Beyond Our Borders

This webinar explores why it may be a good time to look into international equities. From small to large caps, and developed to emerging markets, our experts discuss their unique approaches to international investing, as well as performance drivers and current issues in the market.

Topics include:

• Current valuations in light of recent macroeconomic issues

• Why active management matters in international equities

• Where investors can look for potential opportunities

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  • 01 hr 01 mins 36 secs




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Meco Sparks 00:04 Hello, and welcome! My name is Meco Sparks. On behalf of Macquarie Investment Management and Delaware Funds by Macquarie, I'd like to welcome you to our Capital Markets Coaching Clinic, Beyond our borders. Our panel of speakers will discuss current valuations in light of recent macroeconomic trends, why active management matters in international equities, and where investors can look for potential opportunities. Whether it's learning more about the markets from our team of experts keeping you ahead of the curve, or leveraging technology and social media trends, or helping to make your day more efficient, Macquarie Investment Management strives to be your partner in growing your business and serving your clients. Our discussion will be moderated by Patrick Foley, the Head of Equity, Product Management at Macquarie Investment Management. Welcome, Pat.

Pat Foley 01:36 Thank you Meco. We just wanted to take a brief moment and identify what we think is the opportunity set for equity investors to look beyond the possible behavioral US bias or, let's say, in a lot of portfolios, and just quickly point out a handful of probably relatively obvious things that have happened in the market more recently. Particularly, if you look at the last five years of performance, just simply looking at performance on the [inaudible]-- the past five years of performance of the S&P 500 over the MSCI EAFE Index, the MSCI Emerging Markets Index, and the MSCI All Country World Index, Ex-USA Small which will represent international small caps. You can see a meaningful magnitude of outperformance of the US markets for a lot of reasons we won't go into here. I think that all we really want to show is just that magnitude of outperformance in the US. Now, without calling timing on any potential pullback or mean reversion, we just wanted to identify the fact that there could be, at some point, some mean reversion within the performance of Ex-US versus US equities.

PAT FOLEY 02:58 And if you look over the past-- the next level shows that over a 10-year period, you can still see that magnitude even greater. You're going back. This time frame will show prior to the financial crisis, and you'll see the movement in emerging markets still at the tail end of that large run that EM had had. But then right after the financial crisis, you see that the US market really pull out and take a strong leadership and continue [inaudible]. From the valuation perspective, look very simply on a next 12-month P/E, you can see that the S&P is at a significantly higher multiple than either of those same three benchmarks representing developed Europe and Japan as well as international small [inaudible].

PAT FOLEY 03:55 On the next slide, we're showing the same sort of performance dynamic that we showed before. The top left and top right charts there are showing this in a relatively standard risk/return scattergram format that I think is relatively common for most financial advisers when they talk to their clients about asset allocation and where they should be. So you see the same dynamic when you add risk into the picture using standard deviation on the X axis. You can see that over the 5 and 10-year period, that the S&P 500 is pretty well into the northwest quadrant and looks to be the superior asset class to have been in. Certainly, from a hindsight perspective, that appears to be the case.

PAT FOLEY 04:38 On the bottom left chart, we wanted to show another period where if you take that same 10-year time frame and scale it back to the end of 2007, you really capture a period-- you actually capture the tail ends of the '90s which is actually a good period for the US, obviously, but you're also capturing a significant run in Ex-US assets at the beginning and middle part of the last decade, where you could see with this dynamic, from a performance perspective, can flip. But from when you're looking at these trailing periods-- from a volatility perspective, the US almost always-- or not always, but will have a general risk-specific, but you will see that from a performance perspective and on a risk-adjusted perspective that some asset classes do tend to normalize.

PAT FOLEY 05:36 On the bottom right, you can see another 10-year time frame that really captures the last time that the US has had an outsize performance run. We're going through March of 2000, so capturing the most of the '90s were around the US. And this is notable just to show that the last time we've seen similar to the charts above and as of April of 2017, when you look at it, the last time that we've seen the same magnitude of that performance by the S&P 500, the subsequent 10 years after that showed a very different picture. Notably, the international small cap index that we used here was not available, but it would likely be a similar risk/return picture there with the other Ex-US.

PAT FOLEY 06:31 So moving on, one of the things that we really wanted to convey was not only that there's an opportunity that we believe exists for Ex-US equities, but we wanted to have a bit of a discussion with some of our subject matter experts in the space. We have an investment team that focuses on global and international, and by international, we mean Developed Ex-US primarily in the UK, developed Europe and Japan. And one of our spokespersons for that team is here today. His name is Michael Friedman, he is a CFA and Senior Equity Analyst from the team covering primarily the consumer discretionary and staples area as well as industrials and financial services, including the recently minted real estate peak sector. Michael joined the firm in 2011, and comes to us with an interesting background from the University of Pennsylvania and as well as an MBA from the University of Chicago.

MICHAEL FRIEDMAN 07:33 Glad to.

PAT FOLEY 07:34 So Michael, I wanted to ask you, given that you focus pretty significantly on the Developed Ex-US space, could you talk a little bit about how you guys are viewing that space from your investment perspective and where do you think the opportunity sets are?

MICHAEL FRIEDMAN 07:51 Yeah. Thanks for the introduction. I wanted to talk about a couple of ideas. First, give you an example of what we look for in a stock and then maybe move on to where we see opportunities. We are, as I mentioned, focused on developed markets. We're an international value team. And we look for in a stock primarily is outstanding potential upside but at the price of acceptable risk. Our rule of thumb is 50% upside over a three-year period, but we do have to adjust for volatility as well. Volatilities are friend when we're buyers if the market overreacts on bad news. But it can also create a lot of headaches if we're owners, particularly in international markets. So we have a downside scenario for every company as well as an upside. And it would certainly demand more than that 50% upside for a stock that has that outside risk.

MICHAEL FRIEDMAN 08:43 Now, what are the benefits of international investing? It's simply the size of the global market. US generates only 25% of the world's GDP, but domestic assets make up over 70% of investor's portfolios. So there is clearly a bit of home bias here. When we take a look at it, we screen our entire universe and divide the stocks in the quintiles, giving each company a label of one to five. We only buy stocks that are five-rated. We want the cheapest 20%. Our criteria include both traditional measures such as cash flow and earnings, which apply to a company no matter where it's located, but it also factored in market related forces, not just sentiment and earnings revision. We also get a list of which stocks are the most attractive in a given week. About 80% of the stocks in the screens are always there, and most of those qualify as value traps. It's those other 20% that are coming and going that we want to look at.

MICHAEL FRIEDMAN 09:41 One of the nice things about being a value investor is we let stocks come to us. We're never in a rush. There are thousands of stocks in the universe and we only have 50 or 60 of them in our portfolio. Our analysts maintain watchlists of stocks that we'd like to own, but aren't vibrated yet. So when a company does move into the screens, we can act quickly. The policy has saved us from blow ups on more than one occasion and helps to prevent us from falling in love with a stock. We're value investors, but we don't avoid growth. We like growth. We just don't particularly want to pay for it. And finally, in terms of what we look for, we're bottom-up investors. One benefit of international markets is that they're less efficient and they're not as well covered by the sell-side. Meaning that fundamental research can generate that much more alpha. We don't actively target particular geographies, although our stock-picking process often does result in being overweight to certain regions.

MICHAEL FRIEDMAN 10:39 One thing that's unique about us is every team member is involved in every buy or sell decision. Analysts don't present a decision to a single portfolio manager, but rather to the entire team. So it's not simply that we're able to participate in the process, we're expected to. And in the more complicated markets, like the international market, it's better to have five heads than one. It results in a carefully vetted portfolio of ideas.

MICHAEL FRIEDMAN 11:04 Now, I want to move on to the next slide and talk a little bit about where we see opportunities. If you look at this chart, the US relative performance cycle, as you mentioned earlier, it's getting very, very old. The average cycle duration is 68 months, and prior to this particular cycle, the longest we've seen was 91 months of Russell 1000 versus MSCI outperformance. We're now in the 112th month, so we're closing in on double the average of cycle duration. Now, I don't know when that cycle is going to end. I don't know when international will overtake domestic, but from a risk/reward point of view, it looks very attractive to us.

MICHAEL FRIEDMAN 11:48 As we noted earlier, our approach is geographically agnostic. Our core competency is company-focused, it's fundamental research, so that's what we stick to. Right now though, given the outperformance of the US markets, most international markets look comparatively cheap. We move in the direction that the screens tell us are cheap, and right now those, in particular, lead to Japan and Europe. We're seeing some gradual recovery in Japan with inflation having poked its head above zero, leading to a bit of pricing ability. Inflation isn't commonly thought of as a good thing, but when you've had deflation every year for several years, you need to get a little bit of pricing power to get your earnings moving again.

MICHAEL FRIEDMAN 12:30 The job markets, particularly in the metro areas, have also benefited our positions. And Europe's a similar story. It's recovering from the devastation that we saw earlier in the decade, but multiples on stocks have remained undemanding even if the economy has begun to recover. First quarter earnings growth in Europe was almost twice that of the domestic markets, but those stocks remain a little bit cheaper and they have very good yield. I thought it might be useful to talk about a high conviction idea that we have in the portfolio to give you an example of how we look at stocks. So I'll give you the elevator pitch, so to speak, on a French auto parts company that we bought last year. One thing I should mention is that while the company is France-domiciled, only 15% of their sales are actually the French manufacturers. In other words, looking at the portfolio by corporate headquarters may not give an entirely accurate version of the regions that mattered to us. It may not also tell us the importance of each region or where our money is at that point.

MICHAEL FRIEDMAN 13:34 The auto parts supply business is not exactly a sexy one, but it is a very profitable one particularly in the sectors that our company, that we bought, is in. It's a safety, powertrain, interior comfort, and driver assistance. These segments are all in the fastest growing parts of the auto business. They have very high barriers to entry. Of course, when you have a company that's high quality, you're not the only one to notice it, and it was never cheap enough to get into our screens. But we did the work on it and kept it on our watchlist. And then Brexit happened. The market panicked and anything that was viewed as being exposed to macroeconomic factors was crushed. That category would include autos and auto parts. And investors threw out the babies, they threw at the bathwater, they threw at that little stopper that keeps the water from going down the drain. I mean, everything was hit hard.

MICHAEL FRIEDMAN 14:21 So despite being a high-quality company, it did finally make it into our screens, and that's where volatility was our friend. And since we'd already done the work on the stock, we moved right into a team discussion. So we re-examined the base case and we determined that Brexit would have little to no impact on the company, and that the company's fundamentals haven't actually changed. So we bought the stock and it's outperformed since. This may sound like an ideal scenario, but it's also the type that fits our style, and we take advantage of those opportunities when we see them. It's a typical example of how we can capture investment opportunities through adversity. Anyway, thank you for your time. We're going to continue to manage reward and risk wisely and we look forward to continuing our performance.

PAT FOLEY 15:07 Great. Moving along to our next speaker, Jeff Wang is also CFA and a Senior Equity Analyst on the emerging markets team, primarily covering the Asia region and looks-- their coverage is regionally rather than as specifically like [inaudible]. Jeff joined the firm in 2007, coming up on 10 years, and comes to us from time spent in the emerging market investments at Pictet as well as Putnam. He's a Harvard University undergrad and an MBA from University of Chicago. Jeff, we'll turn the same question to you, asking you to give us an idea of how you guys view your investable universe and where you think some of the opportunity set lies.

JEFF WANG 15:52 Right, thanks, Pat. So emerging markets, I think it would be helpful perhaps just to take a step back and just try to articulate why emerging markets is attractive as a potential investment opportunity. I think the primary reason for that is growth potential. So with emerging markets, as to Mike's earlier point, international markets and particularly emerging markets, they have a very strong foundation for growth in population, in demographics. Many of these countries are very populous, but also quite young. And with urbanization, we do expect over the long-term that people will have growing incomes and that will contribute to rising consumption power. And if anything, the proliferation of technology and global capital flows only accelerates this process. So from that perspective, the growth potential is certainly very exciting in emerging markets, particularly in consumption.

JEFF WANG 16:51 At the same time, we should also bear in mind that many of these emerging markets are still very well-resourced and that's still a very important part of global growth. And this would include oil reserves, lithium for example for batteries, and also farmland. So these are all things that are also playing in the favor of emerging markets. Besides growth potential, valuation is also another reason for emerging markets as a potentially attractive area for investments. To Pat's earlier point, emerging market has historically traded at a discount to developed markets, and that is certainly the case these days after several years of underperformance compared to developed markets. A third point, perhaps a little bit less well-appreciated is diversification. So this is primarily within emerging markets. Put simply, there are just a lot of different dynamics at play among the various emerging market countries, as well as within countries. So you have some companies that are very domestically focused and from fundamental perspective are quite insulated from what's happening in a developed world. So that can be, oftentimes, a very attractive place to look for opportunities.

JEFF WANG 18:03 Now, for all the potentially good reasons to invest in emerging market, there are also a lot of concerns. And the common ones, first and foremost, are high risk and volatility. So it is absolutely true that emerging market has had its history of financial crisis, Asian crisis, Russian crisis in the '90s, currency swings, political upheaval, more recently we've also seen a lot of volatility put forth from the Eurozone crisis, US interest rate rises, as well as commodity price swings. A second concern is perception about poor transparency in corporate governance. And these are related to some of the scandals that you might see, or concerns that accounting standards are not quite to the same level as the US standards. And thirdly, there are concerns about robustness of institutions, be that legal, political, or monetary. So again, in the past, we have had instances of expropriation of assets, capital controls, and such. So all this is to say that there's a lot of opportunities in emerging markets, but also a lot of concerns. So as investors, how do we manage this balance? And how do we seek to generate performance and focus on the good opportunities while avoiding the pitfalls?

JEFF WANG 19:21 And for us, our approach to investing in emerging market is driven by bottom-up fundamental research. So we believe very strongly that understanding companies, understanding their history, their business models, understanding the industries, how they're positioned is crucial in order to make good decisions from a long-term standpoint. We believe it helps us to appreciate the diversity and dynamism of companies and how they change, as opposed to looking at things through just a screen which may not appreciate some of these changes which happen quite quickly. At the same time, we do believe that bottom-up research helps us to manage risk to the extent that we do identify risks that's unavoidable. We do believe that having a bottom-up approach helps us to understand these risks and to quantify that, and to incorporate that into our valuation framework.

JEFF WANG 20:16 So for us, again, bottom-up research is very important. We also like to focus a lot on understanding how structural changes are occurring. What change are taking places within industries, and companies, and consumer behavior? So we're very focused on trying to understand how value is distributed across the supply chain. Which companies are in a better position to extract value from the growth opportunities that we see? On the other hand, which companies are at risk for having their product or service being commoditized or disintermediated? These are all situations that happen very regularly. So our objective is to really focus on the future and to understand which companies are best placed to defend their businesses and to grow.

JEFF WANG 21:05 To that end, we focus primarily on two key criteria when we invest. The first is sustainable franchises, and this is a reflection of the quality of business with respect to its competitiveness, with respect to profitability, and also its ability to adapt, and there's an evolutionary aspect to it. So what has worked for our companies so far to this point in terms of its business model or strategy, those may not necessarily serve the company well in the future. So we are always looking, again, to the future to understand how companies manage their businesses, to see whether they're able to be resilient in the face of challenges, and whether they're able to adapt to changes and challenges that come their way.

JEFF WANG 21:52 In terms of valuation, we also, as Mike articulated earlier, we do care about valuation as well. We want to be investing in companies that we believe are undervalued relative to their intrinsic value. And the time frame that we have is indeed long-term, so we're not looking for companies to just simply beat estimates on the next quarter or next year. We're really looking much beyond that to look for what we think the company should be worth over a long period of time, and that's what helps us, guide us with respect to identifying undervalued companies. So oftentimes what we find is that you have companies that may be experiencing short-term headwinds or challenges, perhaps there's headline or a news item that the market interpreting negatively from a short-term perspective, but if this development is not necessarily pertinent or we don't think that really affects the long-term franchise, then that's something that could be an interesting opportunity for us to invest at that point. But the bottom line as well for us is that we are patient investors. In emerging market, volatility is unavoidable. And in that sense, having a long-term time horizon does help us to whether through some of these gyrations, helps us to be opportunistic as far as picking good opportunities. But our strategy does require patience, and we do believe that this is what helps us to contribute to long-term, positive performance.

JEFF WANG 23:27 If we turn to the next slide, we can talk a little about our outlook. Again, from a long-term perspective, we do have a positive view on emerging markets. In the short-term, we do believe that there are many economies which are stabilizing or recovering. This is in contrast to fears that China was facing an imminent crisis or that the US interest rate rises would have a severe impact as far as slowing down growth in emerging market. We do believe that this year is at least showing evidence that the economies are in fact stabilizing, or in many cases, actually recovering. But more importantly, from a long-term standpoint, we continue to see the long-term consumption growth story intact. And this is not just about quantity of consumption, but also quality of consumption: people caring more about brands, services, not just goods, but also method of consumption. So again, the proliferation of mobile technology has dramatically changed the way goods can be distributed in these emerging markets. Historically, infrastructure, the [foreign?] infrastructure has been an impediment to growth, but these days with mobile technology, many of these issues have been somewhat de-emphasized. So that's something which is very exciting to see.

JEFF WANG 24:50 Another positive point from emerging markets, in our opinion, is structural reforms. So we do believe that in many countries, there are a lot of structural reforms underway. And while the benefits may take some time to see, and we do think that their-- the direction, things are moving in a good direction. One example would be in India where they are introducing a tax reform, and this is potentially very positive as far as removing some of the barriers and hurdles to operating businesses there efficiently. So that's something which from a long-term standpoint we view quite positively. In the case of China, state-owned enterprise reform is a high priority for the government. These are sectors where historically there has been inefficiencies and in many cases unprofitable businesses, and the government is starting to take measures to try to remedy these chronic problems. So whether this is through consolidation or shutting down inefficient capacity, we do believe that they are taking incrementally positive steps to help address these problems. So again, longer term as far as the impact, but certainly we're encouraged by what we see happening now.

JEFF WANG 26:06 Now, with respect to political uncertainty, it's really nothing new in emerging market. So as concerning and as alarming some of the headlines may be about elections or other sort of disruptions that you see to politics in emerging markets, it is just part of the nature of emerging markets and it's not the first time we've seen this. At the end of the day, we do believe that institutions are what matter most, and as well as just this human innate desire to want to live their lives and improve their quality of life. So people do find a way to work through adversity, and that's ultimately what we're focused on at an individual company level. And furthermore to the extent that there are misdeeds or corruption which are publicized, ultimately, again, these are things which should bring up for improvement in the future. The sort of public uproar that we've seen in the face of corruption in recent years has been very strong, and that, in our opinion, does suggest that there needs to be more accountability going forward, and that again can only be a positive from a longer term perspective. And then finally, again, valuations are supported in emerging markets, so that's something which is another reason why we hold a positive long-term view towards the emerging markets.

JEFF WANG 27:31 As we turn to the next page, we can just talk briefly about an example and just how our bottom-up process works and-- a little bit to just earlier with respect to the mobile technology, but in emerging market, there's really been a few change as far as the confluence of telecomm and Internet. This is underpinned by the launch of high-speed mobile data networks, lower cost for mobile devices, young demographics, rising consumption. These are all things which have dramatically changed consumer behavior and how they engage with the Internet, how they engage with the retail stores, how they engage with their banks and financial payments. So it's really been very exciting to see this unfold in front of our eyes. But despite all these sort of growth opportunities, what's most pertinent to us is trying to understand who captures value from these changes, and this is where different players in different markets or different industries can extract value. So it's not necessarily the same players in every country that we see as being the main beneficiaries of this. So whether that's device makers or mobile service providers, content owners, platforms, really that's what we're trying to understand at a bottom-up level to see who really benefits from these changes in consumer behavior.

JEFF WANG 28:53 So in the case of China, there's certainly some very powerful Internet platforms that have emerged over the recent years, whether that's an Alibaba for e-commerce, for example, but really the platforms are very, very powerful in China, and that's where we see a lot of opportunities,especially with respect to advertising, the shift from offline traditional advertising into mobile and online. That's a trend that we see really continuing. And as consumers in China spend more, we believe that advertisers will continue to devote more their resources onto these platforms that have proven to have quite loyal and sticky user bases. So that's something that we see as being quite well-positioned for this trend.

JEFF WANG 29:43 In the case of India, by contrast, this is perhaps a little bit different where when we look at the Indian landscape, the Western companies, whether that's a Google or an Amazon, they're very much present in India, and that makes it competitively quite challenging for some of the local players. But we do believe that there is still opportunity for value to be captured from this growth in the mobile service providers space, so these would be telecomm operators, for example. It's historically been a very difficult sector in terms of excessive competition and weak profitability, but we are seeing quite strong consolidation happening, and that's something which ultimately if we are to see a more consolidated industry with better pricing power, the data growth and appetite for mobile data, we think, is very strong and can support good profit growth for this type of business. So just an example of how this idea of mobile proliferation and technology can really be articulated and reflected in different types of stocks and different types of markets.

JEFF WANG 30:55 So in conclusion, I would just say that, reiterate that the emerging market, we think, presents strong opportunities for structural growth. We do believe, however, that selectivity is very important as far as investing. There's really a wide array of quality of companies in emerging markets, so selectivity, we think, is critical, but also having a long-term investment horizon. This emerging market is a long-term story. Over a short period of time, certainly there can be high volatility, but we believe that with patience and discipline, you will be rewarded for that over the long-term. I'll turn it back to Pat. Thank you.

PAT FOLEY 31:34 Great, thanks, Jeff. I'd also like to turn the attention to Stephan Maikkula, who's a Senior Portfolio Manager, CFA, CFP, Senior Portfolio Manager on the global Ex-US equities team which came to us in March of last year, so a relatively fresh new face for the firm, but that the investment team that he came from, we've been working together for quite some time. Stephan's over 19 years of investment experience. And prior to investment management worked out with Cargill in the commodities analysis space, is a undergrad from St. John's and an MBA from the University of Texas at Austin. And Stephan, I'll ask you the same question, and focusing on the international small cap space that you're representing, give us an idea of how you guys view your investable universe and give us a sense for what you believe the opportunity set to be.

STEPHAN MAIKKULA 32:32 Great. Thanks Pat. Pat mentioned, I'm a Senior Portfolio Manager on our global Ex-US team and I focus on our international small caps strategy. So I'll be going over how we view the international small cap space. I'll start by briefly explaining how our investment philosophy and really what we're looking for in terms of investment ideas. I'll also discuss our overall view on the asset class, and then lastly, walk through a high conviction idea. You can really get a feel for the type of opportunities that we look for. So in terms of our investment philosophy, there are two key things that I'd like to cover. First of all, what we believe. We believe that companies that are undergoing positive fundamental change will likely outperform. And secondly, why do we believe that? So we feel the positive change, it's often underestimated by the market, and that leads better than expected earnings growth. So we believe that the market tends to underestimate the magnitude and/or the duration of earnings growth. It's driven by a positive change.

STEPHAN MAIKKULA 33:35 So the first question we often get is people will ask, "Well, what is positive change? What do you mean by that?" Positive change can be a number of things. It can be a new market, could be a new product, could be a new geography a company's entering, could be some improvement in pricing dynamics, could be a new management team, or maybe a macro development. So our investment process is bottom-up driven and it's really focused on finding companies that are potentially undergoing positive change. So our fundamental research really focused on identifying what is the change, is that change sustainable, and then what are the risks around the investment case. So I'll get into one of our high conviction ideas in a moment just to give you a better understanding of how that investment philosophy is carried out. But first, I just wanted to hit on a couple key points in terms of the overall asset class and some of our thoughts there.

STEPHAN MAIKKULA 34:25 So if you turn to the next slide. Great. So in terms of the outlook for the asset class, I mean, we're really excited about international and international small caps in particular, and they're both strategic and maybe some more tactical reasons for our optimism. From a strategic standpoint, international small caps as an asset class have a number of key drivers in their favor. First of all, it's an inefficient asset class, as Michael mentioned with international in general, but we see that even more so within the small caps. There simply isn't as much coverage of the individual companies. On international small cap space, you maybe have, on average, five or six sell-side analysts covering each stock, and there are a lot of companies that are really yet to be discovered. And so that information inefficiency really provides opportunities for active managers who are researching, investing in these companies to add alpha.

STEPHAN MAIKKULA 35:24 Secondly, international small caps have historically delivered strong risk-adjusted returns in comparison to large cap stocks. So people often think of these companies as being quite volatile. And yes, on average, an individual small cap stock is probably more volatile than a larger cap company. The interesting thing though is that once you put together a diversified index or portfolio of international small cap stocks, the overall volatility of the portfolio or index is actually relatively close to a larger cap index. And why is that? Well, on average, individual small cap names, they tend to behave more uniquely, so they tend to have lower correlations with each other, we tend to see bigger return dispersions within the small caps. So essentially you have more stocks that have returns that are further away from the benchmark. So again, these companies tend to operate on a smaller scale and they have fewer products. They tend to be more domestic, originally-focused, so they're not necessarily as driven by some of the larger global themes. Additionally, the type of positive change that I mentioned earlier can have an outsize impact on smaller companies. Depending on the specific things you're looking at, I mean, it's something that can be transformational for a smaller firm.

STEPHAN MAIKKULA 36:40 Another key point that kind of ties in with that is that they can offer investors a chance to gain access to key growth areas or industries that might be more difficult to access with a larger company. And finally, I would just add too, the international small cap universe really provides a broad opportunity set. Our investable universe, for example, the way that we define that in terms of liquidity and so on, we're looking at around 2,500 stocks. So there are a lot of unique and exciting companies. It's really a broad opportunity set. It provides us the chance to find strong growth names around the globe. So basically, with international small caps, you have this broad opportunity set that's less information efficient and a situation where the stocks tend to behave more uniquely, and we think that's a powerful combination.

STEPHAN MAIKKULA 37:28 So those are some of the key kind of strategic reasons why we like the asset class. In terms of - I don't know - maybe more tactical or just in terms of some of the geographic things that we look at, there are a few specific things that point to that [inaudible] have us optimistic. First of all, Europe and-- I would just echo some of the comments that Michael made. Europe has struggled on a relative basis post the financial crisis due to a long list of issues, like had issues with European banks, with Greece, the peripheral countries, Euro breakup fears, Brexit, and so on. The ECB too is also behind the Fed, if you remember, they actually raised rates in 2011 before following the Fed and easing. So really, it feels like it's been kind of one thing after the other in Europe. But now, it seems like with the reduction in political risk here with some of the recent election results and some more encouraging macrodata, we're starting to feel more confident there. And additionally, too, I mean we're really focused on the bottom-up, we're focused on earnings growth and revisions, and we're seeing strong earnings out of Europe. We're seeing the number of upgrades versus the number of downgrades being strong. And importantly too, we're actually starting to see some top-line growth. So this is not an earnings growth [inaudible] that's driven by cost cutting.

STEPHAN MAIKKULA 38:44 Secondly, emerging markets. And Jeff did a good job covering that in terms of some of the growth potential there, some of those themes in terms of rising incomes, consumption, and so on. That's an area too that has us optimistic. And then even Japan, that was touched on earlier as well, but obviously that hasn't been a dynamic growth market in terms of GDP growth over the years, but we've seen some positive [inaudible] too in terms of some of the uptick in inflation expectations and the recent GDP numbers. The unemployment rate too is relatively low, and here too, the recent earnings upgrades versus downgrades have been positive. So to kind of sum things up there, I mean, we're optimistic on the asset class for both the strategic and also based on some of the other things that we're seeing in the geographies themselves.

STEPHAN MAIKKULA 39:36 If we move on to the next slide, I'd like to briefly discuss one of our high conviction ideas. You can really get a feel for the type of opportunities that we look for, and you can really see where the rubber meets the road. So I just mentioned Japan. And I'd just like to walk through one of our high conviction ideas that also happens to be a Japanese company. On the slide, you'll see a few key bullets on one of the stocks that we really like and this one that we've owned for some time. This company is an online apparel retailer in Japan. So basically, the firm essentially operates an online mall where third-party merchants are able to sell to customers in virtual stores. The company has over 950 stores. They've got around 3,900 brands within their online mall. And they've got strong market share in the trend fashion segment of the apparel market. So the company's main target market from a demographic standpoint are customers that are in their late teens to late 40s, so the average age is probably just over 30. And the positive change impacting the company has been the increasing influence of online or e-commerce retail and the strong growth in that segment, specifically within the fashion space in Japan. So in terms of assessing the sustainability of that change, we've felt that with the general increase in online retail, you combine that with the increasing influence of mobile purchases, the overall penetration rate of online purchases in Japan relative to other markets, and given that the majority of the company's sales are actually via consignment, so that helps them mitigate inventory risk, it's a positive change and one that's most likely to be sustainable and have a positive impact on the company's earnings trajectory. They've also developed various initiatives. They've got a social media element that they've added to the mix. As I mentioned, it's a market share leader within trend fashion, and their strategy has really been to take more customers from the traditional department stores. So the company has just continued to perform and grow. Our confidence has risen, and it's become one of the larger weight in the portfolio.

STEPHAN MAIKKULA 41:42 And one final point too I'd like to just quickly make. Earlier I had mentioned that one of the benefits of international small cap stock is that they can potentially provide an opportunity to access industries or parts of the market that might otherwise be difficult to gain exposure to. And I think this company really demonstrates that and really fits the bill. If you look at the chart on the left, you can see what the growth rate looks like for online apparel revenues relative to the kind of the overall retail and apparel sales in Japan. So clearly, it's a much faster growing segment of the market. So we're able to identify a pocket of growth within a broader industry, a broader economy where the aggregate level, the gross numbers are much lower. So a larger firm might have some of their business coming from this segment, but here we have a company that's focused specifically on this faster growth area. So again, that's one of the reasons that we really get excited about international small cap. And with that, I will turn it back over to you Pat.

PAT FOLEY 42:39 Great. Thanks, Stephan. So the next section, this next segment here, we wanted to go through a handful of topical macro comments and just have the teams, as relevant, give their opinions from their different investment perspectives. So I'll start with you, Michael, given that the focus is on developed large cap Ex-US, and the question is regarding the protectionism and the rise of some nationalism in Europe, and we'll focus on the French election results. Can you talk a little bit about how you guys view-- what impact that has on your investable universe?

MICHAEL FRIEDMAN 43:24 Yeah. I think our team breathed a sigh of a relief when Macron won the French election. Open borders, free trade, they're important to us. As I mentioned, a company might be located in a specific country in terms of its corporate headquarters, but it's got business all over the world. So to us, the open borders, the free trade is extremely important. And the nationalism, it scares us a little. You start putting up barriers, you start introducing tariffs between countries, that slows down trade, slows down growth, slows down earnings, and the value of the company therefore goes down.

PAT FOLEY 44:04 And Stephan, given that you focused on similar regions but more on the small cap side, how did that manifest in the small cap space?

STEPHAN MAIKKULA 44:14 Yeah, it's interesting. I mean, I would definitely say that the political situation in continental Europe is probably one of the bigger concerns, the risks out there coming into 2017 and kind of for the first 3-4 months of the year. So we had a pretty heavy election calendar. We have both coming up in the Netherlands, France, Germany, and certainly all the issues that Michael highlighted there kind of front and center with that. So while there's, I guess, still some concerns maybe out down the political front, I know they have definitely been reduced recently. We had the Dutch elections in March that kind of went from one of these potential canary in the coal mine type situations, one where the moderate fared better. And obviously, the French election too turned out better than expected or as positive as could be expected, I guess. And then we've seen some election results from Germany that have turned out better too for Merkel. So it's really from a small cap standpoint, the positive, Michael touched on, kind of the drivers for large caps and small caps in that perspective are similar too in terms of free trade, and protectionism and so on too can kind of throw a wrench in the system.

STEPHAN MAIKKULA 45:20 But I think the big thing for us is having kind of that macro risk out of the way. Because situations like that where you get kind of these risk-on, risk-off type markets, and all of the sudden you're looking at a company from a bottom-up standpoint, you're looking at some really positive fundamentals on a smaller cap company, and then boom, all of the sudden you get these macro risks which just completely overwhelmed that. So I mentioned some of the macro and some of the earnings, surprised that numbers out of Europe are getting more positive. So we're really, really happy and also breathed a sigh of relief here too with the way some of that political stuff has turned out, because, again, it gets that macro risk kind of muted and out of the way. And then we can focus again on the company fundamentals.

PAT FOLEY 46:04 And Jeff, is there any relevance in your world? Is there any catch on effect to the companies that you cover?

JEFF WANG 46:12 Well, I think that, first of all, we need to separate rhetoric from reality. So for us, the sometimes the fear of what might happen is far different from the actual reality. So we're always trying to stay focused on actual policies and trying to really interpret the details of what the true impact is. Because in our experience, the market sometimes gets carried away with that. But with emerging markets, we still feel much more strongly that the opportunities are much more about domestically oriented growth. So it's not so that we don't invest in companies that have export exposure or that export to developed markets, but the bigger part of our portfolio is certainly more geared toward the domestic growth opportunity. And to that extent, probably a bit less impacted at a fundamental level at what we're seeing. Now, if trade deals get renegotiated, yes, that could certainly impact some of our companies, but we feel much more interested in kind of domestic story in emerging markets.

PAT FOLEY 47:22 [inaudible] move over specifically into the emerging markets on the next question here, and talk a little bit about China and sort of growth. And Jeff, you talked a little bit about this earlier, but can you go maybe a little deeper into some of the team's thoughts on the slowing growth but still obviously higher than developed in China?

JEFF WANG 47:42 Right. Well, growth in China is a very controversial topic because they have the headline numbers, you have the reported numbers, and then you have people out there who can argue that those numbers are fabricated and they don't mean anything. So I think that it's not really our place to try to decide who's right and who's wrong. I think that for us, growth in China, economic growth, does need to slow down as we've seen, and it's not a bad thing at all. The growth levels that China has experienced over the past decade are unsustainable and have resulted in a number of imbalances and asset bubbles and excesses, which are just not healthy from a long-term perspective. So we do believe that many of these issues need to be addressed through, and slower economic growth is part of that. So when I mentioned earlier about removing excess capacity and shutting down inefficient capacity, that will, from a numerical and mathematical perspective, lower GDP growth, but that's ultimately a positive thing in terms of quality of growth and long-term sustainability. On top of the fact that the government does appear to be paying more attention to environmental issues, environmental impact to some of their past policies, these are also things which, again, may not necessarily promote headline GDP growth, but the underlying quality will be much better.

JEFF WANG 49:12 But I think for us, our job again when we look at China is to try to understand where the risks and where the opportunities are. And certainly there are still areas of concern with respect to asset quality and overcapacity that leads us to be cautious in certain sectors whether that's real estate or banks or industrials, but underlying all this, there's still a very robust consumption growth story. So this notion that China's shifting from manufacturing economy to a more domestic consumption oriented economy, I mean, it is actually happening even if it doesn't show up at a headline number. And it's our objective to try to focus in on the companies that are benefiting from this growth in consumption. So China's a country that offers tremendous opportunities but also risks, and that's where, again, the bottom-up investing and selectivity is important from our perspective.

PAT FOLEY 50:12 Great. Stephan, you focus on Ex-US small caps, primarily developed, but also have a meaningful exposure to emerging markets, as you mentioned. Talk about it from the small cap perspective.

STEPHAN MAIKKULA 50:24 Yeah, I mean, I think some of the same type of comments apply. I mean, obviously, China and sentiment towards China too definitely drives a lot of things. And we have seen some tightening in China recently and it's something that we're definitely keeping an eye on in terms of either rate, property restrictions, those type of things. But that being said too, I mean, I think some of Jeff's comments too in terms of the positives, in terms of the longer term sustainability of that are definitely worth noting. But yeah, I mean, it's something that we'll definitely keep an eye on. I imagine the government too would probably attempt to cushion any slow-downs too with maybe some renewed fiscal stimulants if things are slowing too quickly. But yeah, it's the same kind of thing on the macro front. I mean, we're bottom-up investors. We're looking for bottom-up stock ideas to the extent that we don't get these kind of big macro things coming at us and overwhelming those individual company fundamentals. It's definitely a positive. But yeah, I mean, China is an important country. It drives a lot of things. And like I said, even just from a sentiment standpoint too, so it's definitely something that we monitor very closely as well.

PAT FOLEY 51:33 And Michael, turning to you, even though it's sort of some of the larger names that might be a little bit-- global names that might be relevant.

MICHAEL FRIEDMAN 51:41 Yeah. We don't focus on China specifically. Obviously, Chinese growth is important to us in that a lot of our companies' customers are in China, and for that matter, a lot of their suppliers have factories in China. We don't have as much exposure to the domestic Chinese companies. We are selling to Chinese consumers. We are unlikely to try to determine where Chinese growth is going to be. I think the one thing we can agree on is that over the long-term, it's going to be up. But what's important to us is what is the impact to the region having on the individual companies. We're looking at the fundamentals of our particular companies. So even if we don't look at the Chinese economy as a whole, we might be concentrating on what the region's impact would be on our holdings.

PAT FOLEY 52:35 I think we're over the 50-minute limit here for the continuing ed credits. However, for folks that want to stay-- I don't know if we can offer extra credit, but we can offer some extra on some topics here. I think given what's recently happened on more recently in Manchester, I think, just instability in general. We see it pop up in the Middle East, we see it pop up with North Korea. Can you talk a little bit about-- I want to talk a little bit about how we manage volatility and manage this big picture of geopolitical risks in the portfolio? I'll start back with you again, Michael.

MICHAEL FRIEDMAN 53:18 Yes. So geopolitical risks fall into the category of the unknown. There's simply no way to account for these types of incidents ahead of time. We manage them through a diversified portfolio. We don't generally have a concentration in one particular region. The other issue is a one-time geopolitical event, be it good or bad, might lead to opportunities as certain stocks get dislocated or feel the effect of a macroeconomic issue that really is not going to impact their fundamentals. So I mentioned earlier an auto parts company that was affected by Brexit. Because of Brexit, everything that had any volatility to it was essentially thrown out. We'll take advantage of those opportunities. We don't try to guess the geopolitical risks, but we do look at what are the impacts of these companies. And one term I referred to earlier was opportunities through adversity. With each particular example of adversity, we say, "Is this going to impact the story for a short period of time, or is this going to change the story over the long-term?" And if the market overestimates the impact over any given time period, we'll take advantage of it.

PAT FOLEY 54:44 Steph, an overview, how do you guys manage through a term period of volatility based on either geopolitical or even acts of terror?

STEPHAN MAIKKULA 54:56 I mean, again, from a bottom-up perspective, I mean, we're really looking at the company too and to see if there's anything that's specifically impacting them, or just some kind of a more broad, kind of risk-on, risk-off. I mean, frankly, it gets difficult to [inaudible] or forecast some of these issues and their implication, especially when politics are involved. So depending on the specific issue too, I mean, that outcome could be binary, which can complicate things as well. So whether it's Europe, North Korea, Brazil, etc., I mean, I think these macro issues, they're definitely things you need to be aware of. And on certain occasions too, you've got to to acknowledge kind of the political news and noise that's out there. But we really try to maintain our focus on the economic, on the company fundamentals, and again, to try to avoid making macro calls, I guess, so to speak.

PAT FOLEY 55:47 Same question to you, Jeff, particularly considering that the Brazil situation earlier in the week kind of gave you a relatively short-term experience with new term volatility.

JEFF WANG 55:59 Right. We can't manage volatility. It just happens. So all we can control is how we respond to it. And when it comes to political uncertainty, as I mentioned earlier, it's just part and parcel of investing in an emerging market. And more often than not, these things end up blowing over. I don't mean to downplay what happened in Brazil. I mean, certainly pension reform is very important for Brazil's long-term fiscal health. So that's something that was appeared to be close to be getting done and that may be sidetracked now. We don't know, but that's something which could have longer term implications by at least from a short-term perspective. We do believe that the economy is still on a recovery footing, and so we don't think that the allegations, whatever, whether they're true or not, again, we don't know. We don't think that will necessarily derail sort of the short-term economic recovery, but we're always focused on the robustness and resilience of franchises, and these are companies that have been around for quite some time and have-- we've seen worse, surprisingly as it may seem. Yeah, this is not the worst that we've seen in Brazil at all.

PAT FOLEY 57:32 Some of the questions that have come in from audience either before or during. A couple of them are concerning liquidity in currencies. Some are asking whether we're buying [inaudible] securities in the local markets or buying ADRs. The quick answer there is that, in many cases, we're buying both. And certain strategies where it requires only an ADR-only version or requires a separately managed account format, we will modify portfolios to accommodate an ADR-only portfolio. Generally speaking, the folks that you're listening to in this webinar are actively buying and selling securities in local markets and where it makes sense. They may also be buying ADRs or other exchange rate in US dollars or whatever currencies that provide potentially more [inaudible]. Another question that came in on currency, and just in general, how that affects returns in your local investable universe? Michael, do you want to speak on that one?

MICHAEL FRIEDMAN 58:42 Sure. I mean, currency obviously plays an impact on a couple of different levels. First, if your currency is strong, you're going to have fewer people able to buy your products. You might be a buyer and vice versa. So it's pretty much what you'd expect in terms of taking place within transactions. The other issue, of course, is the exact change in currency front in a stock price perspective. Am I translating from the local currency to US dollars for stock? And that might not be the case. But the bottom line is we don't try to guess what the currency's going to be. What happens, happens. It's impossible to predict. So it certainly has an impact on the fundamentals of the company and the fundamentals of regions. And we'd like to be aware of what changes in currencies will do to the earnings of our companies, but it's not something that we spend a lot of time thinking about, other than the impact on the company, because frankly we're never going to be able to guess what a currency does.

PAT FOLEY 59:45 Right. So we're not making macro bets on currencies or even muting currency impact by hedging?

MICHAEL FRIEDMAN 59:51 No, we're not.

PAT FOLEY 59:51 Right. It's part of the total return profiles of the security.

MICHAEL FRIEDMAN 59:56 That's right, and we accept the risk that comes with it.

PAT FOLEY 59:59 Stephan, how about from you?

STEPHAN MAIKKULA 60:02 Yeah, similar. I mean, we're not hedging currencies at all. Like Michael said, I mean, there's the translation, there's a transaction impact for individual companies. One thing too that we want to be aware of is kind of at least being aware of the reason a currency is strengthening or weakening. Is it a risk-on, risk-off type of event? Or is it because there's more demand, or there's more growth, people are more optimistic on the country? So [inaudible] investments standpoint. But yeah, I mean, we're not trying to make big currency calls either, and really, it's more kind of looking at the individual companies and seeing what impact it could have on an individual company level.

PAT FOLEY 60:43 Jeff, anything to add from your perspective?

JEFF WANG 60:45 Yeah. From our perspective, I think it's-- the big question's really about risk and what sort of risk does currency movement pose to company's long-term franchise sustainability. So specifically, mismatch is where you have to be very careful when you have companies that earn revenue in one currency and their costs are primarily in different currency. That's where profitability can be severely impacted. Also in the balance sheet, assets and liabilities, you have current companies that have had borrowed in foreign currency that it's something that could really come back to hurt them. And we've seen plenty of instances of that. So that's where we had to be very conscientious of, is understanding what sort of risks may arise to sustainability of the franchise by virtue of currency fluctuations.

PAT FOLEY 61:35 Great. Well, we are past the hour mark. I want to thank our speaker in walking through these important topics with us. And with that, I'll turn it back to our host, Meco Sparks.

MECO SPARKS 61:49 Great. Thanks so much, Pat. And thank you everyone for your participation. We hope you found this information useful and valuable. Thank you also to our experts for sharing this conversation with us. For more information from our team, to learn more about The Evolving Advisor practice management program or to sign new Delaware Funds wholesaler, please visit our financial adviser website at delawarefunds.com. Thank you again for joining us and have a great day.

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