International Small Cap

Portfolio attribution

The Portfolio 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. Returns to our value factors were positive in December and the quarter, and value was the best performing alpha factor group in 2022 as higher interest rates led to a derating of growth stocks. The strategy’s earnings growth alpha factors posted modestly positive returns in December but negative returns for the fourth quarter overall. Our technical factors delivered positive returns in December, but negative returns in the fourth quarter as November witnessed a change in the Fed’s posture and early signs of a China reopening, the combination of which led to an abrupt change in market leadership. Our competitive strength factor category delivered negative returns for the month and the quarter. Our macroeconomic and country aggregate factors delivered positive returns in December as countries exhibiting superior metrics (such as China and Turkey) outperformed those with relatively weaker macroeconomic characteristics (such as Brazil and Canada). All factor group returns remain positive from inception of the Strategy (10/20/14) to the end of December.

Investment outlook

Signs continue to indicate an easing in U.S. inflation, which should allow the Federal Reserve to continue slowing or potentially pause interest rate hikes in the coming months. The change in expectations around U.S. monetary policy has recently led to a weakening USD. International small caps, deriving more of their revenues from local currencies compared to large caps, stand to potentially benefit from appreciating local currencies relative to the USD.

Though we analyze many different stock selection factors in our alpha model, value factors receive the largest weight on average. As of the end of December, the MSCI ACWI ex USA Small Cap Growth Index traded at a 16.0x forward P/E multiple compared to 9.4x for the MSCI ACWI ex USA Small Cap Value Index, a 70% premium.

The Fed has begun to slow the pace of rate tightening, but global monetary policy is expected to remain restrictive for some time. As long as economic growth remains intact, higher policy rates should continue to favor value stocks over longer-duration growth stocks.

International small caps exhibit greater valuation dispersion than large caps on both a forward earnings yield and B/P 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.

International Value Select

Portfolio attribution

The Portfolio outperformed the Index during the month, due primarily to stock selection. Portfolio holdings in the consumer services, insurance, and banks industry groups contributed to relative performance. Holdings in the household & personal products and transportation industry groups, along with an overweight position in the technology hardware & equipment industry group, offset some of the outperformance compared to the Index. The top contributor to return was life insurer, Prudential Plc (United Kingdom). Other notable contributors included integrated resort developer & operator, Sands China Ltd.(Hong Kong), and bank, Sumitomo Mitsui Financial Group, Inc. (Japan). The largest detractor was electronic equipment manufacturer, Samsung Electronics Co., Ltd. (South Korea). Additional notable detractors included pharmaceuticals & chemicals company, Bayer AG (Germany), and business software & services provider, SAP SE (Germany).

Investment outlook

Weak earnings and a drain of global liquidity – the opposite of the post-GFC bull market – do not bode well for equity markets in the next several months. We anticipate margins coming under pressures as higher costs flow through income statements. Nominal revenue growth may remain elevated, but real earnings growth in certain sectors appears vulnerable in our view. Lower valuations and relatively greater cyclicality in non-US equity markets should give non-US markets a chance to again outperform the US. Attractively valued cyclical stocks may deliver relatively good returns in the second half of 2023 as global markets discount post-recession recovery. Further monetary tightening should favor stocks with reasonable valuations and abundant financial strength over those where earnings expectations and multiples still appear too high. Barring another oil supply shock, we believe energy is unlikely to lead the markets to the same extent as in 2022 as global oil & gas demand –besides China – wanes. The end of the era of free money combined with sharply rising short-term interest rates may expose weaknesses in the global financial system. We have reduced our bank weighting and added to economically defensive stocks, which should reduce portfolio risk at the margin. As economies slow, we expect to reduce the portfolio’s lower-ranked defensive stocks to add more, in our view, competitively well-placed cyclical companies with the potential to improve free cash flow and return more capital to shareholders. We remain focused on identifying management teams able to increase free cash flow, boost dividends and reward shareholders with cash or share buybacks.

International Opportunities

Portfolio attribution

The Portfolio outperformed the Index during the month. Portfolio holdings in the banks and insurance industry groups, as well as an underweight position in the energy industry group, contributed to relative performance. Holdings in the household & personal products and technology hardware & equipment industry groups, along with an underweight position in the media & entertainment industry group, offset some of the outperformance compared to the Index. The top individual contributors to return were life insurer, Prudential Plc (United Kingdom), as well as banks, Sumitomo Mitsui Financial Group, Inc. (Japan), and UniCredit S.p.A. (Italy). The top individual detractors from return were integrated circuit manufacturer, Taiwan Semiconductor Manufacturing Co., Ltd. (Taiwan), business software & services provider, SAP SE (Germany), and pharmaceuticals & chemicals company, Bayer AG (Germany).

Investment outlook

Weak earnings and a drain of global liquidity – the opposite of the post-GFC bull market – do not bode well for equity markets in the next several months. We anticipate margins coming under pressures as higher costs flow through income statements. Nominal revenue growth may remain elevated, but real earnings growth in certain sectors appears vulnerable in our view. Lower valuations and relatively greater cyclicality in non-US equity markets should give non-US markets a chance to outperform the US. Attractively valued cyclical stocks may deliver relatively good returns in the second half of 2023 as global markets discount post-recession recovery. Further monetary tightening should favor stocks with reasonable valuations and abundant financial strength over those where earnings expectations and multiples still appear too high. Barring another oil supply shock, we believe energy is unlikely to lead the markets to the same extent as in 2022 as global oil & gas demand –besides China – wanes. The end of the era of free money combined with sharply rising short-term interest rates may expose weaknesses in the global financial system. We have reduced our bank weighting and added to economically defensive stocks, which should reduce portfolio risk at the margin. As economies slow, we expect to reduce the portfolio’s lower-ranked defensive stocks to add more, in our view, competitively well-placed cyclical companies with the potential to improve free cash flow and return more capital to shareholders. We remain focused on identifying management teams able to increase free cash flow, boost dividends and reward shareholders with cash or share buybacks.

Within the EM portion of the Portfolio, the sectors with the weakest net upgrades were information technology, materials, and utilities. Forecasts for the information technology sector reflect falling demand for semiconductor memory components. Weak expectations for materials are due in part to the impact of slowing global growth on commodity prices. The sectors with the strongest net upgrades were consumer discretionary, communication services, and energy. Both consumer discretionary and communication services are heavily exposed to China and have benefited from the government’s efforts to rekindle economic growth. While we incorporate growth expectations into our multi-factor EM investment process, we continue to emphasize valuation in our approach. With a balance of favorable valuation, growth, and price momentum characteristics relative to the Index, we believe the portfolio offers attractive risk-adjusted return potential looking forward.

Emerging Markets Equity

Portfolio attribution

The Portfolio underperformed the Index in December 2022. We use both bottom-up “stock-specific” and top-down factor categories to seek to forecast alpha for the stocks in the Portfolio’s investable universe. Our bottom-up technical and competitive strength factors were negative indicators during the month. Our valuation and growth factors were positive. Of our top-down factors, sector and currency were negative indicators. Our macroeconomic and country factors were positive indicators in December.

Investment outlook

Earnings growth upgrades for EM equities continue to lag those in ex-US developed markets. The EM sectors with the weakest net upgrades were information technology, materials, and utilities. Forecasts for the information technology sector reflect falling demand for semiconductor memory components. Weak expectations for materials are due in part to the impact of slowing global growth on commodity prices. The sectors with the strongest net upgrades were consumer discretionary, communication services, and energy. Both consumer discretionary and communication services are heavily exposed to China and have benefited from the government’s efforts to rekindle economic growth. While we incorporate growth expectations into our multi-factor investment process, we continue to emphasize valuation in our approach. With a balance of favorable valuation, growth, and price momentum characteristics relative to the Index, we believe the portfolio offers attractive risk-adjusted return potential looking forward.

Global Value Equity

Portfolio attribution

The Portfolio outperformed the Index during the month, due primarily to stock selection. Portfolio holdings in the software & services, insurance, and consumer services industry groups contributed to relative performance. Holdings in the media & entertainment and household & personal products industry groups, along with an underweight position in the food beverage & tobacco industry group, offset some of the outperformance compared to the Index. The top contributor to return was life insurer, Prudential Plc (United Kingdom). Other notable contributors included business services provider, Concentrix Corp.(United States), and banking & financial services company, UniCredit S.p.A. (Italy). The largest detractor was technology conglomerate, Alphabet, Inc. (United States). Additional notable detractors included media & entertainment conglomerate, The Walt Disney Co. (United States), and electronic equipment manufacturer, Samsung Electronics Co., Ltd. (South Korea).

Investment outlook

Weak earnings and a drain of global liquidity – the opposite of the post-GFC bull market – do not bode well for equity markets in the next several months. We anticipate margins coming under pressures as higher costs flow through income statements. Nominal revenue growth may remain elevated, but real earnings growth in certain sectors appears vulnerable in our view. Lower valuations and relatively greater cyclicality in non-US equity markets should give non-US markets a chance to again outperform the US. Attractively valued cyclical stocks may deliver relatively good returns in the second half of 2023 as global markets discount post-recession recovery. Further monetary tightening should favor stocks with reasonable valuations and abundant financial strength over those where earnings expectations and multiples still appear too high. Barring another oil supply shock, we believe energy is unlikely to lead the markets to the same extent as in 2022 as global oil & gas demand –besides China – wanes. The end of the era of free money combined with sharply rising short-term interest rates may expose weaknesses in the global financial system. We have reduced our bank weighting and added to economically defensive stocks, which should reduce portfolio risk at the margin. As economies slow, we expect to reduce the portfolio’s lower-ranked defensive stocks to add more, in our view, competitively well-placed cyclical companies with the potential to improve free cash flow and return more capital to shareholders. We remain focused on identifying management teams able to increase free cash flow, boost dividends and reward shareholders with cash or share buybacks.

International Value Equity

Portfolio attribution

The Portfolio outperformed the Index during the month, due primarily to stock selection. Portfolio holdings in the consumer services, insurance, and banks industry groups contributed to relative performance. Holdings in the transportation and household & personal products industry groups, along with an overweight position in the technology hardware & equipment industry group, offset some of the outperformance compared to the Index. The top contributor to return was life insurer, Prudential Plc (United Kingdom). Other notable contributors included integrated resort developer & operator, Sands China Ltd.(Hong Kong), and bank, Sumitomo Mitsui Financial Group, Inc. (Japan). The largest detractor was electronic equipment manufacturer, Samsung Electronics Co., Ltd. (South Korea). Additional notable detractors included pharmaceuticals & chemicals company, Bayer AG (Germany), and business software & services provider, SAP SE (Germany).

Investment outlook

Weak earnings and a drain of global liquidity – the opposite of the post-GFC bull market – do not bode well for equity markets in the next several months. We anticipate margins coming under pressures as higher costs flow through income statements. Nominal revenue growth may remain elevated, but real earnings growth in certain sectors appears vulnerable in our view. Lower valuations and relatively greater cyclicality in non-US equity markets should give non-US markets a chance to again outperform the US. Attractively valued cyclical stocks may deliver relatively good returns in the second half of 2023 as global markets discount post-recession recovery. Further monetary tightening should favor stocks with reasonable valuations and abundant financial strength over those where earnings expectations and multiples still appear too high. Barring another oil supply shock, we believe energy is unlikely to lead the markets to the same extent as in 2022 as global oil & gas demand –besides China – wanes. The end of the era of free money combined with sharply rising short-term interest rates may expose weaknesses in the global financial system. We have reduced our bank weighting and added to economically defensive stocks, which should reduce portfolio risk at the margin. As economies slow, we expect to reduce the portfolio’s lower-ranked defensive stocks to add more, in our view, competitively well-placed cyclical companies with the potential to improve free cash flow and return more capital to shareholders. We remain focused on identifying management teams able to increase free cash flow, boost dividends and reward shareholders with cash or share buybacks.