Quality First

LAZARD INTERNATIONAL Focusing on quality in growth investing can open up the investment universe to more COMPOUNDERS FUND sectors and regions and uncover potential opportunities that many growth strategies may overlook. In the first of a series on quality Quality growth investing, we show here that quality has outperformed other investing styles historically and how we believe a bottom-up approach to quality, focused on high financial productivity, First has differentiated the Lazard International Compounders Fund from its competitors. LAZARD INTERNATIONAL COMPOUNDERS FUND Quality First

Equity markets over the last few months have upended We believe the current period, like the dot-com boom, some long-standing trends—particularly in the U.S., will come to an end. When it does, we would expect although this has also spilled over to international markets. quality and the importance of profits to come to the fore In one of the more striking reversals, quality investing, once again. which has generally outperformed growth (and the Although we have described this growth phenomenon broader market) in the U.S. very consistently over the last in the U.S., a similar group of stocks in international 45 years, has underperformed growth dramatically since markets, like those driving the MSCI USA Growth Index the outbreak of COVID-19 early this year (Exhibit 1). over the past few months, grow sales very quickly, The only other period when growth (the fastest-growing but report losses or minimal profits, and trade on businesses) outperformed quality (the most profitable enormous sales multiples or triple-digit price-to-earnings businesses) was 1999—the so-called dot-com boom. (P/E) ratios. Many international growth portfolios Many investors will have noticed similarities between have significant exposure to this group of companies. the last few months and the end of 1999 in terms of While the recent performance of this group has been some behaviour by investors and companies that seems exceptional, we think these companies are riskier amid somewhat irrational. the current growth frenzy, and looking ahead, we believe

Exhibit 1 U.S. Quality Outperformed Growth with Two Exceptions: 1999 and 2020 MSCI USA Growth Index/MSCI USA Quality Index 0.0

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-0.5 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020

As of 31 August 2020 The performance quoted represents past performance. Past performance is not a reliable indicator of future results. This information is provided for illustrative purposes only and does not represent the performance of any product or strategy managed by Lazard. The indices are unmanaged and have no fees. One cannot invest directly in an index. Source: Bloomberg

2 investors may want to consider investing in companies Quality, Growth and Value that have demonstrated profitable business models Some investors tend to spend a huge amount of time rather than those hoping to grow into one. and energy discussing growth and value investing and Lazard International Compounders Fund is designed to when to switch. But our analysis suggests that they focus on quality first. Every stock we buy has higher financial would have been better off owning the style that has productivity than the overall market, as defined by cash flow consistently outperformed the market since at least the return on investment (CFROI), return on equity (ROE) and/ 1970s: quality. or return on invested capital (ROIC). The companies we own Performance data for different investing styles from grow—but we expect them to do it profitably by reinvesting the MSCI ACWI ex USA Index is available dating back without diluting their financial productivity. to 2001. Initially, value outperformed growth, with the outperformance peaking in August 2009. Since then, growth has outperformed value. However, quality has not only outperformed both value and growth since 2001 but has also outperformed an investor who started in value and timed the switch to growth perfectly in August 2009 (Exhibit 2).

Exhibit 2 Quality vs. Value/Growth Switch in International Markets (%) 5

MSI WI ex US Value until uust 2009, then MSI WI ex US Growth MSCI ACWI ex USA Quality 4 MSCI ACWI ex USA Value MSCI ACWI ex USA Growth

0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

3 What Is Quality Growth? Quality means different things to different people. MSCI Many investors are contemplating a shift in allocations as constructs its quality index by looking for companies with they detect signs of overexuberance in some growth high and stable financial productivity and low financial stocks. We believe that quality will continue to be an leverage. Our focus is on the most financially productive attractive style exposure even if value comes back into businesses, as we believe high financial productivity is fashion and that our Lazard International Compounders the driver of earnings stability, cash generation and low Fund can provide the growth characteristics investors financial leverage. may seek while its focus on quality has differentiated it from peers. Lazard International Compounders Fund invests in 40 to 50 of the world’s most financially productive companies. We select companies that we believe have competitive advantages, which have enabled them to sustain high financial productivity for longer than the market expects. We also require that these companies have opportunities to reinvest at the same high level of financial productivity to drive growth.

This content represents the views of the author(s), and its conclusions may vary from those held elsewhere within Lazard Asset Management. Lazard is committed to giving our investment professionals the autonomy to develop their own investment views, which are informed by a robust exchange of ideas throughout the firm.

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Other Important Information Originally published on 1 October 2020. Revised and republished on 2 October 2020. The performance quoted represents past performance. Past performance does not guarantee future results. Mention of these securities should not be considered a recommendation or solicitation to purchase or sell the securities. It should not be assumed that any investment in these securities was, or will prove to be, profitable, or that the investment decisions we make in the future will be profitable or equal to the investment performance of securities referenced herein. There is no assurance that any securities referenced herein are currently held in the portfolio or that securities sold have not been repurchased. The securities mentioned may not represent the entire portfolio. The MSCI Emerging Markets Index is a free-float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets. The MSCI Emerging Markets Index consists of 26 emerging markets country indices: Argentina, Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Pakistan, Peru, Philippines, Poland, Qatar, Russia, Saudi Arabia, South Africa, Taiwan, Thailand, Turkey, and United Arab Emirates. The index is unmanaged and has no fees. One cannot invest directly in an index. This document reflects the views of Lazard Asset Management LLC or its affiliates (“Lazard”) based upon information believed to be reliable as of the publication date. There is no guarantee that any forecast or opinion will be realized. This document is provided by Lazard Asset Management LLC or its affiliates (“Lazard”) for informational purposes only. Nothing herein constitutes investment advice or a recommendation relating to any security, commodity, derivative, investment management service or investment product. Investments in securities, derivatives and commodities involve risk, will fluctuate in price, and may result in losses. Certain assets held in Lazard’s investment portfolios, in particular alternative investment portfolios, can involve high degrees of risk and volatility when compared to other assets. Similarly, certain assets held in Lazard’s investment portfolios may trade in less liquid or efficient markets, which can affect investment performance. Past performance does not guarantee future results. The views expressed herein are subject to change, and may differ from the views of other Lazard investment professionals. This document is intended only for persons residing in jurisdictions where its distribution or availability is consistent with local laws and Lazard’s local regulatory authorizations. Please visit www.lazardassetmanagement.com/globaldisclosure for the specific Lazard entities that have issued this document and the scope of their authorized activities.