Portfolio attribution

The Causeway International Small Cap Fund (“Fund”) outperformed the Index during the month. To evaluate stocks in our investable universe, our multi-factor quantitative model employs four bottom-up factor categories – valuation, earnings growth, technical indicators, and competitive strength – and two top-down factor categories assessing macroeconomic and country aggregate characteristics. In July, the strategy’s value factors produced positive returns, and value remains the best-performing factor in 2023 and over the last twelve months. Our earnings growth factors posted negative returns last month, though returns remain positive over the last twelve months. The strategy’s technical factors generated slightly positive monthly returns in July, though returns are negative for the year-to-date period due to a particularly challenging January. Competitive Strength generated negative returns in July, though it is the second-best performing factor group year to date. Our macroeconomic factors were positive indicators in July due, in part, to correct calls on Turkey and China. However, our country aggregate factors were negative indicators as countries exhibiting superior metrics, Japan in particular, generally underperformed those with relatively weaker characteristics. All factor groups remain positive from inception of the Fund (10/20/14) to the end of July.

Economic outlook

The Federal Reserve’s rate-hiking cycle may be ending, but the lagged effect of sharp rate rises, inverted yield curves, and negative money supply growth should weigh on the US economy in 2024. Monetary tightening may be felt more deeply in Europe, given its greater credit demand sensitivity to variable interest rates (including through mortages). Higher borrowing costs for European governments and corporations create spending headwinds for the region’s economic objectives. Recession looms in the UK, where stubborn inflation has prompted unrelenting rate hikes. The Bank of Japan modestly relaxed its yield curve control, allowing yields to rise to 1% (from a prior ceiling of 0.5%), but appears committed to ultra-loose monetary policy for the near term. In China, policy makers announced measures to boost production of consumer goods and showed support for the nation’s ailing property market.
Economic data from China suggests the surge of consumer spending that led the economy’s Covid reopening has subsided. Chinese industrial activity also has slowed: the June reading of China’s official manufacturing purchasing managers’ index fell to 49, indicating contraction. The People’s Bank of China cut policy interest rates in June and the government currently appears likely to deploy targeted fiscal stimulus, but real gross domestic product growth in China may slow to 3% or less in 2024.

Investment outlook

We believe that international small caps, and international small cap value stocks in particular, still have some “catching up” to do with larger cap and growth stocks from a valuation perspective. On a forward price to earnings basis, international small caps have traded at a median 1.3x multiple premium to large caps over the last 20 years. As of the end of last month, however, international small caps are still trading at a slight discount despite outperforming in July. During similar periods historically, small caps have gone on to outperform over the following twelve months. Within our international small cap alpha model, value factors receive the largest weight on average. The MSCI ACWI ex US Small Cap Growth Index traded at a 17.6x forward P/E multiple compared to 10.2x for the MSCI ACWI ex US Small Cap Value Index as of 7/31/2023, a 73% premium. Even if the U.S. Fed is near the end of its interest rate hikes, interest rates should remain elevated for some time. A higher cost of capital should translate into a continued preference for value stocks.

The market commentary expresses the portfolio managers’ views as of the date of this report and should not be relied on as research or investment advice regarding any stock. These views and the fund holdings and characteristics are subject to change. There is no guarantee that any forecasts made will come to pass. Any securities identified and described in this report do not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in the securities identified was or will be profitable. Diversification does not protect against market loss. Current and future holdings will be subject to risk. International and emerging markets investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from social, economic or political instability in other nations. Emerging markets and smaller companies involve additional risks and higher volatility.