MASTERCLASS: International Investing

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  • 52 mins 11 secs
Russia’s invasion of Ukraine has shaken the world, as well as global markets. Two panelists cover geopolitics, inflation, supply chain issues, ESG, and some of the key themes facing international investors. They also explore where they see the biggest risks and opportunities in different parts of the world and different sectors.
  • Steven Nguyen, CFA®, Portfolio Manager, Causeway Capital Management
  • Danton Goei, Portfolio Manager, Davis Advisors

Jenna Dagenhart:  Hello, and welcome to this Asset TV, International Investing Masterclass. Russia's invasion of Ukraine has shaken the world as well as global markets. Today we'll look at geopolitics, inflation, supply chain issues and some of the key themes facing international investors right now.

Jenna Dagenhart: Joining us to share where they see the biggest risks and opportunities are two panelists, Steve Nguyen, portfolio manager at Causeway Capital Management, and Danton Goei, portfolio manager for the Davis Global & International Portfolios at Davis Advisors.

Jenna Dagenhart: Well, thank you both for joining us. And Steve kicking us off here, could you start by giving us an overview of the state of international markets?

Steven Nguyen: Yeah. Thanks Jenna. And it's great to be here again. It's been a really rocky ride, I would say in the last couple of years in global equity markets. It just seems like we've been going from one thing to another. So certainly COVID has been dominating since early 2020, impacting economies around the world.

Steven Nguyen: And definitely in different fits and starts there were periods of time when it seemed like Europe and international markets in particular were more affected by the U.S, and then other points in time where changes in policies made it seem like perhaps the U.S. was more impacted.

Steven Nguyen: But there's also been differences in the pace of the rollout of vaccines and various solutions. And we're still not entirely out of the woods there. So that's been an ongoing issue that's weighed upon the market. We've seen massive volatility in certain markets like China, where you had this huge rebound from the trough in COVID to the peak in early 2021.

Steven Nguyen:  And then now the impressive fall back to levels below where we saw the bottom of COVID. And just been issue there as well as geopolitical tensions, regulatory concerns and now another wave of lockdowns. Inflation last year certainly was an issue around the world, where I think we went from thinking that it was entirely a transitory issue at the beginning of last year to now being one that the policy makers have to grapple with.

Steven Nguyen:  And you've seen a shift from central banks and pretty much every economy perhaps outside of China, where you're moving towards tightening and removal of this enormous fiscal and monetary stimulus that was put into place over the past couple of years.

Steven Nguyen: So that's another headwind. And also compounding inflationary concerns, just supply chain issues, of course, around the world. And then now most recently in 2022, the focus has been on what's happening in Ukraine, and that's just another set of thorny issues to navigate.

Steven Nguyen: So certainly a lot to focus on and to think about in international equity markets. A lot of complexities, but I'm sure as we'll talk about today, a lot of exciting opportunities as well.

Jenna Dagenhart: Yeah. Building off of the situation with Russia and Ukraine Danton, how should the war in Ukraine impact a long term investor's portfolio?

Danton Goei: Sure. First thank Jennifer for having us on. And first of course, we've all been very touched by the unimaginable human suffering that's ongoing. From investment point of view, we really try to separate the short term and the long term effects.

Danton Goei: So in the short term of course, we've seen a number of impacts from the conflict there in terms of higher food prices, higher energy prices, certain metals have seen a large increase in price as well. From a long term perspective though, we think the impact will be more limited. If you look at first, the participants in here in terms of their size, Ukraine is a 0.1, 0.2% in global GDP, Russia about 1.7. So together less than 2% are being impacted.

Danton Goei: The other thing is that we expect that this war will resolve itself. Eventually it's rather costly war. And the long term drivers that have been in place for global growth from a long term perspective, continue to be in place, whether it's emerging markets growth, the rise of the middle class, productivity and the efficiency improvements that we're seeing across the globe, those continue to be in place.

Danton Goei: So as an investor, you don't want to try to optimize for any short term situation, but really position yourself for these long term trends, which continue to be positive over the long term.

Steven Nguyen: Yeah. I really like the way that Danton put that in terms of separating long term from short term. I think at Causeway we think about things in a similar way, whenever we have this sort of macro shock, and we had one a couple of years ago with COVID and again, we're seeing it with Ukraine. We try to think about, what is temporary and then what is more structural.

Steven Nguyen: And certainly I think one thing that comes to mind in terms of the immediate market reaction after the invasion of Ukraine, I think it was February 24th was the formal date, the initial reaction from the markets was to move interest rates down. So you saw in the U.S. the tenure, I think was over 2% at that point in time, came back down to about one and three quarters.

Steven Nguyen:  In Germany the bund was about 30 basis points and positive territory moved back to negative territory. And that was ensuing one to two weeks after the invasion. The thinking there was that with this new conflict and the uncertainty and perhaps the economic impact, policy makers around the world wouldn't have to raise rates as quickly as they otherwise would have.

Steven Nguyen:  So that was going to perhaps keep inflation down, keep rates down, turns out that was a very temporary reaction. And right after that, we saw continue to hire inflationary data prints. The first ECB meeting in March after the invasion was surprisingly hawkish, and they actually accelerated the pace of tightening.

Steven Nguyen: And then now you fast forward to today, interest rates are well passed where they were pre Ukraine, moving from about 2% to now almost 3% in the U.S. and nearly 1% in Germany. So actually the temporary impact of lower interest rates ended up giving way to really structural or at least more longer term impact of higher rates, which that certainly is impacting growth areas like technology, and also raises some challenges for U.S. equity markets.

Steven Nguyen: Structural, longer term impacts, I think the obvious one, as Danton mentioned, certainly there's an impact on energy prices now, both in the short term and in medium term that could benefit energy companies of that also hurts economic growth.

Steven Nguyen: So we have to think about what's the economic impact and how long lasting that is. And there's also opportunities that come out of that. So because of that obvious economic impact cyclicals have gotten hit and we think that actually has created some opportunities in this market.

Jenna Dagenhart: And Steve, I'm hearing a lot more these days abouts stagflation fears. I have to ask you about that given your points on inflation, as well as the growth story.

Steven Nguyen: Yeah. Stagflation really is the nightmare scenario that I think nobody wants to see, and we don't really have a lot of experience with how to navigate and every cycle does end up being a bit different. All I could tell you in terms of how to address that risk is that the valuation matters.

Steven Nguyen: And so if we look at the valuations of the more cyclically oriented stocks that I was mentioning, especially after the invasion of Ukraine, these stocks have sold off significantly as they already think pricing in a good amount of that growth coming down, which would be the case of stagflation.

Steven Nguyen:  So for example, several large multinational European banks in our portfolio are down 25 to 35% this year, that leaves them anywhere from 30% to 70% discount to tangible book value. Those valuations we think are actually close to pricing in a recession.

Steven Nguyen: You look back at PE multiples in 2009, and again, in 2016, we're actually below those levels today. So it may be true that we are certainly headed towards an economic slowdown and potentially recession in Europe, but we're not necessarily there yet. And in some cases, these stocks are already pricing that in.

Jenna Dagenhart:  And Danton, given the dominance of the U.S. market over the last decade, why look outside of the U.S. for investment opportunities, especially given the current geopolitical issues?

Danton Goei: It's true that investing internationally has been a difficult question, difficult problem for advisors talking to their clients. The clients are asking, why should I bother? United States has been so strong versus international markets over the last decade. And that's definitely true. But if you take a step back and look at one, just the opportunity.

Danton Goei: Of course, 95% of the world is population is outside the U.S. 75% of the global GDP is outside the U.S. 90% of listed stocks are actually outside the U.S. So one is just the opportunity. Growth also, many markets are growing faster than here in the U.S. And now today of course, we got the valuation differential. Right now international markets are trading in over a 30% discount to the S&P 500.

Danton Goei: So that's a very, very large differential. And we know that in the past, there have been long periods, decades where international stocks have outperformed U.S. ones by 300 basis points a year for a decade, or even there's been decades in the past where international stocks have outperformed by 600 basis points a year for a decade.

Danton Goei: And given that big differential in starting point valuation, it is very likely we feel that the next decade will be quite different than the last decade when we're having this conversation 10 years from now. And the last point I would just say is that the companies that we invest in because of course we're investing in companies we're not investing in sort of countries or regions are also increasingly better in quality as well.

Danton Goei: So you've got the quality of the companies, you've got sometimes higher growth rates, you've got the size of the markets outside the U.S., and then today you've got the big advantage of lower valuations.

Danton Goei: So we think the case is quite compelling to actually look at your allocations, which probably have skewed now because of the last decade where maybe you've started at 70, 30 U.S., you might be 90% U.S. today. It makes a lot of sense to look at that allocation now given the differential in evaluations that we're seeing today.

Jenna Dagenhart: Yeah. And I'm sure a lot of advisors are also getting questions about geopolitical issues as we've been discussing. Steve, how should they be talking to their clients about international versus domestic opportunities?

Steven Nguyen:  Yeah. I can imagine how in a lot of cases might be tempting to think that in the U.S. it's much cleaner. You don't have to worry about a lot of U.S. geopolitical issues and there's a lot more noise, a lot more complexities in international markets. Obviously Causeway is an international equity manager. So we have our opinion about that, but we do believe that there's a price for everything.

Steven Nguyen: We're a value manager, our view of value is the difference between the current price and the intrinsic value, whether multiple is high or low. And looking at valuations there's been a huge difference in the U.S. versus international markets as Danton mentioned.

Steven Nguyen:  So using MCI indices, and maybe this is a little bit different from the numbers that Danton was referencing, but we see U.S. equities have increased maybe six times versus where they were at the financial crisis in 2009, whereas international developed equities have only gone up about two times. So that's a pretty massive difference in performance over the past decade plus.

Steven Nguyen:  And yes, some of that difference has been because U.S. markets are growing faster, but certainly not all of it. There's also been a lot of that outperformance just from an increasing valuation of premium. So looking at next 12 months, price to earnings, we've seen that the delta between U.S. multiples and international multiples has more than tripled.

Steven Nguyen:  It was about two turns back in 2009, and it was actually just a little bit more than that about three turns heading into COVID in 2019, now it was end up being about seven turns at the end of last year. So a pretty astronomical difference that's actually about 50% more expensive in the U.S. than in international markets. And a lot of this outperformance just accelerated about COVID.

Steven Nguyen: It was the last couple of years where this difference really took off. And the good thing about having this conversation now is that it's not just a one ways street, we've actually started to see this turn. I think some of this U.S. versus international conversation has to do with value versus growth. There's a lot more growth in the U.S. than there is internationally.

Steven Nguyen:  And when we're seeing interest rates start to move up as we were talking about earlier, that's driven a reversal. So you see obviously growth stocks have struggled a lot recently, really since the end of last year through current times. And with that, you're seeing international markets start to close some of the gap versus the U.S.

Steven Nguyen: I think there is a light at the end of the tunnel in terms of looking at international markets. The Ukraine situation is certainly throwing a wrench into that a bit, but at the end of the day, markets are very global.

Steven Nguyen: So if there's going to be an impact in Europe and around the world, it certainly will impact the U.S. as well. So the advantage you have from international markets is that your starting point from valuations is much less demanding than the starting point for U.S. stocks.

Jenna Dagenhart:  I see you nodding your head Danton.

Danton Goei: Yeah. I totally concur. Right now it's hard to wipe out the memory of the last decade, but when you start with that compelling of evaluation discount for this international stocks, that really is the opportunity that you're seeing right now and it's right in front of us.

Jenna Dagenhart: And Danton, your portfolios have been typically underweight Europe. Are you finding any attractive opportunities there today though?

Danton Goei:   You're right. We have been underweight and we've been underweight Europe even before obviously the Ukraine crisis for a number of sort of long term reasons. The challenging demographics there, the sort of high hurdles around bureaucracy and regulatory that's led to slower economic growth, less innovation there.

Danton Goei: Those have held us back. However, we have found a number of compelling opportunities on a selective basis, includes some very selective financials in the stronger economies there. So for example, DNB Bank in Norway or Danske Bank in Denmark, Scandinavia has continues to do quite well, or a strong wealth manager in Switzerland, Julius Baer.

Danton Goei:  So those are opportunities that we're seeing there or select multinationals like Schneider Electric that can take advantage of global growth. So what we're trying to avoid here has just been companies that only rely on European growth, just rely on Italian, on Spanish, on French growth only.

Danton Goei:  And then now of course, with the higher energy costs because of the Ukraine conflict, the higher defense spending that's going to come, that's going to crowd out government spending in other non-defense areas. I think the case is probably more true than ever that you want to be very selective in Europe. I mean, there are opportunities, but there's a number of challenges there as well. So we continue to be underweight in Europe right now.

Jenna Dagenhart: Yeah. To your point, we're seeing a lot of pressure on commodities prices, Steve, what's your outlook on energy and energy transition, especially in light of all the commodities and inflation headlines that we've been seeing.

Steven Nguyen: Yeah. I actually I've covered a lot of different industries over the past, been at Causeway for about 10 years. Energy is one of the industries that I have covered in the past. And I've seen oil prices at current levels before, and then also plummeting to 60, 30 and even zero very briefly. And what we're seeing currently in the market, it really is extraordinary and you don't see these kinds of prices very often.

Steven Nguyen: It certainly seems like in the near term, both oil and natural gas prices should remain higher. Oil prices were already high going into the conflict in Ukraine because a demand for oil hadn't recovered post COVID and supply just really hadn't. And supply just takes a lot longer to recover, particularly in areas like the U.S. where you have a huge 60% sort of plus decline rate for production there.

Steven Nguyen: And also there's been a shift more towards capital discipline for a lot of producers. So it's been slow for supply to keep up. And now you have this significant amount of barrels from Russia that's having a harder time finding a home. Natural gas is even worse I would say, especially in Europe.

Steven Nguyen: So Russia as you know supplies, 40% of Europe's natural gas. And so Europe has been firming up plans over the past several months to significantly reduce and maybe over time even eliminate this exposure. So that results in a lot of tightness in global natural gas markets. LNG in particular.

Steven Nguyen:  So we're trying to pull LNG from other parts of the world, bring it into Europe. So we're seeing prices like we've never really seen before in natural gas and LNG. So this is positive for energy stocks. We do own several integrated energy majors that happen to be domiciled in Europe. There are certainly very global companies.

Steven Nguyen: They're going to benefit from higher oil and natural gas prices, as well as LNG. But we also like them because they have positions in renewables and in the energy transition, they're going to be growing that over time. And certainly longer term, I would still be cautious about energy.

Steven Nguyen: When you see oil prices in this level, 100 plus that actually tends to drive consumers away from oil. You'll see a move even in a more accelerated fashion towards EVs or towards other sources of energy that are less expensive. So near term, this is positive, certainly longer term it's difficult.

Steven Nguyen:  The other part of this is renewable, so clean energy. That's going to be a part of the solution in Europe and elsewhere and that's what Europe is talking about, accelerating the rollout of renewables. So about a quarter of Europe's natural gas consumption is for power generation.

Steven Nguyen:  And so to reduce this over time, we need renewables and other sources of clean generation. You're already seeing countries like the UK increase significantly some of their targets in areas like offshore wind. You're seeing a trend towards electrification as well. So this addresses not only residential consumption, but also industrial consumption.

Steven Nguyen:  Countries like Germany, power consumption is going to be about 50% higher in 2030 than it is today. So that's again positive for energy companies that are developing renewables, also positive for a number of utility companies who are leaders in renewables and will also be building out a lot of clean energy infrastructure.

Jenna Dagenhart:  A lot has changed in the past two years. You talk about us seeing prices that we haven't seen right now and then just rewinding a few years, they were in record contango, you couldn't give oil away.

Steven Nguyen: It's pretty dramatic how quickly things change, especially in commodity markets. So that's where the one thing I've learned from covering energy is you definitely want to shy away from making concrete predictions, either in the near term or the long term. It's difficult for me to say that $100 oil is something that's sustainable.

Steven Nguyen: But just given the magnitude of the potential supply disruption that we're seeing from Russia and also the geopolitical risk premium, I think that's certainly a big component of where oil prices are today and that's going to be here to stay even if there is some resolution to the conflict in Ukraine.

Jenna Dagenhart: And turning to China Danton, you have a handful of select investments in China despite current headwinds. Why do you think the long term bullish thesis around China is still intact? And what do you say to investors that wonder why bother given all the issues?

Danton Goei:  China definitely has been in the news, in the headlines lately. I would just start out saying that as investors you want to be very pragmatic. We look at and revisit our thesis continuously. So to the extent that, that changes you want to change your mind as well. And in this case, of course you want to try to take emotion out of the equation and look at it kind of clear eyed.

Danton Goei: And of course today China is a very emotional issue. I mean, it's emotional in the sense of say financials during the financial crisis, or technology stocks in the early 2000s were. And so you have investors on each side, and some investors obviously don't care whether it's attractive fundamentals, financials, valuation.

Danton Goei:  I haven't heard the word used uninvestible as often as I've heard with China in recent periods. So for some people, for some investors it's just something they didn't want to deal with, they don't want to look at. Now, of course we know in the back of our minds that often is where the opportunity is, right? Looking back at financials during the trough of the financial crisis or technology in the early 2000s, those are areas you want to look at.

Danton Goei: Now of course, some of these opportunities are and sock puppets, and others are Amazon and Google, that are going to be huge long term opportunities. And so you want to be very selective in this process, but we do think there are really big opportunities here. If you think about just the track record of China, even as a market.

Danton Goei: So for example, at Davis, we've been investing for nearly two decades in China and despite the recent headwinds that we've seen, and it's certainly been a headwind. If you look over the long period of time that we've invested there, it's actually been pretty good contributor for long periods of time.

Danton Goei: And over the last two decades, the MSCI China index has actually returned over 700% cumulatively over those two decades versus the S&P 500, which has returned over 500%. So both have done quite well, but actually the Chinese index has done quite bit better than the U.S., even though we know that the last few periods have been quite good for U.S. equities.

Danton Goei:  Now we know that from recent periods, it can be quite volatile, and that certainly is the case. But if you can invest through that volatility, even maybe take advantage of that volatility, we think that there's a real opportunity.

Danton Goei: And we think that the long term drivers of what's driven these last two decades of outperformance in China equities continue to be in place. So for example, the long term record there, the government is created in terms of GDP growth, continues to be in place.

Danton Goei: The growth of the middle class there, the scale of the country, of course, in the economy, as the number two largest economy in the world. And you often hear that the number two, but what people don't realize is it's actually larger than the third, fourth, fifth, and sixth economies put together. So really, U.S. and China are in a different category.

Danton Goei: And so that's actually if you look at the global Fortune 500 list of companies, you can really see that China and the U.S. kind of dominate that list. And so that's no accident. And that's why I think you want to look at as a global investors those two large economies as a source of strong performance over the coming years. And the growth of this middle class.

Danton Goei: I mean, the growth of this middle class actually led China now to be the largest retail market in the world. So that means that for most companies out there, China is now their largest market. And also for most countries, it is their largest trading partner.

Danton Goei: So I think when you look at all those things put together, the long term opportunity, this idea that it's under a cloud now, but there could be a strong opportunity just because people think of it as something they don't want to deal with. And then you think about the valuation discount.

Danton Goei: So today the MSCI China index is trading about a 45% discount to the S&P 500, that's of course massive as a starting point. So I think when you put all those things together, in your selective, you can find very interesting opportunities despite all the noise and all the news headlines that are out there.

Danton Goei: And of course, we all know that you don't want to invest based on headlines. You want to invest based on the fundamentals and the facts. And the fundamentals and the facts, whether it's the long term record or the valuation do look quite attractive.

Danton Goei: And we would suggest looking at the space. Of course, you want to have the dosage right, understand sort of the probabilities and the evaluations, but it does look like a space that you want to spend time and look at.

Jenna Dagenhart:  And Steve, I know you're are more of a value investor, where do you stand on international value versus growth? And where are you finding those value opportunities right now?

Steven Nguyen: Yeah. So we talked a little bit about how tough it's been for international versus the U.S. It's also been really tough for value versus growth. And those comparisons are valid in terms of being parallel. So international markets as I mentioned, they have a much greater value component and U.S. markets tend to have a greater growth component.

Steven Nguyen: So in a similar way as to how we track the premium of U.S. versus international, we also look at the valuation difference between growth in global developed markets versus value. And looking at price to book levels, if you look at that premium it's about 120% is the average since 1999.

Steven Nguyen:  So that means that growth price to book multiples have been a little bit more than double that of value price to book multiples. The multiple, or that premium in the multiple was a bit above that in 2019, and then it's skyrocketed to about 300% in 2020.

Steven Nguyen: So similar as to what we were talking about with U.S. versus international, this growth versus value difference really took off in the last couple of years in the middle of COVID. We talked about how that's perversed a bit with interest rates coming up.

Steven Nguyen: So that 300% has come back down closer to 200%, but a 200% premium is still similar to the level that we last saw at the peak of the TMT bubble back in 2000. So we're still at pretty dislocated levels.

Steven Nguyen: And it's also nice to see that we peaked and we come back down because we had been flagging us for some time and it just seemed like a one way street and there was no hurdles for a change in growth versus value. And I think now clearly the catalyst is a shift towards rising interest rates or a shift towards more tightening as opposed to more easing.

Steven Nguyen: And when you have higher rates that just takes the wind out of the sales of growth stocks, where they depend on longer term cash flows, longer duration stories. So I think this shift that we saw in the beginning of the year, it's going to continue. It was certainly shrouded a bit by what we were seeing in Ukraine.

Steven Nguyen: So the first seven or eight weeks of the year, you have this dramatic growth versus value under performance. And then that actually reversed post the invasion of Ukraine, but we're seeing that again pick up and certainly for at least more defensive value stocks they're certainly in favor.

Steven Nguyen: So perhaps the remaining opportunity is in cyclical value stocks where you still have those attractive value characteristics, but they're still underperforming because of this additional macroeconomic uncertainty.

Danton Goei: Yeah. I mean, I concur with Steven. Valuations for long periods of time recently have just been, not something that people have considered. We would bet that going forward value, the price that you pay is going to matter again.

Danton Goei: And so looking at the companies where the valuations are low, are cheap are actually making money and generating free cash flow is likely to be a winning approach over the next decade.

Jenna Dagenhart: And circling back to China Danton, where are you finding opportunities there today?

Danton Goei: Yeah. One of the really interesting things about China in addition to sort of the big picture and why it looks attractive is the quality of the companies there. So increasingly the quality companies have been improving, whether they're just being more entrepreneurial and innovative, increasingly global in nature as well.

Danton Goei: And so we found a number of opportunities that we think right now there's a big opportunity in some of these tech leaders, especially around e-commerce. China is the world's largest e-commerce market. So companies like a JD, or an Alibaba, or a Meituan, are trading at incredibly low valuations despite proven business models, despite leadership positions.

Danton Goei:  And of course, so we'll likely talk about some of the headwinds that they're facing. But when you have leaders like that trading at single digit multiple, some even as low as five times earnings, that is a great starting point. So I think those in China look pretty interesting. We also have select domestic financials that look interesting.

Danton Goei: For example, a Ping An Insurance, that is the one of the leaders there, the best run Chinese insurance company. In the past people have been saving money through basically real estate, and that's driven the property market there. But increasingly people understand that life insurance, health insurance are good investments and they don't want to have all their money in property.

Danton Goei:  And so the under penetration of insurance we think is a big opportunity for someone like Ping An. We also own AIA, which is based in Hong Kong it's the original Asian arm of AIG and is also extremely well run. In fact, the regulators often go there to see how things are done, to understand how maybe to regulate and to put rules in place for the Chinese market.

Danton Goei: So that's also I think a really interesting company. So select financials, and then certainly some of these tech leaders that are under a cloud now, but have proven business models and generate a lot of cash, and also often have 15, 20% of their market cap in net cash are really track to opportunities there.

Steven Nguyen:  We find China pretty interesting right now too. I think as a value investor you tend to be a contrarian. And you certainly want to look at markets like China, as Denton said, that sediment is so low and people are calling it uninvestible. We do have probably lower exposure directly to China today than we have in the past.

Steven Nguyen: We certainly have plenty of indirect exposure investing in whether it's financials, commodity related companies, pharmaceutical companies for almost any company in the world, China is a huge growth market.

Steven Nguyen: Directly in China the reason why we have less exposure is because we rotated out of some of these companies in the midst of COVID and then also in the midst of the rally post COVID, but we're definitely very interested. We've been cautious on the sort of political regulatory uncertainties in that there's a lot of, I think headwinds last year in terms of which areas the government was going to target next.

Steven Nguyen:  But we have a small team on the ground in Shanghai, which is a really good source of information for us. In our sense there from talking to people in China is that the regulatory environment could be bottoming. So maybe we've reached the peak of regulatory headwinds and uncertainty.

Steven Nguyen:  It's always difficult to tell, but that would certainly be a hugely supportive trajectory for, especially some of these large leaders in the e-commerce space that Danton mentioned. So we're keeping a very close eye in this. I think the other thing that we're looking at though in the near term is the impact from COVID, because we're still in a shutdown in areas like Shanghai.

Steven Nguyen: We think that this zero tolerance policy the government has is pretty unsustainable. So one way or another they're going to have to open up. And as long as COVID cases don't get out of control there's a decent vaccine penetration there, but booster penetration is still low.

Steven Nguyen: There's some oral antiviral solutions that are coming out in China as well. So we do think that the reopening from these current round of shutdowns will also be a positive for the Chinese economy.

Danton Goei: Yeah. And Steve, kind of brings up good points around COVID. I mean, certainly a near term challenge right now, Q2 growth will be heavily impacted just because the size of the lockdown in Shanghai, the length of it, and just the size of the Shanghai and the surrounding areas GDP is quite large within China.

Danton Goei: So in the short term, it definitely have an impact. We do think that if you take a step back, the Chinese government has proven to be sort of very pragmatic, very resourceful, have strong sort of operational capabilities so that they will eventually be able to just like the rest of the world kind of move through COVID.

Danton Goei: So we don't think that COVID is a particular long term challenge for China. I mean, China will find a way to live with COVID now that's becoming so endemic, just like the rest of the world will as well.

Jenna Dagenhart: And China's GDP came in above expectations at 4.8% in the first quarter. But as you said, we probably won't really feel the impact of a lot of these COVID lockdowns until Q2. Building off of COVID, I mean Steve, what are your expectations for COVID there? It sounds like you're on the whole pretty optimistic.

Steven Nguyen: Yeah. So I mentioned that I covered energy in the past. I covered healthcare is one of the industries I cover today, but I don't have any medical or scientific backgrounds. I sort of play researcher in my spare time. But it's been very difficult to make these predictions on COVID. We did several deep dives a couple years ago.

Steven Nguyen:  And some of the things that we were looking at and predicting came true, but also some things have really been much worse than we'd expected. Certainly been very positive in terms of development of effective vaccines and other therapeutics and testing solutions.

Steven Nguyen:  I would say that the rollout of vaccines actually last year ended up being also more positive than we had anticipated, yet the number of waves that we've had, Delta and then Omicron, that's certainly been worse than we would've anticipated. And also the level of breakthrough infections still permeating through the world today.

Steven Nguyen: We wouldn't have necessarily expected this a couple of years ago. And even though it seems like for a lot of us today that COVID has really faded into the background, it's pretty sobering to think that there's been worldwide over 500 million cases, over 6 million deaths and globally we're still seeing, I think something like 700,000 cases per day.

Steven Nguyen: So it's not over, we're still dealing with it. I think COVID was part of the international versus U.S. on a performance. So Europe was hit harder initially, and then it was slower to roll up vaccines. And so you could say that it was more impacted by shutdowns and other parts of the world as well, have seen pretty significant impacts.

Steven Nguyen: And then in the U.S. technology companies in particular that dominate the index have really boomed throughout COVID, there's been a huge pull forward of demand for consumption of all things digital. So we do think that as COVID fades, even though it is becoming endemic as Danton mentioned, we think some of these trends should reverse.

Steven Nguyen: So in some of the more COVID exposed names, travel oriented companies, we actually see upside because those companies haven't yet bounced back to pre COVID levels. And in particular we're seeing companies like airlines actually seeing very strong demands.

Steven Nguyen: Consumers have been pent up for a couple of years or eager to get back out there and spend on things like travel. And perhaps if they're tightening their belts in other areas, it could be in hard goods and things that they've spent money on the past couple of years, and they maybe will shift their spending preferences now more towards things like travel.

Jenna Dagenhart:  And circling back to regulation Danton, how concerned are you about the regulatory environment in China and the potential de-listing of Chinese companies?

Danton Goei: Yeah. The regulatory environment really has been probably the biggest headwind for Chinese equities over the last year and a half. I mean, just the speed and the breadth of the regulatory actions in China have been quite breathtaking. Now a lot of the issues that China is dealing with are very similar issues that we're dealing with here in the U.S. or in Europe in the idea of monopoly.

Danton Goei: Actions by these large tech companies, whether it's around data privacy or the use of algorithms and understanding how they're being used, those are all the same issues, they've just moved really fast on them. And they also probably had some catch up to do just because they have historically been more really say fair and I trust approach.

Danton Goei: Now that a lot of these regulations are in place, we do think that we are towards the tail end of the regulatory wave. I mean, we are already seeing a government coming out, Vice Premier Liu He, for example, providing very supportive comments for the companies, for the markets out there. We're seeing not just talk about supporting these companies, but also regulatory actions.

Danton Goei: I mean, for example, the hold on video games has been lifted and so new video games for example, are being approved. So we are seeing some actions there. And so we do think that the worst of it is behind them, doesn't mean that there's not going to be future actions or certainly the implementation is ahead of them. But they're adapting now to this new normal.

Danton Goei: They understand now the new regulations. And we think that the last 18 months is not indicative of sort of the next several years. It was really a catching up period for China in implementing some things that, in the West we've also thought are maybe necessary actions take place.

Danton Goei: And in terms of de-listing, I think that's one area where certainly investors are probably overreacted. Whether the company is listed here in New York or in Hong Kong is not a major driver of the value of the company. I mean, for example, if these companies had been listed in Hong Kong to begin with just like a Tencent or Meituan already are, it would be a non-issue.

Danton Goei: And so if they have to move, now there are some quite sort of encouraging signs and comments that are especially coming from the Chinese side in terms of their willingness to compromise, to abide by the Sarbanes Oxley and the PCAOB requests.

Danton Goei:  Now, it's hard to kind of forecast where these negotiates are going to go, but I think those are encouraging. But even if it happens that these companies end up going back home, going and re-listing and basically moving their primary from New York to Hong Kong, we don't think that's a major driver of the value. And so the big hit that these market caps of these China companies have taken because of this delisting fear we think is probably overblown.

Jenna Dagenhart:  And Steve, how do you differentiate your investment process and where are you ending opportunities in the current environment, given everything that we've been discussing today?

Steven Nguyen: Yeah. I think in this kind of environment where there's so much volatility, it is really important to stay true to your process and be consistent. So we've tried to do that. Our process is very bottom up oriented. So we don't try to take a top down approach in terms of targeting certain sectors or countries. We look individual stocks.

Steven Nguyen: We have a very rigorous process in terms of how we look at companies, talking to management teams, industry experts, and really an intense focus on valuation and running different scenarios. And then we package together those stocks into portfolios that we think have the best risk adjusted returns, that's where our rank sheet process comes in.

Steven Nguyen: So we look at not only the potential return to our price targets, but we also think about the risk of a stock. And again, we think of risk of the overall portfolio volatility. So the risk of a stock is how much that stock is going to contribute to portfolio volatility.

Steven Nguyen: And so in this environment, stocks that underperform they'll move up our rank sheet because they'll have a higher return, but then we'll also be weighing that higher return against their risk profile.

Steven Nguyen:  And then also any return can change based on any fundamental change in a price target, things are happening for example, with the invasion of Ukraine, any company that had significant Russian exposure, we'd have to make adjustments in the price target for that.

Steven Nguyen: But I think this is also that having this process is important, because we have a very team based approach to managing the portfolio. We don't have a star system with a single person that's in charge of the entire strategy.

Steven Nguyen: We have a number of portfolio managers like myself that have specializations in different industries. So we need to have this risk adjusted return process to have a way to rank our companies that we're looking at on that basis.

Steven Nguyen: In terms of opportunities that we're looking at today, I think I talked a little bit about opportunities we're seeing in areas like European banks and areas like travel stocks or energy stocks. We do also like healthcare, an area that I cover.

Steven Nguyen: So pharmaceuticals, especially value oriented pharmaceutical companies have underperformed the last couple of years during COVID, despite really being part of the solution with innovation, creating therapeutics, vaccines and testing solutions. There was a rotation away from pharma towards cyclicals when the economies were recovering from COVID. And so pharma really lagged until the beginning of this year.

Steven Nguyen: So once we saw interest rates start to move up, then there was a rotation towards value and pharma was seen as an attractive place to go. But despite the outperformance we've seen so far, we still think that valuations are attractive.

Steven Nguyen: We look at a number of the large multinational European pharmaceutical companies that are still trading in the low-to-mid-teens forward PE ratios, which we think is very attractive given defensive growth characteristics, diversification, and also free cash flow generation.

Steven Nguyen:  They're generating free cash flow over the next five years, that's anywhere from 30 to 50% of current market cap with a good portion of that cash coming back to shareholders in the form of dividends.

Jenna Dagenhart:  And pricing power too. I was just watching an MSCI video and they were talking about it. If we do get a stagflationary environment, that's one area, the healthcare sector that has a little bit more pricing power and tends to do better than other areas.

Steven Nguyen:  Absolutely. Yeah. In this environment where inflation is such a concern, I think investors are also going to gravitate towards industries that are not as exposed to inflationary issues.

Steven Nguyen: And so while there have been supply chain issues for certain drugs, certainly being exposed to inflation and having the ability to price things through, that's certainly supportive of a lot of pharmaceutical companies.

Jenna Dagenhart: And Danton, what strategies does Davis offer with exposure to non-U.S. markets and how are they differentiated?

Danton Goei: Yeah. We have a couple of strategies there. We have the international strategies, so that's all non U.S. companies those are our best ideas outside the U.S. And we have a global strategy where they have both U.S. and international in the same portfolio.

Danton Goei: They're both offered in traditional mutual fund form, in ETFs and also in separately managed accounts. And they're common in the sense that they're both very selective. They have 30 to 40 names, around 10, 15% of the overall index there. So really best of breed companies there on a very selective basis.

Danton Goei: And then when you look at the portfolio, and you look at the growth rates there, this is really compelling. I mean, if you look at the, for example, the five year historical earnings per share growth rate of the portfolio, it's over 20% versus the index, which is been about 15%.

Danton Goei: And so that's a big, pretty compelling outperformance there and growth. But then when you look at the valuation, you see a big differential where our portfolios are on average 40 to 50% lower in terms of PE than the index.

Danton Goei: So you've got a situation where you've got these selective companies growing at much faster growth rates, but trading at much lower valuations. We think that's really compelling from a portfolio point of view, really compelling from a future return perspective going forward.

Jenna Dagenhart: And Steve, I can't let you go without asking about ESG because I know that's a big focus at Causeway. How are you incorporating ESG into your investment approach and what are some of the key ESG considerations globally right now?

Steven Nguyen: Yeah. So we try to incorporate ESG into our fundamental research process. And we've also recently introduced ESG focused strategies as well. So in terms of the process, we do have our own proprietary ES and G scores, and those are a mix of both top down and bottom up inputs, a mix of both quantitative and qualitative inputs.

Steven Nguyen:  So both the quant team and the fundamental team are working on this. The overarching concept is that we believe that certain ESG factors are really material. ESG factors can potentially impact a stocks return as well as its risk characteristics. And so we have a big focus on just looking at which ESG factors can actually relate to alpha generation.

Steven Nguyen: And so we've done a lot of research, both quant and fundamental that supports this view. We also just look at structural ESG drivers, things like consumer preferences, policy, regulatory attention, what companies are looking at to so potential liabilities and also you're seeing some pretty big corporate strategy shifts.

Steven Nguyen: We've seen surveys recently to suggest that at least half of investment managers out there either have an ESG product or a planning one, and the vast majority do see the number of ESG mandates increasing. And we're still seeing large inflows into ESG funds.

Steven Nguyen: Both last year and this year, some estimates have total ESG A1, at nearly $4 trillion as of this quarter, and that's still up double digits from last year. So in terms of how we've been implementing it into our research process, we did governance G first that's really the most pervasive across the board.

Steven Nguyen:  And then last year we also implemented ENS, environmental and social. Now the focus this year for us is looking more at industry specific materiality. So figuring out from an industry by industry or sector by sector basis, which areas are most material and what data can we actually use to assess and to track those issues.

Steven Nguyen:  And then ultimately figuring out if and how we can incorporate these issues into our valuation. And then the final piece is also engaging with management teams. So one we've figured out which ESG issues are material, which ones we think matter, we need to talk to management teams, talk to members of the board and make sure that they're aligning their longer term strategy with how we're thinking about these issues.

Steven Nguyen: So that's the process. And in terms of strategies, so it's pretty exciting. We've started a couple ESG strategies recently, and the reason why we've taken two different approaches because ESG is one of these things that it means different things for different people.

Steven Nguyen: So there are certain investors we think that are specifically looking for a more ESG or a sustainability focused strategy, because they want direct dollars specifically in that way. And so there we have a product called global sustainable leaders. So we're just starting up.

Steven Nguyen: Here we use our proprietary ESG scores, the same ones that we use in our fundamental process. And that's the sole alpha generators is a quantitatively derived product. We do have some tracking error limits to manage risk. And we expect to outperform the global benchmark over time on a risk adjusted return basis.

Steven Nguyen: And then for other investors that are looking for more, a broad factor based approach, but to believe that ESG factors are increasingly becoming relevant, we have a product called global sustainable equity, and that uses our internal ESG factor alongside other factors to seek to maximize alpha again, over a global benchmark.

Jenna Dagenhart: And Danton, any final thoughts on your end that you'd like to leave with everyone out there watching?

Danton Goei: Well, at Davis we've been investing for over five decades. We've invested through all kinds of markets, all kinds of cycles, all different kinds of crises out there, managed to generate above average returns through those different periods. Certainly today we're facing a difficult period, but by some measures investor sentiment is at a 30 year low.

Danton Goei: However, we know that if you can take emotion out of the equation, if you can put your long term investor hat on, these are times when you can really do well and generate strong returns going forward. So thank you for your time and consideration.

Jenna Dagenhart: Of course. Great to have you. And Steve, anything you'd like to leave with the financial advisors watching this?

Steven Nguyen: Yeah. I would echo the same sentiment about long term investing. There are certainly dramatic cycles that happen in equity markets, but they don't happen very frequently. I think with COVID and now with Ukraine, you had a couple of shocks in a short period of time, but anybody that's been investing for a long time knows that you want to take advantage of these cycles and these levels of volatility.

Steven Nguyen: So Causeway, we try to stick to our process that we've had for a couple of decades, and we've been consistent in terms of how we employ that process. And we're certainly trying to take advantage of opportunities and dislocations that we see in the market today.

Jenna Dagenhart: Well, Steve, Danton, thank you both for joining us.

Danton Goei: Thank you.

Steven Nguyen: Thank you very much.

Jenna Dagenhart:  And thank you to everyone watching this International Investing Masterclass. I was joined by Steve Nguyen, portfolio manager at Causeway Capital Management, and Danton Goei, portfolio manager for the Davis Global & International Portfolios at Davis Advisors. And I'm Jenna Dagenhart, with Asset TV.


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