How RCM beat the herd

Australian Financial Review, Managed Funds Quarterly, March 2008

International share funds in Australia suffered in 2007, more because of the currency than any wobbles in international stock markets. The powerful Australian dollar, which went from $1.26 against the US dollar at the start of the year to $1.14 at the end, turned many gains into losses. Consequently, according to Mercer, the median overseas share fund returned a 1.6% loss in 2007, which is at least better than the performance of the MSCI World ex-Australia index, which lost 2.6%.

There were, however, some excellent exceptions, and they used a variety of means to beat the herd.

Top of the pile among managers Mercer classifies as “core” – that is, neither value or growth-biased – was the RCM Global Equity Unconstrained Fund. “Unconstrained” means not only that the fund doesn’t have to track any indices, or any country or sector weightings, but also that it can go into cash when it thinks that’s a prudent thing to do. One version of the fund can put up to 20% of its money into cash, the other can put the whole lot in there if it sees fit.

Paul Schofield, a director in the global equity team in London, has been using that facility heavily in recent months. Today the cash balance is between 40 and 45% of the fund, reflecting the uncertainty he has had about valuations in the market; however, in the more recent volatility, those valuations have started to look much more appealing. “You’ve got to go back to ’92 to get European markets on a similar level of PE,” he says. “It all looks quite reasonable. I wouldn’t be throwing all the cash balance into the market in one hit – I think volatility is here to stay for six to 12 months – but opportunistically it seems good to us.”

One of the bigger calls he will have to make is when to return to financials, having held none over the last year other than stock exchanges. Instead, particularly good holdings over the last year have included Rio Tinto and Xstrata.

A quite different approach has served Intrinsic Value Investments well, which (through the Equity Trustees vehicle which retail investors can buy) is the highest ranked value-based manager in the Mercer survey, returning 13.8% in 2007. As head of investments Neville Hathaway explains, IVI never picks a single stock – it picks markets.

“The biggest inefficiency in markets is home bias,” he says. “If you look around the world you see big disparities between the performance of markets, but within markets they are quite efficient. Between 2001 and 2007 the US market made 48%; Austria made 247%.”

So IVI picks the markets it thinks are undervalued and waits for them to come back into balance. It doesn’t pick stocks, rather getting exposure to the entire national market, through a Morgan Stanley vehicle called Opals. It only invests in developed markets and recently has done particularly well out of Austria, Norway and Sweden – and by avoiding the USA. “Not being there has been one of our best performing investments,” he says, partly because of the falling US dollar. Today, he thinks Canada and Hong Kong are undervalued, and has allocations to New Zealand, Germany and Spain.

Another manager which reaches Australian investors through Equity Trustees is Marvin & Palmer, whose Composite Fund tops the growth-biased rankings in the Mercer survey, and indeed the whole overseas shares survey, with 19.1% in 2007. “We focus on high quality large cap growth stocks, and also we are a trend investor,” says Lorraine Berends, principal at Marvin & Palmer Associates. She says all the things M&P look for in a stock – quality, size, growth and trends – worked in their favour in 2007, which had not been the case in previous years when, for example, small caps were in vogue. Trends included materials, energy and industrials, and the secular bull market in emerging markets.

Equity Trustees’ Harvey Kalman – whose roster of managers pepper the best-performing tables from Pimco in fixed income to the Charitable Balanced Fund – believes managers like IVI and Marvin & Palmer make for a useful combination in a portfolio. “Marvin & Palmer, with a growth style bias, is a consistent long term fund manager, a fantastic core component to a portfolio because it delivers very sturdy results and outperforms over the long run. And IVI is a top performing, lowly correlated fund that sits well with anything you’ve got in your fund at present.”

The coming year will truly test the mettle of international fund managers as they deal with a US slowdown or recession, the credit crunch, and the unpredictable knock-on effects of those two things on other world markets. It’s been a horrible start to the year: the median overseas share fund is down 9.5% in January alone. A dip that creates value? Or just the start of a bad year? The best managers will call that right.