December was a weak month for equities. Investor sentiment was driven by worries about a weakening economy. According to the International Monetary Fund (IMF) 2023 is going to be tougher on the global economy than the one we have left behind. The economies of the EU, the US and China are simultaneously slowing down. The IMF expects that about one third of the world economy will end up in a recession. Although technology stocks are a relatively modest part of the European stock market, the strongly negative returns in this sector pulled back the performance of the market. At the start of 2022, these stocks were priced for perfection. Now that the growth outlook of these companies are deteriorating, the stocks are experiencing a substantial derating. Given our disciplined valuation-driven approach to investing, we were able to sidestep much of the downturn in these tech-related companies. Investors have clearly changed their attitude towards value stocks. Value stocks in general did substantially better than growth stocks. In this environment, the performance of the Fund was ahead of the broader market. The Fund also outperformed the style index (Morningstar Developed Europe Dividend Yield > 2.5% Index).

Part of the strong performance in December was driven by the sale of the position in the depository receipts (GDR’s) of PhosAgro. In normal market circumstances, these GDR’s closely tracked the share price performance of the underlying Moscow-listed shares. After the Russian invasion of Ukraine the trading in these GDR’s was halted. International sanctions made it likely that we would not recoup any of the value of our holdings in PhosAgro. Late 2022 we got the opportunity to sell our position, which resulted in a substantial capital gain.

The sector that contributed most to the absolute and relative performance of the Fund was the industrials sector (ALD was up 16% in December). The relative performance was also benefited from strong stock selection within the healthcare sector. The sector that detracted most from the absolute and relative performance of the Fund was the consumer discretionary sector (Autoliv performed poorly).

One of the top contributors was ALD (auto-leasing). Earlier in 2022, ALD announced the acquisition of LeasePlan, which would almost double the size of the company. To finance this acquisition, ALD announced a rights issue in November. The rights issue was a success and the transaction will proceed as planned. An important reason for a lowly rated share price had been the limited free float of the shares. I.e., Societe Generale owned 80% of ALD, which made it hard for institutional investors to buy a sizable position in ALD. After the rights issue, the free float will be substantially higher. Societe Generale’s ownership has been reduced to just over 50% of ALD. On our estimates, earnings per share could be 1.65 EUR within the next two years, which would leave the shares trading at less than 7 times earnings. For a market-leading company in and a strong management team, the shares are substantially undervalued. With the increased liquidity in the shares, we believe that the shares will benefit from a strong re-rating over the next two years.

One of the detractors from performance was Autoliv (-16% in December). Autoliv is the world market leader in passive automotive safety products like airbags and seatbelts. After a strong run earlier in 2022, investors have become concerned about the runup in Chinese Covid-infection. They are also concerned that Autoliv’s customers (i.e., auto manufacturers) will take longer to ramp up auto production. Although we carefully monitor the situation, we believe that our thesis is still intact. We expect that the company will be benefiting from a strong recovery in the automobile market. A strong uplift for automobiles will be driving a strong uplift in demand for Autoliv’s safety products. By raising prices and controlling costs, Autoliv is able to show a strong recovery in profitability. At the current price, the shares trade at a 3.4% dividend yield. If the earnings of Autoliv continue to grow as expected, we believe that the shares remain substantially undervalued.

In December, we built up a position in Knorr-Bremse. Knorr-Bremse is the global leader in braking systems for commercial transit vehicles such as trains and buses. The company has a 50% market share in breaking systems for trains, metros and other light rail vehicles. Thanks to safety regulation, best product line up, and strong customer relationships, it is likely that KB will be able to maintain their market share for many years to come. Big accidents caused by failing breaking systems cause human harm, wreak havoc on the train maker’s safety reputation, and puts pressure on local transportation authorities. Customers are therefore more interested in having the best product and not so much in paying the lowest price. Besides the strong market position, we also like the substantial stream of after-market revenues (e.g., brakes wear out, systems need periodic revision). The strong market position and cash flows allow KB to reinvest in R&D, thereby increasing their technological lead. The shares had shed more than 50% of the market price over the last 2 years. Much of the decline can be attributed to China (Covid-lockdowns and increasing local competition), Russia (Ukraine invasion), and cost inflation, which caused a substantial decline in operating margins. The latest quarterly report showed that the company is making progress on each of these problem areas. Operating margins appear to be on the rise again. The high quality nature of the business is not reflected in the valuation of the shares. We could establish our position in Knorr-Bremse at a price/earnings ratio of around 14. The shares provide a dividend yield of 3.5%.

To finance the new position, we sold our shares in Siemens. Over the first months of 2022, the shares had sold off substantially. Investors were worried about Siemens being exposed to Russia, about being a German company that would suffer from high energy prices, about falling demand and about suffering from supply chains issues. These worries proved to be unfound. Although Siemens did report a negative effect from its business in Russia, it showed strong results in many other parts of its business. It has been able to keep its supply chains intact and demand remained strong. The shares rebounded sharply in the final months of 2022. We sold the shares once they hit our conservative assessment of fair value. Especially since several cyclical companies have sold off over 2022, we see better opportunities elsewhere. We have therefore sold our position in Siemens.

We currently expect a dividend yield of around 5.6% for the Fund. This number is based on the consensus estimate of dividends paid out over the next 12 months. The Fund still trades at a strong discount versus the market (the average valuation of all the holdings in the Fund versus the broader equity market). Historically, this has led to a strong relative performance in the medium term. Also, the absolute valuation of the strategy is compelling. We continue to focus on attractively valued companies, that have good capital discipline and generate positive cash flows through the cycle. In summary, the current environment offers the opportunity to buy a well-diversified portfolio with solid earnings power at an attractive valuation. In addition, ESG (Environmental, Social and Governance) is fully incorporated in our investment process.