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Getting Ahead by Standing Still

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“All of man’s evil stems from his inability to stand still.” This is the way William Browne explains the Tweedy, Browne Global Value Fund’s patient style of investing.

Browne, his brother Christopher Browne, John Spears, Thomas Shrager, and Robert Wyckoff, make up the seasoned management team at Tweedy, Browne. Named Morningstar’s International Stock Fund Managers of the Year for 2000, the crew pride themselves on offering stability and simplicity that investors may not find in other funds.

Stability comes in several forms. First is experience. Christopher Browne, William Browne, and Spears, who comprise Tweedy Browne’s management committee, all have been with the firm for at least 20 years, and have been working with each other as principals for 20 years. Perhaps even more impressive: No managing director or former general partner has ever left Tweedy, Browne to join another investment firm.

The current team of directors has led the Tweedy, Browne Global Value Fund to consistently above-average rate of returns since the fund’s inception in June 1993. With total returns of 25.28% in 1999, 12.39% in 2000, and 2.45% through May 31, 2001, the fund has consistently outperformed Morningstar’s Foreign Stock Index. A no-load fund with an expense ratio of 1.38%, the Global Value Fund’s turnover ratio of 16% is perhaps its most attractive offering. Or perhaps it’s that the fund is fully hedged against fluctuations in the value of the dollar, making it appealing to U.S. investors wanting to invest globally without concerns that currency market gyrations will give them sleepless nights.

We recently spoke with William Browne, Robert Wyckoff, and Thomas Shrager at their offices overlooking New York’s Park Avenue.

Your fund maintains a low portfolio turnover ratio. How and why have you been able to do this?

Browne: The advantage of a low turnover is simple. It makes the tax man a smaller partner. High turnover is associated with cost. When there is friction going in and friction going out, costs are higher. Also, turnover a lot of times doesn’t produce anything other than poor returns. There is an inner energy with people in this business to be active, to do things. Why is our turnover low? The turnover is simply a fallout from the process. We sit there and ask ourselves why the turnover is so high for people who manage growth funds. You buy a growth stock, put it away, and it grows and compounds. The ideal value stock is [when] you buy a company at a discount from what it’s worth, and it is at the same time a terrific company. I think there is a misperception that value investing is buying the hospice patients of corporate America: badly beaten, about-to-die stocks. We don’t sit there and say ‘Let’s have a low turnover.’ It is simply a fallout of the process. Buy good businesses and hang on. We are not involved in trying to guess the stock market. Also, we are painfully cognizant of the impact of taxes. We’re taxpayers and we have all of our dough there, too.

Wyckoff: Between the managing directors at Tweedy and our families, there is over $50 million invested in the Global Value Fund. Almost all of that money is taxable money. While we are community minded, we want the government to be as small a partner in that investment program as we can have them be. Low turnover helps that.

This fund seems to take a buy and hold approach. Would it be fair to say this fund is ideal for a long-term investor?

Browne: I don’t think of dividing it between long-term and short-term investors. Obviously we think what we do is appropriate for any investor because on a long-term basis, if you look at the returns we’ve earned, we’ve beaten the indexes. What I think is inappropriate is people who try to guess and jump around between styles. There is no data anywhere to suggest that you are ever going to get that right.

Wyckoff: The approach that we practice derives from the work of Benjamin Graham. Ben’s big idea for investing, which is still the idea that forms the thesis for what we do today, is [that] there are two prices for every share of stock: The price the shares closed at and the price that would accrue the investor if the entire company were sold. One of the great things about value investing is that it tends to produce above average rates of return over time, while at the same time doing so in a manner in which you can sleep well at night. There’s collateral value in the portfolio backing up each and every investment we make. From a risk standpoint, risk in this portfolio is controlled by price. We buy at a discount to value. We diversify by issue. The Global Value Fund has 193 stocks in it. It’s diversified by industry group. We typically don’t put more than 15% to 20% in any one industry group. It’s diversified by country. We typically don’t have more than 20% to 25% in a particular country. Its primary investments are in developed markets, not emerging markets. From a risk standpoint, again we’re in the developed world. We own a few securities that are domiciled in emerging markets, but only about 3% of the total portfolio.

Browne: The essence of what Graham said is you should concern yourself with trying to figure out what a business is worth. We sometimes say to ourselves that what the process does is direct you toward trying to know the knowable–trying to figure out the intrinsic value of a business. While you’re never going to get it right all the time, you have a much higher probability in that exercise than in trying to figure out the stock market because you can look at other business and transactions and see what people have paid. You can get a sense of worth and range, and then see what the discount is. There is a lot of data to work with. The probabilities are higher, and today investing is to a great extent just an exercise in probability, whereas in trying to guess the stock market there is not a lot of data points that you can go on. It enables us to separate all the emotional content of investing from the process. One of the biggest problems investors have is their behavior. All you have to look at is the past 18 months to see what behavior has done.

A recent Goldman Sachs study noted that much of the selloff in March and April to pay capital gains taxes was concentrated in global and international funds. Have you noticed any impact from such selling in your fund?

Wyckoff: I would think that if you were selling a fund to pay capital gains taxes you might sell a fund you had at a loss, so you are not generating more gains by selling a fund to pay your taxes. We had a positive year last year when a lot of people were in negative territory. We were up 12.39%. We have not noticed selling in our fund. We had positive cash flow. It would make sense not to have sold this fund.

What advantages does being fully hedged hold for investors?

Wyckoff: When we were forming the Global Value fund back in June1993, we realized when investing outside the United States you confront two main risks. First is your risk of owning a security. Second, you face the risk of currency issues. In essence you have two investments; investment in a foreign security, and an investment in that foreign security’s currency. We found currencies to be completely unpredictable and extremely volatile over time. We came to the conclusion that if it were possible to eliminate that risk at virtually little or no cost, we wanted to do it. Why face that risk? What we have done here in the U.S. is make money in this deep value style of investing in securities. We were confident that this approach would produce attractive rates of return abroad as well. What we weren’t confident about was the currency issue. When we started in 1993 we were one of the few funds that hedged. Obviously, the dollar has had some strength in recent years and you’ll find more funds hedging. You’ll find funds that dynamically hedge, meaning they’ll hedge certain currencies. When you do that you are making a bet on currency. From our perspective, we believe it is outside our realm of competence, as well as most investors’ competence, to make a bet on currency. We thought if we could eliminate it at little or no cost we’d do it, and that’s what we’ve done.

Browne: I think of our firm and some of the theoreticians of international investing sometimes as two ships passing in the night. They’re going one way and we’re going the other. We went into international investing for one simple reason: it enabled us to look at another 5,000 possible investment candidates. We were trying to get the local stock market return by buying a stock in Amsterdam. We wanted to make the process of buying a stock in Amsterdam as similar as we could to buying a company in Kansas City. The way you do that is remove the currency issue from the equation. Again, one of the greatest enemies of anybody investing is their own emotion, and a big contributor to your emotions is volatility. So [being fully hedged] picks that emotion up, puts it off to the side, and takes it out of the equation. You can sit there and see what’s going on in the security you own. And the other point I make is that if you eat in dollars, sleep in dollars, dream in dollars, and purchase in dollars, why not get it valued in dollars?

Shrager: Just look at the Japanese yen over the last five years. It has gone from $1.40 to 80 cents, and is now $1.20. This is huge volatility, and we are talking major currencies. If the dollar weakens over the next couple of years we may do worse. It’s hard to know.

Where do you see the dollar headed in the next 12 months?

Browne: If I knew I wouldn’t tell anybody. That’s why we hedge. If I knew I’d go out and lay out all the derivative contracts I could.

What does your sector exposure look like?

Browne: We try to build a portfolio based upon financial characteristics of securities, defining them using different methodologies, depending on the industry. Basically we try to define what’s undervalued. We don’t start by saying we’d like to have 15% in a certain sector and once you’ve determined the sector go find the best three stocks in it. A lot of people take this top-down, bottom-up approach. We start the other way by building up a portfolio by finding cheap securities. If we end up finding a lot of cheap securities in a sector we’ll ask ourselves if we’ve got too much in that sector. Or if a sector is out of favor, such as how the newspaper publishing sector is falling out of favor right now because advertising is declining, then you’ll see a lot more names that begin to turn up. What we’ll typically do in a case like that is put a certain amount of dollars in and buy a basket of those stocks.

Wyckoff: We have exposure in about 20 different countries. Our largest exposure is Japan at just over 13%. We have just over 12% in the U.K., and some stocks in the U.S., at just about 10%.

Browne: One of our larger holdings in Panamerican Beverages, which is the largest bottler in Latin America, but it’s traded on the New York Stock Exchange, so SEC rules say it’s U.S. stock.

Shrager: Panamerican doesn’t sell any Coke or have plants in the U.S.

Wyckoff: There are a number of stocks with U.S. exposure that really are foreign businesses.

As value investors, how do you do a valuation analysis on a company whose assets are not physical?

Browne: Most companies are not valued on assets, but on income streams. Pharmaceuticals, for example, are an income stream valuation. It’s what people are buying. People buy the products, thus you have generated income. We try to come up with absolute anchors as opposed to relative anchors. We look at a business and say ‘What do people pay for that kind of business?’ We look at comparables. You have to look at what people have paid. A lot of what you have to do is value income streams.

Shrager: People don’t buy pharmaceutical companies for their factories in Puerto Rico. In the case of pharmaceuticals, because of patents you have a higher predictability of deriving a stream of income from that product. In the case of high tech, its not that they are not innovative or that they don’t produce patents, but those patents can be easily circumvented. You don’t need to do a clinical trial for nine years like with pharmaceuticals to prove that your drug works well, therefore make your patent very valuable. With tech, you put it on the market, someone reverse engineers it, has another patent, a venture capitalist gives them $100 million, and you have the competing product. It’s the uniqueness of the pharmaceutical model that allows it to use its intellectual property in a way that’s very profitable.

Wyckoff: The earnings stream in technology, over a long period of time, just doesn’t have the predictive character that the earnings stream [of] a pharmaceutical business has. A new technology can become obsolete or get leapfrogged very quickly. By the time you have an indication that the technology may be sustainable, the price of entry is extremely high. Technology is tough for value people.

What kind of approach do you take in picking stocks?

Shrager: The process starts with screening. One of the reasons we got involved with international investing is because in the early 1990′s the ability to screen internationally became available. By inputting our criteria, we are able to look at price/earnings ratios, price/book ratios, and price to cash flow. We make sure we don’t buy cyclical companies at peak earnings by having a history of operating performance. The screen is a basis for likely candidates. Once it’s narrowed down, we include candidates in an [old-fashioned] Rolodex. The Rolodex is sort of a memo containing 40 or 50 financial points [that] is presented to the partners. One of the partners may have done the Rolodex. Everyone works equally here. The partners look at the Rolodex, a judgment is set, and the stock will either be approved or rejected.

Browne: The results of what we do are to a great extent the outcome of implementing a process, as opposed to any one particular individual’s insights. We’ve got a framework and it’s something you can sit down and learn and hopefully over time you get better.


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