MARKET RECAP
The broad equity markets finished the third quarter only modestly higher than where they started. Beneath that surface, however, lay a massive rotation and considerable intra-quarter volatility. In July, the AI and momentum trade that had powered markets through the first half of the year unwound sharply, as questions about the payoff from record AI spending collided with heavily leveraged positioning. Market leadership broadened from July through August as capital returned to areas that had been left behind, before narrowing again in September toward U.S. technology.
Two macro forces shaped the backdrop throughout. Renewed conflict in the Middle East left oil roughly 40% higher over the quarter, with the Strait of Hormuz yet to fully reopen. Additionally, inflation pressures persisted, fed in part by energy, and led the Federal Reserve (Fed), European Central Bank (ECB), and Bank of Japan (BOJ) to raise rates within days of one another in September. In the Fed's case, it was the first increase since 2023. Long-term yields rose as well, with the 10-year Treasury above 5%.
Our Funds outperformed their benchmarks during the quarter, though both remain well behind for the year. The gains came from stock selection in a quarter when growth lagged value. In International, what had worked against us in the second quarter worked in our favor in the third, as the memory stocks we did not own sold off. Moreover, as the AI infrastructure trade cooled, the intact but de-rated franchises we own benefited when leadership broadened. This was most notable in health care, where WuXi Biologics, BeOne Medicines, and Genmab rose sharply, and separately at Recruit, which is using AI to deepen its competitive advantage. Our other software and digital holdings, the area most questioned in recent quarters, were steady if less dramatic contributors. And our Greater China holdings far outpaced a local market that rose moderately. However, our AI infrastructure holdings lagged in this environment too, and our lack of exposure to energy weighed on results as oil prices rose.
During the quarter, we also continued to rebalance the portfolios. We further reduced our exposure to AI infrastructure, trimmed biotech after a strong rebound to reduce specific risk, and reduced several other positions, redirecting the proceeds toward businesses where our conviction is highest and valuations remain compelling. We added to 3i, Adyen, AIA, Constellation Software, and Suzuki. We also initiated a position in Linde, a high-quality and durable industrial gases compounder whose long-term contracts and pricing power have supported consistent growth across cycles.
These decisions reflect a process that has not changed. We are long-term investors in businesses with durable competitive advantages, healthy margins, strong balance sheets, and consistent cash generation. We do not position for rotations in market leadership; we measure our holdings by the progress of their businesses. Much of the pressure on our holdings this year reflected compressed valuations rather than deteriorating earnings, and this quarter offered early evidence of that gap beginning to close.
See more: Foreign ETFs Draw Nearly Double U.S. Large-Cap Flows
OUTLOOK
The fourth quarter begins with several pressures still in place, including an unresolved conflict in the Middle East, elevated oil prices, and central banks inclined to tighten further. Against that backdrop, one of the central questions is whether the recent broadening in stock performance marks a durable shift in market leadership or a pause in a market still led by a narrow group of AI beneficiaries.
We do not think that question is settled. Just as July and August showed how quickly capital can return to health care, software, and digital businesses, September showed how quickly capital can return to semiconductors and the largest U.S. technology companies. AI spending and profits are still growing at a pace that keeps drawing investors toward the companies building the infrastructure. At the same time, the conditions for a broader market have improved. The global economy remains resilient, investor positioning is cleaner after the summer's unwind, and the valuation gap between the market's leaders and everything else remains wide.
In the U.S., the Fed has set a high bar for confidence that inflation is returning to its target, and it has signaled that further tightening may follow. The risk is two-sided. Underlying inflation has eased since the first half of the year, and the economy remains strong, but higher rates and expensive gasoline will test consumers whose confidence is already weak. Tariffs remain a persistent cost rather than a new shock, and the midterm elections in November add another source of policy uncertainty.
In Europe, Germany's fiscal expansion and rising defense spending continue to support activity, and growth has held up through this year's energy shock. Against that, inflation has moved back above the ECB's target, markets expect further tightening, and France's fiscal politics remain a source of volatility. Europe's path from here depends heavily on energy prices, and therefore on events in the Middle East.
China's policymakers stepped up support again, but the economy's underlying split has not changed. Exports and advanced manufacturing remain strong while household demand and credit growth are weak. Relations with the U.S. have stabilized for now under the extended trade truce, though proposed new restrictions on technology trade show how quickly friction can return. The shift toward household consumption that Beijing has prioritized remains the key uncertainty.
AI remains a profound secular trend, and the debate over the durability of the spending behind it continues. We continue to own the indispensable semiconductor manufacturing enablers, TSMC and ASML, alongside automation leaders Keyence and Fanuc, though at reduced weights after completing another round of trimming. They give us exposure to the buildout without having to predict which platforms ultimately win.
We avoid businesses where AI threatens an existing competitive advantage. And we are willing to own high-quality companies where we believe the market overestimates the risk of disruption. Recruit, whose Indeed platform is using AI to improve job seeker matching while raising what employers pay for it, is the clearest example in our portfolios.
The valuation compression in many of our holdings this year was a judgment by the market about terminal value. In pricing many of our companies as casualties of AI, the market was asserting that their competitive advantages would erode, that their businesses would be disrupted, or that their addressable markets would saturate sooner than we believed. Our re-underwriting earlier this year tested each of those assertions company by company. Where we concluded the market's judgment was wrong, we held, and in several cases we added. This past quarter supported our judgment in many cases, though not yet in all. We continue to hold meaningful positions in software and digital platforms, health care, and Greater China, the areas that weighed most on results earlier in the year.
In health care, the businesses that had fallen precipitously earlier in the year have recovered, as investors refocused on fundamentals. WuXi Biologics and BeOne Medicines continue to execute well and increasingly benefit from Chinese biopharma’s emergence as a source of innovation that global drugmakers license, and Genmab's proprietary pipeline gives it a path well beyond its Darzalex royalties.
Most of our software and digital holdings also advanced this quarter, though several have yet to be re-rated. September's renewed fears that AI agents could disrupt software and financial services were a reminder that the debate is not over. Our view has not changed. The distinction that matters is between technological vulnerability and structural durability, and an agent still has to act on a system of record. The moats of Constellation Software, Temenos, Adyen, and Sea are built on deep customer integration, regulatory complexity, and network scale, and these businesses remain too critical to daily operations and revenue generation for their users to rip and replace. The wide gap between the fundamentals of Adyen and Constellation Software and the valuations the market had placed on them this year gave us the opportunity to add to both.
Our Greater China* holdings, roughly 21% of International and 14% of Global, remain deliberate overweights and individually underwritten. They are concentrated in secular growth areas of the domestic economy, primarily private consumption, internet, and health care, that align with government priorities. The companies have strong balance sheets, resilient cash flows, and business models driven by domestic demand rather than Western technology inputs. We believe their valuations more than compensate us for the macro risks. Alibaba and Tencent, the latter held through our investment in Prosus, continue to invest in highly profitable core franchises to extend their positions in cloud and AI within China. KE Holdings remains the entrenched real estate platform in a stabilizing housing market, and AIA is the largest pan-Asian life insurer. Both are driven by household demand rather than exports.
The first half of the year tested whether our holdings could sustain their earnings through a rapidly changing technology environment. The third quarter saw the market begin to reward the fact that they did. We anticipate that process to be uneven, and we retain our conviction in our re-underwriting discipline. International markets also continue to trade at a considerable discount to the U.S., which is not a thesis in itself but improves the odds. With most of the gap between our holdings' prices and their earnings power still open, we believe the setup remains attractive for patient capital over our five-year investment horizon.
*Includes China, Hong Kong, and Prosus.
3i Group had a 2.88%, Adyen 3.85%, AIA Group 2.16%, Alibaba Group 3.14%, ASML 5.21%, Constellation Software 3.81%, KE Holdings 3.86%, Keyence 4.20%, Linde 1.28%, Prosus 2.83%, Sea Limited 3.29%, Suzuki 2.76%, Taiwan Semiconductor 8.46%, Temenos 2.58%, and Tencent 0.00%, weighting in the International Fund as of 9/30/2026. 3i Group had a 2.15%, Adyen 2.63%, AIA Group 1.59%, Alibaba Group 1.78%, Constellation Software 3.14%, Incyte 4.03%, KE Holdings 2.33%, Keyence 2.13%, Linde 1.04%, Mastercard 3.89%, Micron 1.75%, Nvidia 2.50%, Prosus 1.94%, Sea Limited 2.03%, Suzuki 2.04%, Taiwan Semiconductor 5.76%, Temenos 1.07%, and Tencent 0.00%, weighting in the Global Fund as of 9/30/2026.
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