Review and Outlook
The first quarter of 2016 witnessed a sharp sell-off and recovery across the global capital markets. We believe this market behavior reflects the fragility of confidence in forward-looking economic and financial conditions in an era of increasing policy intervention. The global markets have exhibited a high correlation, often reacting in unison to events in the U.S., Europe, Japan, and particularly China. We believe the interconnectedness of global markets is likely to remain high while growth remains subpar and stimulative policy intervention in one jurisdiction often triggers unintended consequences in another.
While we were pleased to see the equity, credit, and commodities markets strengthen through the end of the first quarter, we would prefer to see convincing evidence of underlying fundamental strength and an improvement in global imbalances, rather than what appears to be ongoing aggressive monetary and fiscal policy tweaks. In our opinion, the most important such tweak was the shift in rhetoric suggesting the deferral of interest rate hikes by the U.S. Federal Reserve. In addition to the revised Fed communiqué, the European Central Bank, Bank of Japan, and People’s Bank of China, as well as Chinese fiscal policymakers, all appeared to accelerate easing measures during the quarter, particularly shortly after the G20 gathering of finance ministers in late February. While measures of coincident and leading economic indicators have recently responded in kind with fairly broad-based improvement, in our opinion it is difficult to distinguish cause and effect. Are improving economic indicators driving the rally in capital and commodities markets, or are policy-driven markets leading to improved economic indicators via the channels of rising confidence and recovering financial conditions? We believe that fundamental, lasting confidence in the global economy and markets would be inspired by a successful normalization of interest rates, while confidence driven by ever more unconventional measures, such as the recently launched negative interest rate policies in Europe and Japan, will likely remain fragile.
Though we remain somewhat skeptical that the Fed will be able to hold its ground in the face of an anecdotal rise in wage pressures, as of now we respect the improvement in global indicators. While current conditions likely favor those markets where sentiment has been poor in recent quarters, the shift in Fed policy does raise the likelihood of increased pressure in Europe and Japan should recent dollar weakness and Euro and Yen strength persist; such is the challenge of the global monetary sweepstakes in a low-growth environment. While it is certainly possible that global equity markets, as well as commodities, have bottomed, we suspect that confidence will at some point likely be tested. We continue to believe that substantial investment opportunities lie ahead, and believe we are strategically and tactically prepared to take advantage.
Top Contributors/Detractors to Performance
Quarterly Attribution Analysis
When reviewing performance attribution on our portfolio, please be aware that we construct the portfolio from the bottom up, one stock at a time. Each stock is included in the portfolio if it meets our rigorous investment criteria. To help manage risk, we are aware of our sector and security weights, but we do not include a holding to achieve a target sector allocation or to approximate an index. Our exposure to any given sector is purely a result of our stock selection process.
Baron International Growth Fund declined 1.54% in the first quarter and trailed the MSCI ACWI ex USA IMI Growth Index by 122 basis points, mainly due to stock selection in certain European countries and North America and relative sector weights.
Developed market investments underperformed their index counterparts after falling 1.9%, led by those in the U.K., Canada, and the U.S. This negative effect was somewhat offset by outperformance of developed market investments in Israel, Australia, Spain, and Germany.
On a sector basis, outperformance of Consumer Discretionary, Health Care, and Industrials investments contributed the most to relative results. Within Consumer Discretionary, outperformance of Steinhoff International Holdings N.V. of South Africa, lululemon athletica, inc. of the U.S., and Domino's Pizza Enterprises Ltd. of Australia added the most value. Shares of furniture retailer Steinhoff rose after the company reported strong financial results and announced its intent to acquire London-based Darty PLC. We sold lululemon as we believed the rally in share price during the quarter likely exceeded fundamental improvement. Strength in Health Care was partly attributable to the outperformance of Eurofins Scientific SE of France and Fresenius Medical Care AG & Co. of Germany. Shares of Eurofins, which provides food, pharmaceutical, and environmental testing services, rose on strong financial results, including organic revenue growth of over 9.5%. Shares of Fresenius, a provider of dialysis services and products, increased on solid earnings results and 2016 EPS growth guidance of 15 to 20%. Lack of exposure to lagging pharmaceutical stocks, which fell 10.9% within the index, also aided relative performance. Industrials holdings outperformed their index counterparts after increasing 3.7%, led by Spanish airport operator Aena SA, whose shares rose on strong passenger traffic growth. Intertek Group plc of the U.K. and Brenntag AG of Germany also contributed to relative performance.
Consumer Staples, Information Technology (IT), and Utilities investments were the primary detractors from relative performance. Within Consumer Staples, meaningfully lower exposure to this outperforming sector and underperformance of Nomad Foods Limited of the U.K. weighed on relative results. We exited our position in Nomad due to signs of increased competition. Within IT, underperformance of application software and Internet software & services holdings, led by Kingdee International Software Group Co. Ltd. and JUST EAT plc, respectively, detracted the most from relative results. Kingdee was the third largest detractor on an absolute basis, while shares of online food takeout marketplace JUST EAT were down due to Uber’s potential entry into restaurant delivery in the U.K. Payment processing company Worldpay Group plc of the U.K. also hampered relative performance after earnings results fell short of expectations due to softness in the U.S. segment. Weakness in Utilities was attributable to the underperformance of U.S.-based renewable energy company TerraForm Global, Inc., the largest detractor from absolute results.
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