Market Overview
International equities digested some of their recent gains in the second quarter. The MSCI ACW ex-US Index rose 1.0%, while the MSCI ACWI ex-USA Growth Index rose 0.7%. Consensus estimates for 2024 and 2025 earnings rose modestly through the second quarter earnings season as companies, on balance, reported better than expected results. While corporate earnings for developed markets are only expected to grow 4% in 2024, that growth rate is expected to accelerate to 9% next year.
Despite the Bank of Japan raising short-term interest rates for the first time in 17 years in March, the yen fell more than 6% during the second quarter, bringing the year-to-date loss for the currency to over 14%. While local Japanese returns have been strong due to rising inflation and improving corporate governance, USD returns have been negatively impacted by the currency’s weakness.
As the market shifted away from Japan, emerging markets outperformed developed markets the most in a quarter since 2016. Chinese equities led the way, rising 7.1% in the quarter due to continued government stimulus and dramatically lowering market expectations already reflected in valuations.
With inflation subsiding, the European Central Bank pivoted and cut rates by 25 basis points this quarter. While future rate cuts are still a debate in the market, the central bank has signaled that the aggressive rate-hiking cycle is over, which should provide increased confidence for investors. As the US Fed continues to push out rate cuts, the ECB is leading the rate-cutting cycle for the first time in 25 years.
From a style perspective, value outperformed both the core and the growth index during the quarter.
Portfolio Review
The Lazard International Quality Growth Portfolio (MUTF:ICMPX) underperformed the MSCI ACW ex-US Index during the quarter (net of fees).
Positives
Stock selection in the consumer discretionary sector contributed positively to relative returns. Dollarama (DLMAF, 2.5% weighting in the Portfolio) is the dominant discount retailer chain in Canada, operating over 1,500 stores in the domestic market. The next four largest competitors have a combined store count a little more than a third of Dollarama’s. Shares rose after the company reported first quarter 2025 results. Earnings came in ahead of consensus expectations, attributed to a better- than-expected gross margin. Additionally, Dollarama increased its stake in Dollarcity, their LATAM discount retailer, by 10%, which brings Dollarama’s overall stake in Dollarcity to 70%. Dollarcity is a long-term growth driver for Dollarama and this announcement was also accompanied by a store target upgrade of 1050 stores by 2031 for Dollarcity, as compared to the 850 target before. While we believe our investment thesis remains intact, and the long-term compounder dynamics remain unchanged, we trimmed our position as the stock had rerated materially. Stock selection in the consumer staples sector positively contributed to relative returns.
Clicks (OTCPK:CLCGY, 2.7% weighting in the Portfolio) is the leading health and beauty retailer (health, beauty, and lifestyle products) in South Africa, with very strong barriers to competition from the regulatory environment, scale and brand. We expect them to continue to deliver ROCE north of 50% with strong earnings growth. Shares rebounded, having been weighed down by the weaker consumer environment caused by local inflation and elections, reporting a positive outlook for FY 2024 with accelerating new store openings from 40 to 50 to 50 to 55. We maintained our position. Lack of exposure to the underperforming materials sector positively contributed to relative returns. We have no investments in commodity-related businesses due to their lack of a sustainable competitive advantage.
Negatives
Stock selection in Japan detracted from relative returns, as the MSCI Japan Value Index outperformed MSCI Japan Quality by 250 bps during the quarter. Shares of Japan-based online healthcare platform M3 (OTCPK:MTHRF, 1.4% weighting in the Portfolio) underperformed. The market appears to be focused on the performance of the Pharmaceutical Marketing Support business. However, we feel that while the market narrative of weakness in the most important business is correct in the short term, the driver of this is tied up with the extraordinary growth during COVID and not reflective of a change in the fundamentals of the business. Moreover, the focus on this business is ignoring the success of the other parts of the company. These businesses were the overwhelming driver of the compounding of the business in the 10 years leading up to COVID, performed well through COVID, and look set to continue to do so going forward. In our view, not many companies can sustain a 50% CFROI ex-cash and have a history, and likely future, of growing top and bottom lines at better than 15% per year and trade on a 20x PE with 10% of their market cap in cash. We maintained our position.
Based in Japan, SMS (1.4% weighting in the Portfolio) is a high-quality provider of various services to the medical and elderly care industries in Japan and Asia. Shares declined despite reporting results that were largely in line with consensus expectations. We added to our position.
Additionally, two Ireland based stocks significantly detracted from performance. Domiciled in Ireland, Accenture (ACN, 2.7% weighting in the Portfolio) is one of the highest-quality IT services companies benefiting from the global transformation of digital infrastructure. They continue to lead customers through the digital disruption taking place in all industries, and this differentiation coupled with their unique vertical capabilities is enabling strong growth and market share gains. Cost discipline is gained through leverage in winning a bigger share of existing customers wallets, which requires less expense for Accenture than seeking out new business, and pricing power in digital offerings enables margin expansion and cash flow growth. Strong and consistent cash flow has enabled a robust capital allocation framework built on opportunistic acquisitions in addition to dividends, buybacks and reinvestment in the business, all of which are driving strong double-digit EPS growth. Shares have underperformed on near-term industry softness, however recent results highlight that book to bill has turned, and we believe IT spending should improve as we move through the year and remain optimistic on the structural growth of the industry.
Shares of Ireland-based global Insurance broker AON (3.3% weighting in the Portfolio) declined after reporting first quarter results where organic growth came in below consensus expectations. Long-term, we believe our investment thesis remains intact. As a broker and an asset-light company in a fairly consolidated industry, Aon generates strong returns on capital, which we believe will be sustained due to strong pricing power (particularly in its insurance brokerage business) and cash flow generation, and may benefit from margin expansion opportunities longer term as they digest the NFP acquisition. We maintained our position.
Outlook
We remain focused on our philosophy of investing in quality companies that can sustain elevated levels of financial productivity.
In our view, quality companies are well positioned to generate strong returns due to a range of characteristics, including brand recognition, network benefits, and long competitive advantage periods. As active stock pickers, we believe we have opportunities to add capital to high-quality companies whose long-term potential is underappreciated.
We continue to focus on company fundamentals and making sure we own companies that we believe are prepared for a range of economic scenarios.
Appendix: Investment Philosophy
Our investment philosophy is based on the belief that great companies can also make great investments. In other words, we believe companies that sustain the highest levels of financial productivity are likely to outperform the market.
We think the market undervalues these companies because of its adherence to the economic law of competition. This theory prescribes that high returns on capital attract competition, which results in an erosion of these returns towards the cost of capital. However, in the real world, we think that there are plenty of examples to show that this theory does not work. We are convinced that companies that beat the market-implied fade of returns also beat the market.
In addition to high financial productivity, we are also looking for companies that have the opportunity and appetite to reinvest in their businesses to grow (but only if at similarly high levels of financial productivity). This combination of high financial productivity and growth produces a compounding effect on cash flow and earnings, which we believe is particularly valuable. These types of exceptional businesses are often inefficiently valued by market participants, who are likely focused on near-term multiples rather than the longer-term earnings power of the company.
Putting this together, we seek to invest in companies that generate sustainably high financial productivity, those that can reinvest for growth, and those for which the market is pricing in a fade in returns faster or sooner than we expect.
Note, our investment philosophy has been validated by the work done by co-lead portfolio manager/analyst Louis Florentin-Lee in a long-term study of global financial markets. Please see Quality Investing for more details.
Important Information Please consider a fund’s investment objectives, risks, charges, and expenses carefully before investing. For more complete information about The Lazard Funds, Inc. and current performance, you may obtain a prospectus or summary prospectus by calling 800-823-6300 or going to www.lazardassetmanagement.com. Read the prospectus or summary prospectus carefully before you invest. The prospectus and summary prospectus contain investment objectives, risks, charges, expenses, and other information about the Portfolio and The Lazard Funds that may not be detailed in this document. The Lazard Funds are distributed by Lazard Asset Management Securities LLC. Information and opinions presented have been obtained or derived from sources believed by Lazard Asset Management LLC or its affiliates (“Lazard”) to be reliable. Lazard makes no representation as to their accuracy or completeness. All opinions expressed herein are as of the published date and are subject to change. The MSCI ACWI ex-USA Growth Index captures large and mid-cap securities exhibiting overall growth style characteristics across 22 Developed Markets countries and 24 Emerging Markets countries. The growth investment style characteristics for index construction are defined using five variables: long-term forward EPS growth rate, short-term forward EPS growth rate, current internal growth rate and long-term historical EPS growth trend and long-term historical sales per share growth trend. The index is unmanaged and has no fees. One cannot invest directly in an index. The MSCI Japan Value Index captures large and mid-cap Japanese securities exhibiting overall value style characteristics. The value investment style characteristics for index construction are defined using three variables: book value to price, 12-month forward earnings to price and dividend yield. The index is unmanaged and has no fees. One cannot invest directly in an index. The performance quoted represents past performance. Past performance does not guarantee future results. The current performance may be lower or higher than the performance data quoted. An investor may obtain performance data current to the most recent month-end online at www.lazardassetmanagement.com. The investment return and principal value of the Portfolio will fluctuate; an investor’s shares, when redeemed, may be worth more or less than their original cost. Different share classes may have different returns and different investment minimums. Please click here for standardized returns: https://www.lazardassetmanagement.com/us/en_us/funds/mutual-funds/lazard-international-quality-growth-portfolio/f2901/s204/ Allocations and security selection are subject to change. Mention of these securities should not be considered a recommendation or solicitation to purchase or sell the securities. It should not be assumed that any investment in these securities was, or will prove to be, profitable, or that the investment decisions we make in the future will be profitable or equal to the investment performance of securities referenced herein. There is no assurance that any securities referenced herein are currently held in the portfolio or that securities sold have not been repurchased. The securities mentioned may not represent the entire portfolio. Equity securities will fluctuate in price; the value of your investment will thus fluctuate, and this may result in a loss. Securities in certain non-domestic countries may be less liquid, more volatile, and less subject to governmental supervision than in one’s home market. The values of these securities may be affected by changes in currency rates, application of a country’s specific tax laws, changes in government administration, and economic and monetary policy. Emerging markets securities carry special risks, such as less developed or less efficient trading markets, a lack of company information, and differing auditing and legal standards. The securities markets of emerging markets countries can be extremely volatile; performance can also be influenced by political, social, and economic factors affecting companies in these countries. The MSCI All Country World ex-US Index (ACWI ex-US) is a free-float-adjusted, market capitalization-weighted index designed to measure the performance of developed and emerging equity markets outside the United States. The index is unmanaged and has no fees. One cannot invest directly in an index. Certain information included herein is derived by Lazard in part from an MSCI index or indices (the “Index Data”). However, MSCI has not reviewed this product or report, and does not endorse or express any opinion regarding this product or report or any analysis or other information contained herein or the author or source of any such information or analysis. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any Index Data or data derived therefrom. Certain information contained herein constitutes “forward-looking statements” which can be identified by the use of forward- looking terminology such as “may,” “will,” “should,” “expect,” “anticipate,” “target,” “intent,” “continue,” or “believe,” or the negatives thereof or other variations thereon or comparable terminology. Due to various risks and uncertainties, actual events may differ materially from those reflected or contemplated in such forward-looking statements. |
Original Post
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
Read the full article here