Aristotle Capital Management’s Value Equity letter to investors for the first quarter ended March 31, 2015.
Aristotle Capital Value Equity – Quarterly Markets Review
The S&P 500 Index posted its ninth consecutive quarterly gain (albeit modest), reporting a total return of 0.95% in the first quarter of 2015. Despite finishing the quarter nearly fl at, U.S. equity prices were quite volatile as investors shifted their focus from one economic report or news event to the next. Equities vacillated between caution and optimism on mixed data from around the world. The European Central Bank belied Europe’s persistent economic troubles by announcing a larger-than-expected bond-buying program, while China reported its slowest economic growth rate in 24 years (still a 7.4% expansion) and began its own form of quantitative easing to encourage spending and lending. Meanwhile, oil prices continued to decline, which pleased consumers but soured energy-related companies. The U.S. economy showed further signs of improvement as unemployment declined and GDP grew. Nonetheless, the Federal Reserve appeared patient, and the timing of the seemingly inevitable yet elusive interest rate hike remained uncertain at the end of the quarter.
While the U.S. equity market ended the quarter only slightly higher than it began, some segments of the market performed better than others. The trend from the fourth quarter of 2014 continued, as performance was inversely related to size, reflecting investors’ comfort with taking on additional risk. Among the U.S. Russell equity indices, small cap companies performed the best, followed by mid caps, while large caps trailed for the quarter. With regard to style, so-called “growth” companies meaningfully outperformed their value counterparts within each market cap segment. By sector, nearly 12 percentage points separated the leader from the laggard. Performance ranged from the Health Care sector’s total return of 6.47% in the S&P 500 Index to -5.17% for the Utilities sector.
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Meanwhile, most major developed equity markets outside the U.S. outpaced the S&P 500 Index, many of them rallying on the launch of the European Central Bank’s major economic stimulus efforts in March as well as signs of economic improvement. The MSCI EAFE Index (net) reported a first quarter total return of 4.88% in U.S. dollars. Performance was even better in local currency terms due to the strong U.S. dollar, with MSCI EAFE (net) posting a gain of 10.85% for the quarter. Among the MSCI developed country indices, both Denmark and Japan posted double-digit advances, reporting U.S. dollar returns of 15.82% and 10.21%, respectively. The worst-performing developed market in the quarter was resource-dependent Canada, with a total return of -6.04% in U.S. dollar terms. Only four other developed markets—Singapore, New Zealand, the U.K. and Spain—posted U.S. dollar losses. However, in local currency terms, all developed markets reported gains in the quarter.
The emerging markets also advanced in U.S. dollar terms in the first quarter, though to a lesser extent than the developed markets. The MSCI EM Index (net) reported a 2.24% total return in U.S. dollars, while the gain was 4.90% in local currencies due to the dollar’s strength. Dispersion among the MSCI emerging markets was vast, ranging from a total U.S. dollar return of 18.61% for Russia to -29.34% for Greece.
This past quarter witnessed a sharp increase in the value of the U.S. dollar relative to most major foreign currencies, as the Wall Street Journal Dollar Index, which compares the greenback against a basket of 16 foreign currencies, gained 5.9% for the quarter (after a 12.0% rally in 2014). The lone exception was the Swiss franc, which de-pegged from the euro and rose sharply initially, though it finished the quarter very near where it began relative to the U.S. dollar.
In the fixed income markets, U.S. government bonds posted their fifth consecutive quarterly gain, the longest winning streak since the bursting of the dotcom bubble in 2001. Despite the impending hike in U.S. interest rates, investors bid up U.S. Treasury prices on continued dovish comments from the Federal Reserve as well as less-than-attractive investment alternatives around the globe. As of March 31, 2015, the 10-year Treasury yield was 1.930%, down from 2.173% at the start of the quarter. As low as that sounds, it compares quite favorably to the 0.183% yield on the German 10-year government bond and the 0.397% yield on the similar-maturity Japanese government bond.
With respect to commodity prices, oil’s decline slowed from its breakneck pace in late 2014, as U.S. crude oil prices slid 10.6% in the quarter, on top of the roughly 50% decline in 2014.
Aristotle Capital Value Equity – Performance And Attribution Summary
For the first quarter of 2015, performance of Aristotle Capital’s Value Equity portfolio was strong on both an absolute and a relative basis. The Value Equity Composite posted a total return of 3.39% gross of fees (3.30% net of fees), meaningfully outperforming both the Russell 1000 Value Index and the broad S&P 500 Index, which reported total returns of -0.72% and 0.95%, respectively. For the year ended March 31, 2015, the Composite gained 10.77% gross of fees (10.38% net of fees), outpacing the 9.33% increase in the Russell 1000 Value Index but trailing the 12.73% rise in the S&P 500 Index. Longer-term performance was favorable, with the Value Equity Composite gaining 17.67% gross of fees (17.23% net of fees) for the three years ended March 31, 2015, ahead of both the Russell 1000 Value Index, 16.44%, and the S&P 500 Index, 16.11%.
Given our bottom-up, fundamentally focused security selection process, any value added relative to the Russell 1000 Value Index is typically generated by stock selection rather than sector allocation, and the first quarter of 2015 was no exception. (Sector allocation for the Value Equity portfolio is merely a by-product of individual stock selection decisions.) Security selection added value in most of the ten sectors, while in the aggregate, sector allocation detracted from relative performance for the quarter. The top five contributors to relative return were in five different sectors. As the graph on the next page shows, the investment team added at least 45 basis points to relative return in half the sectors. A few sectors were neutral, while the only sector to subtract value was Utilities.
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