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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 11.78%, reflecting the performance at the net asset value (NAV) of Class A shares, with all distributions reinvested for the quarter ended September 30, 2013. The Fund's benchmark, the S&P Developed Ex-U.S. Small Cap® Index,2 returned 14.57% in the same period. 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: 19.72%; five years: 10.59%; and 10 years: 9.12%. Expense ratio: 1.52%.
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, stock selection from the financials and energy sectors was the reason for the Fund's relative underperformance, versus the benchmark, during the third quarter of 2013. Within the financials sector, shares of Rizal Commercial Banking Corp., a Philippines-based bank, were hurt when Moody's downgraded Rizal's subordinated debt rating, based on the notion that the Philippine government may no longer be as willing to supply support to those banks involved in this class of debt. Though this downgrade is not a reflection of Rizal's otherwise strong operations, according to Moody's, it would appear the shares of the bank are being pulled down due to an overall negative market sentiment toward the Philippine banking industry. Another holding from the financials sector, Takara Leben Co. Ltd., a Japan-based real estate company, reported poor sales and profit numbers for its fourth quarter fiscal year as compared to a year ago. While earnings were lower, it is believed that it was an anomalistic quarter as the company benefitted from low land prices and low levels of competition geographically. Takara is also ramping up for share buybacks in the near-term. Within the energy sector, Electromagnetic Geoservices ASA, a Norway-based electromagnetic technology company that performs research for oil and gas companies, saw its shares remain depressed as oil-drilling firms have unexpectedly begun reining in spending due to unpredicted rises in costs.
Contributing to relative performance was stock selection in the consumer discretionary and telecommunication services sectors. Within the consumer discretionary sector, shares of YOOX SpA, an Italy-based online retailer, rose dramatically in July thanks to a very strong earnings report highlighted by an 18.5% increase in revenues and a nearly 39% increase in its core earnings for the first half of 2013. CEO Federico Marchetti credits the positive earnings to sales made on mobile phone applications and sites. Another contributor from the consumer discretionary sector was Plastic Omnium SA, a French plastic processor specializing in auto exteriors and waste containment. Plastic Omnium saw a surge in its share price in July after they announced outstanding results for the second quarter. The company continued to win market share and see its content per vehicle grow through the third quarter and as a result, Plastic Omnium announced a three-for-one share split in September; a decision that pleased investors. Within telecommunication services, Japan-based communication services company Okinawa Cellular Telephone Co. produced a strong earnings report that showed the first revenue increase in five years. This helped to push the company's operating profits up over 33% versus the same period in 2012.
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 the portfolio's 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 PMI3 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 the portfolio's 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.