and life insurer Resolution. We sold the holding in Cairn Energy largely on the back of our top-down downgrade to the Energy sector as a whole. Analyst downgrades on Russian natural gas giant Gazprom and UK pharmaceutical company Shire, the former on concerns over the high levels of capital spending it is undertaking, led to its sale of both stocks.
Finally, following a bid for Japanese cable operator Jupiter Telecommunications we sold the position to fund higher conviction ideas in Japan such as Takeda Pharmaceutical, Japan Tobacco, previously mentioned Denso, and factory automation play Mitsubishi Electric. All of these stocks came highly recommended by our regional analysts, and fit well with our top-down view that weakness in the yen will selectively benefit strong companies operating in good end-markets.
The positive first quarter result for international equities continued the good run of performance the group has seen since the middle of 2012. Japan performed well on the back of continued hopes for further monetary easing and yen weakness. New Prime Minister Abe has continued to promote a reform agenda and the new leadership at the Bank of Japan has managed the unusual feat of beating already raised expectations with some very bold policy easing. Such action is likely to continue to weaken the yen, aiding the competitiveness of Japanese industry. Domestic reflation plays are also likely to continue to benefit from this policy shift. This might eventually broaden into a widespread Japanese economic recovery though it remains too early to see strong evidence of this yet.
Attention will now turn to Abe’s new growth package, which he is likely to announce in June. One of the most significant changes of view from our top-down Strategic Policy Group has been the upgrade of Japan to our highest regional rating in response to the above developments. This has led to the new additions to the portfolio noted above that focus on finding companies that are likely to see an improved competitive position because of the weakening yen, but which also sell into strong end-markets. For now, this is less a view that overall global growth will accelerate or that Japanese domestic growth will improve, but more a recognition that many Japanese companies having suffered the last four years under a very strong yen will reclaim the market share they lost.
In Europe, we have seen a number of developments that prove the end of that region’s economic crisis remains some way off. Data remains soft, with unemployment continuing to rise to new records and industrial production remaining weak. German manufacturing now sits squarely in the crosshairs of a more competitive Japanese manufacturing sector. The situation in Cyprus continues to evolve with a number of potential repercussions threatening the euro zone. With the likelihood of a large confiscation of deposits in Cyprus, the risk remains high that deposit flight in other peripheral economies applies renewed funding pressures on the European banking sector as depositors seek to protect their wealth.
Italy remains without a government several weeks after an inconclusive election, with the anti-establishment Five Star party under the leadership of Beppe Grillo holding the balance of power. It is hard to see how the reform agenda in Italy can maintain momentum in this political climate. Political tensions are likely to continue as austerity fatigue and the high unemployment rate bolster protest movements. Italy should not be seen as a unique case but more as a precursor to what is likely to come with increasing frequency. We continue to believe that political developments as much, or more, than economic issues threaten to reignite a renewed crisis phase. From a top-down perspective, Europe is not one of our favored regions and the Fund has a significant underweight there, especially in peripheral countries and commercial banks.
On a brighter note, the economic recovery in the U.S. continues to gain traction led by the housing and the auto sectors. Housing activity continues to show strong incremental improvement while house price rises appear to be accelerating and broadening. With policy likely to remain highly supportive in the near-term, the U.S. is likely to be a source of stability and may prove to be the only significant growth engine for the global economy.
We’ve have grown incrementally more cautious on Emerging Markets, with our Strategic Policy Group downgrading the region to a neutral rating. China faces the headwinds of new leadership intent on stamping out corruption and investment excesses. The result has been a less accommodative policy environment. In addition, the ongoing intention of the leadership to rebalance the economy away from exports and investment towards greater consumption continues to add an element of uncertainty to the economic outlook. We have also seen increased strain in Latin America with developments in Brazil in particular worrying investors. With Gross Domestic Product (GDP) growth low and inflation accelerating, Brazil appears to be approaching the limits of its recent growth model as the focus there is on credit expansion and consumption growth. A substantial reform agenda now looks required to address these concerns.
With Chinese growth moderating and likely to be less materials intensive with its attempt to shift expansion towards consumption, our Strategic Policy Group has downgraded both the Materials and Energy sectors to an underweight rating. We have thus begun to lower the portfolio’s stake in Energy. The Fund has long held very low exposure to cyclical Materials stocks, preferring to invest in the structural themes of agricultural and precious metal miners. With respect to recently hard hit miners, we continue to remain constructive on the medium-term outlook as the key drivers of negative real interest rates and strong central bank demand will continue to exert upward pressure on the price of gold. In the short-term, we have reduced the portfolio’s exposure slightly, aware that the improving U.S. economy will continue to raise expectations of an approaching policy tightening, while retaining our view that eventually such expectations will prove incorrect.
We have also sought to lower the stock/country specific risk embedded within the Fund’s holdings. Despite the continued strength we have seen in equity markets, leadership continues to remain largely focused within traditionally defensive sectors such as Healthcare and Consumer Staples. We continue to be of the view that the internal dynamics of the market support our view of a relatively muted global growth recovery, with equities supported by strong liquidity and the associated hunt for yield. This environment is likely to persist in the near-term, but we think it will ultimately favor structural growth stocks.
Baring Asset Management
As of March 31, 2013, Baidu comprised 1.07% of the portfolio's assets, Golden Agri-Resources – 1.09%, China Pacific Insurance – 0.70%, Roche – 1.56%, Rakuten – 1.32%, Denso – 1.40%, Adidas – 1.42%, Sberbank – 1.29%, Mobile Telesystems – 1.06%, Reckitt Benckiser – 1.25%, Takeda Pharmaceutical – 1.25%, Japan Tobacco – 1.62%, and Mitsubishi Electric – 1.24%.
Note: Investing in foreign markets involves the risk of social and political instability, market illiquidity, and currency volatility.
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