With market sentiment firmly shifted to pessimism, the current environment presents an opportunity for U.S. investors to consider diversifying their portfolios with international equities. Despite doom-and-gloom headlines, we believe that non-U.S. equities are poised to benefit, and that investors can weather disruption by diversifying with international stocks over the long run.
From our vantage point as manager of the Virtus Vontobel Foreign Opportunities Fund, there are several reasons for international investors to be optimistic.
1. Valuation and consensus have no margin of safety built in for increased macro risks
Although the U.S. economy is likely to weaken, it should endure an economic downturn better than many other countries. As a result, the U.S. dollar – at its highest level in decades – is expected to remain strong. International companies generating sales in dollars should benefit. In our view, the Virtus Vontobel Foreign Opportunities Fund is positioned to take advantage of this trend, with greater than 34% aggregate U.S. revenue exposure (as of 8/31/22).
U.S. Dollar Strength Close to 20-Year High
Past performance is not indicative of future results. Source: FactSet, as of June 30, 2022.
2: Multinationals Can Be Resilient to Rising Inflation
Higher energy prices in Europe will undoubtedly have a negative impact on economic growth across the region. However, there are many high-quality, globally dominant franchises listed in Europe that benefit from diverse geographic exposure, deriving revenues from around the world. Further, many non-U.S. companies with high gross margins and pricing power can withstand rising costs and a weaker economy and are thus well positioned to combat inflation.
Consider these examples from the portfolio:
- French-based cosmetics and hair care company L'Oreal has high gross margins of 74%. If production costs increased by 10%, it would only need to raise prices by 2.6% to earn the same gross profit.
- Inflation is a tailwind for Dutch payments company Adyen’s top-line growth since it charges a percent of each transaction.
- French luxury goods company Hermes appeals to wealthy consumers who can afford high-end brands whatever the market conditions and are unlikely to balk at price increases.
3: Non-U.S. Equities are Trading at Historic Discounts
The U.S. equity market has become relatively expensive, with the S&P 500® Index trading at more than 17.5 times forward P/E (as of 8/31/22). Headlines around China lockdowns, Europe’s gas shortages, and foreign currency declines have led to historic discounts in both developed and emerging equity markets. While timing is uncertain, we believe that discount should reverse as these issues resolve.
Valuation Premium of S&P 500 to the MSCI ACWI Ex-U.S. Index is Close to a 20-Year High
Past performance is not indicative of future results. Source: FactSet, as of August 31, 2022.
In the meantime, we are taking advantage of current discounts to pick up high-quality non-U.S. companies at compelling valuations – for example:
- Spirax-Sarco is a British manufacturer of steam management systems and peristaltic pumps. Its end-demand should be positively supported in the future by energy efficiency, a desire to reduce carbon-dioxide emissions, and industrial outsourcing. We added it to the portfolio at a discount of more than 30% since the beginning of 2022.
- Budweiser Brewing Co. APAC (Hong Kong) is the leading premium and super premium brewer in China, which represents 75% of the firm’s EBITDA. We believe its stock is undervalued due to COVID’s lingering effects on restaurants and bars. Taking a longer view, we believe the company should grow revenue in the high single-digits and EBITDA should grow in the low to mid-teens.
International Opportunities Abound for Active, Bottom-Up Investors
We believe international equities are not a substitute for U.S. equities, but a complement, offering investors access to great businesses that are not available (or of the same quality) in the U.S. Our international strategy seeks to invest in high-return growth businesses around the world with strong profitability and durable franchises, trading at attractive valuations. The strategy seeks superior alpha capture with lower risk over a full market cycle, aiming to lower overall portfolio volatility and offer a hedge against potential U.S. market weakness. As we see it, the best investment ideas may be conceived in down markets, only to be realized during more buoyant times.
This commentary is the opinion of Vontobel Asset Management. This material has been prepared using sources of information generally believed to be reliable; however, its accuracy is not guaranteed. Opinions represented are subject to change and should not be considered investment advice or an offer of securities.
Companies discussed are holdings of the Virtus Vontobel Foreign Opportunities Fund. References to fund holdings and/or other securities illustrative only and should not be deemed as a recommendation to buy, hold, or sell any of the securities discussed herein. There is no assurance, as of the date of publication, that the securities referenced remain in the Fund or that securities sold have not been repurchased. Additionally, it is noted that securities discussed do not represent all securities purchased, sold, or recommended during the period referenced, nor should any assumption be made as to the profitability or performance of any company identified or security associated with them.
Top Ten holdings in the Virtus Vontobel Foreign Opportunities Fund as of August 31, 2022: Constellation Software (6.14%), RELX (5.24%), Mastercard (5.23%), London Stock Exchange Group (4.72%), Wolters Kluwer (4.41%), Nestlé (4.09%), Diageo (3.64%), Rentokil Initial (3.50%), OBIC (3.48%), and Alcon (3.31%).
Past performance is not a guarantee of future results.
Risk Considerations: Equity Securities: The market price of equity securities may be adversely affected by financial market, industry, or issuer-specific events. Focus on a particular style or on small or medium-sized companies may enhance that risk. Foreign & Emerging Markets: Investing in foreign securities, especially in emerging markets, subjects the portfolio to additional risks such as increased volatility, currency fluctuations, less liquidity, and political, regulatory, economic, and market risk. Market Volatility: The value of the securities in the portfolio may go up or down in response to the prospects of individual companies and/or general economic conditions. Price changes may be short- or long-term. Local, regional, or global events such as war, acts of terrorism, the spread of infectious illness or other public health issue, recessions, or other events could have a significant impact on the portfolio and its investments, including hampering the ability of the portfolio’s manager(s) to invest the portfolio’s assets as intended. Prospectus: For additional information on risks, please see the fund’s prospectus.
Please consider a Fund’s investment objectives, risks, charges, and expenses carefully before investing. For this and other information about any Virtus Fund, contact your financial professional, call 800-243-4361, or visit virtus.com for a prospectus or summary prospectus. Read it carefully before investing. Past performance is not a guarantee of future results.