As U.S. stock prices and indexes continue to fall, an overall economic rebound seems far off. Enron, WorldCom, and other large American firms have contributed to billions of lost investor dollars and, more significantly, lost investor confidence. Meanwhile, there’s plenty of partisan talk but little action coming out of Washington, and the markets reflect the dour mood of investors.
So where does this leave your clients? Fear not, for their diversification options are not as limited as one might think. Perhaps the answer to some portfolio woes won’t be found in some domestic undiscovered mom-and-pop company, but rather across the ocean in Europe.
“Europe is in a big bear market, but it’s a major economic zone of activity,” says David Winters of Mutual European Fund. “And any sensible investor should invest in Europe because it just gives you more opportunities to find good deals.”
Winters is a fund manager who prides himself on the research this fund requires. As the lead manager for Mutual European Fund, and president, CEO, and chief investment officer of Franklin Mutual Advisers, LLC (Mutual Series), he can’t afford to do things any other way in this “strange industry.”
Last May, Winters took over as lead manager of the Mutual European fund after 15 years of holding every position from analyst, to bond trader, to portfolio manager of other Franklin funds, to director of research. “I’ve been involved with Mutual European since its inception (1996),” he says. “So I’ve been an idea generator since then.”
Given a five-star rating by S&P and Morningstar, the Mutual European fund is up when the rest of the world is down. In S&P’s market comparison, Mutual European Fund/Z had an average annualized total return of 15.9% for the five-year period ended May 31, 2002, versus a total return of 0.8% for the FTSE Actuaries World Index (excluding U.S). This fund also ranks seventh within the International Equity category of 971 funds, and ranked second within the 83 funds in its peer group.
What’s the secret behind his fund’s success? “Today you have tremendous fear in the financial markets,” he says. But by adapting a three-pronged approach to choosing his European investments–he seeks out companies that have undervalued common stocks, that practice arbitrage, and are in bankruptcy–Winters says he is confident in the European Fund’s future. Mutual European has followed this same strategy throughout its history.
Characterizing the fund as “more a developed Europe fund than a developing Europe fund,” Winters focuses his investments in Western European companies of all caps, with a particular focus on the United Kingdom and Scandinavia.
The fund’s top holdings are in food, beverage, and tobacco, and also includes companies in a wide variety of industries, including railroads, candy, timber, media, and consumer goods. “We have a few U.S. companies,” he adds, “but it is a pan-European value sector fund and we want to maximize our ability to find good companies.” But as a European fund, Winters concedes that his limited domestic investments were only kept because of previous fund manager’s practices. “Historically, we owned a few U.S. stocks that we thought were incredibly compelling,” he says. “But today the U.S. portion of the fund is a couple percent, and candidly, we might eliminate it. All it does is make people ask us questions as to why it’s there.”
Today, the Z-share class of Mutual European is closed, but the fund’s A, B, and C classes are open and carry similar investing styles. Mutual European/A is front-end loaded 5.75%, the B-share class deferred load is 4%, and the C-share class front-end and deferred loads are 1%.
We recently spoke with Winters about his fund’s strong performance, and the challenges of researching European-based companies.
What makes you an expert on European businesses? I’ve always been fascinated with Europe. One of the first stocks I ever bought in my personal account was a European stock. I have been studying European companies, investing in them, and visiting Europe for many years. European companies used to trade at a bigger discount than a comparable company would in the States. So there was a lot of opportunity to buy good companies very cheaply.
Is doing research on European companies different than U.S. companies? It’s even harder work. In many respects there is less information–although ironically, with the plethora of information in the United States, lately it’s been pretty worthless because so much of it’s wrong. But it’s harder, because you have to dig even deeper and it is just more complicated. For example, we own shares in Carlsberg A/S in Copenhagen. Carlsberg is a company that has two classes of stock, and is controlled by a foundation created by Jacob Carlsberg 150 years ago to benefit Danish cultural institutions. Its principal asset is 60% of the Carlsberg brewery. Carlsberg is just waking up to all the issues of the 21st Century and behaving like a proper business, like caring about its shareholders. It is actually a good company but it’s been in a different world for the last 100 years. So to research Carlsberg and figure out its people was very complicated. It is not like reading the Anheuser-Busch annual report. I could give you 10 examples of things that we own in similar situations. We are special situation investors; we are not going for the big, well-known blue chips. Occasionally we will if they are really cheap, but we have to do more research. But the irony of the whole European thing is this: we are based in Short Hills, New Jersey, and we’ve done a good job managing money in Europe. And I am convinced that having some distance between them and us is a good thing.
Is Europe a hard sell for American investors? What can be done to change Americans’ perceptions of investing in Europe? I think it is going to become an easier sell with the weaker dollar. But I don’t know how to change people’s perceptions. Hopefully people will start to take notice that this is a great fund, it’s a nice size at $1.1 billion [for all the fund's share classes, combined], and I am amazed it’s not bigger. It seems to me that individuals and institutions should all be investing in Europe.
What is it about your fund that makes it so unique? We don’t think with the crowd and we do a lot of detailed work. We carry out a three-pronged approach and have a willingness to hold cash when we can’t find enough [good companies] to buy. I have a material portion of my net worth invested in the fund so I’m not just shooting to beat the index. I think that smart investors–those who didn’t get sucked into the mania–should be carefully making smart investments, especially now that securities prices are low, or rather, lower than they were. Bear markets are where the great wealth is created if you’re a buyer. That doesn’t mean that the market can’t go lower, bur we’ve kept people’s capital intact and have been able to find some great opportunities in this mess.
What is the average number of stocks held each year? How do you decide which ones to invest in, and when is it time to get out? We probably have 60 positions in the equities and 10 different positions in distressed bonds. We are big players in bankruptcies. We’ve found it to be highly profitable over the years. Financial distress is an area where you can find misplacements between assets and what you can buy securities for. You want to buy something at a big discount compared with what it is worth, and as it hopefully begins to approach what you think it’s worth you start selling. You also sell if you’ve made a mistake.
What positions/stocks are you currently invested in that you are pleased with? Can I be controversial? I like British American Tobacco. It yields 5%, trades at 10 or 11 times earnings, is well run, generates oodles of cash, and has good management. I also like Heineken Holdings, a good business with conservative accounting that generates a lot of cash.
Have you any poor investment choices you were forced to abandon? We had an investment in KPN, a leveraged Dutch telecommunications company. With the whole telecom mess, I didn’t want to own anything in that area that had a lot of debt. And we owned a relatively modest position so I sold it. I just decided it was not worth the risk.
Do you hedge your currency risk at all? We made a conscious decision to underhedge the euro, so we’re 70% hedged. However, the performance of the fund only partially reflects the benefit of the depreciating dollar. I made the decision to hedge because I thought the euro was undervalued and the dollar was overvalued. The fund has done well primarily because of stock-picking as opposed to just the currency. The fund’s performance is even more exceptional considering we are 70% hedged.
Are there any restrictions on the fund? The fund has multiple stock classes, and the Zs are closed. But the others are open, and each has different sales features.
As a rule, we don’t spotlight load funds, partly because we tend toward the opinion that cheaper is better for investors. What’s your opinion? Franklin Resources is a load fund dealer. There are classes of shares that have a lower expense ratio if you are oriented toward being a long-term investor. We believe the value of good advice does matter.
The fund is at $456 million in assets. Has that number continued to grow? It is actually much bigger than that if you count all the classes and the foreign investments, it is at $1.05 billion, and has definitely grown since inception. Europe has been in a severe bear market for the last two years, was down 25% last year give or take, and down another 20% or 22% this year. So there is some serious carnage out there. And unfortunately most investors only buy when things are going up, as opposed to when it is rough.
Have you experienced a net inflow or outflow from the fund since the bearish market began, in the spring of 2000? We have gotten a little money in, but it is surprising how little. Even with the drop of the S&P 500 and today’s carnage, the fund is still up for the year. It is up 1.3% in [an economy] that’s down 25% in dollars and 15% in local currency, depending on the index you use. But let’s just say for argument’s sake, the world is down 20%; we’re still up a little bit.
You have a large percentage of your portfolio in cash. Why is that? That’s right. Well, I have to admit that it hasn’t been easy to find really undervalued situations, and we went from a very overvalued stock market to one that’s becoming much more reasonable to undervalue. So we have been putting the money to work as we have found things to buy.
This has been part of the way that we’ve run money for the last 50 years. And I like lots of cash.
Will expansion of the E.U. make your job easier or harder, and will it make investing in Europe more transparent and appealing to U.S. investors? Who knows? We just want to buy undervalued securities. If it’s in the E.U., great; if it’s not, then great. Who cares, as long as it’s a good investment?
Will there be higher financial reporting standards for companies outside the U.S.? Yes, although I don’t think the Europeans drank as much of the punch as the United States did. There are less abusive tendencies in terms of accounting in Europe. But European countries do have other issues.
Has the introduction of the Euro made any difference in evaluating companies? It has just made things a little simpler. You don’t have to juggle as many currencies.
What else is there about your fund that you think we should know? We have been able to do well in good times and bad times. That doesn’t mean every day or every quarter or every year, but rather that we’ve compounded a very nice rate of return through what’s been a severe bear market. There aren’t very many funds that have been able to do that, and it’s because of the way we go about doing things. There is really no one who approaches it quite the way we do. It may not be the sexiest get-rich-quick scheme that most people seem to want, but if you are interested in making sensible long-term investments in Europe, we think this fund is an excellent way to participate.