The Big Impact of International Small Caps · 5/18/2017 · Causeway Capital Management LLC 5 Small cap stocks compose a sizable portion of the international equity universe Note:

Causeway Capital Management LLC

The Big Impact of International Small Caps

May 18, 2017

SOLELY FOR THE USE OF INSTITUTIONAL INVESTORS AND PROFESSIONAL ADVISORS

> Independent institutional investment manager

> Founded in June 2001 and headquartered in Los Angeles, California

> Focus on global equity strategies

> 83 employees including 30 investment professionals

> Approximately $51 billion assets under management (as of 4/30/17)

CAUSEWAY STRATEGIES

International Value

Global Value

Emerging Markets

International Small Cap

Global/International Opportunities

Global Absolute Return


Causeway Capital Management

About Causeway

2


Causeway Capital Management

Today’s Speakers

SARAH KETTERER

Co-founder and

CEO of Causeway,

Fundamental

Portfolio Manager

3

DUFF KUHNERT

Quantitative

Portfolio Manager

RYAN MYERS

Senior Quantitative

Research Associate


The Big Impact of International Small Caps

Discussion Topics

4

Attractive Asset Class

Universe Well-suited for Active Management

Causeway International Small Cap Strategy

Small caps comprise 84% of international stocks by number

Greater exposure to domestic economies

Lower pairwise correlation offsets higher stock volatility

Active managers have generated consistent alpha

Significant valuation dispersion and inefficient pricing

Flat small cap index construction makes passive replication

challenging

Combines superior value and growth exposure to asset class

Quantitative stock selection with fundamental review

Contextual model tailors factor weights for each stock

Causeway Capital Management LLC 5

Small cap stocks compose a sizable portion of the international equity universe

Note: “Small Cap” refers to companies with a maximum $3 billion market float. International equity universe represents all public equities outside the United States with at least US$0.5 million average daily trading volume over last 30 days as of March 31, 2017. Source: MSCI, FactSet

20.7%

% of Market Float

84.0%

% of Stocks


Small caps have less sensitivity to protectionism due to higher domestic revenue exposure

Note: Represents the float-weighted revenue exposure to each constituent’s respective domestic market for year ended December 31, 2016. Source: MSCI, Causeway Analytics

37%

56%

68%73%

64%

80%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

MSCI WorldxUSA

MSCI WorldxUSA Small

MSCI EM MSCI EMSmall

MSCI USA MSCI USASmall

% o

f R

even

ue

Do

mes

tic

(Flo

at-W

eigh

ted

)


The volatility of the median small cap stock is generally high…

Note: Represents the median annualized constituent volatility calculated using trailing 156 weeks of $US returns for each index through March 31, 2017. See Disclosures for more information about the indices. Source: Causeway Analytics, MSCI

20%

25%

30%

35%

40%

45%

50%

55%

60%

Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17

MSCI AC World ex USA Small Cap

MSCI AC World ex USA

MSCI EAFE

MSCI Emerging Markets

MSCI USA


…but index volatility is surprisingly low…

Note: Annualized volatility of trailing 36 months of USD gross unhedged index returns through March 31, 2017. See Disclosures for more information about the indices. Source: MSCI, FactSet

0%

5%

10%

15%

20%

25%

30%

35%

40%


MSCI AC World ex USA Small CapMSCI AC World ex USAMSCI EAFEMSCI Emerging MarketsMSCI USA


…because pairwise correlation is low.

Note: Mean pairwise correlation (average correlation among every pair of index constituents) using weekly USD returns on a trailing 156-week basis through March 31, 2017. See Disclosures for more information about the indices. Source: MSCI, Causeway Analytics

0.00

0.05

0.10

0.15

0.20

0.25

0.30

0.35

0.40

0.45

0.50


MSCI AC World ex USA Small Cap

MSCI AC World ex USA

MSCI EAFE

MSCI USA


MO

RE SIM

ILAR

MO

RE IN

DEP

END

ENT


Higher borrow costs reduce market efficiency among international small cap stocks

Note: Assumes Federal Funds rate of 0.75%. Data as of April 13, 2017. Source: Broker-quoted borrow costs (may not be representative of actual transactions), Causeway Analytics

0.20%

0.39%

0.95%

1.84%

0.00%

0.20%

0.40%

0.60%

0.80%

1.00%

1.20%

1.40%

1.60%

1.80%

2.00%

MSCI USA MSCI USA Small MSCI ACWI xUS MSCI ACWI xUS Small Cap

Flo

at-w

eigh

ted

An

nu

aliz

ed E

ffec

tive

Bo

rro

w

Co

st o

f In

dex

Co

nst

itu

ents


High constituent count and flat construction…

Note: All data as of March 31, 2017. See Disclosures for more information about the indices. Source: MSCI, FactSet.

4,273

929

1,650

627 830

0.22%

1.83%

2.15%

3.60%

4.14%

0%

1%

2%

3%

4%

5%

0

1,000

2,000

3,000

4,000

5,000

MSCI ACWI x USASmall Cap

MSCI EAFE MSCI World MSCI USA MSCI EmergingMarkets

We

igh

t o

f La

rge

st C

on

stit

ue

nt

(%)

Nu

mb

er

of

Ind

ex C

on

stit

ue

nts


…make passive replication challenging.

Note: Tracking error calculated using trailing 5 years of weekly returns as of March 31, 2017. Source: MSCI, FactSet.

4.46%

0.44%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

Vanguard FTSE All World (ex-US) Small Cap ETF("VSS")

Vanguard S&P 500 ETF ("VOO")

An

nu

aliz

ed T

rack

ing

Erro

r (%

)

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

US SMALL US LARGE ACWI EX US SMALL ACWI EX US LARGE

Med

ian

An

nu

aliz

ed E

xce

ss R

etu

rn (

vs. S

tate

d B

ench

mar

k)

Trailing 3 Years Trailing 5 Years Trailing 7 Years


Active managers have produced more alpha in international small cap

Note: Represents excess return of the median strategy for each universe and each date range. Excess returns means returns in excess of a benchmark. Returns are gross of fees, and through March 31, 2017. Categories and designations of strategies within a category determined by Evestment. Source: Evestment

2 x

3 x

4 x

5 x

6 x

7 x

8 x

9 x

10 x

MSCI ACWI xUSSmall Cap

MSCI ACWI xUS MSCI World xUS MSCI USA MSCI EmergingMarkets

NTM Price/Earnings Spread Price/Book Spread


An active approach can exploit the high valuation dispersion among small caps

Note: Ranking the constituents of each universe according to NTM Price/Earnings and Price/Book Value, respectively, the ratio of the valuation multiple of the most expensive quintile relative to the valuation multiple of the cheapest quintile is recorded at the end of each month. Bars plotted represent median monthly ratio from last 120 months ended March 31, 2017. “NTM” means next twelve months. Source: MSCI, FactSet

MSCI USAMSCI World

MSCI EAFE


MSCI ACWI x USA Small Cap

Causeway ISC Portfolio

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

8 x 10 x 12 x 14 x 16 x 18 x 20 x

Lon

g Te

rm E

PS

Gro

wth

Tre

nd

Price / Earnings (Next 12 Months)


Causeway’s small cap portfolio provides a sizable valuation discount with superior growth prospects

Note: Portfolio and MSCI Index statistics as of March 31, 2017. “EPS” means earnings per share. See Disclosures for more information about the indices. Source: MSCI, FactSet, Causeway Analytics


Causeway International Small Cap Stock Selection

Alpha Model

• Calculates alpha score for each stock in the investable universe (~2,800 stocks)

• Sector-specific valuation models

Stock Selection Factor Categories• Valuation• Earnings growth• Technical Indicators• Quality

Proprietary Risk Model

• Calculates expected marginal contribution to active risk

• Proprietary cross-sectional model with 156 risk factors

Risk Model Factors• 8 style• 77 country• 60 currency• 11 sector

Portfolio Optimization

• Benchmark-relative constraints: Country/Sector (+/-5%), Currency (+/-10%), Stock (+/-2%)• Incorporates risk penalties, trading costs, and market impact• Seeks to maximize alpha to 4-5% targeted tracking error vs. MSCI ACWI xUS Small Cap Index

Fundamental Review

Proprietary contextual

model assigns stock-

specific weights based

upon relative importance

• Fundamental analysts review stock attributes that may be outside the scope of quantitative models (e.g., corporate events, potential M&A, off-balance sheet liabilities)

Contextual weighting customized factor weights for each stock

17

Value / Momentum

Book / Price

NTM EPS / Price

LTM EPS / Price

6-Month Local Return

12-Month Local Return

Growth

5-Year Historical Sales Growth

Long-Term EPS Growth Rate

Buyers of different stock types (Value/Momentum, Growth) seek distinct traits

We rank stocks on a uniform distribution along two dimensions (Value/Momentum and Growth) and assign greater weight to the most relevant traits

Cheap / Recent Loser

Expensive / Recent Winner

Low Growth High Growth


Our fundamental review enhances the quantitative process

Fundamental ReviewGlobal Sector Specialists Responsible for Identifying

Evidence that Quant Model May be Missing Important Information (“Quant Traps” or “Blind Spots”)

Periodic Portfolio Rebalancing

Trade Candidates from Optimization

Existing Positions

Identify Stocks with Significant Price Moves or News Flow

• Corporate Governance• Regulation• Political Risk• Off Balance Sheet Assets/Liabilities

Final Portfolio

Stock Remains in Final Portfolio

YesNo

Portfolio Managers Decide to

Intervene?

Final Portfolio

Stock’s Weight is Reduced or Eliminated in Final Portfolio



Causeway International Small Cap strategy provides a greater percentage of idiosyncratic exposure

4%

18%

5%

22%6% 11%

12%

22% 13%

23%

1%

8%

16%

5%7%

6%

11%

4%

24%

19%

11%

12%

36%

47%

9%

21%51%

7%

42%

30%21%

32%

13%

31%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Causeway ISC Columbia AcornInternational

T. Rowe PriceInternational

Oakmark ISC MFS InternationalNew Discovery

Brandes ISC

% o

f To

tal E

xpec

ted

Tra

ckin

g Er

ror

World Equity Country Sector Currency Style Idiosyncratic

Note: Portfolios selected include Causeway International Small Cap representative account and the 5 largest funds by total net assets (as of 3/31/2017) in the Lipper International Small/Mid Cap equity fund category that have at least 10% of fund assets invested in emerging markets as of 3/31/2017.


• Meaningful segment of international

equity universe

• Greater exposure to domestic economies

• Lower pairwise correlation offsets higher

stock volatility

• Higher borrow costs of international small

caps reduce efficiency

• Significant valuation dispersion

• Flat small cap index construction makes

passive replication challenging

• Combines superior value and growth

exposure to asset class

• Quantitative stock selection with

fundamental review

• Contextual model tailors factor weights

for each stock

Attractive Asset Class

Causeway International Small Cap Strategy

20

Small Caps Well-Suited to Active Management

Why International Small Cap?


DisclosuresThis presentation expresses the presenters’ views as of May 18, 2017 and should not be relied on as research or investment advice regarding any investment. These views

and characteristics are subject to change, and there is no guarantee that any forecasts made will come to pass. Forecasts are subject to numerous assumptions, risks and

uncertainties, which change over time, and Causeway undertakes no duty to update any such forecasts. Information and data presented has been developed internally

and/or obtained from sources believed to be reliable; however, Causeway does not guarantee the accuracy, adequacy or completeness of such information.

Past performance is no guarantee of future performance. In addition to the normal risks associated with investing, international investments may involve risk of capital loss

from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations.

Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. Investments in smaller companies involve

additional risks and typically exhibit higher volatility.

The MSCI EAFE Index is a free float-adjusted market capitalization weighted index, designed to measure developed market equity performance excluding the U.S. and

Canada, consisting of 21 stock markets in Europe, Australasia, and the Far East. The MSCI World Index is a free float-adjusted market capitalization weighted index, designed

to measure developed market equity performance, consisting of 23 developed country indices, including the U.S. The MSCI World ex USA Index is a free float-adjusted market

capitalization index, designed to measure developed market equity market performance, consisting of 22 developed country indices, excluding the U.S. The MSCI Emerging

Markets Index is a free float-adjusted market capitalization index, designed to measure equity market performance of emerging markets, consisting of 23 emerging country

indices. The MSCI All Country World Index ex U.S. is a free float-adjusted market capitalization weighted index, designed to measure the equity market performance of

developed and emerging markets excluding the U.S. consisting of 45 country indices. The MSCI ACWI ex USA Small Cap Index is a free float-adjusted market capitalization

weighted index, designed to measure the equity market performance of smaller capitalization stocks in developed and emerging markets excluding the U.S. market,

consisting of 45 country indices. The MSCI ACWI ex USA Small Cap Index covers approximately 14% of the free float-adjusted market capitalization in each country. The MSCI

USA Index is a free float-adjusted market capitalization weighted index, designed to measure large- and mid-cap US equity market performance. The MSCI USA Index is a

member of the MSCI Global Equity Indices and represents the US equity portion of the global benchmark MSCI ACWI Index. The Indices are gross of withholding taxes, assume

reinvestment of dividends and capital gains, and assume no management, custody, transaction or other expenses. It is not possible to invest directly in these indices.

The MSCI ACWI ex USA Small Cap Index was launched on June 1, 2007. Data prior to the launch date was backfilled by MSCI.

Slide 19 illustrates the marginal contribution to risk, as calculated by holdings-based portfolio-level risk exposures, and the historical covariance matrix of the risk factor

returns, across 8 style dimensions, 11 sectors, different countries, currencies, and overall exposure to the MSCI World Index, as well as idiosyncratic risk. Risk contribution is

measured for the portfolio’s “active” risk exposures relative to the benchmark index (MSCI ACWI ex USA Small Cap Index). “Tracking Error” is the volatility of alpha over the

stated preceding period. “Alpha” is a measurement of performance return in excess of a benchmark index. “Volatility” refers to the standard deviation of returns.

MSCI has not approved, reviewed or produced this report, makes no express or implied warranties or representations and is not liable whatsoever for any data in the report.

You may not redistribute the MSCI data or use it as a basis for other indices or investment products.

Documents

The Big Impact of International Small Caps · 5/18/2017 · Causeway Capital Management LLC 5 Small cap stocks compose a sizable portion of the international equity universe Note: