The global economy appears to be recuperating from the Great Recession. At the same time, regional and national recovery rates, somewhat predictably, have been far from synchronized. Industrialized nations, with the United States at the forefront, have been mending faster than many emerging markets, although parts of Europe remain sluggish. What might this uneven recuperation mean for investors? The editors of Capital Acumen asked three portfolio managers with significant international investing experience to weigh in.
U.S. Trust International
Focused Equity Portfolio
Michael J. Kirkbride, Portfolio Manager
Michael, how has your team responded to the uneven global recovery?
Michael Kirkbride: The past few years have been difficult overall for international markets relative to the U.S. markets. Within the International Focused Equity Portfolio, we have generally benefited from a focus on high-quality companies with reasonable valuations. We look for companies with transparency and liquidity, which allow us the comfort of knowing that we can buy and sell with few if any issues. We also invest with a belief that U.S. markets will not always outperform and that emerging markets will strengthen and, in time, appear more attractive.
Regional differences in financial reporting and operating currencies add an element of currency risk.
How do you moderate the risks often associated with international investments?
Kirkbride: First of all, let’s talk about some of those risks. Companies that we seek to invest in generally operate in many different countries, selling to vastly different consumers, and are exposed to varying degrees of macroeconomic risks at any given time. In addition, regional differences in financial reporting and operating currencies add an element of currency risk. In order to better understand these types of risk, we look at portfolio exposures on a number of levels. We review sources of company revenue by examining their operating segment, region of domicile, home currency, and operating currency. Understanding the portfolio’s exposures is key to achieving diversification and sound risk management.
How do U.S. Trust “themes” fit into your approach?
Kirkbride: U.S. Trust has a number of long-term themes that our team feels will play out over coming business cycles; and we’ll often seek to invest in companies that tie into those themes. It’s a blend of the bottom-up research and the top-down macro work U.S. Trust’s thought leaders have produced. One theme that’s key for us is the emerging markets middle-class consumer. It’s one reason we’ve had a fair amount of exposure to areas such as Chinese Internet companies and high-end luxury brands, which we consider related-growth areas. These areas have driven Asian markets for some time now, and could continue to do so into the future. But, again, we would advise to not invest blindly. Selecting what, in our view, are the right companies with the right market position and management is essential.
Describe some of the risks and opportunities you see over the medium to long term.
One theme that’s key for us is the emerging markets middle-class consumer.
Kirkbride: One area of concern, especially in Europe, is deflation. Several companies we’re familiar with there have been experiencing significant pricing pressure — worse than they did during the financial crisis. So we’re watching to see if the data points indicate a greater economic challenge or are more industry-specific in nature. In terms of opportunities, China’s gross domestic product has come down a great deal compared to recent peaks, but its per capita income has been climbing. Gaining exposure to the increase in consumer spending that will likely accompany that climb will arguably remain one of the most important investment themes over the next few years.
Charles Wilson, Portfolio Manager
Charlie, what are some highlights of your strategy?
Charles Wilson: Our Thornburg International ADR Strategy seeks long-term capital appreciation by investing in American Depositary Receipts or other dollar-denominated securities that are economically tied to international markets. When we’re evaluating companies, we look for global industry leaders, who usually benefit from their position through pricing power, higher profitability and capital efficiency.
You often use a three-basket strategy. What are the advantages?
Wilson: Our approach is a flexible valuation strategy, which allows us to consider companies across a spectrum from growth to value. For a fast-growing emerging franchise, the first basket, we might look for robust revenue or earnings growth. The second basket is made up of companies that demonstrate sustained earnings growth and provide ballast to the portfolio. The third basket is focused on traditional value stocks. The three-basket philosophy helps us to construct portfolios that continue to perform in different market environments.
How do you respond when an idea doesn’t pan out as planned?
Wilson: We think it’s important to recognize as early as possible when forecasts are wrong and to be honest about it. We recognize that we work with substantial uncertainty. Our team tries to protect our investments by identifying ways we can still be successful with an investment, even when it doesn’t play out as we originally expected.
Where are you looking for opportunities today?
Wilson: One area we like is the semiconductor manufacturing market. It’s getting increasingly expensive and technically challenging to keep shrinking semiconductor chips. That’s creating opportunities for the companies with strong technical capabilities and strong balance sheets. There would normally be three or four companies on the leading edge of an industry, but due to higher capital intensity and increasing technical challenges, two have pulled into the lead. That market leadership has manifested in market share gains and sustained pricing power.
We look for stocks that can improve the overall diversity of the portfolio.
What would you like to see happen to the cash many companies have been stockpiling lately?
Wilson: We usually think that management teams should use cash surpluses in ways that can provide the highest return, ideally in areas they already know well. That might be building new growth projects or buying other companies. If there are no opportunities out there, we like to see the cash returned to shareholders, which could mean share buybacks or dividends.
MainStay Epoch Global Equity
Shareholder Yield Strategy
Eric Sappenfield, Portfolio Manager
Eric, when you’re looking for investment opportunities, where do you start?
Eric Sappenfield: We start by running a screen of the world’s stock markets every Monday morning. We look at stocks in the screen and ask one simple question: Can this stock improve the overall outcome of the portfolio? We look for certain important factors, including a history of attractive dividend yields, positive growth in operating cash flow, share buybacks and debt reduction. We also look for stocks that can improve the overall diversity of the portfolio.
What’s the next step?
Sappenfield: Once we decide that a company’s stock can improve the portfolio, we assign it to a fundamental analyst. Before we make a purchase, we analyze the quality of the business, company management, profitability, the strength of the balance sheet, and the external forces that may affect day-to-day business. We try not to rely on future projections beyond two or three years. Another precaution is diversification. The portfolio does not rely on any single security to achieve its targets for shareholder yield and the underlying growth of free cash flow.
Do you meet with management?
Sappenfield: Yes. We find out their intentions and approach to opportunities ahead of them. We establish expectations about cash flow and how they plan to allocate excess capital. Then we measure management against their promises, which gives us confidence about dividends, share buybacks, debt reduction and other actions that we believe can create returns on equity.
What impact do macroeconomic issues have on your stock picks?
Sappenfield: We’re always concerned about macroeconomic influences, such as oil prices or the level of consumer discretionary spending. We try to understand the risks and discover new things that we didn’t know, because they can affect the companies we own or are considering.
We try to understand the risks and discover new things that we didn’t know.
What’s the mix of U.S.-based and foreign companies in your portfolio?
Sappenfield: About half the companies in our portfolio are U.S.-domiciled. But the percentage of companies, both domestic and foreign, with global reach is far greater. The portfolio’s exposure to various countries or regions in an economic sense is more diversified than what a list of companies and where they are domiciled might suggest.
How about direct investment in emerging markets?
Sappenfield: We acknowledge that emerging economies may have a higher growth rate than developed ones. Yet we maintain very little direct exposure to emerging markets, because emerging markets carry greater risks. They tend to be less liquid and more volatile, and sometimes local laws do not provide the same level of protection for investors as those in developed markets. Yet, emerging markets can be a significant source of profit and revenue for companies with global reach. One way to potentially capture some of that profit with less risk is to invest in companies that are “global champions,” which are domiciled in developed markets but have substantial and growing businesses in emerging markets.
For more information on these investment strategies, and on the special risks that can accompany international investing, please contact your U.S. Trust advisor.
Investing involves risk. There is always the potential of losing money when you invest in securities.
Projections made may not come to pass due to market conditions and fluctuations.
Past performance is no guarantee of future results. Asset allocation, diversification and rebalancing do not ensure a profit or protect against loss in declining markets.
Any information presented about tax considerations affecting client financial transactions or arrangements is not intended as tax advice and should not be relied upon for the purpose of avoiding any tax penalties. Neither U.S. Trust and its representatives nor its advisors provide tax, accounting or legal advice. Clients should review any planned financial transactions or arrangements that may have tax, accounting or legal implications with their personal professional advisors.
Always consult with your independent attorney, tax advisor, investment manager and insurance agent for final recommendations and before changing or implementing any financial, tax or estate planning strategy.
OTHER IMPORTANT INFORMATION
Equity securities are subject to stock market fluctuations that occur in response to economic and business developments.
Stocks of small and mid cap companies pose special risks, including possible illiquidity and greater price volatility, than stocks of larger, more established companies.
International investing involves special risks, including foreign taxation, currency risks, risks associated with possible differences in financial standards, and other risks associated with future political and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility.
Dividend payments are not guaranteed. The amount of a dividend payment, if any, can vary over time.