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 -0.1 -0.2 -0.3 -0.4 -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 MSCI ACWI ex USA Value until August 2009, then MSCI ACWI ex USA Growth MSCI ACWI ex USA Quality 4 MSCI ACWI ex USA Value MSCI ACWI ex USA Growth 3 2 1 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 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 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. FOR DISTRIBUTION TO INVESTORS BY REGISTERED DEALERS ONLY. Bridgehouse Asset Managers® is a trade name of Brandes Investment Partners & Co. Brandes Investment Partners® is a registered trademark of Brandes Investment Partners, L.P., which is an affiliate of Bridgehouse. Brandes Investment Partners & Co., operating as Bridgehouse Asset Managers®, is an affiliate of Brandes Investment Partners, L.P. As the manager of the Bridgehouse Funds, Bridgehouse has hired Lazard Asset Management (Canada), Inc. (Lazard) as portfolio sub-advisor in respect of certain of the Bridgehouse Funds. Bridgehouse and Lazard have taken reasonable steps to provide accurate and current data. The data has been gathered from sources believed to be reliable, however Bridgehouse and/or Lazard are not responsible for any errors or omissions contained herein. Indices are unmanaged and cannot be directly invested into. This material has been provided by Bridgehouse and is for informational purposes only. It should not be construed as a recommendation to buy or sell. This report may contain forward-looking statements about the economy, and markets; their future performance, strategies or prospects. The words “may,” “could,” “should,” “would,” “suspect,” “outlook,” “believe,” “plan,” “anticipate,” “estimate,” “expect,” “intend,” “forecast,” “objective” and similar expressions are intended to identify forward-looking statements. Forward-looking statements are not guarantees of future performance. Forward-looking statements involve inherent risks and uncertainties about general economic factors, so it is possible that predictions, forecasts, projections and other forward-looking statements will not be achieved. You are cautioned to not place undue reliance on these statements as a number of important factors could cause actual events or results to differ materially from those expressed or implied in any forward-looking statement. Before making any investment decisions, you are encouraged to consider these and other factors carefully. 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. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. 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