A Top International Fund for Risk-Tolerant Investors

The following is our latest Fund Analyst Report for Causeway International Value CIVIX.

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Causeway International Value continues to benefit from excellent personnel and an exceptional process, and its disappointing performance in recent years is unsurprising. Both of its share classes retain their Morningstar Analyst Ratings of Gold.

A topnotch team is at the helm here. Sarah Ketterer and Harry Hartford, who have led this strategy since its 2001 inception, are two of the most seasoned and skilled foreign-stock managers around. They're backed by five comanagers--who average 15 years on the team and 21 years in the investment field--as well as a sizable squad of analysts and quantitative experts.

The team employs a value-driven process that is disciplined and distinctive. In particular, the team pursues companies that are facing operational, but not financial, distress. After stock screens narrow the investment universe to stocks that look cheap, the firm's fundamental analysts--arranged in six sector clusters--conduct in-depth research on prospective holdings. The appropriate cluster team assigns each prospective holding a two-year price target; the quant team assigns each stock a risk-adjusted return ranking; and the comanagers strive to hold the highest-rated stocks on a risk-adjusted basis. While doing so, the team readily allows its stock selection to lead to atypical country and sector weights, invests in roughly 55-65 stocks, and devotes around 30% of its assets to the top 10 holdings.

This bold value process often causes the strategy to struggle in downturns, and foreign value stocks have sank regularly and deeply during the past few years. It's not shocking that the strategy has suffered in absolute terms and posted mixed results in relative terms over shorter periods. The strategy has delivered better total and risk-adjusted returns than its typical rival and relevant benchmarks over the long run, thanks to the team's talent and process.

This strategy remains a first-rate foreign large-value vehicle for investors who have long time horizons and who can handle ample volatility and stretches of underperformance.

Process | High This approach is disciplined, distinctive, and well-executed, and the strategy earns a High Process rating.

The team seeks non-U.S. firms that are facing operational, but not financial, distress. It combines fundamental and quant analyses in executing this somewhat aggressive approach. After stock screens narrow the investment universe to stocks that look cheap, the firm's fundamental analysts--arranged in six sector clusters--conduct in-depth research on prospective holdings.

Ultimately, the appropriate cluster team assigns each prospective holding a two-year price target. After the firm's quant team conducts a detailed risk analysis, it assigns each stock a risk-adjusted return ranking, which weighs the two-year price target versus its potential risks. The comanagers make final portfolio decisions, ideally holding the highest-rated stocks on a risk-adjusted basis. This ranking system also helps the team identify sell candidates: It trims or sells when a stock's risk-adjusted ranking declines.

While doing so, the team readily allows its stock selection to lead to atypical country and sector weights, invests in roughly 55-65 stocks, devotes around 30% of its assets to the top 10 holdings, and stays fully invested. Finally, once the team buys a stock, it tends to wait patiently while its theses play out, so annual portfolio turnover has hovered around 30%.

People | High The team is seasoned, sizable, and strong, and the strategy merits a High People rating.

Lead managers Sarah Ketterer and Harry Hartford left Hotchkis & Wiley in 2001 to establish Causeway and launch this strategy. Manager Jonathan Eng, who has worked with the duo since 1997, also joined the firm at that time. In all, the management team has seven members and has been quite stable, losing just three managers in its 19-year history. Longtime manager James Doyle retired in June 2020, but the team's depth and collaborative approach mitigates the impact of his departure. Senior research analyst Brian Cho took over Doyle's leadership of the tech sector. Cho, who has served as a tech analyst at Causeway since joining the firm in 2013 and has 15 years of industry experience, has strong credentials for his new role. Overall, the management team averages 24 years of investment experience.

The firm has steadily grown its investment team to 37 members. There are six sector-based clusters; Ketterer and Hartford oversee the greater team, while this strategy's other five managers each sit on one or two clusters. The firm's eight fundamental senior research analysts are typically members of at least two clusters, which helps increase collaboration and reduce key-person risk. Eleven quant specialists and 11 research analysts provide additional support.

Parent | Above Average Causeway's strong investment culture merits an Above Average Parent rating.

Sarah Ketterer and Harry Hartford established Causeway in 2001, when they left value-oriented investment boutique Hotchkis & Wiley. They brought several former team members with them, including current portfolio manager Jonathan Eng, and launched the firm's flagship strategy Causeway International Value.

The firm has experienced robust growth. It had 103 employees--36 of whom were investment professionals--and $49 billion in assets under management as of September 2019, but it has maintained a narrow focus on value-oriented non-U.S. and global-equity offerings. Indeed, product development has been judicious. The firm has just seven strategies, and it has launched just one, Causeway International Small Cap, during the past five years.

The firm has a fundamental and quantitative investment team. The fundamental team is responsible for the bulk of the firm's assets, but the two teams work in complementary fashion. The quant team provides a risk overlay on the fundamental strategies, while the fundamental team provides a check on the quant models. The firm has done an excellent job retaining talent on both teams, owing in good measure to the breadth of employee ownership. All portfolio managers and several senior research analysts have equity in the 100% employee-owned firm.

Price It's critical to evaluate expenses, as they come directly out of returns. The share class on this report levies a fee that ranks in its Morningstar Category's second-cheapest quintile. Based on our assessment of the fund's People, Process and Parent Pillars in the context of these fees, we think this share class will be able to deliver positive alpha relative to the category benchmark index, explaining its Morningstar Analyst Rating of Gold.

Performance The strategy has suffered in absolute terms and produced mixed results in relative terms over the trailing one- and three-year periods. Its institutional class incurred a 15.6% loss during the 12 months through October 2020, in fact, which was much worse than the 12.1% decline of the typical foreign large-value fund, roughly the same as the 15.9% drop of the MSCI All-Country World Index ex USA Value, and much better than the 18.4% fall of the MSCI EAFE Value Index. And its institutional shares posted a 7.2% annualized loss during the three years through October versus annualized declines of 5.5%, 6.3%, and 7.4% for the typical foreign large-value fund, the MSCI ACWI ex USA Value, and the MSCI EAFE Value Index, respectively.

These results are disappointing but not surprising. The management team employs an aggressive value process; the strategy often posts big losses in downturns as well as hefty gains in rallies; and foreign value stocks have sold off frequently and sharply in recent years. Meanwhile, the merits of the process and the skill of the team are evident in the strategy’s long-term returns. The strategy has outpaced its typical rival and both indexes over 10 years, over 15 years, and since its 2001 inception. And despite extra volatility along the way, it has also earned better Morningstar Risk-Adjusted Returns than its average peer and both indexes over all three periods.

Portfolio As of September 2020, the team had found nine names in Germany that met its price and other criteria, including the top two holdings, Volkswagen and BASF. That gave this strategy an 18.5% weighting in that market versus 10.2% for the typical foreign large-value fund, 7.6% for the MSCI ACWI ex USA Value, and 11.8% for the MSCI EAFE Value Index. The team found relatively few stocks in Japan that measured up to its standards. The portfolio had a much smaller stake in that country than its average peer and both indexes. And the strategy had a 7.5% weighting in emerging markets versus 10.2% for the typical foreign large-value fund, 28.8% for the MSCI ACWI ex USA Value, and 0.0% for the MSCI EAFE Value Index.

The team invested in 15 industrials stocks--including Japanese automation company Fanuc--and the strategy had a 21.4% weighting in that sector versus 14.6% for the typical foreign large-value fund, 11.1% for the MSCI ACWI ex USA Value, and 14.6% for the MSCI EAFE Value Index. The strategy also had significantly more exposure to the tech sector and less exposure to the energy sector than its average peer and both indexes.

Finally, the strategy owned 64 stocks and devoted 32% to its top 10 holdings versus 85% and 25% for its average actively run rival, 1,600 and 10% for the MSCI ACWI ex USA Value, and 543 and 15% for the MSCI EAFE Value Index.