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Mondrian International Small Cap Equity
International Small Cap at a Glance
Total Product Assets: USD 6.4 billion Product Inception: January 1998
Active value-oriented defensive strategy
Consistent application of income oriented valuation approach
History of outperformance versus the benchmark, with lower volatility
Dedicated small cap team
Universe: Securities that have a maximum market capitalization of approximately USD 3.5bn at time of purchase
Portfolios contain 70-120 securities Annual turnover is generally 20-40%
Our Organization
Founded in 1990, with 30 years of stable, consistent leadership
Approximately USD 59 billion under management and advisement
Mondrian is employee owned; approximately half of employees are partners today
Consistent, income-oriented value discipline has been applied to all products since the firm’s inception
Highly experienced team of 58 investment professionals in London
Philosophy
We invest in stocks where rigorous dividend discount analysis isolates value in terms of the long-term flow of dividends. Dividend yield and future real growth play a central role in our decision making process and over time the dividend component is expected to be a meaningful portion of expected total return.
Benefits of Our Approach
Mondrian’s approach focuses on providing a rate of return meaningfully greater than the client’s domestic rate of inflation. Our portfolios seek to preserve capital during protracted global market declines. Additionally, our portfolio performance has historically been less volatile than the international small cap benchmarks and performance of most other international small cap managers.
Investment Process
A value oriented dividend discount analysis at both the individual security and market level isolates value across geographic and industrial borders in a unified manner A long term purchasing power parity approach, supplemented by shorter-term probability assessment Fundamental research is strongly emphasized. An extensive program of company and market visits enhances initial qualitative and quantitative desk research, both prior to the purchase of a stock and after its inclusion in the portfolio
Cumulative Returns (USD) January 1998 = 100
1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 Mondrian ISC Equity Composite (Net)
SI: 9.9% (ann)
MSCI World ex-US Small Cap SI: 7.9% (ann) 0 100 200 300 400 500 600 700 800 900
Performance Summary (USD)
Composite
Composite Gross (%) Composite Net (%) MSCI World ex-US Small Cap (%) Cumulative Q420 19.31 19.08 17.55 Annualized 1 Year 11.08 10.22 12.78 3 Years 6.40 5.58 5.04 5 Years 10.15 9.30 9.63 10 Years 8.19 7.36 6.98 15 Years 9.64 8.80 5.90 SI Jan 1, 1998 10.71 9.86 7.91See Important Notes & Disclosures on page 5. 2 Q42 0 ISC Q uar terly Up date
Market Background
The MSCI World ex US Small Cap Index rose 17.5% during the quarter (all returns in US dollars)
International small cap equities rose sharply during the fourth quarter. Initial concerns over the second wave of Covid-19 infections spreading across Europe and the announcement of further lockdown measures in response, were assuaged by encouraging results from vaccine trials announced in November and the subsequent approval of a number of vaccines for use in December, leading markets to register a 12.8% gain for the full year.
All markets appreciated during the fourth quarter
The Irish small cap market was the best performer in the index, gaining 47.4%, driven by a strong financials sector. The UK small cap market outperformed the index, up 26.6%, following strong performance across a number of sectors as the UK began an ambitious Covid-19 vaccination program and approved a trade agreement with the European Union before the December 31st deadline. Elsewhere in Europe, the French and German small cap markets rose 21.2% and 21.1% respectively. Despite registering growth of 9.4%, Belgium was the weakest market in the region.
In the Asia Pacific region, the New Zealand and Australian small cap markets were the best performers, rising 30.7% and 22.2%
respectively. The Hong Kong and Singapore small cap markets both underperformed, up 12.6% and 10.1% respectively. Meanwhile, Japan was the weakest small cap market in the index, albeit up 8.0%.
The Canadian small cap market rose 20.6%, supported by the materials, energy and industrials sectors.
All sectors gained during the quarter
Energy was the strongest performing sector in the quarter, up 33.8%, but remained the weakest performer in 2020, down 29.0% for the year. The cyclically sensitive industrials and materials sectors both gained 21.3%, meanwhile the financials, consumer discretionary and information technology sectors also outperformed the index, rising 20.2%, 18.9% and 18.4% respectively. The consumer staples sector was the weakest performer, up 5.3%.
Exchange rate movements boosted US dollar returns
All major currencies in the index appreciated against the US dollar during the fourth quarter. The Norwegian krone was strongest currency in the index, appreciating 9.3%. The British pound and euro rose 5.7% and 4.3% respectively, while the Japanese yen was the weakest major currency in the index, albeit up 2.2%.
Performance Attribution for the Fourth Quarter
The index rose sharply in the fourth quarter, gaining 17.5%. In this strongly rising market, the composite portfolio (net of fees) delivered a positive return of 19.1%, outperforming the benchmark by 1.3%.
Japan was a key contributor to outperformance, with the portfolio benefitting from strong stock selection and its underweight exposure to the relatively weak local market and Japanese yen. Stock selection in Canada and Switzerland further supported relative returns, partially offset by Australia and Germany, leaving overall stock selection strongly positive. Market allocation also contributed positively, in particular the portfolio’s overweight exposure to the strong French and Irish markets in addition to Japan, while currency effects were marginally negative to portfolio performance.
Performance Attribution for the Year ended December 31, 2020
2020 was a volatile year for equity markets, as the spread of Covid-19 led to widespread restrictions and supply chain disruption as well as significant job uncertainty and losses. At their nadir in March, markets had fallen 40% but rallied during the remaining 9 months, to end the year up 12.8%. The composite portfolio (net of fees) returned 10.2%, underperforming the benchmark by 2.3%.
The key drivers of underperformance were stock selection in Australia, France, the Netherlands and the UK, and market allocation, as the portfolio’s overweight exposure to the relatively weak markets in France and Singapore held back returns. This was partly offset by strong stock selection in Canada and Japan, as well as the portfolio’s overweight exposure to the strong Canadian market. Currency effects also detracted from performance, largely due to the portfolio’s overweight exposure to the weak Canadian and Singapore dollar.
Return Summary
Composite
Gross Return Composite Net Return ex-US Small Cap MSCI World
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Investment Outlook
Global markets experienced significant volatility in the wake of the Covid-19 crisis during 2020. Markets fell by 40% at their nadir towards the end of the first quarter, as restrictive measures such as social distancing and national lock-downs caused a global demand and supply shock affecting aggregate demand, trade and global GDP. Unlike the global financial crisis (GFC) in 2008-2009, this was not a systemic crisis, but the scale and speed of fiscal and monetary stimulus led by the US Federal Reserve (the Fed) to support business capacity and jobs/income drove global markets to stage a remarkable bounce, registering strong gains for the full year. Having experimented with various conventional and unconventional monetary tools with negligible inflationary pressures over the past decade, policymakers were willing to implement a response which was far greater in magnitude and speed than after the GFC. Policymakers have avoided a GFC-style liquidity crunch through the use of quantitative easing (QE), extending from government securities to corporate bonds, as well as government guaranteed lending schemes. The emerging economies have also shown a willingness to increase their fiscal spending and their budget deficit, and some have undertaken innovative policies never employed before in their history such as unconventional monetary policy with their central bank as lender of last resort to support domestic interest rates. The path to normality will be uneven, and may include further restrictions along the way. The success of each government’s response to the virus is dependent on the strength and preparedness of public health systems, fiscal headroom and implementation of test and trace systems, as well as the successful roll-out of a vaccine across the globe. The full impact of the virus remains unclear but one can only look to the countries that are ahead of the Covid-19 recovery curve to understand the trajectory, conditional upon the above mentioned factors. Much of North Asia as well as parts of South East Asia have dealt with the crisis much more efficiently due to their past experience of handling pandemics, as have Australia and New Zealand.
As observed, few industries and sectors across the globe were completely insulated from the spread of the virus. Some industries have been more negatively impacted than others especially in hospitality, leisure as well as bricks-and-mortar retail, particularly given that more flexible working structures have damaged ecosystems reliant on commuting and office working.
We believe monetary policy is likely to remain accommodative for a prolonged period until the Fed is assured of a sustained economic recovery with full employment (as per its dual mandate) and to ensure that rising indebtedness across the government, corporates and households does not pose a long term burden on their respective finances as a result of higher debt servicing costs. Central banks elsewhere are likely to follow the lead of the US with a move towards “average inflation” targeting in an effort to keep real interest rates negative and spur economic recovery. Within the tool kit available to the Fed are “yield curve control” as well as negative interest rate policies adopted by other regimes, notably by the Bank of Japan and the European Central Bank respectively, so as to ensure liquidity and lower long term borrowing costs to induce investment and employment. Of particular note are geographies with fiscal headroom that are more capable of pursuing counter cyclical spending to spur growth making them less reliant on the need for interest rates to go below zero reducing the negative implication on their currency. We believe that investment is likely to be along two themes: i) productivity improvement through technology such as the adoption of automation across both manufacturing and service based sectors; and ii) localisation of supply chains to ensure self-sufficiency, notably in technology, healthcare and food sectors.
Coordinated monetary and fiscal policies will continue to support widening budget deficits, leading Debt-to- GDP ratios to likely exceed 120% for both the US and the eurozone. Concerns over rising bond yields may be quelled by the use of “yield curve control” as is currently in use in Japan. Nonetheless, this cycle of higher debt, lower interest rates and lower real bond yields could make it difficult for central banks to eventually normalise monetary policy when the recovery does arise as we have observed during the last decade.
Prolonged accommodative financial and liquidity conditions following the GFC have resulted in slow progress in deleveraging and lax implementation of structural reforms to improve productivity. Asset price inflation caused by these accommodative conditions, in addition to lacklustre real economic growth, have led to wealth inequalities which, coupled with inadequate social safety nets to cater for those disadvantaged by globalization and automation, have created social issues with implications to politics, stability and growth. Unless these issues are resolved, and without significant improvements in productivity and structural reforms, we believe developed economies will face a path of lower trend growth, modest inflation and lower short-term policy rates relative to history. This will continue to drive the search for yield and investments providing growth, favoring investment in inefficient asset classes such as developed and emerging small cap which further offer structural growth prospects.
Despite running “twin deficits” (fiscal and current account) for many years, the US dollar’s unique position as reserve currency coupled with its safe haven status as well as stronger relative economic growth has ensured that the currency has displayed strength, while the US equity market has been one of the best performing markets since the GFC. Valuations are rich and a strong US dollar limits further upside. As a result the investment case for international equities – both developed and emerging small cap – is compelling to a US-based investor thanks to their attractive valuations coupled with the overvaluation of the US dollar against most currencies. Further the small cap asset class, with its large universe of relatively under-researched and often mispriced stocks, creates alpha generation potential which can be unlocked through active management. Market uncertainties with tail risks present opportunities for a manager like Mondrian which adopts a disciplined investment approach focused on target real rates of return, downside protection and minimized volatility.
See Important Notes & Disclosures on page 5. 4 Q42 0 ISC Q uar terly Up date
The Mondrian International Small Cap equity portfolio adopts a diversified and balanced approach capturing attractively valued investments with well capitalized balance sheets, enjoying structural growth opportunities with sustainable business models and strong cash flows to support growth and progressive dividend payments. This strategy aims to deliver both downside protection during periods of volatility as well as upside capture during periods of optimism. The strategy has remained consistent since the end of 2015, with a focus on increasing exposure to fiscally strong economies, and this will continue given their ability to support a post Covid-19 recovery.
Investment Strategy
The main highlights of the strategy being adopted for the portfolio are:
•
A defensively positioned portfolio focused on well managed, high yielding companies, with structural growth prospects, robust balance sheets and attractive valuations•
Exposure to fiscally strong economies which are able to undertake counter-cyclical fiscal policies to boost domestic growthPortfolio Managers
Ormala Krishnan Chief Investment Officer Small Cap Equities Managing PartnerAidan Nicholson
Senior Portfolio Manager Partner
Bhavin Manek
Senior Portfolio Manager Partner
Investment Outlook (continued)
Sector Allocation
Mondrian (%)MSCI World ex-US Small Cap Communication Services 2.9 4.3 Consumer Discretionary 12.6 12.3 Consumer Staples 8.3 5.6 Energy 1.6 2.3 Financials 1.8 10.1 Health Care 3.0 6.9 Industrials 28.9 22.4 Information Technology 11.8 10.3 Materials 5.3 10.8 Real Estate 12.2 11.8 Utilities 9.7 3.3 Cash 1.8 — Total 100.0 100.0
Country Allocation
Mondrian (%)MSCI World Ex-US Small Cap North America 10.2 8.2 Canada 10.2 8.2 Asia Pacific 40.3 39.0 Australia 10.5 8.3 Hong Kong/China 5.5 1.7 Japan 17.1 26.3 Singapore 7.1 1.7
Other Asia Pacific — 1.0
Europe & Middle East 47.7 52.8
Belgium 1.1 1.4 France 8.0 3.0 Germany 6.7 4.9 Ireland 1.3 0.5 Italy 1.7 2.6 Netherlands 3.6 2.4 Norway 2.1 2.1 Sweden 3.7 6.9 Switzerland 2.7 4.8 United Kingdom 16.8 16.2 Other Europe — 8.1 Cash 1.8 — Total 100.0 100.0
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Important Notes and Disclosures
1. Mondrian claims compliance with the Global Investment Performance Standards (GIPS®). Mondrian is a value-oriented defensive manager seeking to achieve high real returns for its clients. All products utilize an income-oriented value discipline. Mondrian’s methodology is applied consistently to markets and individual securities, both bonds and equities. The International Small Cap Equity Composite includes US dollar based discretionary fee paying portfolios, measured against the MSCI World Ex-US Small Cap Index net of US withholding taxes. The portfolios are invested in non-US based small capitalisation equities with the allowance for hedging. The MSCI World Ex-US Small Cap Index assumes the reinvestment of dividends after the deduction of withholding tax and approximates the minimum possible
dividend re-investment. To receive a complete list and description of composites and/or a presentation that adheres to the GIPS standards, contact Mondrian Investment Partners (U.S.), Inc at 215-825-4500.
Neither MSCI nor any other party involved in or related to compiling, computing or creating the MSCI data makes any express or implied warranties or representations with respect to such data (or the results to be obtained by the use thereof), and all such parties hereby expressly disclaim all warranties of originality, accuracy, completeness, merchantability or fitness for a particular purpose with respect to any of such data. Without limiting any of the foregoing, in no event shall MSCI, any of its affiliates or any third party involved in or related to compiling, computing or creating the data have any liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits) even if notified of the possibility of such damages. No further distribution or dissemination of the MSCI data is permitted without MSCI’s express written consent.
2. This Quarterly Update contains supplemental information which complements the Mondrian International Small Cap Equity Composite GIPS compliant presentation. Additional information is available upon request.
3. Total Product Assets may consist of multiple composites. Performance for the main composite for the product is shown. Accounts may not be included in the main composite for reasons such as client domicile or client specific investment restrictions.
4. Calculations for P/E, P/B, dividend yield, sector country allocations and market caps are based on generally accepted industry standards. All characteristics are based on a representative account and derived by Second calculating the characteristics for each security, and then calculating the weighted-average of these values. The details of exact calculations can be provided upon request.
5. Past performance is not indicative of future results. An investment involves the risk of loss. The investment return and value of investments will fluctuate. 6. There can be no assurance that the investment objectives of the strategy will be achieved.
7. All characteristic data provided is produced using Mondrian’s accounting system data.
8. Performance results marked “Gross” do not reflect deduction of investment advisory fees but are net of transaction costs and withholding tax. Investment returns will be reduced accordingly. Performance returns marked “Net” reflect deduction of investment advisory fees and are calculated by deducting a quarterly indicative fee from the quarterly composite return. The indicative fee is defined as being the effective fee rate (or average weighted fee) at the composite’s minimum account size. Actual net composite performance would be higher than the indicative net performance shown because some accounts have sliding fee scales and therefore lower effective fee rates.
9. Views expressed were current as of the date indicated, are subject to change, and may not reflect current views. Views should not be considered a recommendation to buy, hold or sell any security and should not be relied on as research or investment advice.
10. This Quarterly Update may include forward-looking statements. All statements other than statements of historical facts are forward-looking statements (including words such as “believe,” “estimate,” “anticipate,” “may,” “will,” “should,” “expect”). Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct. Various factors could cause actual results or performance to differ materially from those reflected in such forward-looking statements.
11. This introductory material is for informational purposes only and is not an offer or solicitation with respect to any securities. Any offer of securities can only be made by written offering materials, which are available solely upon request, on an exclusively private basis and only to qualified financially sophisticated investors. The information set forth herein is a summary only and does not set forth all of the risks associated with the investment strategy described herein.
For institutional investors and professional financial advisers only.
It should not be assumed that investments made in the future will be profitable or will equal the performance of any security referenced in this piece. Examples of securities bought or sold may not represent a complete list of all transactions in the period. Holdings are subject to change.
Mondrian Investment Partners Limited is authorised and regulated by the Financial Conduct Authority
