Causeway International Value Fund’s letter to shareholders for the third quarter 2014.
For the fiscal year ended September 30, 2014, Causeway International Value Fund’s (the “Fund’s”) Institutional Class returned 5.00% and Investor Class returned 4.69% compared to the MSCI EAFE Index (Gross) (“EAFE Index”) return of 4.70%. Since the Fund’s inception on October 26, 2001, its average annual total returns are 8.97% for the Institutional Class and 8.70% for the Investor Class compared to the EAFE Index’s average annual total return of 7.05%. At fiscal year-end, Causeway International Value Fund had net assets of $6.685 billion.
Causeway International Value Fund: Performance Review
After a liquidity-fueled ascent in the first three quarters of fiscal 2014, international equities reached a plateau during the final quarter of the fiscal year. Every major currency except the Pound Sterling depreciated versus the U.S. dollar during the fiscal year, thus diminishing returns on overseas assets from the perspective of a U.S. dollar-denominated investor. Only three markets in our developed markets universe posted negative returns for the fiscal year. The worst performing markets in the Fund’s investable universe included Austria, Portugal, Australia, South Korea, and Japan. The best performing markets in Causeway International Value Fund’s investable universe included Israel, Denmark, Italy, Spain, and Finland. The two worst performing sectors in the EAFE Index posted negative returns: materials and consumer discretionary. The two best performing sectors each posted double digit gains: health care and utilities.
For the fiscal year, Fund holdings in the telecommunication services, materials, insurance, food beverage & tobacco, and media industry groups contributed the most to Causeway International Value Fund’s performance relative to the EAFE Index. Holdings in the capital goods, energy, banks, transportation, and diversified financials industry groups detracted from relative performance. The largest individual contributor to absolute return was pharmaceutical & consumer healthcare products producer Novartis AG (XSWX:NOVN) (Switzerland). Additional top contributors to absolute return included wireless communications operator SK Telecom Co., Ltd. (XKRX:017670) (South Korea), telecommunication services provider KDDI Corp. (TSE:9433) (Japan), mobile telecommunications operator China Mobile Ltd. (HKSE:00941) (Hong Kong), and insurance company Aviva PLC (LSE:AV.) (United Kingdom). The biggest laggard was energy services firm Technip SA (XPAR:TEC) (France). Additional top individual detractors included optical & camera equipment manufacturer Nikon Corp. (TSE:7731) (Japan), global investment bank UBS AG (XSWX:UBSG) (Switzerland), energy management firm Schneider Electric SE (XPAR:SU) (France), and automaker Hyundai Motor Co., Ltd. (XKRX:00538) (South Korea).
Causeway International Value Fund: Significant Portfolio Changes
Our disciplined purchase and sale process led the portfolio management team to reduce exposure to several holdings that reached fair value in our view. The largest sales during the period included private wealth management and investment bank UBS AG (XSWX:UBSG) (Switzerland), telecommunication services provider KDDI Corp. (TSE:9433) (Japan), and Lloyds Banking Group PLC (LSE:LLOY) (United Kingdom). In addition, we exited two stocks whose risk-adjusted rankings were reduced following fundamental reviews: food retailer Tesco PLC (LSE:TSCO) (United Kingdom) and jet engine manufacturer Rolls-Royce Group PLC (LSE:RR.) (United Kingdom).
Significant purchases this fiscal year included energy services company Technip SA (XPAR:TEC) (France), mobile telecommunications operator China Mobile Ltd. (HKSE:00941) (Hong Kong), optical & camera equipment manufacturer Nikon Corp. (TSE:7731) (Japan), energy management company Schneider Electric SE (XPAR:SU) (France), and pharmaceutical giant Sanofi-Aventis SA (XPAR:SAN) (France).
Fund exposures to currencies, industries, and countries are mostly a by-product of our bottom-up stock selection process. Causeway International Value Fund’s weights in the telecommunication services, food beverage & tobacco, and consumer durables industry groups increased the most compared to the beginning of the fiscal year, while weights in the energy, food & staples retailing, and utilities industry groups incurred the greatest decrease. From a regional perspective, the most notable weight changes included higher exposure to companies listed in South Korea and France. The most significantly reduced country weights included the United Kingdom and Germany. At the end of the fiscal year, the three largest industry group exposures (absolute weights) in Causeway International Value Fund were in banks, materials, and pharmaceutical & biotechnology.
Causeway International Value Fund: Investment Outlook
Muted economic growth and historically low interest rates imply a muted forecast for equity market returns. In a world of single digit returns, dividend income can make a significant contribution to total portfolio performance. Some of the most recent Fund sales include stocks with strong performance, but which we desired to sell before operating conditions deteriorated or failed to meet elevated expectations. One example is the French automotive manufacturer, Peugeot SA, where — despite severe cost cutting — the business remains vulnerable to stagnant European growth and falling prices. We have added the South Korean automotive champion, Hyundai Motor Co., Ltd., as a more diversifying and potentially stronger consumer discretionary stock. With imminent new model launches and a domestic central bank determined to keep South Korea competitive, this automotive company may experience improved earnings growth.
As international markets moved into the red for the final quarter of this fiscal year, the pullback has provided some modest relief in terms of valuations and upside potential. Segments of consumer staples, one of the more expensive global market sectors, have seen improved valuations. We currently expect interest rates to rise modestly in the U.S. next year, and no increase in the euro zone or Japan through 2015. As a result, asset prices, including equities, will likely remain elevated. Investor appetite for stocks with generous and rising dividend payouts should continue. With stocks in the healthcare and telecommunications sectors acting as ballast, the upside in the portfolio may come from companies in cyclical industries offering some improvement in operations and profitability. Greater profits and cash flow typically precede an upturn in dividends and/or share buybacks. We are encouraging portfolio companies to return capital to shareholders, and resist the temptation to make acquisitions.
We thank you for your continued confidence in Causeway International Value Fund.