Dear Fellow Investor,
Non-U.S. equities finished lower in the 12 months ended September 2015. Concerns about slowing economic growth, especially in China, contributed to the decline, along with weak oil prices and uncertainties over the timing of a U.S. interest-rate increase.
European and Japanese markets fell, most significantly in the third quarter, amid fears that weakness in China and other emerging markets may weigh on exporters who rely heavily on Chinese demand. In Japan, those same fears seemed to have overshadowed renewed optimism and investor sentiment that have buoyed the market in the past two years.
Emerging markets suffered the brunt of the market decline. China’s renminbi devaluation in August, although relatively minor, raised fears of a potential spillover to other emerging countries. In Brazil, investors continued to grapple with political and economic challenges, including falling commodity prices and rising inflation. The real lost about 40% (vs. the U.S. dollar), making it one of the worst-performing currencies over the last 12 months.
Against this backdrop, the net asset value of the Brandes International Equity Fund (Class I Shares) decreased 8.30% during the 12 months ended September 30, 2015. For the same period, the Fund’s benchmark, the MSCI EAFE Index, fell 8.66%.
The Fund
Major contributors included holdings in financials, especially Japanese insurance companies Sompo Japan Nipponkoa and MS&AD Insurance Group, as well as Austria-based Erste Group Bank (WBO:ESTE, Financial). The allocation to materials was a detractor from an absolute-return perspective, but was a positive contributor on performance versus the MSCI EAFE Index. Within the sector, Ireland-based CRH and Italian Italcementi performed well, while Mexico’s Cemex and South Korea-domiciled steelmaker POSCO (PKX, Financial) hurt performance. Italcementi saw its stock appreciate as Germany-based HeidelbergCement entered into a purchase agreement to buy the firm in late July. The deal is expected to close in 2016 and we continue to hold the shares as they traded below HeidelbergCement’s acquisition price.
Significant detractors included holdings in oil, gas & consumable fuels. With the exception of Russia’s Surgutneftegas, all of the Fund’s holdings in the industry declined, most notably Brazilian Petrobras, Spain-based Repsol and Italy’s Eni. Our energy holdings were concentrated in the large oil & gas businesses that operate globally across many parts of the hydrocarbon value chain. Along with what we see as compelling valuations, these companies feature good cost positions, are vertically integrated, and have developed — or are in the process of developing — a geographically diverse resource base.
Among the names above, Petrobras hurt returns the most. The company’s shares continued to suffer as a result of a number of factors, including the economic situation in Brazil, a corruption scandal and a recent debt downgrade. While we recognize that the risks to our investment continue to be elevated given Petrobras’ levered balance sheet, high incremental funding needs over the next five years, current low oil price and the uncertain political environment in Brazil, we believe the risk/reward tradeoff remains attractive at the company’s current valuation. Over the longer term, we see a number of reasons for optimism, including:
- Petrobras (PZE, Financial) continues to have a tremendous and valuable asset base. Our analysis suggests that the market is valuing Petrobras’ proven resource base at a substantial discount to our estimate of its true worth.
- In recent months, the company has announced a medium-term strategy with specific plans to improve its balance sheet, including cutting capital expenditures and using asset sales to reduce leverage. Additionally, governance and transparency appear to be improving.
- Petrobras recently instituted a much needed increase in domestic gasoline and diesel prices. The move contributed to the recent profitability and positive cash flows for the company’s downstream segment, and alleviated pressure from weakness in the Brazilian real of late. Furthermore, this event helped ease concerns that the Brazilian government would forbid fuel-price increases.
- Increased production from the company’s pre-salt assets (large oil basins in deep waters off Brazil’s coast) could improve upstream profitability over the long term.
- We believe additional capital expenditure cuts are possible if oil prices decline further and/or the economic situation in Brazil deteriorates.
Positions in utilities also detracted from returns, specifically France-based Engie (formerly GDF Suez), as well as Brazilian electric utility Eletrobras and water utility Companhia de Saneamento Basico do Estado de Sao Paulo.
From a country perspective, stock selections in Japan and the United Kingdom helped relative performance, along with a lack of allocation to Australia. Conversely, the Fund’s allocations to Brazil, South Korea and Hong Kong weighed on performance.
During the period, the investment committee made a number of transactions. New purchases included France-based electrical equipment company Schneider Electric, Spanish oil firm Repsol (XMCE:REP, Financial), Swiss watchmaker The Swatch Group and Russia’s Surgutneftegas. Divested positions included Netherlands-based consumer goods company Unilever, Japanese automaker Toyota Motor, Mexico’s wireless telecommunication services provider America Movil and Singapore-domiciled semiconductor equipment manufacturer Flextronics.
Schneider (XPAR:SU, Financial) provides electrical products and systems addressing a wide range of industrial, commercial and consumer markets. Key businesses include operations in low-voltage and building automation, discrete and process automation, critical power and cooling, and medium voltage and grid automation. Schneider’s revenues are fairly diversified, with 28% generated in Western Europe, 28% in Asia Pacific, 25% in North America and 19% in the rest of the world.
The market appears to underappreciate Schneider’s potential. Given that emerging markets make up nearly 45% of the company’s sales, some may be worried that potentially slowing economic growth in many developing countries would negatively affect Schneider’s businesses, especially those which are construction-driven. Additionally, the company has shown a penchant for mergers and acquisitions, which can carry risks of overpayment as well as integration and execution uncertainties.
Nonetheless, we believe these risks are more than accounted for in Schneider’s share price. Contrary to market perception, we see a very high-quality business with strong positions in attractive end markets. Unlike those of many other industrial businesses, a number of Schneider’s end markets are still operating below mid-cycle volume and have much room to grow, in our view. The company generates high returns on incremental capital and possesses a reasonably healthy balance sheet with strong free-cash-flow generation. For these reasons, we believe the company offers an attractive risk/reward proposition to long-term investors.
Outlook
The recent spike in market volatility around the world appeared to cause many investors to overlook fundamentals at the company level. Remaining cognizant of unfolding macroeconomic and geopolitical developments that contributed to the increased volatility, we monitor these events in the context of their effects on the intrinsic value estimates of our individual holdings. We view short-term price fluctuations and market selloffs as good opportunities to actively search for value among companies that may be mispriced.
Looking ahead, we believe that company fundamentals, while seemingly obscured by the market’s recent preoccupation with volatility, will eventually gain investor recognition. We hold the view that selectivity and a focus on margin of safety remain paramount in any market environment, as we retain and invest in companies we believe to be worthy of inclusion in the Fund.
Thank you for your business and continued trust.
Sincerely yours,
The Brandes International Large-Cap Investment Committee Brandes Investment Trust
Amelia Morris, CFA, Luiz Sauerbronn, Jeff Germain, CFA, Brent Woods, CFA, Shingo Omura, CFA
Past performance does not guarantee future results.
Because the values of the Fund’s investments will fluctuate with market conditions, so will the value of your investment in the Fund. You could lose money on your investment in the Fund, or the Fund could underperform other investments. The values of the Fund’s investments fluctuate in response to the activities of individual companies and general stock market and economic conditions. In addition, the performance of foreign securities depends on the political and economic environments and other overall economic conditions in the countries where the Fund invests. Emerging country markets involve greater risk and volatility than more developed markets. Some emerging markets countries may have fixed or managed currencies that are not free-floating against the U.S. dollar. Certain of these currencies have experienced, and may experience in the future, substantial fluctuations or a steady devaluation relative to the U.S. dollar.
Current and future portfolio holdings are subject to risk.
Cash Flow: The amount of cash generated minus the amount of cash used by a company in a given period.
Free Cash Flow: Total cash flow from operations less capital expenditures.
Margin of Safety: The margin of safety for any security is defined as the discount of its market price to what the firm believes is the intrinsic value of that security.
Please refer to the Schedule of Investments in the report for complete holdings information. Fund holdings, geographic allocations and/or sector allocations are subject to change at any time and are not a recommendation to buy or sell any security.
The foregoing reflects the thoughts and opinions of Brandes Investment Partners® exclusively and is subject to change without notice.
Brandes Investment Partners® is a registered trademark of Brandes Investment Partners, L.P. in the United States and Canada.
Must be preceded or accompanied by a prospectus.
Index Guide
The MSCI EAFE (Europe, Australasia, Far East) Index with net dividends measures the equity market performance of developed markets in Europe, Australasia, and the Far East. One cannot invest directly in an index.
MSCI has not approved, reviewed or produced this report, makes no express or implied warranties or representations and is not liable whatsoever for any data in the report. You may not redistribute the MSCI data or use it as a basis for other indices or investment products.
The Brandes International Equity Fund is distributed by ALPS Distributors, Inc.
