Review and Outlook

as of 12/31/18

Last quarter, we suggested several potential catalysts that could likely trigger a mean reversion where international equities would begin to outperform their U.S. counterparts. Such catalysts included indications of a credible truce between the U.S. and China on trade, market recognition that U.S. corporate profits and equities were quite exposed to disruption from escalating tariffs and foreign policy tensions, and finally, a peak in unconstrained executive privilege, or what we termed “peak Trump political currency.” During the fourth quarter, the above catalysts have all come into play, and as a result, international equities outperformed the U.S. for the first time in several quarters. We believe such outperformance is a welcome precondition to forming a durable bottom and a return to positive returns.

We now enter 2019 with various risks to U.S. corporate earnings increasingly priced in and speculative and leveraged positioning in equities, bonds and oil having corrected and normalized. Our conclusion is that much that could go wrong has been priced in, particularly in mid-cap growth stocks globally, which suffered an outsized correction in the fourth quarter. Consistent with the above conditions, as well as our view that the U.S. midterm elections might represent an important inflection point where we begin to see constraints on U.S. executive privilege, we became considerably less defensive and exited the quarter with a much-reduced cash position. In the near term, we believe a notable rally in international equities is more likely than a further decline, as markets begin to anticipate a de-escalation of protectionist measures and improving global trading conditions, as well as a more flexible Fed mandate. Such a development would likely suggest a peak in the U.S. dollar and further outperformance by international equities. While this is our base case expectation for now, we also maintain caution, as in our view the global capital markets will remain sensitive to the elevated risk of policy error.

While we believe unconventional U.S. foreign policy initiatives have driven international equity risk premium higher and earnings multiples lower in the short term, we are encouraged by several emerging bright spots. We believe we are nearing a conclusion to the Brexit drama, and suspect a near-worst case scenario is expected and largely priced into markets. During the quarter, we increased our domestic U.K. exposure and currently see both attractive risk/reward and a catalyst likely to emerge soon. Should the outlook for foreign and trade policy reduce pressure on China, and Fed policy shift to a marginally more accommodative stance, we believe many of our existing investments offer material upside from current levels. As always, we remain confident that our forward-looking and bottom-up fundamental approach positions us to discover exciting long-term investment opportunities regardless of the market environment.

Top Contributors/Detractors to Performance

as of 12/31/18

Contributors

  • Argenx SE is a Dutch biotech company focused on developing antibodies to treat patients with cancer and severe autoimmune diseases. Recent positive performance comes from resolution of some confusion regarding a bleeding safety concern. This was amplified by a large licensing deal from Johnson & Johnson for argenx's asset to treat acute mylegenous leukemia. We believe argenx’s antibody platform is one of the most valuable assets in the biotech development space.
  • Mellanox Technologies Ltd. is a supplier of high-performance switch systems, adapters, cables, and software supporting InfiniBand and Ethernet networking technologies. Mellanox shares were up in the quarter following the company's strong quarterly results, which exceeded its guidance on top line and margins, in addition to rumors around a potential takeout deal. We believe Mellanox is an attractive long-term investment due to its technological leadership in high speed interconnects, which are becoming increasingly relevant in a world of big data and AI.
  • Shares of China Tower Corporation Limited grew in the quarter as fears of a merger between two important customers eased. China Tower is the largest owner of wireless towers globally with dominant market share in China. We continue to believe that China Tower will be a significant beneficiary of the carrier 5G network build in China. In addition, we think that despite offering deflationary pricing terms to customers, China Tower should be able to compound value in the double-digit range for more than five years.

Detractors

  • Encana Corp. is a Canadian-based exploration and production company with primary operations in Western Canada and Texas. Shares declined after the company announced the acquisition of Newfield Exploration, which has limited geographic overlap with Encana's core position in the U.S. In our opinion, Encana is one of the most attractively valued E&Ps. We believe investors underappreciate the company’s long-term free cash flow, returns potential in the Permian and the Montney, and potential operational synergies and cash flow accretion from the Newfield deal.
  • Shares of Fresenius Medical Care AG & Co. KGaA declined in the quarter. As the world’s leading provider of dialysis products and services, the company is a beneficiary of increased onset of End Stage Renal Disease due to growing rates of diabetes and obesity. Earnings weakness owing to unfavorable reimbursement trends pressured shares. The company also issued below-consensus 2019 earnings guidance as it plans to incur upfront costs to drive future growth. We retain conviction as Fresenius is a stable, defensive, cash generative health care business in our view.
  • Shares of Eurofins Scientific SE detracted from performance in the quarter. Eurofins provides analytical testing services to clients in the food, pharmaceutical, and environmental industries. Shares fell due to questions about the sustainability of Eurofin's organic growth and its ability to make acquisitions given current leverage levels. We believe the company's organic growth is sustainable in the mid-single digits, and it has balance sheet capacity to make acquisitions. We have confidence in management.

Quarterly Attribution Analysis

as of 12/31/18

Yearly Attribution Analysis (for year ended 12/31/2018)