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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 10.59%, 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 All Country World Ex-U.S. Value Index with Gross Dividends,2 which returned 11.45%, and the MSCI All Country World Ex-U.S. Value Index with Net Dividends,2 which returned 11.36%. 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: 11.05%; five years: 4.64%; and since inception (6/30/2008): 0.88%. Expense ratio, gross: 1.36%, 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.
Overall, weak stock selection from the consumer staples and utilities sectors was the reason for the Fund's relative underperformance, versus the benchmark, during the third quarter of 2013. Within consumer staples, Tate & Lyle plc, a United Kingdom-based food and beverage ingredient provider, came under pricing-pressure from two Chinese generic sucralose manufacturers. On the sales front, 80% of Tate and Lyle's sucralose profits can be tied to the U.S.3, where an increased demand for healthy, all-natural food and beverages are steering consumers away from products produced with artificial sweeteners. Metcash, Ltd., an Australia-based grocery, liquor, hardware, and automotive parts wholesale distributor, was also a significant detractor from the consumer staples sector. This major player in the consolidated supermarket industry faced earnings forecast reductions as it would appear their competitor's ability to pair their stores' discount cards with their wholly-owned network of petrol stations has shifted customer loyalty toward the savings their competition provides and put Metcash at a temporary disadvantage. Utilities holding Spark Infrastructure Group, an Australian-based electricity distributor, had positive sentiment regarding their previous quarter results erased by an Australian Taxation Office audit of their 2008-10 tax years. This audit will remain in the forefront for the foreseeable future as it could have considerably negative repercussions on their free cash flow given any potential additional tax liabilities.
Contributing to relative Fund performance was stock selection within the telecommunication services and materials sectors. Shares of Koninklijke KPN NV, a Netherlands-based telecommunication services provider, rose to a price target of EUR2.4, which represents a potential offer price by Mexican telecom group, America Movil. Also from the telecommunication services sector, Israel-based Bezeq-Israeli Telecommunication Corp. Ltd. met 2Q13 estimates which had a dramatic effect on Bezeq for the third quarter. Also, the telecom provider was able to produce enough free cash flow to announce the 6th and final installment of a dividend program announced in 2010 for shares that do not meet their profit test. From the materials sector, UPM-Kymmene, a Finland-based pulp, paper, and timber manufacturer performed well after it announced in August an improved profit target of roughly EUR400M from existing business. Key sources of growth include biofuels and woodfree specialty papers and expanded production from existing mills. Investors rewarded the announcement and efforts with increased share-purchasing throughout the third quarter.
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 PMI4 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.