February 16, 2017 - Eric Liu
Eric Liu is a Portfolio Manager and Senior International Investment Analyst at Harris Associates. Prior to joining Harris Associates in 2009, Eric was a Research Associate at Dodge & Cox and an Investment Banking Analyst at Jefferies & Company. He received an MBA from the University of Chicago and a BA from the University of California Los Angeles.
2016 was an unusually volatile year for global equity markets and our strategies. The beginning of the year was marked by a sharp sell-off in global equities due to growth concerns in China, the devaluation of the yuan and falling commodity prices. At one point during the first quarter, our International strategy was down over 16%. Markets then recovered from their February lows, but this was short lived as Britain voted to exit the European Union in late June, which led to uncertainty across global markets and another sell off of equities. At the end of the year's first fiscal half, our International strategy was down over 10%. Through this downward volatility, we did not waiver and instead used it as an opportunity to initiate new positions in companies that we viewed as undervalued and further build up stakes in our most underappreciated holdings.
The second half of the year was a complete reversal from the first as economic data from Europe was not as dire as many predicted, China fears abated and the U.S. presidential election caused markets to reprice the country’s growth prospects. In what was a highly volatile year marked by several macro events, our International strategy ended up nearly 8% in 2016.
Investment results are rarely a straight line and focusing on short-term investment performance can be perilous. Over the past five years, our International strategy has had seven quarters where returns were negative and eight quarters where we lagged the market as measured by the MSCI All Country World ex U.S. Index. Despite underperforming 35%-40% of the time, the International strategy has generated an annualized return of over 10% during this time period, outpacing the market return of 5%.
Short-term results can be volatile and negative returns can be difficult to stomach. But we caution our clients that focusing on short-term results and avoiding temporary underperformance can significantly impair long-term investment results. In other words, often one must be willing to underperform in the short term to outperform over the long term.
Calendar year 2016 (and 2015 for that matter) was a prime example as the market significantly undervalued cyclicals, financials and consumer discretionary stocks—areas where we had sizable investments. Conversely, the market overvalued stocks that were perceived to be more safe and defensive such as consumer staples and utilities—areas where we had few investments. The valuation gap between these two groups has been widening for some time and continued to do so in the first half of 2016, causing us to underperform. However, in the second half of the year we were rewarded for our patience as the more undervalued areas of the market outperformed and the spread between overvalued and undervalued stocks mentioned above narrowed (although note that we still believe the discount remains wide).
As value investors that are agnostic to the benchmark, we populate the portfolio with companies we believe have the biggest discount to intrinsic value. This often means we are buying specific companies or areas of the market that are unloved, underappreciated or misunderstood. We have no particular insight into when this pricing anomaly will correct but as long as the discount exists (and we regularly debate and re-test our thesis), we will patiently wait. This can lead to periods of underperformance as it can take time for the gap between the stock price and intrinsic value to close. But at Harris Associates we will gladly sacrifice short-term results for long-term investment success.
The MSCI All Country World ex U.S. Index (Net) is a free float-adjusted market capitalization weighted index that is designed to measure the international equity market performance of developed and emerging markets. This benchmark calculates reinvested dividends net of withholding taxes using Luxembourg tax rates. This index is unmanaged and investors cannot invest directly in this index.
The information, data, analyses, and opinions presented herein (including current investment themes, the portfolio managers’ research and investment process, and portfolio characteristics) are for informational purposes only and represent the investments and views of the portfolio managers and Harris Associates L.P. as of the date written and are subject to change without notice. This content is not a recommendation of or an offer to buy or sell a security and is not warranted to be correct, complete or accurate.