The portfolio underperformed its benchmark index in Q4, mainly due to our Brazilian financial sector holdings Banco Itau and B3, which both fell significantly given the events after the election. We think Brazil is now past the worst and have confidence in our holdings there. Globant (a leading digital consultancy company) was the major individual stock detractor to performance despite reporting excellent results and medium term outlook, as the market worried about short term temporary cost headwinds.

The MSCI EAFE NR Index fell 14.45% in 2022, despite rallying 17.34% in the fourth quarter. Inflation reached 40-year highs in many parts of the world, prompting central banks to hike interest rates much more than expected, leading to fears of a global recession and financial crisis. This market crisis was very different because previously ‘safe haven’ government bonds fell along with equities and 2022 was the worst year for combined equity and bond losses in most investors’ memory. 

In 2022 we underperformed for 5 main reasons:

1. We got inflation and interest rates wrong, expecting moderate, not near-record rises. 
2. This meant we got the valuation wrong for our ‘offence’ high beta growth stocks, especially our technology holdings such as ASML, MediaTek and Tokyo Electron which we sold once their earnings revisions peaked or turned negative. Elsewhere, we had too much duration (interest rate risk) in most other sectors and regions as 2022 was the third fastest rate hike since Arthur Burns in ’72 and Paul Volcker in ’80.
3. Which also meant we owned the wrong type of ‘defensive’ low beta stocks, particularly our COVID beneficiary Healthcare holdings such BioNTech, Icon and Lonza. We sold the former given it’s long term fundamental deterioration, but kept the latter two as their issues were short term (in fact Icon just reported better than expected earnings and outlook). Elsewhere, our other traditionally low beta ‘bond proxy type stocks’ did not deliver their previously good downside protection for us.
4. The classic 60/40 asset allocation model broke down, and our equity-only portfolio construction is based on this model. So it stopped working in 2022 as both our offence and defensive stocks both underperformed. 
5. We have a growth/momentum style which significantly underperformed the value style in Q4 and 2022.

All the above meant we did not deliver our usual ‘relative downside protection’ in 2022. 

During the 4th quarter we purchased high quality economically resilient stocks given our expectation of a recession, such as Unilever (UK consumer staples), Richemont (Swiss luxury products) and Partners Group (Swiss private equity). We followed our investment process of weeding out the losers such as Hong Kong Exchange, Alibaba, Tencent and Prosus. However these four Chinese stock sales significantly detracted from performance as they and the whole Chinese equity market subsequently rallied very strongly after we had sold them. 

We think most equity markets are in a drawn out bottoming process, with risk on/off rotations as inflation and interest rates peak, and equity markets try to look through the probable recession. We see improving relative fundamentals, attractive valuation, and improving relative share price trends in the following neighbourhoods:

1. Quality growth stocks, many of which are already down 30-50%.
2. UK & European global champions plus Japanese exporters
3. Emerging markets domestic consumption stocks
4. China reopening/recovering, both direct and indirect opportunities

But given the Q4 rally and 2023 recession risks we will wait to buy the dips throughout the year.

Our current scenario analysis is 50% bullish and 50% bearish. Short term reasons to be bearish include a recession potentially becoming a financial crisis/contagion. Medium term reasons to be bullish include the Fed regaining credibility with inflation & interest rates stabilising this year. 

Scenario 1 = 40% probability of rally led by quality growth stocks. It is probably nearer the end of the bear market for economically resilient quality growth stocks that are already down 30-50% after their 2022 interest rate shock. 

Scenario 2 = 10% probability of rally led by cyclical value stocks. It is probably nearer the beginning of the Bear market for these stocks given their recessionary earnings risk, but will the equity market look through this? 

Scenario 3 = 50% probability equity market keeps falling. Healthcare is our biggest position relative to benchmark given the sectors positive fundamentals, valuation and trend.

One of our greatest frustrations and disappointments of 2022 was that many of the profitable quality growth stocks we own fell about as much as the unprofitable negative cash flow growth stocks that we do not own. We call the latter ‘Concept Capital’ and think they still have a long way to fall. We are positive about the relative prospects of our profitable quality growth stocks, with low debt-to-equity balance sheets going into the probable 2023 earnings recession - an environment when quality stocks with great balance sheets usually shine (on a relative basis).
 

Sources for all data: JOHCM/Bloomberg (unless otherwise stated).

The performance data quoted represents past performance; past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. The Fund's current performance may be lower or higher than the performance data quoted. Investors may obtain performance information current to the most recent month-end, within 7 business days at www.johcm.com or by calling 866-260-9549 or 312-557-5913.

Returns shown, unless otherwise indicated, are total returns, with dividends and income reinvested. Returns for periods of less than one year are not annualized. Fee waivers are in effect; if they had not been in effect performance would have been lower.

The MSCI EAFE Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada. Any Indicies mentioned are unmanaged statistical composites of stock market performance. Investing in an index is not possible.

Historical performance of the International Select Fund for Class II Shares prior to its inception is based on the performance of Class I Shares. The performance of Class II Shares has been adjusted to reflect differences in expenses.

*Expense ratios as stated in the latest prospectus. JOHCM (USA) Inc. has contractually agreed to waive fees and reimburse expenses so that the Net Total Operating Expenses do not exceed the stated amounts until January 28, 2024.

Fund holdings, sector allocation, regional allocation and top 10 countries are subject to change without notification.

The performance data quoted represents past performance; past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. The Fund's current performance may be lower or higher than the performance data quoted. Investors may obtain performance information current to the most recent month-end, within 7 business days at www.johcm.com or by calling 866-260-9549 or 312-557-5913.

Returns shown, unless otherwise indicated, are total returns, with dividends and income reinvested. Returns for periods of less than one year are not annualized. Fee waivers are in effect; if they had not been in effect performance would have been lower.

The MSCI EAFE Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada. Any Indicies mentioned are unmanaged statistical composites of stock market performance. Investing in an index is not possible.

Historical performance of the International Select Fund for Class II Shares prior to its inception is based on the performance of Class I Shares. The performance of Class II Shares has been adjusted to reflect differences in expenses.

*Expense ratios as stated in the latest prospectus. JOHCM (USA) Inc. has contractually agreed to waive fees and reimburse expenses so that the Net Total Operating Expenses do not exceed the stated amounts until January 28, 2024.