With one of the weakest December months on record, the stock market ended 2022 in style. 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. Tech-related stocks had strongly negative returns. 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 Markets Dividend Yield > 3% 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 performance of the Fund was the real estate sector (Sun Hung Kai Properties was up 10% in December). The sector that detracted most from the absolute performance of the Fund was the communication services sector. From a relative perspective we benefited from not owning tech-related stocks like Amazon, Apple, and Tesla. We also benefited from strong stock selection in the financial, energy and industrials sectors. The relative performance of the Fund was modestly impacted by stock selection within the consumer staples sector (Sysco).

One of the best contributors was Sumitomo Mitsui Financial Group (+16% in December). SMFG is one of the largest Japanese banking groups. It provides retail, corporate, and investment banking; asset management; securities trading; and lending. The Japanese Central bank announced in December that it would allow the yield on 10-year government bonds to rise to a maximum of 0.5%. Previously, the maximum was set at 0.25%. This change in central bank policy makes it much more attractive for banks to provide loans. As a result, earnings estimates for 2023 and 2024 are moving up substantially. Despite a 40% return (in JPY) over the past year, the shares are still not expensive. The shares trade at around 9 times consensus expected earnings for 2023. The shares have a dividend yield of 4.3%.

The worst performing stock in the portfolio was Sysco (-15% in December). The US based company is the world’s largest foodservice distributor and caters food and related non-food items to for example restaurants, schools and hospitals. The company is recovering from the covid-pandemic. In December, the Chief Financial Officer (CFO) of Sysco unexpectedly announced his retirement. Although there appears to be no direct impact on the business, investors were disappointed by the news. We still believe that Sysco will continue its long term track record of growing its earnings and dividends steadily over time. The current dividend yield of Sysco is around 2.6%.

In December, we built up positions in Knorr-Bremse and in Medtronic. 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%.

Medtronic is one of the largest medical technology companies in the world. It has four business lines, which are Cardiovascular (e.g., pacemakers, catheters, stents), Medical Surgical (e.g., surgical stapling devices, robotic-assisted surgical products, and inhalation products), Neuroscience (e.g., spinal cord stimulation, neuro stimulators, implants), and Diabetes (e.g., insulin pumps and monitoring systems). With this wide portfolio of products and an aging population, Medtronic will benefit from strong industry-wide growth. The shares have done poorly over the last years as a result of the covid-pandemic, which has led to a reduction in surgical procedures. Medtronic also suffers from hiccups in their supply chain and from input cost inflation. Over time we expect Medtronic to fully recover from these temporary setbacks. The shares trade at historically modest multiples of earnings (~14x versus 18x), and provide a dividend yield of ~ 3.5%. Once Medtronic recovers from the temporary setbacks, we expect the shares to benefit from growing earnings and multiple expansion.

To finance the new positions, we sold our shares in Principal Financial Group, Siemens, and Verizon Communications. Principal Financial Group is a US-based life insurance company that has changed its business model over the past years. Over time, the company has shifted its income stream from lumpy, traditional life insurance operations towards steady, fee generating activities (e.g. asset management). PFG has also been a strong capital allocator, with a track record of substantial dividends and share buybacks. The shares experienced a strong re-rating over the last months. Although this re-rating is fully justified, we no longer see sufficient upside to our fair value estimate.

We exited our position 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 sold our shares in Verizon Communications. The U.S. telecom provider reported its third disappointing quarter in a row. Not only are they clearly losing customers to AT&T and T-Mobile US, they are also increasing their investments that come with the roll out of a 5G network. Free cash flows are therefore under pressure. These developments have made us reassess the defensive qualities of the business. The valuation is reasonable, but with potential for further potential disappointments ahead we decided to sell our relatively small position in Verizon.

We currently expect a dividend yield of around 4.7% 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 flow 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.