MARKET RECAP
Equity returns were incredibly strong in the second quarter, and yet this was another difficult period for our portfolios relative to the benchmarks. While the de-escalation of the Iran war helped remove macro and energy overhangs, markets were propelled by a narrow and supercharged AI capex trade. To illustrate, the tech sector returned multiple times more than the overall global and international indexes, and by several measures, market leadership was the most concentrated since 1999.
We benefited through overweights in what we regard as the most moated semiconductor companies in the world, TSMC and ASML, and our differentiated exposure through automation leaders Keyence and Fanuc. However, memory stocks, which also benefited from a surge in retail participation including through leveraged ETFs and derivatives, posted triple digits gains and produced the most outsized return contributions to the overall index. This was detrimental to relative performance because we did not own these stocks in International portfolios and under-owned them in Global portfolios, where we hold a position in Micron.
Separately, our holdings in software and digital, health care, and Greater China lagged a market that rewarded very little outside of the AI capex trade. In fact, many of them continued to de-rate. Therefore, we took the opportunities afforded by the strong market to trim holdings that appreciated the most, led by our semiconductor and automation names, and to redirect the proceeds into a small number of higher conviction positions that lagged. For example, we added to beaten down compounders such as Adyen and Constellation Software, and we continued to build our recently initiated positions in 3i and AIA.
Assessing the year so far, much of the portfolios’ declines have been a compression of valuations, not a deterioration of earnings. For many of our holdings, the two have moved in opposite directions. Revenues, profitability, and cash flow have continued to build, even as the multiples placed against them have fallen. That divergence between rising intrinsic value and falling stock price is precisely what coils a spring. As that gap closes, the compression that worked against us becomes the raw material for future returns. We believe we hold a portfolio of healthy, growing businesses whose earnings power has advanced while their prices have reset, and that is the foundation of our conviction over our five-year investment horizon.
See more: 2026 Q2 CIO Review and Outlook
OUTLOOK
While the Middle East overhang has receded, what remains is extreme concentration in the equity markets, compounded by unresolved trade policy, a newly hawkish Fed, and an AI capex trade whose durability is openly debated.
In the U.S., the Fed faces a genuinely two-sided risk. Its June projections turned hawkish, and future hikes remain possible should energy-driven inflation prove sticky. Yet, a quietly softening labor market argues for patience. The clearer near-term catalyst is tariff pass-through. The temporary measures that followed the Supreme Court's ruling expire in late July, presenting a policy cliff that would act as a regressive tax on a consumer whose room to absorb it is already thin.
Europe is more constructive but fragile. Germany's fiscal pivot, which is the largest expansion in its post-war history, should lift eurozone growth through the end of the decade, and manufacturing has returned to expansion as defense spending rises. At the same time, a second energy crisis in four years again exposed the region's vulnerability and drew the ECB into tightening directly into economic weakness. The balance between this fiscal tailwind and energy headwind could steer European performance from here.
China faces a pivotal year. Policymakers have cut their growth target to a record low and elevated domestic consumption to their highest priority, an overdue admission that exports and investment cannot substitute for household demand. The property downturn still weighs on confidence, retail sales turned negative in May, and stimulus has been targeted rather than transformative. The execution of that consumption pivot is one of the key uncertainties.
Our strategy favors companies with durable competitive advantages, healthy margins, strong balance sheets, and consistent cash generation. That commitment is unchanged, but the past two quarters were a humbling reminder of how drastically valuation multiples can compress when a narrative shifts. The year-to-date drawdown in many of our holdings was a function of that compression, not earnings deterioration. Concentrated quality portfolios that endure this kind of sentiment-driven dislocation have historically been well-positioned to recover as valuations normalize, and we have used this volatility to concentrate capital where our conviction is highest.
While AI is a profound secular trend, we respect the skepticism regarding how long hyperscalers can sustain record capex spending and whether AI monetization will keep pace with the hundreds of billions of dollars of data centers either already deployed or under construction. By owning the indispensable semiconductor picks and shovels, TSMC and ASML, alongside automation leaders Keyence and Fanuc, we seek to participate in the economics of the buildout today without having to predict which downstream model platform ultimately wins. And because we also own the de-rated growth franchises that benefit as market leadership broadens, our positioning does not rest on a single binary outcome.
Given how severely the market has repriced our holdings, it is reasonable to ask why we maintain meaningful commitments to the areas that have recently hurt us: software and digital platforms, health care, and Greater China. Across these various sleeves, the common thread has been valuation compression against businesses whose cash flows and competitive positions have continued to build.
The market has de-rated many of our holdings in software and digital businesses, treating them as structural casualties of the AI disruption narrative. We view this terminal value assessment as materially disconnected from operational reality. The competitive moats of Constellation Software, Adyen, and Sea are built on deep customer integration, regulatory complexity, and network scale. We believe these businesses are too critical to clients’ daily operations and revenue generation to rip and replace. Both software and platform holdings continued to execute robustly through the stock price drawdown. In the case of Temenos, there has been an overhang over its Gulf customer base stemming from the Iran conflict, rather than a structural flaw in its software business.
Our Greater China* holdings (roughly 18% of International and 12% of Global) are deliberate overweights and individually underwritten. They are concentrated in secular growth areas of the domestic economy that align with government priorities. Furthermore, the quarter's returns weakness also owed more to capital chasing the AI trade, especially in other emerging markets, than to fundamental deterioration. Alibaba and Tencent may not lead in open-source AI models, but value can accrue to the cloud, distribution, and commerce layers they already dominate. Furthermore, companies such as KE, which is an entrenched real estate platform in a stabilizing housing market, and AIA, which is the leading pan-Asia life insurer, demonstrate business models driven by domestic demand.
In health care, the strongest fundamental stories were among the hardest hit as the sector fell out of favor. BeOne Medicines and WuXi Biologics both continued to execute well, yet fell together in a sharp decline that swept the entire Chinese biopharma complex, a sympathy move rather than company-specific events. Genmab remains valuable for its pipeline, but the market has been fixated on a future royalty step-down for Darzalex. Meanwhile, Galderma has continued to compound its dermatology franchise.
U.S. valuations remain significantly elevated, with the cyclically adjusted price-to-earnings ratio near historical peaks, while international markets trade at considerably lower valuations. We do not lean on that discount as a thesis in itself, having watched it persist for years without reward, but paired with intact earnings, we think it tilts the odds in our favor. The forward setup is a matter of probability rather than prophecy.
The underlying earnings power of our portfolio remains fully intact, and in many cases, it has advanced, while prices have fallen. That divergence between rising intrinsic value and falling stock price is precisely what coils a spring. Valuation remains the raw material of future returns, and we believe the multiple compression of the past two quarters has created an unusually attractive entry point for patient capital over our five-year investment horizon.
*Includes China, Hong Kong, and Prosus.
3i Group had a 1.86%, Adyen 2.51%, AIA Group 1.41%, Bank Rakyat 0.00%, Canadian Pacific Kansas City 3.69%, Constellation Software 3.31%, DBS 4.61%, Galderma 2.66%, Genmab 3.91%, KE Holdings 3.31%, Kioxia 0.00%, Ryanair 2.80%, Safran 4.12%, Samsung 0.00%, Sea Limited 3.09%, SK Hynix 0.00%, Suzuki 2.09%, Temenos 2.46%, Tencent 0.00%, and WuXi Biologics 3.10%, weighting in the International Fund as of 6/30/2026. 3i Group had a 1.41%, Adyen 1.85%, AIA Group 1.04%, Bank Rakyat 0.00%, BeOne Medicines 2.91%, Constellation Software 2.57%, DBS 3.25%, Fanuc 2.51%, Galderma 2.10%, KE Holdings 2.09%, Kioxia 0.00%, Ryanair 2.08%, Safran 3.33%, Samsung 0.00%, Sea Limited 2.08%, SK Hynix 0.00%, Suzuki 1.52%, Temenos 1.16%, Tencent 0.00%, and WuXi Biologics 2.06% weighting in the Global Fund as of 6/30/2026.
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