Closed Energy Gap, Added to Rate-Sensitive, Resilient Stocks

We believe the market's focus on current shorter-term concerns resulted in less consideration being given to longer-term fundamental attractions. As we enter a slower economic environment, the investment attractions of companies with a more sustainable growth outlook should become stronger. We added energy to the portfolio to reduce the risk posed by the wide range of outcomes for oil and gas and the potential paradigm change in productivity. We strengthened several positions where idiosyncratic attractions combined with a degree of protection against higher rates, inflation, and recession. We continue to defend those holdings that have been derated but where the business remains fundamentally robust and may even be stronger after recent events. We began to trim strong performers, particularly among our financial holdings, to raise cash for new opportunities that might arise in the market downturn.

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We initiated positions in six names and eliminated three over the quarter. The materials and financials sectors remain our largest allocations; our smallest is consumer staples. In country terms, we are most exposed to Italy and Sweden and least exposed to France and Denmark.

Energy

We reduced our underweight in energy because we were not comfortable with the risk posed by the wide range of outcomes for oil and gas and the potential paradigm change in productivity.

• We initiated a position in Totalenergies, a France-based oil and gas company that operates in exploration, production, gas, renewables and power, refining and chemicals, and marketing and services. The company has one of the most balanced transition strategies, with continued hydrocarbon growth as it shifts to more low-carbon energy production. The company is well managed, has strong fundamentals, and is undervalued compared with its peers. We believe the market will eventually reward consistently good returns and a sustainable dividend.
• We opened a position in Equinor, a Norwegian integrated upstream oil and gas company that is a leader on climate issues in the energy sector and is accelerating its push into renewable energy to meet its 2050 net zero goal. It has a growing offshore wind business and plans to ramp up spending on renewables. It also aims to be an industry leader in carbon transportation and storage and in the production of clean hydrogen.

Consumer Discretionary

We adjusted our positions in the consumer discretionary sector amid signs that high inflation, surging costs, and an economic slowdown are reducing disposable income, particularly in Europe.

• We exited luxury and sports goods names that may struggle in a downturn, such as Adidas, which relies mostly on sportswear, and Kering, which has benefited from a recovery of Gucci that could falter. We recycled the funds into a new position in LVMH Mo�t Hennessy Louis Vuitton, which we view as a safer bet because of its broad portfolio of brands. So as not to increase our active bet on luxury with these moves, we reduced our position in Prada.

Information Technology

We reduced our exposure to the information technology sector, taking some profits on companies that have performed well. The sector rose in July as the market bounced up but then underperformed as rising interest rates raised concerns that the economy might slide into a severe slump that would weigh on high-growth technology companies.

• We trimmed our holding in Edenred, a supplier of prepaid vouchers to employees, after strong performance. A resumption of business travel, particularly in Latin America, boosted earnings. This coincided with the rollout of the "beyond fuel" strategy (a single-payment system that allows clients to navigate a full network of toll roads), which has proved popular with corporate clients. The company's products and services generally rise in tandem with inflation, which has helped the company ride out current conditions.

Industrials and Business Services

We reduced our overweight to industrials and business services, which has suffered as interest rates rose and an economic slowdown deepened. In our view, the sector contains many high-quality cyclical names that have discounted the bad economic news.

• We initiated a position in Daimler Truck Holding, attracted by what we believe is an extremely attractive risk/reward trade-off that discounts most of the bad macroeconomic news. The market is severely undervaluing the shares, in our view, partly because of a reputation for lackluster performance when it was part of the parent and because multiples for the stock have been distorted by the timing of the initial public offering just ahead of the outbreak of war in Ukraine. Management has made significant progress achieving fixed-cost reduction targets and increasing prices, which should significantly improve margins. Although we are cautious about the direction of orders, there is pent-up demand partly caused by fleet renewal that could boost them.
• We also added to a high-conviction position in Epiroc, a services provider to the global mining and infrastructure markets, but we trimmed some names that have had a strong run, including Flughafen Zurich, the largest airport in Switzerland; Prysmian, a leading cable manufacturer; and Rockwool International, a manufacturer of stone wool for insulation and other applications.
• We exited Airbus, Europe's largest aerospace and defense company, due to a governance issue after the company unexpectedly announced the departure of a senior official.

Materials

The materials sector benefited from a pickup in the paper and packaging industry, which was able to raise prices to counter strong cost pressures, and a pickup in basic metals driven by increased construction activity in China as the impact of coronavirus lockdowns in the second quarter waned.

• We decided to increase our exposure to pulp and reduce it to paper and packaging. We added Svenska Cellulosa, the largest private forest owner in Europe and a producer of forest products such as paper and pulp, to the portfolio. We increased our position in Mondi, an international integrated paper, board, and packaging producer, which should benefit from price increases. We reduced our allocation to Mayr-Melnhof Karton, Europe's largest producer of cartonboard used in consumer packaging, which is also heavily exposed to natural gas?an energy source that has been restricted by Russia?and Verallia, Europe's largest maker of glass containers, which is being affected by shortages of materials.