International Equity Strategies

International Equity Strategies – Q3 Review

The Pembroke International Growth Fund outpaced the MSCI ACWI ex-US Small Cap Index during the quarter ended September 30. The fund’s emphasis on high-quality growth companies bolstered relative performance. Stock selection within the industrials sector was the key driver of outperformance.

Within industrials, Sweden-based capital goods holdings Indutrade (“INDT SS”) and Nolato (“NOLAB SS”) were the top contributors to relative performance during the period. Indutrade is a leader in the Northern European market for industrial component distribution. The company is differentiated by its high proportion of proprietary products (38% of sales), a range of product offerings from high-quality suppliers, and a technically savvy sales team, all of which help to reinforce close relationships with customers. Indutrade management is highly regarded for its long track record of organic and acquisition-driven growth with high returns. Indutrade’s sales growth is a function of two factors: GDP growth in the countries where it operates, and growth from acquired businesses. Second-quarter earnings results were ahead of consensus estimates, supported by the reopening of countries that had been on pandemic lockdowns. Management noted that acquisition opportunities remained favorable, with a good inflow of interesting targets.

Nolato is a provider of high-value-added solutions to customers in the medical, industrial, and technology industries. The company has produced consistently strong financial performance over time, with high cash generation and returns on capital. Nolato posted solid 12% organic revenue growth for the second quarter, well ahead of consensus expectations. Growth in the Medical division of 9% was materially higher than consensus expectations as respiratory and other Covid-related demand more than offset lower volumes for surgical equipment.

Partially offsetting these positive effects were the underweighting to the communication services sector and negative stock selection within the consumer discretionary sector. Within consumer discretionary, UK-based online apparel company Boohoo Group PLC was the largest detractor during the quarter. Boohoo’s asset-light, direct-to-consumer business model has made it a digital winner. The company sells private-label products exclusively on its website but owns no manufacturing and does minimal design. This model supports its test-and-repeat model, in which Boohoo buys designs in small quantities and keeps its merchandise fresh. The share price came under pressure in early July amid allegations by the Sunday Times newspaper that a UK-based Boohoo supplier was paying workers less than the statutory minimum wage. Management took immediate steps to terminate its relationship with the supplier in question and launched an independent review of its UK supply chain, while also committing to tighten supply chain oversight and transparency. These actions helped allay investor concerns and the share price recovered most of its losses by quarter end. William Blair engaged extensively with senior management and independent directors on the supply chain issues as well as corporate governance more broadly, and we maintained our position as we continued to closely monitor developments.

Outlook

The market recovery we have seen has been driven by liquidity. Major central banks acted early and decisively, such that periods of funding stress typical in acute and sudden recession were fleeting. Domestic financial conditions are normalizing rapidly, and both the US Fed and Europe’s ECB have assured the markets that they will remain committed to eliminating pockets of funding stress wherever necessary. In China, the People’s Bank of China (PBoC) has aggressively increased liquidity provisions, such that the total credit impulse in the economy is now among the strongest we have seen in a decade. Importantly, funding conditions remain adequate for most emerging market economies, supported by ample dollar liquidity and lower oil prices.

While valuation multiples appear inflated due to depressed earnings, this is largely consistent with historical recovery environments.  Looking forward, however, successful containment of the virus, combined with improving prospects for an effective vaccine, are likely to pave the way for a broadening of market leadership to include more traditional cyclical companies as their earnings begin to stabilize and reaccelerate. This will be the ultimate catalyst to see a style reversal in the market, where the valuation differentials of high-growth companies relative to all others will likely compress.  We are monitoring this closely.

Given that backdrop and this period of high uncertainty, we are focused on understanding the durability of the competitive advantage of those “digital winners”, trying to understand the nature of the acceleration of their growth; and how much of that future success is priced into the stocks.

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• See Our Solutions page for Pembroke’s range of funds.
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