A tough time to hold your nerve

Australian Financial Review, Managed Funds Quarterly, August 2008

Fund managers in international equities are facing a stern test of nerve. Their results, in line with global stock markets and a weak US dollar, look appalling. But they know that if they get their selections right now, they’re going to look like geniuses in a couple of years.

“Great money is made when people are being contrarian,” says Bill Barbour at Deutsche Asset Management, whose areas of coverage include Deutsche’s Global Thematic fund. “We are setting this up [the fund’s portfolio] with a two to three year view.”

He adds: “We can see companies that are severely undervalued. There is 30, 40, 50% upside for markets, and within that 100% upside for some stocks. It’s not if, but when. The key thing is the when, and how much lower markets go before it happens.”

According to Mercer Investment Consulting, the Deutsche fund lost 24.2% in the year to June 30, below the median core-styled global equities fund performance of a 20.9% loss (and, indeed, below the market: the MSCI World ex-Australia is down 21.3%). Its longer term numbers, such as a return of 9.4% annualised over the last five years, show the benefits of trying to think of a distant horizon, but it can be painful at the moment.

The Deutsche fund bases its selections on a number of key themes, such as the emergence of three billion new consumers in places like India, China and Latin America, or the growth in global agribusiness on the back of population and wealth growth alongside increasingly limited land. Other themes include talent and ingenuity, “based on the idea that until recently we had an abundance of capital where any fool could borrow $1 billion and take over an airline,” as Barbour puts it. That’s now changed, but Deutsche sees merit in investing in companies known for their ability to attract and nurture cleverness, among them Goldman Sachs, Apple and Porsche.

In practice, these themes give the fund a portfolio more skewed towards emerging markets than most: almost 30% of the fund goes here, including 16.4% in Asia and 8.8% in Latin America; North America accounts for just 27%, compared to 52% in the MSCI index. The biggest holding is the vast Russian gas utility Gazprom; others include the Indian bank, ICICI, and the Swiss group Bank Julius Baer, which is a beneficiary of Middle Eastern money and the rising oil price.

Of core-style funds, only one made a positive return in the year to June 2008 according to Mercer: the RCM Global Equity Unconstrained fund, which returned 0.3%. Portfolio manager Paul Schofield explains the fund has benefited from its flexibility, with no requirement to track a benchmark; furthermore, it is allowed to go heavily into cash, and today has around one third of the fund deployed in this way. It did well in part by what it didn’t invest in, chiefly banks. “In that period [the year to June 30] if you didn’t have any exposure to banks then you were laughing,” says Schofield, although he adds: “the interesting question now is when does that decision have to change.” Instead the fund has been heavily invested in commodities and energy, with holdings including Devon Energy in the US, Canadian Natural Resources, and several solar and alternative energy companies.

More data from Mercer shows how difficult the job has been for international managers in the last year. On a sector basis, only energy and materials have generated positive returns over that period, while some sectors, such as financials (down 39.2%) and consumer discretionary (down 32.9%) have been absolutely hammered. Canada is the only large market to have turned a positive return.

Some interesting trends include the fact that growth stocks outperformed value stocks by almost 8% for the year, after four years of the reverse being true; and the median manager in the survey, outperforming the index by just 0.4%, would have come out behind the index when fees are considered.

The worst performing international equities fund in the Mercer survey was the Bernstein Global Diversified Value fund, which lost 29.4% and is also in negative territory over three years. Also worth comment are the Aberdeen Global Equity Composite fund and the Zurich International Equities fund – the only ones to have recorded double digit growth annualised over the last five years even after the recent declines.