October 15, 2024 • 32 mins
Since the US market can be profitable for European companies, any slowdown in the US economy could harm earnings in Europe, but also alleviate high valuations. On this episode of Inside Active, host David Cohne, mutual fund and active management analyst with Bloomberg Intelligence, along with co-host Laurent Douillet, senior equity strategist for Bloomberg Intelligence, spoke with Sarah Ketterer, Chief Executive Officer and Fundamental Portfolio Manager at Causeway Capital Management, including the Causeway International Value Fund (CIVVX). They discussed Causeway’s value investment philosophy, including its risk-adjusted return ranking model, as well as the criteria she looks for in potential holdings. They also spoke about how AI tools are being integrated into the investment process and where she sees investment opportunities in artificial intelligence.
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Episode Transcript
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Speaker 1 (00:13):
Welcome to Inside Active, a podcast about active managers that
goes beyond sound bites and headlines and looks deeper into
their processes, challenges and philosophies and security selection. I'm David Cohne,
I lead mutual fund and active research at Bloomberg Intelligence.
Today my co host is Laurent Duier, senior equity strategist
(00:33):
at Bloomberg Intelligence. Laurent, thank you for joining me today.
Speaker 2 (00:37):
Thank you foroving me.
Speaker 1 (00:38):
I wanted to ask you about a recent note you
wrote about industrial valuations in Europe. Can you tell our
audience how current valuations compare historically and how potential showdown
in the US could affect those valuations.
Speaker 2 (00:53):
Yes. In fact, the industry lay is a very interesting
sector in Europe because it offers many growth opportunities, but
also it is the most the second most expensive after technology.
Currently trades on a forward peer of about nineteen times,
which is the thirty seven percent premium to European equities,
(01:16):
and historically it has always treaded at a premium between
fifteen to twenty percent. So I mean today, what explain
a higher premium for European industrials compared to the market.
It's all the clean energy investment. Also you have the
rearmament in Europe, and also you have the massive US
(01:37):
fiscal programs, which I think are major gross drivers for
companies in arrow space, defense and also capital goods. And
I think these growth opportunities for many of those companies
are not just for the next twelve or eighteen months.
It may be for several years to come, so I
think it puts them on your growth trajectory, which justifies
(01:59):
the higher valuation ratios. Regarding your question about what could
happen to European industrials if there is a wobble in
the US economy, I think definitely it will be a
problem because US is about thirty percent of the sector
cells and I think the US market is also quite
(02:21):
profitable for European companies, So any wble in the in
the US economy will create a problem with earnings, but
also potentially are durating on many of those companies given
the rich multiple. And the last point I would like
to make as well is that if you look at
the valuation of industrial companies which are challenged either by
(02:45):
the green transition or the adoption of AI, they are
currently trading at very low multiples compared to their own history.
And I think it's suggests that some of the venues
that started to be discounted in the share price. For sure,
some of them will be value trap along the line,
but I think that potentially some of them could offer
(03:05):
some good investment opportunities. So lacking many sectors in Europe
stockpicking is key.
Speaker 1 (03:11):
Great. Well, let's bring in our guests who can talk
about Europe and other international markets. I'd like to welcome
Sarah Ketterer, who is chief exggative officer and a fundamental
portfolio manager at Causeway Capital Management. Sarah, thank you so
much for joining us.
Speaker 3 (03:25):
Thank you for inviting me.
Speaker 1 (03:26):
Well, I want to start by asking you how you
got your start in the investment industry.
Speaker 3 (03:31):
Well, the short answer was a long long time ago.
But I rose up through the ranks, went to the
school of hard knocks in investment banking, and was in
business school and more investment banking. And that turns out
and it still is today, a resonably good background for
fundamental research, and then it instills valuation techniques and skills.
(03:53):
The only thing I couldn't get a job at Causeway today, however,
because we need so much more than that the next
several decades are going to require an ability with data
that just didn't exist when I started. Nonetheless, I had
an opportunity with my co founder Harry Hartford in two
thousand and one to start Causeway, and we've had a
(04:15):
twenty three year record of managing predominantly international equity fundamentally,
but we also have global equity and we manage quantitative
strategies including emerging markets and small cap.
Speaker 1 (04:29):
Well, actually, you mentioned Causeway, so you know I like
to talk a little bit about it. What would you
consider the overall investment philosophy of the company.
Speaker 3 (04:37):
We are very much steeked in a value investment philosophy,
particularly in the work we do fundamentally to identify companies
we believe our training at levels below their intrinsic value.
And this is both a combination of very intensive understanding
evaluation tools and the assumptions we make about the business
(05:00):
layer of subjectivity that comes with experience. So our portfolio
managers we have six cluster heads, individuals responsible for in
depth work in sectors. They have to make the final
decision on stocks and they rely heavily on value and
then quantitatively we use value amongst other factors. Albeit, value
(05:23):
has a very large weight, So overall, Causeway is very
focused on the price we pay in our analysis of
the likely return we'll see for our clients.
Speaker 1 (05:34):
Great well, I do want to ask you specifically about
the International Value Fund, the ticker symbols civv X. Is
there a specific process, you know, investment process for that
particular fund.
Speaker 3 (05:47):
Yes, there is, and it's the same process we've used
since our inception. In fact, parts of a date back
to antiquity. But the whole idea here is that we
sift through thousands of companies outside the US market to
identify and nes Laran noted there's plenty of under evaluation.
The US market is the most expensive and has been
(06:10):
amongst the developed world for a number of years. And
you might say rightly so, because of its emphasis more
on growth, a greater exposure to technology, and less what
we call old world businesses, But that we're indifferent to
the types of businesses. We're looking through these thousands of
stocks for certain criteria we need looking for income companies
(06:34):
that are predisposed of returning capital to shareholders. At the
same time, those stocks are generally trading on a price
to cash flow basis below their industry average, so they
tend to look in expensive. There's capital coming back to shareholders,
which in all interest rate environments except zero, is very important.
(06:55):
And then from there we narrow the group and do
quite a bit of intense research on under standing in
this fund where the opportunities are bi sector. And then
as we present these incredibly interesting companies that have had
some sort of setback and that's why the share price
is nowhere near its ultimate valuation, or we call a
(07:18):
two year price target, we then decide as a team
if that price target is the one that we have
arrived at is reasonable, and then we know what we
expect the company's return should be including income, and then
we risk adjustment using our quantitative risk model, so we
can get a risk adjusted return. And all the stocks
(07:40):
that we are considering for this fund, we rank them
daily on risk adjusted return and it's the highest risk
adjuster return stocks they'd end up in our fund with
the largest weights.
Speaker 2 (07:54):
Given the large amount of data which have to be
processed by your equity pms at least, I mean, are
you already using or do you intend to use AI
to potentially improve your investment process?
Speaker 3 (08:09):
Yes, definitely, I have great admiration for our Digital services
area and run by my colleague Pete Peterson. He's made
a huge effort to ensure that not only do we
have access to tools already embedding AI in them, such
as Facts or Bloomberg, but we are also developing our
(08:33):
own tools so that we can be more productive as
a research team. And this is true quantitatively as well
as it is fundamentally. We've been working with large language
models quantitatively for some time, but that research, some of
that translates into what we can do in the rest
of the organization. But specifically for fundamental research, we use
(08:54):
a chat function that's embedded in a system we have
that's connected with facts that that allows us to do
queries because if you think about it, we have twenty
six fundamental research channels scouring the globe constantly taking notes,
meeting with companies that information. We need to be able
to access it, assimilate it, distill it, understand better what
(09:19):
the management said the last time we met with them,
so that we can ask even better questions going forward.
So from a productivity perspective, we're at the early stages
of implementing AI. What would be more interesting in what
we're working on, i'd say next horizon type project is
how we can use AI to generate investment ideas, and
(09:40):
part of that will come from having our IT experts
spend more time with our research channels, understanding better what
they go through and how they think about their areas
of coverage in order to be able to automate some
of that.
Speaker 2 (09:57):
Maybe a flow of question on AI as an investment opportunity,
which Checter do you think would allow the greatest investment
over the next three to five years.
Speaker 3 (10:11):
We think about AI in stages and how it's impacting
the companies that we could buy. And again I'm speaking
to you from the lens of a value investor, so
we're not going to pay large multiples that embed growth
that we are concerned might not occur, might be vulnerable.
(10:32):
But some of the most interesting stocks right now are
in the building phase. That's the phase that's focused on
getting the infrastructure needed, all the computing infrastructure, and a
lot of that are semiconductor firms and they've been pretty
awful lately. So the opportunities are considerable. Companies in the
(10:54):
microcontroller and power semic inductor area that have an industrial focus,
like infinion firm or Renaissance in Japan or We also
are very interested in the two big memory non US
memory companies, Memory semiconductors, Samsung Electronics and sk Heinex. So
they we think they that given the the increasing need
(11:19):
for semiconductor content, whether it be in automotive applications or
other industrial applications, not to mention in the devices that
we all use smartphones, PCs, and then of course there's
data centers that the demand will pick up quite significantly
in these areas of what we call building, which is
(11:42):
predominantly again semiconductors. And then in AI delivery that would
be phase two. That would be companies that are involved
in network infrastructure and end devices, so we like Marauder
manufacturing for example, and then Samsung and Heinex are involved
there too. And then I say you said three to
(12:02):
five years. At the five year mark, that could be deployment.
And so enterprises now Causeway as an example, we're deploying AI,
but we know we're early, and we're looking for all
we're asking our peers what they're doing, any type of
consulting help, if we need it, we get it. We
(12:23):
think enterprises globally are at the early stage, particularly those
that are already just engaged in digital transformation, they need
quite a bit of help. And that's where it services.
Companies like Fujitsu in Japan or SAP in Germany, where
enterprise software is their main line of business, they should
(12:43):
do quite well. And then companies that are just going
to imbue AI in their products or embed I would
say ten Cent and China is an example of that.
So I've just rottled off a whole lot of stocks,
and none of them are Nvidia.
Speaker 1 (13:00):
Well, I actually do you know you mentioned a video.
You know that's obviously you know, trading at a much
higher valuation. You know, no one would consider that a
value stock. But I do want to ask you a
follow up on valuations. You know you mentioned it in
your process, and you know you alluded to a few metrics.
I guess you know, when you're looking at companies, is
there kind of like a cutoff of certain metrics that
(13:23):
you would consider? You know, like, how does that fit
into the entire process of evaluating companies?
Speaker 3 (13:29):
There are we don't have strict multiples where we walk away,
but we are we get very uncomfortable when we see
that there are high multiples in a stock where we're
already observing record levels of earnings or what we call
cyclical peaks in earnings. And this is where value investing
(13:50):
can be a little bit confusing because it simplistically and
per the indices, value investing consists of low pe multi
full low price to book, low price to cash flow stocks.
But that could be for a deep cyclical stock when
earnings are at its zenith, just the absolute long time
to own them. In fact, you might be much better off.
(14:13):
And we know this and so do our quantitative colleagues
through their research that some cyclical companies and Laurent referred
earlier to some of the European industrials that they'd make
great examples of. We invested in is about two years ago.
A French rail operator, rail equipment manufacturer, signaling manufacturer Alstom
(14:35):
and Alstam was made a poor acquisition in Bombard det
Transport in Canada, so they ended up with an integration problem,
They ended up with a cost problem through COVID, and
they also ended up with a pricing problem with contracts,
so they the earnings were collapsing, so the multiple began
to expand, but it wasn't because this was a growth stock,
was because it was broken cyclical, and that was precisely
(15:00):
time to own it. They had to show up their
balance sheet and that gave us an opportunity. So we're
very opportunistic. That core of our strategy international is to
make sure we own companies that are well positioned as
long as we have that, And another example would be
in aerospace with the wide body aircraft engine manufacturer Rolls Royce.
(15:25):
The pandemic was devastating for them and they bled cash
flow and they too had to shore up their balance sheet.
But what a phenomenal market position with two competitors Pratt
and Whitney and ge and a great business that needed
to be better managed. But as long as we have that,
(15:47):
and or the companies in fine financial shape, they've just gone.
They've just had some mix miss execution by management that
makes a huge difference. We're again this is a long
with an answer, but there are no specific multiples that
are appropriate. There's more a question of what are normalized
learnings when can the company get Can they do that
(16:09):
in our two year window? How long will it take?
Speaker 2 (16:12):
Yeah? I have a question on another important aspect of
the investment process, which is ESG. ESG has been a
big investment theme in Europe for the past few years,
but we have seen a bit of pushback. So how
ESG criteria impacting your investment decisions? And as a stock picker,
(16:32):
do you think it makes a difference, because there is
a lot of debate about the value add of ESG
data in an investment process. So what is your view
on this topic.
Speaker 3 (16:43):
Well, we are convinced that material sustainability factors have the
potential to impact investment performance. We've seen it and it
wasn't until we hired our colleague in our con area
more over five years ago, who helped us create a
(17:05):
systematic way to understand ESG within the companies that we
were analyzing. And this is important. It's one thing just
to ask a few questions about governance. It's another to
ask specific questions that we know lead to that when
we score them, we can compair all companies on a
level playing field within the country of their listing and
(17:30):
that's been very helpful. So governance the G. If you
were to put ESG together, the G is the one
that has we think of the greatest potency, but E
isn't very far behind and neither is s and the
way we think about ease in terms of companies carbon
emissions and water usage, and we get that information from
(17:52):
databases and then we supplement within company conversations. But polluters
and companies that misused sources are typically badly managed. So
there's a perfect or an excellent alignment between what we're
looking for, which are which are underlying good businesses that
have great potential but something is going awry, and the
(18:13):
way they treat the resources they have, So everything about
that is aligned with what we do. And as for
social our understanding of how they how companies treat their
labor and what is what may be occurring in their
supply chain such concerns, for example, with modern slavery. The
(18:37):
more companies can tell us about that, the more transparency
we have into how they run their operations. And again
that's totally aligned. So our process involves quantifying through a
series of questions and companies ESG, positioning, scoring, and then
comparing the scores over time, and we talk about ESG
(18:59):
and sustainability at the time we present a new stock,
we'll review it if there are significant changes, which there
often are. Albeit most of our information comes in annually,
and we have discussions with companies about how they are
going to reach the goals they've set. And this is
true across the ESG spectrum as well as financial and
(19:20):
they're often interlinked because that's our job as investors. It's
an active approach we take to hold the companies accountable
for the goals they have established.
Speaker 2 (19:30):
So now moving on more to investment opportunities in different
parts of the world. At this stage, I mean, where
do you think are the best opportunities globally in terms
of Europe or emerging markets? Emerging markets? What are your
use potentially on China evens that they are I would
say many issues there. And also are you view on
(19:56):
geography acquisition depending on what is going going to oppen
to the US economy as well.
Speaker 3 (20:03):
The opportunities are widespread, and our geographic exposure in the
International Fund is entirely a byproduct of our bottom up
stock selection process. Okay, but I did mention risk model,
and I mentioned it very briefly. If it turns out
that we become as portfolio managers too enthusiastic about a
(20:26):
certain geography, we will start to see the risk scores
begin to increase on those stocks because we will have
concentrated risks in one particular area. So it's our quantitative
risk model that keeps us diversified when a portfolio that
averages about sixty stocks, and that's really important across the
(20:48):
whole spectrum of factors, but region is certainly one of them.
We've had clients ask us why do you have so
much in the UK, and it is a large overweight
for our fund, and one of the reasons why is
because the companies listed there don't do very much business
(21:09):
in the UK, so it's not really UK risk we're taking.
An example would be the UK beverages company Dago Dago,
known for world class spirits, and they have six percent
(21:29):
of their revenues in the UK market, so they're listed
in the UK, their headquarters are there, but that is
really not where their economic exposure resides. Or maybe more
extreme and one of the stocks that we think has
considerable upside is the Life in Asia life insurance company Prudential,
listed in the UK for historic reasons, and yet they
(21:51):
have no revenue in the UK. So the country of
listing can be a little deceptive, and we spend time
with our clients showing them where the economic exposure resides
from a revenue perspective versus the benchmark, typically the EFA
or world XUS Index. But our risk model does an
(22:14):
even better job of discerning where our risks are geographically
and making sure we don't concentrate where the opportunities are.
I was going to get to that, which is just
about everywhere. I'd say some of these UK companies I mentioned,
like Rolls Royce still significant upside, or the financials company Barclays,
(22:38):
or in energy we're very much like VP, the integrated
oil company. I'm just rattling off a few UK but
there are plenty in Europe too, and quite a few
listed in France I'd mentioned earlier Alstom, and then the
luxury goods company Caring, the owner of Gucci, amongst other brands.
(22:58):
Sangobin and Materials are airly keyed in industrial gases, Sanathee
in healthcare. All of these companies have a reason they're
in the portfolio, and it's it's because their risk adjuster
return is very attractive versus the other alternatives. We're not hesitant, however,
(23:20):
if their share prices rise, we will be reducing the
weight in the portfolio and then recycling those sales proceeds
back into higher ranking stocks. But I again would reiterate
Europe looks very attractive from a yield perspective, dividends and
buybacks versus rescue the world. But there's no there's no
(23:42):
one part that we favor over another. They're just where
we can find the stocks.
Speaker 2 (23:47):
Okay. And so given you your US based investors, given
the large positions that you're have in the UK and Europe,
all the countries, how do you manage the currency risks?
I mean, is it integrated in your risk EDUSM model
because some of the currencies could be very volatile. We
saw it very recently with the yen. So how do
(24:09):
you manage I mean this type of risk as a
US based investor in.
Speaker 3 (24:15):
Two ways That primarily through as you noted, our risk model,
because our risk model does include currency, and our risk
model is very because we review it once a week
in our portfolio manager meeting with one of our quantitative
portfolio managers, it becomes very clear where we are taking
(24:35):
large active bets, where our weights in the portfolio either
greatly exceed or maybe maybe we are very underweight versus
benchmarking currencies. And the end it has been one of
them where we've been underweight because our allocation to Japanese
stocks has been less than that a benchmark. But as
(24:56):
for what the vault of the currency actually does to
the portfolio, that we think about at the stock level,
So in order to arrive at a two year price target,
we have to be very confident in how sensitive earnings
are of the particular company to fluctuations, and it's in
the currencies that are meaningful to it. Then for a
(25:18):
big exporter in Japan, dollar yen or dollar or yen
euro can be very important. So we'll look at that
and then if it turns out we think the stock
is too vulnerable to currency fluctuations, we may that we
may hesitate or certainly create a greater hurdle so that
(25:39):
we buy the stock even cheaper. The beauty of having
a great proprietary multi factor risk models and we blend
all the currencies in the portfolio, they tend to negate
some of the risks of having too much of any
one of them. So there's a there's an element of
duristfication that is fair useful in ensuring the portfolio doesn't
(26:04):
end up, for example, being taken for a ride by
the yen volatility.
Speaker 1 (26:09):
You know, we've talked about your selection criteria, what you
look for. You know, if we talk kind of about
on the opposite side, what triggers or sell. Is it
when a company hits its price target or you know
the fundamental you know, could a company still be undervalued,
but it's fundamentals changed that that could lead you to
selling a position.
Speaker 3 (26:29):
Yes, so well, we typically sell because stocks drift down
that ranking and they're no longer in the top say
quartile of the ranking, and then they're no longer in
the top half and at some point in time we
have to take profit and then reinvest those selle proceeds
in the higher ranking stocks. So that's the major reason
(26:53):
why we sell. And for some stocks, they can have
a very sharp price appreciation and then we have no
reason and to raise our price target and then our
holding perier turns out to be very short. But that's rare.
It's kind of a good day. Most of the time.
It takes it takes years. It can take the full
two years, if not longer, for companies to implement the
(27:17):
operational restructuring needed to improve the business. And earlier you're
asking about China, I gracefully skipped over, but it is
a good time to mention it because there are It's
not that we have many Chinese stocks in the portfolio.
We have very less than two percent of the portfolio
is exposed to China directly, but so many of the
(27:39):
companies we invest in they have exposure to China, and
it's cross all industries. We see it in technology, we
see it in consumer, we see it everywhere. And one
I'd mentioned earlier, Caring, is a great example. This is
a stock where we bought too early, there's no doubt
(28:00):
about it, and not we underestimated how significant the consumer
downturn would be with the Chinese consumer, so that's likely cyclical.
And the company has been restructuring it's Gucci division with
a new creative director, so that's all good. But this
sort of market is very unforgiving, and I think this
(28:23):
has become as the amount of capital that's focused in
on equities has increased. It is almost as if the
discounting mechanism of markets is amplified. So stocks where there's
or there will be a weight until recovery, nobody wants
to bother, or so it seems, so that's really the finesse.
(28:45):
That is part of our job is that we see
the stock. It looks very undervalued. It's now buoyed up
to the top of our ranking. But is it a
two year weight or is it longer? Those are the
questions we're asking because clients don't really want to wait longer.
They'd like as the time the return perfectly, which is
quite difficult. We have to be early. These guys need
(29:07):
to be pretty dark for us to get the valuation
we want. But we need an improvement in the weather
pretty soon. And when there is a setback, we talk
amongst ourselves as a team and we say, is this
is this has changed? Did something go wrong with this
business and now it's we have to sell it out
of the portfolio? Or is it just a delay? And
(29:29):
vast majority of the time it's a delay.
Speaker 2 (29:32):
I mean it seems that in the market, I mean
these mentality of techno Prisoner has accelerated over the past
few years. I mean, do you think it could change
or do you think it is a new state of
the market, of the equity market where now as soon
as the company disappoints and its evaluation is going to
be annihilated.
Speaker 3 (29:56):
I think this is the status quo. I believe we
are in an farm up where money is very fungible
across borders. There are enormous investors out there with maybe
shorter timeframes then I would like to see, like lots
and lots of hedge fund activity, and they pay the
(30:20):
brokerage bills, and so the brokerage firms deliver research that's
oriented to perhaps a much shorter time holding period, and
that feeds on itself. But if you think about what's
happened post to global furnatural prices post two thousand and eight,
the amount of money created by central banks globally is
just head spinning. The US got up I think nine
(30:42):
the FED balanceship and nine trillion and has slipped back
to seven. But it was something like three hundred and
fifty billion at two thousand and eight, Like where did
all that money go? When did a bank reserve and
they got lent out? And it's there's just lots and
lots of money in the financial system. And that to
(31:05):
me is that level of financial liquidity is one of
the reasons why markets react as they do so quickly.
Speaker 1 (31:13):
No, that makes sense. Before we go, I did you know,
I'd love to ask what advice would you give your
younger self just starting out in the business.
Speaker 3 (31:22):
Sleep more. I stayed up all night sometimes. I first,
when I first get into this industry, I didn't I
wanted to know what was happening to the other side
of the trades. I decided to travel the globe and
suit with cell side trade desks. That was a lot
of jet lag, and there was always because there's always
a market open when you cover non us, not to
(31:44):
mention us the granddaddy of them all. So you have
to force yourself to sleep because there's always something to
be looking at, researching, thinking about. And now that I
have put on a few years, I'd say I have
to sleep. But when I was younger that would be wise.
I think I would have I think I would have
sudden a lot more intelligent meetings if I had more
(32:06):
than two hours of sleep.
Speaker 1 (32:08):
That's a good answer. Well, thank you Sarah for speaking
with us today, Thank you for much time in Laurent.
Thank you for serving as my co host today. Thank
you very much to you until our next episode. This
is David Cohne with Inside Active
Welcome to Inside Active, a podcast about active managers that
goes beyond sound bites and headlines and looks deeper into
their processes, challenges and philosophies and security selection. I'm David Cohne,
I lead mutual fund and active research at Bloomberg Intelligence.
Today my co host is Laurent Duier, senior equity strategist
(00:33):
at Bloomberg Intelligence. Laurent, thank you for joining me today.
Speaker 2 (00:37):
Thank you foroving me.
Speaker 1 (00:38):
I wanted to ask you about a recent note you
wrote about industrial valuations in Europe. Can you tell our
audience how current valuations compare historically and how potential showdown
in the US could affect those valuations.
Speaker 2 (00:53):
Yes. In fact, the industry lay is a very interesting
sector in Europe because it offers many growth opportunities, but
also it is the most the second most expensive after technology.
Currently trades on a forward peer of about nineteen times,
which is the thirty seven percent premium to European equities,
(01:16):
and historically it has always treaded at a premium between
fifteen to twenty percent. So I mean today, what explain
a higher premium for European industrials compared to the market.
It's all the clean energy investment. Also you have the
rearmament in Europe, and also you have the massive US
(01:37):
fiscal programs, which I think are major gross drivers for
companies in arrow space, defense and also capital goods. And
I think these growth opportunities for many of those companies
are not just for the next twelve or eighteen months.
It may be for several years to come, so I
think it puts them on your growth trajectory, which justifies
(01:59):
the higher valuation ratios. Regarding your question about what could
happen to European industrials if there is a wobble in
the US economy, I think definitely it will be a
problem because US is about thirty percent of the sector
cells and I think the US market is also quite
(02:21):
profitable for European companies, So any wble in the in
the US economy will create a problem with earnings, but
also potentially are durating on many of those companies given
the rich multiple. And the last point I would like
to make as well is that if you look at
the valuation of industrial companies which are challenged either by
(02:45):
the green transition or the adoption of AI, they are
currently trading at very low multiples compared to their own history.
And I think it's suggests that some of the venues
that started to be discounted in the share price. For sure,
some of them will be value trap along the line,
but I think that potentially some of them could offer
(03:05):
some good investment opportunities. So lacking many sectors in Europe
stockpicking is key.
Speaker 1 (03:11):
Great. Well, let's bring in our guests who can talk
about Europe and other international markets. I'd like to welcome
Sarah Ketterer, who is chief exggative officer and a fundamental
portfolio manager at Causeway Capital Management. Sarah, thank you so
much for joining us.
Speaker 3 (03:25):
Thank you for inviting me.
Speaker 1 (03:26):
Well, I want to start by asking you how you
got your start in the investment industry.
Speaker 3 (03:31):
Well, the short answer was a long long time ago.
But I rose up through the ranks, went to the
school of hard knocks in investment banking, and was in
business school and more investment banking. And that turns out
and it still is today, a resonably good background for
fundamental research, and then it instills valuation techniques and skills.
(03:53):
The only thing I couldn't get a job at Causeway today, however,
because we need so much more than that the next
several decades are going to require an ability with data
that just didn't exist when I started. Nonetheless, I had
an opportunity with my co founder Harry Hartford in two
thousand and one to start Causeway, and we've had a
(04:15):
twenty three year record of managing predominantly international equity fundamentally,
but we also have global equity and we manage quantitative
strategies including emerging markets and small cap.
Speaker 1 (04:29):
Well, actually, you mentioned Causeway, so you know I like
to talk a little bit about it. What would you
consider the overall investment philosophy of the company.
Speaker 3 (04:37):
We are very much steeked in a value investment philosophy,
particularly in the work we do fundamentally to identify companies
we believe our training at levels below their intrinsic value.
And this is both a combination of very intensive understanding
evaluation tools and the assumptions we make about the business
(05:00):
layer of subjectivity that comes with experience. So our portfolio
managers we have six cluster heads, individuals responsible for in
depth work in sectors. They have to make the final
decision on stocks and they rely heavily on value and
then quantitatively we use value amongst other factors. Albeit, value
(05:23):
has a very large weight, So overall, Causeway is very
focused on the price we pay in our analysis of
the likely return we'll see for our clients.
Speaker 1 (05:34):
Great well, I do want to ask you specifically about
the International Value Fund, the ticker symbols civv X. Is
there a specific process, you know, investment process for that
particular fund.
Speaker 3 (05:47):
Yes, there is, and it's the same process we've used
since our inception. In fact, parts of a date back
to antiquity. But the whole idea here is that we
sift through thousands of companies outside the US market to
identify and nes Laran noted there's plenty of under evaluation.
The US market is the most expensive and has been
(06:10):
amongst the developed world for a number of years. And
you might say rightly so, because of its emphasis more
on growth, a greater exposure to technology, and less what
we call old world businesses, But that we're indifferent to
the types of businesses. We're looking through these thousands of
stocks for certain criteria we need looking for income companies
(06:34):
that are predisposed of returning capital to shareholders. At the
same time, those stocks are generally trading on a price
to cash flow basis below their industry average, so they
tend to look in expensive. There's capital coming back to shareholders,
which in all interest rate environments except zero, is very important.
(06:55):
And then from there we narrow the group and do
quite a bit of intense research on under standing in
this fund where the opportunities are bi sector. And then
as we present these incredibly interesting companies that have had
some sort of setback and that's why the share price
is nowhere near its ultimate valuation, or we call a
(07:18):
two year price target, we then decide as a team
if that price target is the one that we have
arrived at is reasonable, and then we know what we
expect the company's return should be including income, and then
we risk adjustment using our quantitative risk model, so we
can get a risk adjusted return. And all the stocks
(07:40):
that we are considering for this fund, we rank them
daily on risk adjusted return and it's the highest risk
adjuster return stocks they'd end up in our fund with
the largest weights.
Speaker 2 (07:54):
Given the large amount of data which have to be
processed by your equity pms at least, I mean, are
you already using or do you intend to use AI
to potentially improve your investment process?
Speaker 3 (08:09):
Yes, definitely, I have great admiration for our Digital services
area and run by my colleague Pete Peterson. He's made
a huge effort to ensure that not only do we
have access to tools already embedding AI in them, such
as Facts or Bloomberg, but we are also developing our
(08:33):
own tools so that we can be more productive as
a research team. And this is true quantitatively as well
as it is fundamentally. We've been working with large language
models quantitatively for some time, but that research, some of
that translates into what we can do in the rest
of the organization. But specifically for fundamental research, we use
(08:54):
a chat function that's embedded in a system we have
that's connected with facts that that allows us to do
queries because if you think about it, we have twenty
six fundamental research channels scouring the globe constantly taking notes,
meeting with companies that information. We need to be able
to access it, assimilate it, distill it, understand better what
(09:19):
the management said the last time we met with them,
so that we can ask even better questions going forward.
So from a productivity perspective, we're at the early stages
of implementing AI. What would be more interesting in what
we're working on, i'd say next horizon type project is
how we can use AI to generate investment ideas, and
(09:40):
part of that will come from having our IT experts
spend more time with our research channels, understanding better what
they go through and how they think about their areas
of coverage in order to be able to automate some
of that.
Speaker 2 (09:57):
Maybe a flow of question on AI as an investment opportunity,
which Checter do you think would allow the greatest investment
over the next three to five years.
Speaker 3 (10:11):
We think about AI in stages and how it's impacting
the companies that we could buy. And again I'm speaking
to you from the lens of a value investor, so
we're not going to pay large multiples that embed growth
that we are concerned might not occur, might be vulnerable.
(10:32):
But some of the most interesting stocks right now are
in the building phase. That's the phase that's focused on
getting the infrastructure needed, all the computing infrastructure, and a
lot of that are semiconductor firms and they've been pretty
awful lately. So the opportunities are considerable. Companies in the
(10:54):
microcontroller and power semic inductor area that have an industrial focus,
like infinion firm or Renaissance in Japan or We also
are very interested in the two big memory non US
memory companies, Memory semiconductors, Samsung Electronics and sk Heinex. So
they we think they that given the the increasing need
(11:19):
for semiconductor content, whether it be in automotive applications or
other industrial applications, not to mention in the devices that
we all use smartphones, PCs, and then of course there's
data centers that the demand will pick up quite significantly
in these areas of what we call building, which is
(11:42):
predominantly again semiconductors. And then in AI delivery that would
be phase two. That would be companies that are involved
in network infrastructure and end devices, so we like Marauder
manufacturing for example, and then Samsung and Heinex are involved
there too. And then I say you said three to
(12:02):
five years. At the five year mark, that could be deployment.
And so enterprises now Causeway as an example, we're deploying AI,
but we know we're early, and we're looking for all
we're asking our peers what they're doing, any type of
consulting help, if we need it, we get it. We
(12:23):
think enterprises globally are at the early stage, particularly those
that are already just engaged in digital transformation, they need
quite a bit of help. And that's where it services.
Companies like Fujitsu in Japan or SAP in Germany, where
enterprise software is their main line of business, they should
(12:43):
do quite well. And then companies that are just going
to imbue AI in their products or embed I would
say ten Cent and China is an example of that.
So I've just rottled off a whole lot of stocks,
and none of them are Nvidia.
Speaker 1 (13:00):
Well, I actually do you know you mentioned a video.
You know that's obviously you know, trading at a much
higher valuation. You know, no one would consider that a
value stock. But I do want to ask you a
follow up on valuations. You know you mentioned it in
your process, and you know you alluded to a few metrics.
I guess you know, when you're looking at companies, is
there kind of like a cutoff of certain metrics that
(13:23):
you would consider? You know, like, how does that fit
into the entire process of evaluating companies?
Speaker 3 (13:29):
There are we don't have strict multiples where we walk away,
but we are we get very uncomfortable when we see
that there are high multiples in a stock where we're
already observing record levels of earnings or what we call
cyclical peaks in earnings. And this is where value investing
(13:50):
can be a little bit confusing because it simplistically and
per the indices, value investing consists of low pe multi
full low price to book, low price to cash flow stocks.
But that could be for a deep cyclical stock when
earnings are at its zenith, just the absolute long time
to own them. In fact, you might be much better off.
(14:13):
And we know this and so do our quantitative colleagues
through their research that some cyclical companies and Laurent referred
earlier to some of the European industrials that they'd make
great examples of. We invested in is about two years ago.
A French rail operator, rail equipment manufacturer, signaling manufacturer Alstom
(14:35):
and Alstam was made a poor acquisition in Bombard det
Transport in Canada, so they ended up with an integration problem,
They ended up with a cost problem through COVID, and
they also ended up with a pricing problem with contracts,
so they the earnings were collapsing, so the multiple began
to expand, but it wasn't because this was a growth stock,
was because it was broken cyclical, and that was precisely
(15:00):
time to own it. They had to show up their
balance sheet and that gave us an opportunity. So we're
very opportunistic. That core of our strategy international is to
make sure we own companies that are well positioned as
long as we have that, And another example would be
in aerospace with the wide body aircraft engine manufacturer Rolls Royce.
(15:25):
The pandemic was devastating for them and they bled cash
flow and they too had to shore up their balance sheet.
But what a phenomenal market position with two competitors Pratt
and Whitney and ge and a great business that needed
to be better managed. But as long as we have that,
(15:47):
and or the companies in fine financial shape, they've just gone.
They've just had some mix miss execution by management that
makes a huge difference. We're again this is a long
with an answer, but there are no specific multiples that
are appropriate. There's more a question of what are normalized
learnings when can the company get Can they do that
(16:09):
in our two year window? How long will it take?
Speaker 2 (16:12):
Yeah? I have a question on another important aspect of
the investment process, which is ESG. ESG has been a
big investment theme in Europe for the past few years,
but we have seen a bit of pushback. So how
ESG criteria impacting your investment decisions? And as a stock picker,
(16:32):
do you think it makes a difference, because there is
a lot of debate about the value add of ESG
data in an investment process. So what is your view
on this topic.
Speaker 3 (16:43):
Well, we are convinced that material sustainability factors have the
potential to impact investment performance. We've seen it and it
wasn't until we hired our colleague in our con area
more over five years ago, who helped us create a
(17:05):
systematic way to understand ESG within the companies that we
were analyzing. And this is important. It's one thing just
to ask a few questions about governance. It's another to
ask specific questions that we know lead to that when
we score them, we can compair all companies on a
level playing field within the country of their listing and
(17:30):
that's been very helpful. So governance the G. If you
were to put ESG together, the G is the one
that has we think of the greatest potency, but E
isn't very far behind and neither is s and the
way we think about ease in terms of companies carbon
emissions and water usage, and we get that information from
(17:52):
databases and then we supplement within company conversations. But polluters
and companies that misused sources are typically badly managed. So
there's a perfect or an excellent alignment between what we're
looking for, which are which are underlying good businesses that
have great potential but something is going awry, and the
(18:13):
way they treat the resources they have, So everything about
that is aligned with what we do. And as for
social our understanding of how they how companies treat their
labor and what is what may be occurring in their
supply chain such concerns, for example, with modern slavery. The
(18:37):
more companies can tell us about that, the more transparency
we have into how they run their operations. And again
that's totally aligned. So our process involves quantifying through a
series of questions and companies ESG, positioning, scoring, and then
comparing the scores over time, and we talk about ESG
(18:59):
and sustainability at the time we present a new stock,
we'll review it if there are significant changes, which there
often are. Albeit most of our information comes in annually,
and we have discussions with companies about how they are
going to reach the goals they've set. And this is
true across the ESG spectrum as well as financial and
(19:20):
they're often interlinked because that's our job as investors. It's
an active approach we take to hold the companies accountable
for the goals they have established.
Speaker 2 (19:30):
So now moving on more to investment opportunities in different
parts of the world. At this stage, I mean, where
do you think are the best opportunities globally in terms
of Europe or emerging markets? Emerging markets? What are your
use potentially on China evens that they are I would
say many issues there. And also are you view on
(19:56):
geography acquisition depending on what is going going to oppen
to the US economy as well.
Speaker 3 (20:03):
The opportunities are widespread, and our geographic exposure in the
International Fund is entirely a byproduct of our bottom up
stock selection process. Okay, but I did mention risk model,
and I mentioned it very briefly. If it turns out
that we become as portfolio managers too enthusiastic about a
(20:26):
certain geography, we will start to see the risk scores
begin to increase on those stocks because we will have
concentrated risks in one particular area. So it's our quantitative
risk model that keeps us diversified when a portfolio that
averages about sixty stocks, and that's really important across the
(20:48):
whole spectrum of factors, but region is certainly one of them.
We've had clients ask us why do you have so
much in the UK, and it is a large overweight
for our fund, and one of the reasons why is
because the companies listed there don't do very much business
(21:09):
in the UK, so it's not really UK risk we're taking.
An example would be the UK beverages company Dago Dago,
known for world class spirits, and they have six percent
(21:29):
of their revenues in the UK market, so they're listed
in the UK, their headquarters are there, but that is
really not where their economic exposure resides. Or maybe more
extreme and one of the stocks that we think has
considerable upside is the Life in Asia life insurance company Prudential,
listed in the UK for historic reasons, and yet they
(21:51):
have no revenue in the UK. So the country of
listing can be a little deceptive, and we spend time
with our clients showing them where the economic exposure resides
from a revenue perspective versus the benchmark, typically the EFA
or world XUS Index. But our risk model does an
(22:14):
even better job of discerning where our risks are geographically
and making sure we don't concentrate where the opportunities are.
I was going to get to that, which is just
about everywhere. I'd say some of these UK companies I mentioned,
like Rolls Royce still significant upside, or the financials company Barclays,
(22:38):
or in energy we're very much like VP, the integrated
oil company. I'm just rattling off a few UK but
there are plenty in Europe too, and quite a few
listed in France I'd mentioned earlier Alstom, and then the
luxury goods company Caring, the owner of Gucci, amongst other brands.
(22:58):
Sangobin and Materials are airly keyed in industrial gases, Sanathee
in healthcare. All of these companies have a reason they're
in the portfolio, and it's it's because their risk adjuster
return is very attractive versus the other alternatives. We're not hesitant, however,
(23:20):
if their share prices rise, we will be reducing the
weight in the portfolio and then recycling those sales proceeds
back into higher ranking stocks. But I again would reiterate
Europe looks very attractive from a yield perspective, dividends and
buybacks versus rescue the world. But there's no there's no
(23:42):
one part that we favor over another. They're just where
we can find the stocks.
Speaker 2 (23:47):
Okay. And so given you your US based investors, given
the large positions that you're have in the UK and Europe,
all the countries, how do you manage the currency risks?
I mean, is it integrated in your risk EDUSM model
because some of the currencies could be very volatile. We
saw it very recently with the yen. So how do
(24:09):
you manage I mean this type of risk as a
US based investor in.
Speaker 3 (24:15):
Two ways That primarily through as you noted, our risk model,
because our risk model does include currency, and our risk
model is very because we review it once a week
in our portfolio manager meeting with one of our quantitative
portfolio managers, it becomes very clear where we are taking
(24:35):
large active bets, where our weights in the portfolio either
greatly exceed or maybe maybe we are very underweight versus
benchmarking currencies. And the end it has been one of
them where we've been underweight because our allocation to Japanese
stocks has been less than that a benchmark. But as
(24:56):
for what the vault of the currency actually does to
the portfolio, that we think about at the stock level,
So in order to arrive at a two year price target,
we have to be very confident in how sensitive earnings
are of the particular company to fluctuations, and it's in
the currencies that are meaningful to it. Then for a
(25:18):
big exporter in Japan, dollar yen or dollar or yen
euro can be very important. So we'll look at that
and then if it turns out we think the stock
is too vulnerable to currency fluctuations, we may that we
may hesitate or certainly create a greater hurdle so that
(25:39):
we buy the stock even cheaper. The beauty of having
a great proprietary multi factor risk models and we blend
all the currencies in the portfolio, they tend to negate
some of the risks of having too much of any
one of them. So there's a there's an element of
duristfication that is fair useful in ensuring the portfolio doesn't
(26:04):
end up, for example, being taken for a ride by
the yen volatility.
Speaker 1 (26:09):
You know, we've talked about your selection criteria, what you
look for. You know, if we talk kind of about
on the opposite side, what triggers or sell. Is it
when a company hits its price target or you know
the fundamental you know, could a company still be undervalued,
but it's fundamentals changed that that could lead you to
selling a position.
Speaker 3 (26:29):
Yes, so well, we typically sell because stocks drift down
that ranking and they're no longer in the top say
quartile of the ranking, and then they're no longer in
the top half and at some point in time we
have to take profit and then reinvest those selle proceeds
in the higher ranking stocks. So that's the major reason
(26:53):
why we sell. And for some stocks, they can have
a very sharp price appreciation and then we have no
reason and to raise our price target and then our
holding perier turns out to be very short. But that's rare.
It's kind of a good day. Most of the time.
It takes it takes years. It can take the full
two years, if not longer, for companies to implement the
(27:17):
operational restructuring needed to improve the business. And earlier you're
asking about China, I gracefully skipped over, but it is
a good time to mention it because there are It's
not that we have many Chinese stocks in the portfolio.
We have very less than two percent of the portfolio
is exposed to China directly, but so many of the
(27:39):
companies we invest in they have exposure to China, and
it's cross all industries. We see it in technology, we
see it in consumer, we see it everywhere. And one
I'd mentioned earlier, Caring, is a great example. This is
a stock where we bought too early, there's no doubt
(28:00):
about it, and not we underestimated how significant the consumer
downturn would be with the Chinese consumer, so that's likely cyclical.
And the company has been restructuring it's Gucci division with
a new creative director, so that's all good. But this
sort of market is very unforgiving, and I think this
(28:23):
has become as the amount of capital that's focused in
on equities has increased. It is almost as if the
discounting mechanism of markets is amplified. So stocks where there's
or there will be a weight until recovery, nobody wants
to bother, or so it seems, so that's really the finesse.
(28:45):
That is part of our job is that we see
the stock. It looks very undervalued. It's now buoyed up
to the top of our ranking. But is it a
two year weight or is it longer? Those are the
questions we're asking because clients don't really want to wait longer.
They'd like as the time the return perfectly, which is
quite difficult. We have to be early. These guys need
(29:07):
to be pretty dark for us to get the valuation
we want. But we need an improvement in the weather
pretty soon. And when there is a setback, we talk
amongst ourselves as a team and we say, is this
is this has changed? Did something go wrong with this
business and now it's we have to sell it out
of the portfolio? Or is it just a delay? And
(29:29):
vast majority of the time it's a delay.
Speaker 2 (29:32):
I mean it seems that in the market, I mean
these mentality of techno Prisoner has accelerated over the past
few years. I mean, do you think it could change
or do you think it is a new state of
the market, of the equity market where now as soon
as the company disappoints and its evaluation is going to
be annihilated.
Speaker 3 (29:56):
I think this is the status quo. I believe we
are in an farm up where money is very fungible
across borders. There are enormous investors out there with maybe
shorter timeframes then I would like to see, like lots
and lots of hedge fund activity, and they pay the
(30:20):
brokerage bills, and so the brokerage firms deliver research that's
oriented to perhaps a much shorter time holding period, and
that feeds on itself. But if you think about what's
happened post to global furnatural prices post two thousand and eight,
the amount of money created by central banks globally is
just head spinning. The US got up I think nine
(30:42):
the FED balanceship and nine trillion and has slipped back
to seven. But it was something like three hundred and
fifty billion at two thousand and eight, Like where did
all that money go? When did a bank reserve and
they got lent out? And it's there's just lots and
lots of money in the financial system. And that to
(31:05):
me is that level of financial liquidity is one of
the reasons why markets react as they do so quickly.
Speaker 1 (31:13):
No, that makes sense. Before we go, I did you know,
I'd love to ask what advice would you give your
younger self just starting out in the business.
Speaker 3 (31:22):
Sleep more. I stayed up all night sometimes. I first,
when I first get into this industry, I didn't I
wanted to know what was happening to the other side
of the trades. I decided to travel the globe and
suit with cell side trade desks. That was a lot
of jet lag, and there was always because there's always
a market open when you cover non us, not to
(31:44):
mention us the granddaddy of them all. So you have
to force yourself to sleep because there's always something to
be looking at, researching, thinking about. And now that I
have put on a few years, I'd say I have
to sleep. But when I was younger that would be wise.
I think I would have I think I would have
sudden a lot more intelligent meetings if I had more
(32:06):
than two hours of sleep.
Speaker 1 (32:08):
That's a good answer. Well, thank you Sarah for speaking
with us today, Thank you for much time in Laurent.
Thank you for serving as my co host today. Thank
you very much to you until our next episode. This
is David Cohne with Inside Active
Host
Gina Martin Adams
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