The Thomas White International Fund primarily invests in equity securities of companies located in the world’s developed countries outside of the U.S. There may also be a portion of the Fund’s assets invested in companies from emerging market countries.
Fund Manager Commentary
September 30, 2011
International equity prices declined sharply during the third quarter, as global economic growth appeared to have decelerated further and fears about the European sovereign debt crisis worsened. Second quarter economic growth fell below expectations for most major economies due to production disruptions that affected industrial output and slower growth in consumer spending. Global growth forecasts have been lowered, and fiscal and monetary policy options to stimulate demand remain limited for most developed countries. The politically polarized debates in the U.S. and Europe over the containment of fiscal deficits, and continued policy inaction dampened investor sentiment further.
The Thomas White International Fund returned -21.41% during the third quarter of 2011, compared to the benchmark MSCI All-Country World ex US Index, which returned -19.85% for the same period. The Fund returned -12.79% for the trailing one-year period, against the benchmark return of -10.81%.
The European debt crisis that has steadily worsened since the first quarter of 2010 appears to be the biggest risk to the global economy. Political opposition in the stronger European economies against enhanced rescue efforts and the violent demonstrations in the distressed countries against public spending cuts have made the tasks of regional governments and the European Central Bank (ECB) even thornier. Investors are still looking for a coordinated effort from the ECB, the International Monetary Fund, and Euro-zone countries to finally restructure the Greek sovereign debt, and protect the banks from defaults that could threaten the stability of the region’s financial system.
Leading economic indicators from most regions have weakened in recent months and commodity prices have corrected on apprehensions over softer demand growth. Though the global supply chain has recovered from the Japanese earthquake, industrial activity remains restricted as manufacturers are not confident enough about the demand outlook. Accordingly, growth in global trade volume has also slowed. Highly accommodative monetary policies have kept borrowing costs at record lows across the developed world, but to a large extent have failed to revive consumer spending as credit standards remain tight and consumers have stayed cautious.
Emerging market equities registered steeper price declines as the central banks in these countries were forced to hurriedly switch from inflation fighting to protecting growth. Some of them have cut interest rates, while most others have halted the rate hikes. Consumer spending growth has yet to see any meaningful deceleration in many of these countries, but credit growth has declined. At the same time, inflation risks remain elevated as the rising number of middle class families have pushed up prices for mostly non-discretionary items.
International currencies, with the notable exception of the Japanese yen, depreciated sharply against the U.S. dollar as fears about the European crisis worsened and market volatility increased. The declines were steeper for emerging market currencies, forcing the central banks in several of those countries to intervene. Despite robust corporate earnings growth and low borrowing costs, merger and acquisition activity slowed. However, if global equity prices remain depressed, it is likely that companies with large cash balances and dominant market shares will look at possible strategic acquisitions.
Portfolio Review
After moderately outperforming the benchmark during the first two months, the Fund lagged in investment returns for the quarter as developed markets in Europe, and emerging market equities came under increased selling pressure. Historically, the Fund has maintained a higher exposure to emerging market equities relative to its benchmark and this has positively contributed to longer term Fund returns. However, the abrupt and steep fall in emerging market currencies against the U.S. dollar also detracted from the Fund’s relative performance. Nevertheless, we continue to believe that valuations in emerging markets are at attractive levels today and the relatively superior economic growth will offer opportunities to businesses domiciled or operating in those geographies.
The Fund’s Japanese holdings benefited from the stronger than expected recovery of the domestic economy from disruptions related to the earthquake, as well as the relative strength of the yen. They included engineering and construction company Taisei Corp. (+22.0%), as well as pharmaceutical manufacturers Suzuken Co. Ltd. (+17.6%), Dainippon Sumitomo Pharma Co. Ltd. (+11.3%), and Eisai Co., Ltd. (+4.1%). Thai telecom services provider Advanced Info Services PCL (+21.3%) gained from expectations of improved political stability after the recent elections. Natural gas and LPG supplier Osaka Gas Co. Ltd. (+10.2%) outperformed as the continued shutdown of nuclear plants in Japan lifted demand for alternate fuels. South African gold miner Gold Fields Limited (+5.3%) added value as gold prices set new highs during the review period.
Metals and resources holdings detracted the most from the Fund’s return on concerns over slower global demand growth. They included global steel producer ArcelorMittal S.A. (-53.5%), Canadian metals and coal miner Teck Resources Limited (-42.0%), global mining group BHP Billiton Plc. (-31.1%), and Brazilian iron ore miner Vale S.A. (-27.1%). European bank holdings in the Fund portfolio, including BNP Paribas S.A. (-47.9%), ING Group N.V. (-42.0%), and Deutsche Bank A.G. (-40.5%) lost value as their exposure to the debt of troubled countries in the region led to credit rating downgrades. Well-capitalized and with strong management teams, we believe these firms will successfully navigate the worst case outcomes from the European crisis and still be in a position to grow organically through geographic expansions or externally via acquisitions.
Outlook
Increased global macroeconomic uncertainties, triggered mostly by the frustratingly slow progress in addressing the long-term fiscal challenges in Europe and the U.S., dragged equity prices lower during the quarter. However, while a sovereign crisis can appear more unnerving than a banking system crisis, we believe that the global financial system is under less stress when compared to 2008. In our view, the sharp political and ideological divisions have only worsened consumer and business sentiments, while the absence of a unified political structure has hampered policymakers in Europe. Nevertheless, growing awareness about the severity of the challenges are already visible in the purposeful steps taken by the troubled European countries to curtail public spending, the fading resistance against debt restructuring, and the increased willingness of Germany and others to enhance their support of financial rescue efforts.
Unless the European crisis spirals out of control, the developed economies are currently expected to maintain their expansion, though at a slower rate. Japan is likely to see acceleration next year as the reconstruction efforts gain full speed. It should also be emphasized that the emerging economies as a group are expected to see growth of 6% this year, allowing the global economy to grow at an annual pace of 4%, as compared to slightly more than 5% achieved last year. This assumes that the U.S. and European economies are able to stave off a recession. Corporate earnings have been robust so far, though they would likely be susceptible in the event of a recession in the U.S. or Europe.
The heightened volatility in emerging market currencies was partly due to the somewhat abrupt shift in the outlook for bond yields. The elevated inflation risks in several of these countries had led to entrenched expectations about continued monetary policy tightening, and widening interest rate differentials. However, the central banks in these countries are now pivoting to support economic growth and market expectations are being realigned accordingly. We expect this to be a relatively short-term trend and it is likely that the U.S. dollar will weaken against most other currencies in the long-term given the deteriorating U.S. fiscal health, and current sentiment that the 2012 presidential election cycle will hamper bi-partisan legislation.
We take this opportunity to assure you that our extensive and disciplined investment research process is designed with relative downside protection as a primary objective. We continue to believe that an international equity portfolio, well diversified across regions and sectors, should deliver superior long-term returns relative to most other asset classes. Thank you for your continued trust in the Thomas White International Fund.
Fund holdings and sector allocations are subject to change at any time and are not recommendations to buy or sell any security. Please click here for fund holdings.
Opinions expressed are subject to change at any time, are not guaranteed and should not be considered investment advice.
Mutual fund investing involves risk. Principal loss is possible. Investing in international markets may involve additional risks, such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. Investments in smaller companies involved additional risks such as limited liquidity and greater volatility.