International and Global Equity Strategies

July 2024

 

The general landscape for global and international equities appears to be moving in the right direction. For example, services Purchasing Managers’ Indexes (PMIs) in both Europe and the US are comfortably in expansion territory, while manufacturing is trending positive as well. Real wages are also continuing to rise in both the US and Europe. If real wage growth in the US has moderated slightly as nominal wage growth has slowed, it is still 1-1.5% above the rate of inflation. In Europe, wage growth has been stronger at around 2-2.5%, which should bode well for continued domestic demand growth in the second half of the year.

In Japan, a weak yen has weighed on the market, diluting the positive impact of nominal wage growth and stock market-driven structural reforms. The weakness, largely caused by persistently low real interest rates in Japan relative to the rest of the world, is raising concerns that inflation could remain higher than expected. The need to import food and energy is further depressing consumption, while at the same time holding back real wage growth. In the medium term, we would expect the yen to at least stabilize as real interest rates converge. We continue to see companies increasing dividends and buybacks to improve total shareholder returns as they implement structural reforms.

As for China, we remain cautious against a backdrop of choppy/sub-par growth and a persistently challenging market environment, despite recent positive developments in policy reforms.

With a share of global Gross Domestic Product (GDP) growth approaching 20%, we consider India to be one of the strongest emerging markets, and its story continues to improve. The country has overtaken Taiwan and Korea to become the second-largest component of the MSCI EM Index. Inflation has cooled, interest rates are no longer rising, GDP growth is robust, and both public and private investment appear to be entering an upcycle.

Although India trades at a premium to the Emerging Markets universe, we believe valuations are justified by impressive levels of earnings per share growth driven by strong tailwinds in the financial and industrial sectors. However, valuation risk needs to be monitored closely.

International Growth Strategy

The Pembroke International Growth Strategy underperformed the MSCI ACWI ex-US Small Cap Index over the first six months of the year. The underperformance was driven by weaker stock selection within Japan Industrials and Information Technology, which more than offset positive stock selection within Communication Services and Consumer Staples.

In particular, the strategy’s positioning and stock selection in Japan detracted from relative performance through exposure to domestically focused, higher-value, human capital intensive business models. These companies have recently been penalized by wage inflation and a significant weakening of the yen.

Positive Contribution to Strategy Returns

Positive stock selection within Health Care was driven by Pro Medicus (PME.AX). The company has developed a best-in-class software solution for medical imaging. Through its proprietary streaming architecture, it leads the market in terms of viewer speed, implementation speed and clinical efficiency. In addition to solid results earlier in the year, the company secured five new contracts with a combined value of $45 million (AUD) across multiple customer types. These contracts highlight the strength of Pro Medicus’ broader product offering and the trend towards cloud deployment.

Negative Contribution to Strategy Returns

Weaker stock selection in Information Technology (IT) was mainly due to SHIFT (3697.T). Through its outsourced software testing business, SHIFT is benefiting from the digitization of Japanese companies, which is currently in its early stages. The stock fell on weaker results, mainly due to declines in revenue and utilization per engineer due to changes in customer needs. Nevertheless, demand for IT services in Japan remains strong across the industry, and demand for the company’s mainstay, software testing, remains robust. The company is working through the mismatch between demand and supply. It reiterated its expectations for sequential improvement in the fourth quarter.

Global Equity Strategy

The Pembroke Global Equity Strategy is a diversified portfolio with exposure to Canadian, US and international developed and emerging equity markets. The managers aim to maintain diversification by region, market capitalization size, manager as well as passive and active strategies. The strategy is benchmarked to a custom index consisting of a 64% weight in the MSCI All Country World Index (ACWI) and a 36% weight in the S&P/TSX Composite Index.

The strategy was essentially flat on an absolute basis in the second quarter of 2024 and underperformed its bespoke benchmark, which was slightly up. Over the period, the strategy experienced negative relative contributions from the Pembroke Canadian Growth Fund (1), the Pembroke US Growth Fund (2), the Pembroke Concentrated Fund (2), the Guardian Capital Global Equity Fund and the Pembroke International Growth Fund. The negative relative returns were partially offset by the Pembroke Canadian All Cap Fund (1) and the Pembroke Dividend Growth Fund (1), which outperformed their respective benchmark component over the period.

For the 12-month period ending on June 30, the strategy closed significantly higher, but trailed its benchmark, which also rose over the period. All of the strategy’s geographic equity allocations and underlying funds contributed to absolute returns. On a relative basis, Canadian equities outperformed, while US and international equities underperformed their respective benchmark component.

The strategy invests in passive exchange traded funds (ETFs) to gain exposure to certain large capitalization liquid equity markets. At period-end, it held four equity market ETFs: the iShares Core S&P500 ETF, the iShares S&P/TSX 60 Index ETF, the iShares Core MSCI EAFE ETF and the iShares Core Emerging Markets ETF.

Overall, the strategy’s allocation to passively managed ETFs was approximately 23.9% at the end of June 2024. By region, approximately 37.6% of the strategy was allocated to Canada, 41.0% to the US, 9.8% to Europe, 2.0% to Japan and 9.6% to other regions. By sector, the strategy’s largest exposures include Industrials, Financials, Information Technology and Consumer Discretionary.

 

(1) See the Canadian Strategies article

(2) See the US Strategies article

 

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