Portfolio attribution

The Portfolio outperformed the Index in August 2023. 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 factor categories, valuation, earnings growth, technical (price momentum), and competitive strength, were all positive indicators during the month. Of our top-down indicators, macroeconomic and currency were positive. Country and sector were negative indicators in August.

Economic outlook

Economic data in the US continue to suggest that inflation is moderating, lowering the likelihood of further rate increases by the US Federal Reserve (“Fed”). The dramatic size and pace of Fed interest rate increases over the last few years have been a headwind for EM assets. As we approach the end of the Fed’s current rate hiking cycle, the outlook for EM equities and currencies should improve. Within EM, the Central Bank of Brazil lowered its target rate by 50 basis points in August. With real interest rates near the highest level of all major countries globally, Brazil has ample room to reduce interest rates. Furthermore, like many developed countries, Brazilian inflation has been moderating. In contrast, Argentina's currency fell during the month and the country’s central bank increased interest rates by 21 percent to combat rising prices in the country. Strong support for Javier Milei in the primary vote contributed to economic uncertainty as he has vowed to eliminate Argentina’s central bank and dollarize the economy. In the Portfolio, we have a small overweight position in Argentina expressed through two companies, both with relatively little exposure to Argentina. One company is an e-commerce business that derives most of its revenue from Brazil and the other is an integrated energy company whose performance is more correlated with global oil prices.

In emerging Asia, Chinese data continues to reflect an anemic recovery for the largest EM country’s economy. July retail sales and industrial production data fell short of expectations and Chinese authorities ceased reporting youth unemployment levels, reflecting a pessimistic view towards one of the weakest areas of the economy. Given the lackluster economic data and tame inflation, we believe Chinese authorities will further stimulate the economy. While significant monetary easing appears unlikely given the economy’s debt load, we anticipate incremental, target support as and when needed. Authorities have recently stimulated growth by cutting the stamp tax on stock transactions, encouraging local governments to address debt risks using special bonds, and vowing to increase housing options for first-time homebuyers. We are overweight Chinese stocks in the Portfolio due in part to compelling valuations, as we believe the growth concerns are more than discounted in share prices. While almost all sectors are trading at significant discounts to their historic valuations, we currently are finding the most attractive opportunities in energy, industrials, financials, and interactive media companies. We are underweight companies in China’s real estate sector, a particularly vulnerable segment of the country’s economy.

Investment outlook

As part of our continuous effort to enhance our quantitative model, we aggregated two “top down” factors, country and sector, in August. This country-sector aggregate factor combines country and sector analysis, recognizing that many sectors are locally-oriented and may not be comparable across countries, while other sectors are global in nature. For example, we believe comparing financials companies across countries has little predictive value as each country has its own central bank, interest rate dynamics, and macroeconomic drivers affecting the credit cycle. However, comparing energy or mining companies across different countries can be useful since these businesses tend to sell into a global marketplace. The country-sector aggregate factor has two components – self-relative valuation and earnings growth – and it has a 12.5% weight in the strategy’s alpha model.

Earnings growth upgrades for EM equities continue to lag those in ex-US developed markets. The sectors with the strongest net upgrades were consumer discretionary and communication services. Consumer discretionary’s strong upgrades reflect solid growth expectations for Chinese e-tailers, despite the slow rebound in Chinese growth. Communications services has been buoyed by a strong outlook for Chinese interactive media companies. On the negative side, net growth upgrades were weak for materials and information technology, reflecting slowing global growth. Within EM, we continue to identify, in our view, attractive investment opportunities in small cap companies. Historically, our investment process has uncovered EM small cap stocks with alpha potential. The Portfolio's allocation to small cap stocks was near the high end of the historical range at month-end.

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 portfolio holdings and characteristics are subject to change. There is no guarantee that any forecasts made will come to pass. The securities identified and described above 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. Past performance does not guarantee future results. For a description of our performance attribution methodology, or to obtain a list showing every holding's contribution to the overall account's performance during the quarter, please contact our product manager, Kevin Moutes, at 310-231-6116 or [email protected].