MARKET RECAP
The first quarter was defined by overlapping macro shocks and a violent shift in market leadership, punctuated by the war in Iran and the closure of the Strait of Hormuz. As capital surged into physical assets such as energy, materials, and defense, software and other digital businesses faced a historic repricing. The market indiscriminately reassessed terminal values of these capital-light platforms on fears of AI disruption. Despite the turmoil, international equities outperformed U.S. equities by a wide margin.
This was a deeply challenging quarter for our portfolios, and we want to address the results directly. Our significant underperformance against the benchmarks was driven not by broad fundamental deterioration, but by the specific intersection of two forces: AI disruption fears and a sharp rotation into physical-asset sectors where we have minimal or no exposure. Nearly two-thirds of the underperformance is attributable to this combination. Specifically, our capital-light holdings experienced severe multiple compression as we underestimated the speed at which the market narrative would shift from viewing AI as a complement to pricing AI as an existential threat.
We responded constructively and decisively by applying our standard re-underwriting discipline to a rapidly evolving post-AI landscape and executing a thorough portfolio triage. We fully exited Atlassian and Tata Consultancy, where long-term economics became too opaque to underwrite with confidence, and we exited Novo Nordisk and HDFC Bank on separate fundamental concerns, protecting capital as several of these positions continued to decline materially post-sale. We maintained our conviction in mission-critical vertical market software, specifically Constellation Software and Temenos. We also concentrated capital into Taiwan Semiconductor further, meaningfully increasing our stake in what was already our largest holding. Combined with price appreciation in ASML and Brookfield Renewable, this increased our tilt toward AI infrastructure beneficiaries. Finally, we initiated new positions in AIA Group and 3i Group. The valuation reset across our remaining holdings provides, in our view, a compelling entry point for our five-year investment horizon.
OUTLOOK
Looking ahead, we enter the second quarter navigating a more uncertain environment than at any point since the pandemic. The key unresolved question is whether the Strait of Hormuz reopens, a single variable that will largely determine whether the current stagflationary impulse fades or deepens. Compounding this risk are structural shifts in trade policy, central bank credibility, and the AI competitive landscape for digital businesses.
In the U.S., the Fed faces its most constrained policy environment in years. With the vast majority of Fed officials projecting at most one rate cut in 2026, the easing cycle has effectively stalled. The Fed is navigating a true two-sided risk. Rate hikes remain possible if tariff and energy-driven inflation reaccelerates, but a quietly deteriorating labor market argues for patience. Furthermore, Chair Powell’s term expires in May, and the impending leadership transition introduces a layer of uncertainty at a sensitive macroeconomic juncture.
The most likely catalyst for an upside inflation surprise remains tariff pass-through. While the Supreme Court’s recent ruling lowered the effective tariff rate from its peak, the administration's temporary replacement measures expire in late July, creating a looming policy cliff. Businesses have thus far absorbed a portion of these costs, but those margin buffers are depleting. Paired with an oil shock that has driven U.S. gasoline back above $4 per gallon, this dynamic acts as a highly visible, regressive tax on a consumer already contending with the highest effective tariff burden since the 1940s.
Europe presents a more constructive but fragile outlook. Germany’s historic fiscal pivot represents the most significant expansion in the country’s postwar history and is expected to add meaningfully to eurozone growth through the end of the decade. European manufacturing has returned to expansion, and defense budgets across the continent are rising rapidly. However, a second energy crisis in four years has exposed the region’s continued vulnerability. With natural gas storage sitting well below seasonal norms and March’s flash inflation accelerating to 2.5%, the ECB has kept all policy options on the table. The fiscal tailwind is real, but so is the energy headwind, and the balance between them will determine European market performance.
China faces a pivotal year. Policymakers have lowered their growth target to a record low of 4.5% to 5% while elevating domestic consumption to their top priority. A record trade surplus in 2025 underscored an unsustainable reliance on exports, signaling that a structural pivot toward household income growth is overdue. While the yearslong property downturn continues to weigh on confidence, consumer price inflation has turned modestly positive. Stimulus measures remain targeted rather than transformative, making the execution of this consumption pivot the key uncertainty. Given China’s unique ability to source discounted, sanctioned crude, a protracted Middle East conflict may actually provide the country with a relative industrial cost advantage that Western economies lack.
Within our international and global portfolios, approximately 20% and 13% of assets, respectively, are invested in Greater China* holdings, both significant overweight positions relative to their benchmarks. We believe these companies trade at valuation levels that more than compensate us for the macro risks. Our Chinese holdings are concentrated in secular growth areas of the domestic economy, primarily private consumption and health care, that align directly with government priorities. They boast strong balance sheets, resilient cash flows, and business models fundamentally driven by domestic consumer behavior rather than direct reliance on Western technology inputs.
Our investment strategy focuses on companies with strong competitive advantages, healthy profit margins, robust balance sheets, and consistent cash flow generation. While our commitment to these fundamentals remains absolute, the recent quarter served as a humbling reminder of multiple compression risk when market narratives violently shift. Crucially, the underlying earnings power of our portfolio remains intact. The drawdown experienced was fundamentally a function of multiple compression, not earnings deterioration. Historically, concentrated quality portfolios that endure this type of sentiment-driven dislocation are well-positioned for recovery as valuations normalize. And we have used this volatility to trade up in quality and concentrate capital where we have the highest conviction. Valuation is the raw material of future returns, and we believe this reset provides a highly attractive entry point. We believe our portfolio companies are poised to compound shareholder value over our five-year investment horizon.
Given the severity of the first quarter’s rotation, it is reasonable to ask why we maintain a meaningful commitment to capital-light software and platform businesses. The answer is rooted in our distinction between technological vulnerability and structural durability. Through active portfolio decisions and the quarter’s price action, we have balanced our “perceived AI winners” to our “perceived AI losers.”
Within our software sleeve, we have narrowed our exposure into mission-critical or regulated systems of record, specifically Constellation Software and Temenos. These businesses operate in environments where deep customer integration and regulatory complexity create formidable barriers to entry. In these arenas, the operational risk of replacing a niche vertical software application or core banking architecture often outweighs the cost savings or untested product features offered by AI tools. Business customers are more likely to maintain these established systems of record.
Similarly, the market aggressively de-rated our holdings in payments, gaming, marketplaces, and network-effects businesses, including Adyen, Sea Limited, Recruit Holdings, and Prosus, treating them as another swath of casualties of the AI disruption narrative. We view this terminal value assessment as materially disconnected from these businesses’ operational realities. The competitive moats for these companies are built on network effects or scale, which have entrenched their market dominance and heightened switching costs. Adyen provides the core digital payments infrastructure for global merchants, an architecture simply too critical to daily revenue generation to rip and replace. Sea operates the dominant retail e-commerce marketplace in Southeast Asia and Taiwan, controlling nearly 50% of the market share. Recruit functions as a deeply integrated classifieds network sitting squarely between employers and job seekers. Prosus, through its core holding in Tencent, operates the undisputed leading messaging and social media platform in China, serving as the essential communications and payments infrastructure for businesses, alongside owning a massive gaming library. We maintained these holdings through the drawdown because their underlying revenue growth, operational execution, and unit economics remain robust. We believe the market’s draconian pricing of their terminal value creates a compelling risk-reward profile, provided these businesses maintain their operational execution as expectations normalize.
Some of the most promising growth opportunities over long investment horizons may not be heavily influenced by current global events. While our long-term secular themes, including cloud computing, digital transformation, and software-as-a-service, remain valid, the current environment requires intense selectivity. Today, we are finding the most legible paths to compounding value in the infrastructure required to power the AI revolution, specifically advanced semiconductors, data centers, and renewable power generation. In our view, slowing global economic growth and short-term multiple compression should not undermine the enduring strength of these specific models and the market positions of the companies in our portfolios.
U.S. market valuations remain significantly elevated, with the cyclically adjusted price-to-earnings ratio near historical peaks. In contrast, international markets trade at considerably lower valuations, offering a better starting point for expected future returns. A softening of the dollar would provide an additional tailwind. We believe our focus on international equities aligns perfectly with the current environment. We remain confident that our selective approach and emphasis on quality will effectively mitigate macro-related risks, while capitalizing on secular growth and valuation-driven opportunities.
*Includes China, Hong Kong, and Prosus.
3i Group had a 0.92%, Adyen 2.55%, AIA Group 1.47%, ASML 4.45%, Atlassian 0.00%, Brookfield Renewable 4.70%, Constellation Software 2.81%, HDFC Bank 0.00%, Novo Nordisk 0.00%, Prosus 3.37%, Recruit Holdings 2.60%, Sea Limited 2.84%, Taiwan Semiconductor 8.51%, Tata Consultancy 0.00%, Temenos 2.74%, and Tencent 0.00% weighting in the International Fund as of 3/31/2026. 3i Group had a 0.69%, Adyen 1.86%, AIA Group 0.97%, ASML 3.95%, Atlassian 0.00%, Brookfield Renewable 2.99%, Constellation Software 2.32%, 3.88%, HDFC Bank 0.00%, Novo Nordisk 0.00%, Prosus 2.37%, Recruit Holdings 1.64%, Sea Limited 1.89%, Taiwan Semiconductor 4.86%, Tata Consultancy 0.00%, Temenos 1.27%, and Tencent 0.00% weighting in the Global Fund as of 3/31/2026.
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