Portfolio attribution

The Causeway International Small Cap Fund (“Fund”) outperformed the Index during the month. To evaluate stocks in our investable universe, our multi-factor quantitative model employs four bottom-up factor categories – valuation, earnings growth, technical indicators, and competitive strength – and two top-down factor categories assessing macroeconomic and country aggregate characteristics. In April, the strategy’s value factors produced the highest returns among our alpha factor groups, and value is the best-performing factor YTD and over the last twelve months. Following a challenging first quarter, our earnings growth factors also posted positive returns last month. However, the strategy’s competitive strength and technical factors generated negative monthly returns. Our macroeconomic and country aggregate factors were also negative indicators in April as countries exhibiting superior top-down metrics generally underperformed those with relatively weaker characteristics. All factor group returns remain positive from inception of the Fund (10/20/14) to the end of April.

Economic outlook

The US economy may have already entered a stagflation period, likely exacerbated by tightening credit conditions and price rises embedded in wages, goods, and services. Despite headline-generating layoff announcements, payroll figures have been resilient, and the nationwide unemployment rate is a low 3.4%. Employers who suffered labor shortages during the pandemic may be reluctant to reduce staff, even as demand weakens. In contrast, data suggests the European Central Bank may have flexibility to slow its tightening policy. Although headline Eurozone inflation rose to 7% in April, the rate of core inflation—which removes the volatile food and energy price categories—declined for the first time in ten months, to 5.6%. In both the US and Europe, credit appears to be contracting after recent banking system shocks. As Europe and the US potentially near the end of their rate hike cycles, the Bank of Japan has yet to begin. We expect the Japanese central bank to continue its policy of monetary easing, conducted through yield curve control.

After a robust reopening from Covid lockdowns, Chinese manufacturing contracted in April; China’s official purchasing managers’ index (“PMI”) declined to 49.2. Our fundamental research corroborates this reading. In the materials sector, where China is the world’s largest customer and a critical link in supply chains, companies doing business with China are reporting a weaker recovery than past economic accelerations. Across developed markets, industrial production is declining from peak levels as companies work through backlogs accrued during the pandemic.

Investment outlook

The latest casualty in the US banking crisis was First Republic Bank, whose assets were seized by regulators and sold to JP Morgan. Outside of this incident, however, there has been relative calm in the banking sector, particularly outside of the US.

As of April 30, the Fund has a roughly 4.0% weight to banks, just slightly above the benchmark weight, and attribution was modestly positive for these positions in April.
Though we analyze many different stock selection factors in our alpha model, value factors receive the largest weight on average. Even if the U.S. Fed pauses future interest rate hikes following its May 3rd 25-bps hike, interest rates are likely to remain elevated for some time. A higher cost of capital should translate into a continued preference for value stocks. As of the end of April, the MSCI ACWI ex USA Small Cap Growth Index traded at a 17.1x forward P/E multiple compared to 10.0x for the MSCI ACWI ex USA Small Cap Value Index, a 71% premium.

International small caps exhibit greater valuation dispersion than large caps on both a forward earnings yield and price-to-book basis, indicating more information content in the valuation ratios of small caps. In addition to exhibiting greater valuation dispersion, small caps exhibit a higher long-term EPS growth trend.

The market commentary expresses the portfolio managers’ views as of the date of this report and should not be relied on as research or investment advice regarding any stock. These views and the fund holdings and characteristics are subject to change. There is no guarantee that any forecasts made will come to pass. Any securities identified and described in this report do not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in the securities identified was or will be profitable. Diversification does not protect against market loss. Current and future holdings will be subject to risk. International and emerging markets investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from social, economic or political instability in other nations. Emerging markets and smaller companies involve additional risks and higher volatility.