Quick Take: Global markets may have hit a rough patch recently, but Kevin McCarey, manager of Fidelity Advisor International Capital Appreciation (FCPAX), thinks the world outlook will improve this year as central bank policies and the more reliable accounting standards of foreign companies lift stock prices. McCarey thinks international large-cap growth stocks look particularly promising, since they’ve been beaten down quite a bit.

Brighter prospects for large-cap growth suits McCarey, who describes his fund as Fidelity’s most aggressive international diversified offering. McCarey has a lot of flexibility, saying “I reserve the ability to go anywhere.” Currently, he’s focused on Europe, with a 60% stake, and Japan, with a 20% stake, although these positions don’t vary very much from his benchmark, the Morgan Stanley All Country World Free ex-U.S. Index.

McCarey says his focus on growing earnings boosted the fund in recent years. The first half of this year, the fund rose 4.98%, while the average international equity fund fell 1.2%. For the three years through December 2001, the fund rose an annualized 6.7%, while its peers lost 1.8%.

Individual holdings were not reviewed in this interview in accordance with Fidelity policy, which prohibits such discussion.

The Full Interview

S&P: How would you describe your fund?

McCAREY: The fund is designed to be Fidelity’s most aggressive diversified international fund. We describe it as a speedboat flying across the world that will be fast and long in good times, but when it gets choppy, the captain will idle the engines until the waters are flat. In performance terms, we hope to be in the top decile in up markets, and in the second quartile in down markets.

S&P: Is shifting gears analogous to market timing?

McCAREY: It could be, but it’s not, because we look mostly at stocks on a bottom-up basis. Market timing would mean that you buy big pharmaceutical companies because they’re defensive, but I’ve been underweight in that sector for a couple of years. Even though pharmaceuticals have growth prospects, their valuations are higher than we’d like.

S&P: What’s your approach to stock picking?

McCAREY: I start with the basic belief that you will make more money in stocks with rising price/earnings ratios. I look for companies where management interests are aligned with shareholder interests. That may not mean (looking just at) stock options, since they aren’t very common outside the U.S.

S&P: The conventional wisdom had been that U.S. accounting standards were generally better than international standards. What’s your view of global accounting?

McCAREY: Overseas, you don’t have as many problems with stock options and accounting quality as in the U.S. International accounting is at least on par with the U.S. and may be a little better. Fidelity has more than 200 analysts in the U.S. and around the world, so we can try to get behind the reported numbers.

S&P: What type of portfolio have you built based on your process?

McCAREY: The fund is fairly concentrated, with about 60 names. I started the fund with 100 to 120 names, but as I’ve gained maturity, I’ve become more comfortable with concentrated bets. I also tend to invest in companies that focus on one or two businesses.

In the last year and a half, I’ve usually ended up in mid-cap stocks — above $1 billion market cap. That wasn’t true four years ago when large-cap stocks tended to be the fastest growers, mainly because they were more global. I reserve the ability to go anywhere. Large-cap stocks have been beaten down so much in the last year and a half that I wouldn’t be surprised if my large-cap weighting started to edge up.

S&P: What is your benchmark?

McCAREY: I’ve specifically picked the Morgan Stanley All Country World Free ex-U.S. Index as our benchmark to have a bigger sandbox to play in. The index is in basically every country outside the U.S., including emerging markets.

S&P: What are your country weighings?

McCAREY: I look at regions rather than countries. I’m neutral to somewhat underweight in Europe, so I have about a 60% weighting. My Japanese position is about 20%, so I’m also somewhat underweight. I’m slightly overweight in emerging markets, which is about 10% of the fund. Right now, my regional weights don’t vary too much from the benchmark, which is somewhat unusual in the history of the fund.

S&P: What are your largest sectors?

McCAREY: I’m overweight in consumer staples, with a handful of companies showing good earnings growth right now. Global markets have focused very closely on companies with good earnings growth, but that may change next year.

Financials is a large weighting, where I’ve made some targeted bets. That includes some Japanese brokers who are also big asset managers. When positive change takes place in Japan, brokers will be on top of everything: corporate restructurings, spin-offs, mergers and acquisitions.

I also own some stock exchanges, which have floated in the last one or two years. It’s somewhat of a new industry sector, and they tend to be very cash-rich with very high margins.

I’m also somewhat overweight in technology, although that has come down. About a year ago, I became overweight in technology, particularly semiconductors, as prices came down and fundamentals began to stabilize. I was a bit early, since prices fell last September, but I held on and they all had huge moves as people gravitated to that area.

S&P: What’s your view of global valuations?

McCAREY: Value has outperformed growth so much that the big bubble in growth stocks from 1998 to 2000 has mostly been reversed. I’m very excited at the way lots of prices have come down. The tough part is that for most of the companies that have come down, you have to look out a year or two to get a story that holds together.

S&P: Would you comment on your returns? The fund held up better than most international funds so far this year and last year.

McCAREY: Holdings with growing earnings helped me at the end of 2000 and early 2001 when the market focused on them. When prices fell in July and August of 2001, I went shopping, although I may have been a little early. When the markets picked up last fall and early this year, I was well situated.

S&P: Has the falling U.S. dollar had an effect on the fund?

McCAREY: More indirectly. When foreign currencies rise against the dollar, that gives us some support, but a number of foreign exporters have the wind in their face rather than to their back. Company fundamentals are more important than the dollar moving up or down 10%. If the dollar goes down 30%, that would be different, but a big drop is unlikely.

S&P: Do you think that international markets have become more correlated with the U.S. market?

McCAREY: International markets aren’t completely correlated, so there are still some benefits from diversification. Given the Internet and other forms of communication, information travels faster, leading economies to become more linked. But until the Federal Reserve determines interest rate policy in China, Korea, and Spain, they won’t be completely linked.

S&P: What’s your outlook for global markets?

McCAREY: I think the next 12 months will be better than the last 12 months. I think some confidence will come back to the market as people focus more on accounting issues, which will put more emphasis on higher quality financial results. Central banks have continued to ease, which will help global economies improve.

Large-cap growth companies outside the U.S. will offer much better values as a whole than at anytime in the last two years because of the pummeling they’ve had.

S&P: Where will the best global opportunities come from in the next year?

McCAREY: Probably China, because they’re doing a great job of building their economy. Many people don’t realize how positive things are there, because many Chinese businesses are government-owned or aren’t open to foreign ownership.