From the February 2007 issue of Wealth Manager Web • Subscribe!

Foreign Bazaars

For the past five years, foreign funds have been running with the wind at their backs. The dollar has been falling steadily, making foreign stocks more valuable for U.S. investors. Since January 2002, the value of the euro has climbed from less than 85 cents to more than $1.30. An American investor who bought and held a mediocre European portfolio would have achieved sizable gains from the currency shifts alone.

Among the biggest winners have been foreign large value funds, which have returned 16.3 percent annually during the five years ending on October 31, 2006. That's more than seven percentage points ahead of domestic counterparts. In addition to benefiting from a currency boost, foreign large value funds have held big stakes in energy and industrial goods, sectors that the markets have embraced in recent years.

Can the foreign funds continue delivering double-digit results? Perhaps. With the U.S. still running huge trade deficits, many traders expect the dollar to remain weak. Moreover, most foreign value funds have maintained their price discipline, shifting away from energy shares as their prices rose. Now the average foreign large value fund has a price-earnings ratio of 14.2, a modest figure at a time when large growth funds in the U.S. and abroad have multiples of more than 18.

Which foreign large value vehicle is likely to provide the best ride? To find a champion we turned again to screens developed by Donald Trone, chief executive officer of Fiduciary360, a consulting firm in Sewickley, Pa. Trone's due-diligence process seeks funds that are at least three years old and have more than $75 million in assets. One- and three-year total returns must exceed the category medians, as must five-year results if the fund is that old. Alpha and Sharpe ratios must also surpass category medians. The expense ratio must fall below the top quartile, and at least 80 percent of the fund's holdings must be consistent with the category.

The screens reduced the field from 146 down to 28 finalists. Top performers included AllianceBerman International Value, Dodge & Cox International Stock, and RiverSource International Select Value. But we awarded the title to Quantitative Foreign Value, the contestant with the top five-year returns and highest alpha.

The fund achieved its record by combing the world for ugly ducklings--solid companies that have failed to attract attention. Portfolio manager Bernard R. Horn screens for companies with low prices and strong cash flows. Many of the holdings are growing at modest rates, but they are in unglamorous industries that rarely skyrocket into the headlines. Such businesses tend to be steady performers. That helps to explain why the fund has a beta of 0.61, the lowest figure of any of the large value competitors in our contest. "When we construct our portfolios, we don't want a lot of risk," says Horn.

While the fund makes little effort to match foreign benchmarks, Horn does try to stay diversified by holding stocks in at least 15 countries and 15 industries. He typically owns about 50 stocks, rarely placing big bets on any one name. The biggest holding currently accounts for 2.3 percent of the portfolio's assets.

To find the gems, Horn will go anywhere in the world, and overweight countries when the stocks seem appealing. Currently he has 10 percent of assets in Finland, a big weighting in a small market. Horn was drawn to the country by a number of stocks that are crucial for global trade. At a time when trade is expanding rapidly, Finnish companies provide vital links, making equipment for modernizing ports and logistics. A top holding is KCI Konecranes, a maker of cranes used in ports. The company recently reported a big increase in orders for its heavy lifting equipment. Sales and earnings are growing smartly.

A dedicated value investor, Horn aims to arrive before the crowd and then ride stocks up for years as the enthusiasm of investors mounts. He began buying British home builders in the late 1990s, a time when many investors assumed that the real estate markets would crash. Since then, the free cash flows of many of the UK builders have tripled. But the stocks remain cheap, says Horn. He still owns Barratt Developments, a leading UK builder.

Another successful stock has been Impala Platinum Holdings, a South African miner. Horn began buying in 2000 when many investors were focused on technology and had little interest in commodities. "The market was giving away commodity stocks," says Horn. "Investors believed that the global economy would grow, but they weren't focused on the idea that commodities like platinum are crucial for many industries."

Horn continues to hold Impala. He figures that platinum remains vital for the auto industry, which uses the metal for catalysts that clean car exhausts.

Earlier this year, Horn began finding more attractive values in Japan. With the country's economy growing, consumer spending is rising. That is translating into better cash flows for companies that rely on the domestic Japanese market. Horn began buying shares of Central Japan Railway, a company that should see its volume of passengers grow along with the national economy.

While Horn remains keen on his obscure value stocks, not everyone agrees with him. Some analysts argue that after rallying for most of the past six years, the cheapest stocks have already been plucked. Horn isn't worried about a shortage of bargains. "We are finding lots of opportunities," he says. "We look at a universe of 24,000 stocks around the globe, and there are many companies out there that investors have overlooked."

Stan Luxenberg ( is a business writer and has long been a regular contributor to Wealth Manager.

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