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After years in the doldrums, many developed markets benefited from a pick-up in business confidence and industrial production during the third quarter of 2013. Emerging markets, on the other hand, were very volatile during this time as fears that the U.S. Federal Reserve Bank (the "Fed") would begin tapering its stimulus program. This precipitated a significant flight of capital from those countries, particularly those running a current account deficit, creating a sell-off in their bond, equity and currency markets. Turkey, Indonesia and India were particularly hard hit. The Fed surprised most market observers in mid-September when it announced it would not pare back the program until it saw move evidence that the U.S. economy's recent improvement would persist which caused a strong rally in global equity markets.
European markets within the MSCI EAFE Index1 picked up after a period of exceptional weakness, although several countries remained in recession and many banks were still insufficiently capitalized and weighed down by bad loans. Among the biggest gainers were Finland, Spain, Austria, Italy, and Ireland. Meanwhile, Japanese equities rallied after a rocky summer with the help of expansionary policies that have fueled healthy gains on a year-to-date basis.
Of the largest emerging markets, China's slowdown appeared to hit a trough, and signs of a recovery moved equities higher by the end of the third quarter, notwithstanding ongoing concerns about the banking sector. Russia and Brazil also advanced in the quarter, but Brazil remained in negative territory for the year. India, which posted another decline, continued its year-long slide.
The best performing sectors in the index included telecom services, materials, and industrials, with a European telecom company leading the way thanks to a buyout offer from a leading wireless services provider in Latin America. Diversified mining companies also posted double-digit gains for the quarter, as did certain energy companies that rallied along with oil prices in response to the unrest in Syria. The lowest sector returns in the index were in consumer staples and health care, where valuations were negatively impacted by higher interest rates, as many companies in these sectors had become "bond proxies" due to their relatively higher yields.
The Fund returned 10.69%, reflecting performance at the net asset value (NAV) of Class A shares, with all distributions reinvested, for the quarter ended September 30, 2013, compared to its benchmark the MSCI EAFE with Gross Dividends Index,1 which returned 11.61%, and the MSCI EAFE with Net Dividends Index,1 which returned 11.56%. Average annual total returns, which reflect performance at the maximum 5.75% sales charge applicable to Class A share investments and include the reinvestment of all distributions, as of September 30, 2013, are: one year: 13.57%; five years: 4.71%; and since inception (December 31, 2003): 5.34%. Expense ratio, gross: 1.47%, and net: 1.12%.
Performance data quoted represent past performance, which does not guarantee future results. Current performance may be higher or lower than the performance data quoted. The investment return and principal value of an investment in the fund will fluctuate so that shares, on any given day or when redeemed, may be worth more or less than their original cost. To obtain performance data current to the most recent month-end, call Lord Abbett at 1-888-522-2388 or visit us at www.lordabbett.com.
Stock selection, particularly within the information technology and financials sectors, contributed to the Fund's overall underperformance versus the benchmark during the third quarter of 2013. From the information technology sector, the Japan-based electronic parts producer, Murata Manufacturing Co. Ltd., saw depressed share prices for the period as a consensus was reached that the upside of providing parts to the latest iteration of smart-phones was already priced into shares. If sales of these smartphones outpace forecasts, Murata could see a quick correcting upward. From the financials sector, Bangkok Bank PCL, a Thailand-based commercial bank, benefited from some positive effects from the postponement of QE tapering; however, the general outlook for commercial banking in Thailand is continued slow growth in the near-term as these banks await disbursement of public funds promised in a government infrastructure investment plan. Another detractor from the financials sector is India-based bank, Axis Bank Ltd. Shares of Axis Bank fell during the period as a result of the tightening of liquidity regulations by the Reserve Bank of India in an effort to control the recent volatility of the rupee. Upcoming elections, unstable economic growth and currency volatility are all taking a toll on the Indian banking sector.
Contributing to relative performance was stock selection within the industrials and health care sectors. From the industrials sector, the Spain-based airline group International Consolidated Airlines Group S.A.'s restructuring of Iberia Air began to pay-off as operating losses for the airline were reduced roughly two-thirds year-over-year. This, coupled with increased intra-European air travel and some positive public relations for British Airways in the announcements of inaugural trans-Atlantic Dreamliner flights, have helped bolster the company's stock price to over 50% for the year. Another holding from the industrials sector, Germany-based integrated technology company Siemens AG, continued its effort to streamline and focus on its core businesses by announcing it is attempting to sell its hearing aid division to private equity firms for an estimated amount of EUR1.2b. Their share price also benefited from winning major contracts in Argentina and Calgary for the creation of a thermoelectric power plant and production of light rail trains, respectively. Within health care, a significant contributor for the period was H Lundbeck A/S, a pharmaceutical company based in Denmark that specializes in the treatment of brain disorders. Clinical data regarding the phase II trials of Lundbeck's Alzheimer's drug, Lu-AE58054, showed significant improvement of cognitive symptoms of Alzheimer's patients when the drug was taken as a supplement with donepezil, an Alzheimer's treatment already available from fellow pharma-company, Otsuka. This study combined with positive sales data of Lundbeck's existing drugs, such as Abilify and Cipralex, helped buoy Lundbeck's shares for the period.
Please refer to www.lordabbett.com under the "Portfolio" tab for a complete list of holdings of the Fund, including the securities discussed above.
As we entered the third quarter, the markets were focused on Fed chairman Ben Bernanke's impending "taper" of quantitative easing. The question at the time was rather "how much?" than "when?" Higher rates and weaker currencies are a toxic combination for emerging market equities, and we significantly reduced our exposure. The markets, too, were very surprised when the Fed chose to take no action in mid-September, and markets rallied in response. We fear that this is only a temporary delay and that barring a significantly weaker economy, the taper is inevitable; thus we remain cautious on the emerging markets front.
In the meantime, we are encouraged by the curtailment of austerity programs in Europe, and we are gaining confidence that the financial crisis there is behind us. We have found several companies whose valuations are still discounting a difficult environment, and we increased exposure to Europe during the quarter.
On a sector basis, we increased exposure to cyclical areas given the continued strength of the U.S. economy and our previously mentioned optimism regarding Europe. Japan remains approximately equal weight at this time, as Prime Minister Shinzo Abe begins his efforts to develop the consensus necessary to enact much-needed economic reforms. Finally, we continue to closely monitor business conditions in China. Recent PMI2 data have been positive, and it appears a soft landing is likely. Further confirmation is needed before we are comfortable making a significant increase in our exposure.
Performance data quoted is historical. Past performance is not indicative of future results. Current performance may be higher or lower than the performance quoted. The investment return and principal value of an investment in the Fund will fluctuate so that shares, on any given day or when redeemed, may be worth more or less than their original cost. To obtain performance data current to the most recent quarter-end, go to quarter ending performance on our Website or call Lord Abbett at (888) 522-2388.
1 The Fund’s dividend yield is shown without sales charges (at NAV) and with maximum sales charges (at MOP). The Fund’s dividend yield takes into account any fee waiver or expense limitation arrangements, if any. Without such fee waivers or expense limitation arrangements, the Fund’s dividend yield would have been lower. Information regarding any fee waivers or expense limitation arrangements applicable to the Fund is provided with the Fund’s expense ratio information.
2 The Fund’s unsubsidized dividend yield is shown without sales charges (at NAV) and with maximum sales charges (at MOP). The Fund’s unsubsidized dividend yield reflects what the yield would have been without the effect of fee waivers or expense limitation arrangements.