Litman Gregory Masters International Fund First Quarter 2019 Attribution

During the first quarter of 2019, the Litman Gregory Masters International Fund gained 15.64%, outperforming the MSCI ACWI ex USA Index, which was up 10.31%. The MSCI EAFE Index returned 9.98% in the quarter and the Morningstar Foreign Large Blend Category gained 10.57%1. Since its inception in December 1997, the fund has compounded returns at an annual rate of 6.76% after fees, outperforming the MSCI ACWI ex USA, MSCI EAFE, and foreign blend category, which have gained 5.14%, 4.69%, and 4.15%, respectively.

Performance quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance of the funds may be lower or higher than the performance quoted. To obtain standardized performance of the funds, and performance as of the most recently completed calendar month, please visit www.mastersfunds.com.

Themes, Trends, and Observations from the Managers*

David Herro, Harris Associates
Global equity prices rebounded significantly last quarter as fears of a global slowdown began to dissipate, China trade talks showed some progress, and the Fed reversed course on a tighter monetary policy. The US equity markets rallied double digits, in sharp contrast to the significant fourth quarter declines, as investors became more enthusiastic about stable and potentially growing global growth. The equity market volatility over the last six months is a great reminder of the futility in trying to time the market. At Harris Associates, we embrace the market’s price volatility to enhance our portfolio positioning but remain stalwart in not letting price movements affect our determination of underlying business value. As we look forward, we continue to believe the outlook for underlying company fundamentals is positive, which should lead to positive returns over the medium term.   

In our international equity portfolio, we opportunistically re-positioned the portfolio across existing holdings. Geographically, our portfolio exposure remains tilted toward developed markets though many of the businesses we hold possess global revenue streams. We continue to focus our research on unique opportunities across both developed and emerging markets. 

Vinson Walden, Thornburg Investment Management
Today, investors debate the future direction of the economies of China, Europe, various emerging markets, and the United States. They consider potential policy actions by the U.S. Federal Reserve, Congress, the Trump administration, and foreign government regulatory and policy actions. Concerns about tariffs and trade policy changes continue to impact share price movements of global producers of tradeable goods, which are volatile day to day. We expect the volatility to continue until new trade policies are established.

We believe people around the world will continue to buy goods and services and trade with each other. Importantly, overall global consumer spending grew in 2018 and appears poised to grow in 2019, along with global population and industrial production. Following the largest annual price declines since 2008 for U.S. and many other equity markets in the December 2018 quarter, prices bounced back by double-digit percentages in most global equity markets in the first quarter. Despite uncertainty around macroeconomic policies and expectations for slowing economic growth in 2019 and beyond, employment and wage growth trends remain positive, consumer debt is under control, and many governments have room to implement expansionary fiscal policies.

Mark Little, Lazard Asset Management
International equities rebounded strongly in the first quarter of 2019 after the weak end to 2018. They were buoyed mostly by confirmation of the dramatic reversal in tone from the Federal Reserve, which is now suggesting that U.S. rates are at or close to a peak, and that balance sheet reduction may not last beyond the summer. Some signs of progress in U.S.-China trade talks were also helpful, accompanied by early signs of stability in China after a variety of government stimulus actions. These factors overwhelmed what was still a cautious company earnings season. With a combination of easing economic fears and a potential peak in rates, gains were broad based as both cyclical areas such as materials and more stable operations such as consumer staples saw gains. The technology sector saw jumps in both the cyclical semiconductor space and in long-duration growth stocks. Financial stocks lagged, however, dogged by poor results, a Scandinavian money-laundering scandal, and falling rate expectations.

On the macroeconomic side, China is showing some signs of stabilization from its credit and sentiment slowdown, though Europe slowed further, not helped by volatile domestic politics. Meanwhile, the U.S. economic data was mixed, with the labor market strong, but forward-looking indicators slowing, as rising rates and cooling global growth started to bite. Company reports have focused on a weakening economy and cost pressures in a number of markets. However, stocks looked oversold at the end of 2018, and we are already starting to see a policy response. China has announced a variety of small stimulus measures, but the major change of tone came from the Federal Reserve, who went from saying rates were “nowhere near neutral” in the fourth quarter to suggesting we may be near the end of rate rises in January. The extent of this change was a surprise, maybe driven by the steep widening of credit spreads in the fourth quarter, which was a particular concern given the overwhelming amount of debt that has continued to pile up on public and private sector balance sheets since the financial crisis. While political issues such as Brexit and the trade war remain concerns, the market appears set to shrug off slowing growth again as the monetary policy headwind fades.

Fabio Paolini and Benjamin Beneche, Pictet Asset Management
The first quarter of 2019 has, to a large degree, been the mirror image of the fourth quarter of last year. Emerging markets, led by China, rebounded along with a sharp recovery in cyclical sectors, notably technology.

In times of high volatility, we typically redouble our efforts as Mr. Market offers attractive opportunities. The past two quarters have been such an occasion where we have initiated positions in two financials: Moscow Exchange and Julius Baer. Financials, in general, have substantially lagged the market over the past few years as a result of persistently low interest rates and regulation. In general, we treat the sector with caution; high leverage and a largely commodity product (loans) do not generally strike us as a great place to invest. However, not all financials are created equal and we believe therein lies the opportunity.

After having purchased Moscow Exchange last quarter, the first quarter saw the addition of Julius Baer to the portfolio. Julius Baer is the largest listed pure-play wealth management business in Europe with a relatively simple business model: offering advice to clients in return for an on-going fee that is typically expressed as a percentage of the client’s assets under management. In a highly fragmented industry, the scope for future growth is significant, and in this regard a key differentiator is Julius Baer’s strategy of aggressively hiring relationship managers (RMs). This has in turn led to relatively faster growth of the asset base on which it is able to charge fees. Management have remained diligent in their deployment of capital, with a combination of mergers and acquisitions and RM hiring. Not only has this strategy allowed them to benefit from economies of scale, but it has allowed them to maintain a sustainably high return on equity of approximately 30%. We believe JB can maintain this return over the long term as its international expansion continues, cost inflation is managed, and capital is either deployed via acquisition or returned to shareholders. The focus on higher-growth regions such as Asia and Latin America creates a long-term structural growth opportunity for the group, driven by the anticipated rapid wealth accumulation in those regions. In the process of acquiring RMs and smaller wealth management firms, Julius Baer has also invested heavily in IT systems that will allow greater efficiency versus peers in the long run, especially with regard to RM productivity and the management of group central costs. This will be reflected in the continued compression of the cost income ratio and higher returns. Julius Baer’s stock has performed poorly since markets became more volatile in early in 2018 and fell more sharply in the fourth quarter. We believe this weakness created the opportunity to add an attractive, growing, fee-based franchise to the portfolio at a price that suggests material upside to our assessment of its intrinsic value.

David Marcus, Evermore Global Advisors
International equity markets rebounded nicely from a very tough fourth quarter of 2018 to show gains in the first quarter. These gains were largely fueled by several factors, including easing of concerns over the China-U.S. trade dispute and as major central banks moved away from tighter monetary policy. Still, concerns remained across the globe about corporate earnings and economic growth. As special-situations investors, our focus is more on the individual companies we select through our bottom-up approach to investing and how catalysts at these companies are developing and coming to fruition.

I had the opportunity to spend a week in the Nordic region in the first quarter to meet with portfolio companies, regional investment banks, and companies in which we have not yet invested. One of the main reasons we decided to visit the region in the first quarter was to attend the Modern Times Group AB Investor Day in Stockholm. During the first quarter, we initiated a position for the portfolio in the company, a $2.4 billion market cap Nordic broadcasting company that also has eSports-related businesses, mobile games, and other online gaming–related assets. At the end of March, Modern Times split into two separately listed companies, which will now operate independently. The traditional Nordic broadcasting business—free TV, pay TV, distribution platforms (satellite, IPTV, cable networks, streaming), and a leading content portfolio—was spun off to shareholders and is now called Nordic Entertainment Group. The other listed company will retain the Modern Times Group name but now will be solely focused on digital entertainment in eSports, including online and mobile gaming, and has the potential to add more verticals in the eSports ecosystem over time.

We had been closely monitoring this interesting situation unfold since Modern Times’s deal to sell the Nordic entertainment business to TDC Group fell apart in March 2018. Neither of these newly split companies has a main shareholder since the former anchor shareholder, Kinnevik, was forced to distribute its Modern Times Group shares to its shareholders to obtain regulatory clearance for the merger between its mobile telecom operator (Tele2) and the largest cable TV operator in Sweden (Com Hem). While not a central part of our thesis, we believe both Nordic Entertainment and Modern Times Group will become potential takeover targets. We initiated our position ahead of the spinoff ex-date and took advantage of the unwarranted weak share price in early February. At our entry price, Evermore was effectively getting the eSports business almost for “free”. We believe both companies are very different equity stories that will now be more appropriately valued by investors.

The opportunity set in the Nordic region and all of Europe remains strong as there continues to be a large valuation gap between the United States and the region, as well as an abundance of strong, aggressive management teams that are themselves catalysts for value creation.

* The opinions herein are those of the sub-advisors at the time the comments are made and are subject to change.

Discussion of Performance Drivers

During the quarter, the fund outperformed its benchmark. Stock selection drove the outperformance in the first three months of 2019. Stock selection in the communication services sector was particularly strong during the quarter. Individual positions within the energy, financial, and materials sectors also contributed positively. It’s important, however, to understand that the portfolio is built stock by stock by our managers so the fund’s overweight or underweight to any individual sector is a residual of the stock-picking opportunities they are seeing, not a macro or sector call by the fund’s sub-advisors.

Litman Gregory Masters International Fund Sector Attribution

International Fund Sector Attribution

  • As mentioned above, stock selection within the communication services sector was strong to open up the year. Four of the fund’s top 10 contributors during the quarter reside in this sector. Strong returns from Informa, Inmarsat, SoftBank, and Vivendi were material contributors. Informa and Vivendi were the fund’s top two positions at quarter-end.
  • Financials also contributed to returns. Lloyds Banking Group was the sector’s largest contributor with a 22.6% return. Aurelius Equity Opportunities also helped returns with a 25.7% gain in the quarter.
  • The materials sector was a positive driver of returns in the quarter. The fund’s third-largest position, OCI, jumped more than 35% and was the top contributor in the first quarter. OCI is owned by two sub-advisors.
  • There wasn’t a sector where stock selection was a material headwind last quarter.
  • In aggregate, sector allocations were a slight negative for the fund during the quarter and not material when compared to the strong positive impact from stock selection. An overweight to communication services and an underweight to technology were the primary negatives from a sector-allocation perspective.

Top 10 Contributors as of the Quarter Ended March 31, 2019

Company Name

Fund Weight (%)

Benchmark Weight (%)

Three-month Return (%)

Contribution to Return (%)

Country

Economic Sector

OCI NV 4 0.01 35.12 1.4 Netherlands Materials
JD.com Inc. ADR 2.46 0.09 44.05 1.04 China Consumer Discretionary
Teekay Lng Partners LP MLP 3.08 0 37.23 1.01 Bermuda Energy
Vivendi SA 5.07 0.16 19.23 0.97 France Communication Services
Informa PLC 4.29 0.06 20.82 0.82 United Kingdom Communication Services
Lloyds Banking Group PLC 3.5 0.27 22.62 0.82 United Kingdom Financials
Inmarsat PLC 1.39 0 49.71 0.72 United Kingdom Communication Services
SoftBank Group Corp. 1.64 0.38 46.1 0.71 Japan Communication Services
CNH Industrial NV 3.69 0.06 13.44 0.53 Netherlands Industrials
MGM China Holdings Ltd. 2.11 0 24.63 0.52 Hong Kong Consumer Discretionary

Portfolio contribution for a holding represents the product of the average portfolio weight and the total return earned by the holding during the period. Past performance is no guarantee of future results. Fund holdings and/or sector allocations are subject to change at any time and are not recommendations to buy or sell any security.

Edited Commentary from the Respective Managers on Contributors

OCI NV (Fabio Paolini and Benjamin Beneche, Pictet Asset Management)

OCI is currently the fourth-largest fertilizer producer globally with approximately 75% of its profits derived from nitrogen-based fertilizers and the balance from methanol production. The company was founded in 2008 by Nassef Sawiris (who still owns 54.5%) and had grown from producing 1.8 million tons of fertilizer capacity in 2008 to 13 million tons at the point it was added to the portfolio in April 2018. The growth had been achieved through a mixture of opportunistic mergers and acquisitions and capital expenditures. Our acquisition timing took advantage of a period of stock price weakness. This was a product of investor concerns about high levels of debt that were in turn a product of heavy CAPEX on two new, large and strategically positioned production facilities in the United States—a fertilizer plant in the Mid-West corn belt and a methanol plant in Texas. Once these plants were fully on stream, 70% of OCI’s production would be in low-cost regions, and it would have the youngest (and therefore most efficient) capacity of the leading producers. We are not lovers of high debt levels, but in the case of OCI we could see a very clear and relatively near-term route from cash “burn” to prodigious cash generation as the wave of CAPEX came to an end and the new assets came into full production. In other words, we believed the group would rapidly convert an enterprise value dominated by debt (a net debt-to-EBITDA ratio of 10x), to one in which equity holders would have a far higher stake (a forecast 2x ratio by the end of 2019). We calculated that this would be achievable with only modest assumptions for fertilizer pricing at a time when the market was regaining a level of order that it had not enjoyed for some time.

With a bit of assistance from fertilizer prices that moved higher than we had anticipated, this thesis played out well through the middle of 2018. However, in the fourth quarter’s market rout, OCI suffered disproportionately thanks to a sharp mark down of levered stocks, a short-term spike in U.S. local natural gas prices (gas is the main input to fertilizer production), and confusion amongst investors about how to forecast a quarter for which the 2017 “base” was a period when the new facilities were coming into production. We believed that all these factors would prove to be ephemeral and added to the holding in mid-December.

Two positive developments during the first quarter of 2019 have prompted a sharp stock price recovery. First, the fourth quarter earnings announcement revealed cash generation that was far stronger than expected, and second, SABIC (Saudi Arabia’s $100 billion market cap chemicals giant) approached OCI with a view to acquiring its methanol assets for a price rumored to be in the region of $4 billion. OCI confirmed the discussions but have so far made no further disclosures.

Clearly, our investment thesis is predicated on OCI realizing the value we forecast as a stand-alone entity, and our conviction in this outcome remains strong. However, should the SABIC deal happen, it opens up a second route to crystallizing that value. If executed with cash, the rumored transaction value would effectively wipe out OCI’s debt for the loss of only 20%–30% of EBITDA—a good trade in our view. It would also leave the group as a pure-play on a set of highly efficient fertilizer assets that could attract significant interest from competitors keen to consolidate the industry. If the potential SABIC deal goes away, we believe the downside is very limited, while most other scenarios suggest significant further upside. We remain holders.

Informa (Mark Little, Lazard Asset Management)

Informa is a business media group focused on exhibitions, academic publishing, and business information. These are highly profitable businesses with strong competitive barriers, trading at an attractive valuation. After the recent acquisition of rival UBM, investors were disappointed with the company’s margin guidance during the latter part of 2018 and concerned about its cyclical exposure to China in particular, pushing down the shares. In the first quarter of 2019, a strong earnings report, and easing macroeconomic fears saw Informa shares perform strongly. We continue to believe the shares are attractively valued from here.

New World Development (Vinson Walden, Thornburg Investment Management)

New World Development is an owner and developer of premier real estate in Hong Kong and China and should benefit from the growth of the Chinese consumer. The company owns a variety of scarce and growing assets and there is option value in its land holdings. New World’s flagship Victoria Dockside project in Hong Kong, scheduled to open over the next year, could double the company’s recurring income and lead to an increase in dividend payouts.

In the first quarter, New World shares benefited from the general recovery in China and Hong Kong stocks, and responded well to its earnings report, which showed excellent underlying profit growth of 29%. In the future, we expect continued earnings growth from the opening and lease-up of the company’s commercial properties in Hong Kong, including the landmark Victoria Dockside project. While valuations are off their 2018 lows, the stock still offers a price-to-book ratio of 0.6x and a dividend yield of 3.5% with attractive dividend growth prospects.

Aurelius Equity Opportunities (David Marcus, Evermore Global Advisors)

Aurelius is a €1.2 billion market cap German-based private equity firm that seeks to buy non-core, non-performing orphaned assets often from large conglomerates. Some notable recent developments include the acquisition of VAG, a Mannheim-based water and wastewater valves manufacturer in November 2018 and the acquisition of Hellanor, a Norwegian wholesaler of auto parts in December 2018. At the end of 2018, Aurelius sold its homecare businesses in England, Scotland, and Wales to the Health Care Resourcing Group. Management has proposed to pay a base dividend of €1.50 per share (in line with last year), which will be voted on during the annual general meeting in July. We believe there are several mature portfolio companies that could be sold throughout the year. Similar to past investment exits, the company will pay special dividends as asset dispositions are completed.

Top 10 Detractors as of the Quarter Ended March 31, 2019

Company Name

Fund Weight (%)

Benchmark Weight (%)

Three-month Return (%)

Contribution to Return (%)

Country

Economic Sector

Scorpio Bulkers Inc. 0.88 0 -30.25 -0.34 Monaco Industrials
Grupo Televisa SAB ADR 0.81 0 -12.08 -0.11 Mexico Communication Services
Incitec Pivot Ltd. 1 0 -2.9 -0.08 Australia Materials
Genco Shipping + Trading Ltd. 0.68 0 -5.45 -0.04 United States Industrials
MultiChoice Group Ltd 0 0.01 -13.32 -0.01 South Africa Communication Services
Bollore NV 0.01 0 14.03 0 France Industrials
SK Hynix Inc. 0.61 0.18 -0.05 0 Korea Information Technology
Toyota Motor Corp. 0.91 0.71 0.38 0 Japan Consumer Discretionary
Nordic Entertainment Group B 0.02 0 1.35 0.01 Sweden Communication Services
British American Tobacco PLC 0.02 0.42 32.8 0.01 United Kingdom Consumer Staples

Portfolio contribution for a holding represents the product of the average portfolio weight and the total return earned by the holding during the period. Past performance is no guarantee of future results. Fund holdings and/or sector allocations are subject to change at any time and are not recommendations to buy or sell any security.

Edited Commentary from the Respective Managers on Detractors

Scorpio Bulkers (David Marcus, Evermore Global Advisors)

Scorpio Bulkers was a detractor to performance in the first quarter. With a market cap of $275 million, Scorpio Bulkers is a dry bulk company with a modern fleet of mid-size dry bulk vessels with an average age of less than three years. In January, all dry bulk equities were negatively impacted by the tragic news of a Vale dam breaking in Brazil. Given that Vale exports most of their iron ore to China, the vessels that would have been impacted the most are the larger Capesize vessels. In spite of Scorpio Bulkers owning mid-size, Karmsarmax and Ultramax vessels, which should have been somewhat insulated from the Brazil impact, all dry bulk equities sold off indiscriminately. During the quarter, the company bought back $27 million of stock (approximately 4.5 million shares at an average cost of $6.05 per share) and still has about $25 million remaining in the repurchase program. We continue to believe Scorpio Bulkers is one of the best-positioned companies to benefit from the recovery and the looming IMO 2020 regulatory changes in the dry bulk market that kicks in January of 2020.

Grupo Televisa (David Herro, Harris Associates)

Even though Grupo Televisa is the world’s largest producer of Spanish-speaking content, pay television and broadband has reached only about half of these respective markets in Mexico, which we believe positions the company to realize growth and enhanced earnings going forward. We find Televisa’s target audience in Mexico and the United States provides an attractive opportunity, as the population is young and growing and this demographic is increasing wealth at a healthy rate. We like that Televisa’s ownership of its distribution helps to both better protect content and save on distribution costs.

Grupo Televisa’s full-year results included total revenue that matched our estimates and earnings that slightly outperformed our expectations. By segment, year-over-year content net sales (ex–World Cup) rose 7% and underlying advertising sales increased 2%, both of which aligned with our projections. The cable segment continues to drive results as net sales advanced almost 10% and revenue generating units (RGU) grew by 1.2 million for the full year with all sub-segments achieving RGU growth (broadband up 18%, video up 5%, voice up 40%). Sky segment revenues were down 1% for the year because of subscriber losses after the World Cup broadcast. However, management expects Sky’s subscribers will return to positive growth in the second half of 2019. Despite these overall acceptable results, it appears investors were disappointed that management decided not to spin off the cable business. We met with CEO Alfonso de Angoitia Noriega and discussed the rationale for keeping the cable business and operating trend expectations for the current year. He expressed that the costs and dis-synergies associated with the cable spinoff would not improve shareholder value. At this point, we agree with this assessment. In addition, Noriega noted that while the government’s decision to decrease advertising spending will impact current-year results, he expects private sector advertising will grow in a range of 2%–3% in 2019, which we view as acceptable. He also supposes that the government will not cut spending further in the near to mid-term. Overall, we are pleased with the incremental improvements management continues to make, and our investment thesis for Grupo Televisa remains intact. 

Incitec Pivot (David Herro, Harris Associates)

Incitec Pivot experienced some unplanned plant outages during the first quarter. The Louisiana ammonia plant (WALA) and Phosphate Hill (Australia) fertilizer facility were shut down for repairs. Management estimated that these shutdowns would reduce current-year earnings by approximately AUD 45 million. Subsequently, adverse weather conditions in Queensland caused a rail line closure that will further impact Phosphate Hill production and result in an additional earnings loss of AUD 10 million each week until full production resumes. Accordingly, management warned that full-year profits would be below original estimates. On a positive note, issues at the WALA facility have been resolved and we expect operations will return to normal. Although we find the production stoppages disappointing, we believe these situations will have only a temporary effect on Incitec Pivot’s performance.

We find that both of Incitec Pivot’s business segments provide the company with unique advantages: Incitec is the leading fertilizer distributor in Australia and is also Australia’s only phosphate producer. We believe Incitec’s explosives business is well positioned to generate solid returns, as the company holds the top market position for explosives in North America and the second position in Australia, and management is committing incremental capital to this segment. Its explosives business is especially attractive to us, as this segment benefits from direct exposure to mined commodity volumes without exposure to commodity price volatility. Certain factors caused by increasing geological complexity (such as a requisite high level of technical expertise, transport restrictions, and heavy regulation) has worked to limit competition in the explosives market, which we think will prolong Incitec’s market shares going forward. Incitec Pivot’s leadership team has a long-standing, solid background in the business and, in our determination, the team is financially disciplined with an impressive track record for successful mergers and acquisitions.