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Good Stock Selection Led to Great Year for Causeway

Causeway International Value comanagers Sarah Ketterer and Harry Hartford discuss how they kept their conviction in Volkswagen.

Andrew Daniels: Hello, I'm Andrew Daniels for Morningstar. Today I'm joined by Sarah Ketterer and Harry Hartford, co-founders of Causeway Capital Management. They both are lead managers on Gold-rated Causeway International Value, which won the 2017 International-Stock Fund Manager of the Year.

Sarah and Harry, thank you for being here today, and congratulations on the award.

Harry Hartford: Thank you. Thank you for having us.

Sarah Ketterer: Yeah. We're delighted to be here.

Daniels: Growth stocks broadly led the way in 2017, but this value-oriented strategy managed to do quite well. Could you tell us a little bit about what led to the really strong results in 2017?

Ketterer: The stock selection was very good, and that's what we do. Our team focuses on finding undervalued companies, no matter where they're located, and understanding them better, determining whether or not management's competent and can affect whatever the restructuring is that needs to be done. If there's a strong balance sheet and ideally some income for our investors to receive while they wait to be rewarded, that's our kind of stock. And we found several of them, and they really paid off last year.

Hartford: I would echo that. I think in part, '17 was a byproduct of how we positioned the portfolio toward the back end of 2016, and specific companies that had been out of favor a little bit in '16 did very well for us in '17.

Daniels: One of the stocks that performed quite well was Volkswagen. What led to the original investment in Volkswagen, and why was it such a top performer in 2017?

Hartford: I think it'd be great if we hadn't owned it in 2015 and 2016. So in part, 2017 came as a result of what had happened post-Dieselgate. We felt that the share price was completely mispriced or misvalued in the marketplace, and having had a modest position in the security, we increased the portfolio's exposure quite substantially. The amount of capital that we had allocated to the security, and the strong performance from the stock, post the recovery from Dieselgate scandal, is in large part the contributing factor.

Ketterer: I'd say the scandal accelerated our investment thesis. We expected--and this was led by our head of industrials, Jonathan Eng, one of our six really talented portfolio managers covering equities fundamentally--he saw this company was under-earning, their operating profit margins were half their peers'. They were fat and happy. They also were fraudulent. This we didn't know, but when we learned, it was time, as Harry mentioned, to really double down and take a position on this stock. Per our disciplines, the company had net cash on the balance sheet to the tune of 24 billion euros.

And today, after paying out $25 billion in all the litigation, fines, etc., they still have 24 billion euros of net cash thereabouts. This company is very well-positioned, not only to get through this scandal, and they cut the costs, operating profit margins are now above 4.5%, on their way to 6% in 2020, but they're also head of the pack when it comes to electric vehicles. They can do scale. They sold 10.7 million vehicles last year. If anybody gets to electric vehicles en masse, it's going to be Volkswagen.

Hartford: It is trading on a mid-single digits earnings multiple. The ability to pay significant cash distributions to shareholders also, in likelihood in 2018 and beyond, will lead to very high dividend yield for investors.

Daniels: Sarah and Harry, thank you for being here today, and congratulations on the award.

Hartford: Thank you very much. We're delighted to be honored today. Thank you.

Ketterer: Yeah, our entire team thanks Morningstar.

Daniels: For Morningstar, I'm Andrew Daniels, thanks for watching.

Andrew Daniels does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.