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Part 1:Down Under Rising

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Lately, I bet you’ve heard from more than one client who suggested, in language that I can’t repeat here, that you should have put his or her cash under the mattress rather than into the stock market. Today we’re going to look “down under” the mattress of our markets, and head to New Zealand and Australia for some long-term capital appreciation and current income from securities markets that few know much about. We’ll talk to Robert Scharar, manager of the Commonwealth Australia/New Zealand Fund (CNZLX), which focuses on the New Zealand and, to some extent, Australian markets. Scharar runs a tiny (under $5 million in net assets) fund, and he’s been beating his benchmark and, lately, the S&P 500–not just in relative terms, but in absolute ones.

No doubt they are relatively small, obscure markets, and there aren’t many easy ways to make meaningful diversified investments in them. But the markets are certainly worth a look, with stable political and economic institutions, trading economies closely linked to the Asian/Pacific region, lower market volatility than the rest of the region, and cheap stock market valuations.

Australia and New Zealand are about as far from the U.S. as you can get. (If you dig a hole straight down from Kansas, you won’t end up in China, but rather in the middle of the Indian ocean about 2,000 miles west of Australia’s shores.) Nevertheless, they are, with the exception of Canada, more like the U.S. than any other country. They’re English-speaking, and they’re former British colonies. As with Canada, parting was peaceful, and while all three have parliamentary democracies, they share Queen Elizabeth II as head of state.

Australia’s per capita GDP of $23,200 is virtually identical to that of the United King-dom, Canada, France, and Japan. New Zealand’s figure is slightly lower at $17,700, but both numbers are impressive given the smaller populations of Australia and New Zealand (just under 20 million and 4 million, respectively) and their relative geographic isolation from other industrialized nations. Australia and New Zealand have benefited from commonwealth status and other political and legal ties to English-speaking nations, and naturally it’s easier for U.S. investors to deal with picking stocks and following economic news under these conditions.

How best to invest in Australia and New Zealand? Despite the fact that even Americans can read their newspapers, stock reports, and financial filings–which is certainly a plus–for all but a few of the largest (and most involved) investors, the flexibility of choosing individual stocks will take a back seat to the professional management and diversification provided by a fund or ETF investment. This month we’re raising two options from down under. An actively managed fund, Commonwealth Australia/New Zealand Fund (CNZLX), that’s more heavily invested in New Zealand, and an unmanaged index exchange-traded fund (ETF), the iShares MSCI Australia Index Fund (EWA) that’s weighted more to Australia. They complement each other.

We also recommend that you click into the main papers: the New Zealand Herald ( and the National Business Review ( so that you can tell a Zack from a pinch of woffle dust when you’re investing down under.

Scharar is based in Houston and has been investing in common stock in New Zealand and Aus- tralian companies with dominant market positions, reliable earnings, and exposure to exports. Scharar is president of FCA, and co-founded its predecessor, First Commonwealth Associates. Previously, he was an accounting professor at Bentley and Nichols Colleges, an officer of U.S. Trust Company, and a tax specialist at Coopers & Lybrand. Scharar is a member of the Florida and Massachusetts Bar Associations, as well as a certified public accountant.

The Commonwealth Australia/New Zealand Fund was launched in 1991 as Capstone New Zealand, and expanded its investment universe to include Australia in October of 2000.The fund is notable for its low $200 minimum initial investment and its very small size. While it is a no-load, the small size has put its annual expense ratio in the range of 6%. Despite this hindrance, it has so far shown a solid performance record–that’s scarce as hen’s teeth in this or any market.

Scharar essentially stays fully invested, sometimes holding a small position in the iShares MSCI Australia Index, basically a holding that’s almost as liquid as cash, but that participates in the fund’s benchmark equities. Its small-cap, value-oriented stock holdings are, by necessity, quite concentrated, with 46 total holdings (as of April 30, 2002), and 49.5% of assets in the top 10 holdings. His latest annual turnover was a minimal 10%.

When did you first invest down under? I think I invested $1,000 or $2,000 in New Zealand in the early 1980s–it was a lot for me because I was going to school, and scraping dollars together. By early 1990, I realized from reading and communications that New Zealand was going through immense changes. Here we had a very democratic country that was also very socialistic. There was a company called Capstone, which is another mutual fund group that was in Houston, and it had an international series, and I went to them and said, “Hey, I’d like to run a fund. Could I manage a New Zealand fund as a part of your series? I’ll take responsibility for worrying about it. I just need somebody to house me.”

I’ve managed the fund since its inception. A couple of years ago I renamed them Commonwealth Funds. I’m one of the older managers you’ll ever talk to who’s running a $7 or $8 million mutual fund. This is not all I do, mind you. I run an investment advisory firm; we have just under 40 people, we’ve been in business 27 years–same company essentially. We do a lot of other things besides this, but I’ve continued to shepherd this fund over that period and that has something to do with the style we use. We expanded to Australia about two years ago just because I felt we needed that additional diversification of opportunity if we were going to grow the fund size-wise, because that would reduce some of our operating costs obviously. And then we’re rolling out a global fund in another month or so that will aid us in that process.

What are you thoughts about New Zealand’s future? It certainly is a beautiful part of the world, and therein lies another one of its secrets for success as an economy: It’s a nice place to be. And everybody has to be in Asia, I think. U.S. companies and others have to be a part of the Asian experience. The question is, where do you want to house your people and where do you want to put your assets if you want to play in the market but you don’t necessarily physically want to re-staff or relocate everybody there? Australia and New Zealand both are in the right time zones, you can do business vertically throughout Asia and only be an hour or three off in terms of time-zone difference. For U.S. companies and other European companies that want to do business in the Asian Rim, it’s a logical starting point to have activities in Australia and New Zealand.

And the economies? The economies are fairly strong because they do provide a lot of developed products that are desperately needed throughout Southern Asia, whether you go over as far as India, all the way up and around through China and Japan. And they provide raw resources, they provide technical assistance, they provide things like lumber, and other products of that sort; they provide food products. Fisher & Paykel, which is a maker of refrigerators and washing machines and so forth, even exports into the U.S. now.

We think the growth rate next year in Australia will probably be in the low 3% GDP growth rate, so it’s clearly not a big problem. As for the blow-ups in financial issues: Go back and read the 1987 papers in Australia. They went through Enron-like disasters in 1987, with accounting irregularities and all those kinds of things. I’m not suggesting they’re perfect, but a lot of those things are now non-issues. And then you have to look at what else can affect it.

Take Australia, for example. They already have in the pipeline an almost $3.5 billion railway project from Alice Springs to Darwin that’s underway now. They have another $2.5 billion highway system called the Pacific Highway Upgrade going on, plus $1.6 billion for an LNG train system and a new magnesium facility for $1.3 billion. They’re doing construction now for a synthetic hydrocarbon facility for $1 billion, a new gas field development is $2.7 billion, and a new aluminum plant for $1.5 billion. Those projects are all in the pipeline, going on right now, which should sustain a lot of the local economy as the world economy sort of muddles along.

What about local consumers? The typical house in New Zealand is smaller than a U.S. house, but everything works the same. One of the things that I noticed early on is that it reminded me of the houses when I was growing up; it’s kind of like turning the clock back 20 or 25 years. Things are simpler. The houses are modern, but people still hang a lot of clothes on the line. Their refrigerators are just as fancy and good as ours are, but often they’re a little bit smaller. It’s just a different scope. And that’s very good if you’re trying to export in the emerging markets and have a developing middle class that wants those kinds of consumer goods.

And both countries are poised to issue both technical services, some commodities, some finished goods, technical support in the communication industry, and a host of other things which I think makes them a very viable economy.

How do you participate in the trading economy? We buy the ports–every commodity that goes in and out of New Zealand goes in or out of the ports. We own Lyttleton Port. We own South Port, and Northland Port. We don’t own all the ports, but we own a lot of them. By owning the ports, we get a toll-charge, if you will.

We also bought companies like Mainfreight and Owens Group, which deal with freight-forwarding and shipping. They have a presence in both New Zealand and Australia. We didn’t make a big investment in Air New Zealand or Qantas, but we do own Auckland International Airport.

Why move from a pure play on New Zealand to include Australia? One of the reasons was to have some kind of financial holding. New Zealand didn’t even have a bank we could buy. The major banks were all really Australia companies doing business in New Zealand. And Australia, of course, has these immense natural resources: A company like BHP Billiton (mining), oil and gas, a lot of mineral resources, a lot of that sort of stuff gets overlooked in terms of what a country can do. Tourism is a big business there, too. Even education–a lot of people from the lower Pacific Rim are being educated in Australia and New Zealand. By American standards, you wouldn’t call it much of a GDP benefactor, but in a smaller market like that, it’s not inconsequential to have students and tourists coming in.

Aren’t many of the companies you invest in thinly traded? One thing you have to have is patience. These markets require you to know why you bought the company. These are not timing markets, because you have to have a reason for buying, and you’ve got to be patient on the buy side. And if you’re willing to accumulate over time and don’t have any minimum buy orders on this stuff, you can get some great deals.

It’s the same on the sell side. You can usually get out of things, if you don’t have to get out of them. It’s almost like trading OTC stocks in the U.S., except for a few of the big ones like Carter Holt Harvey (forest products), or BHP, which are global companies. I don’t recall ever putting a market order in for a security, although I couldn’t swear to that. There’s always a limit, and you’ve got to approach it that way.

There’s a particular company we’re trying to buy–I’ve been on the bid side for 100,000 shares for about three months. I found the company because I read the New Zealand paper every week, and I saw a little article. It’s one that was basically not followed by most people. The brokers were not putting reports out because it’s a smaller listing. I saw an article and I told the brokers there, if I could ever get 100,000 shares of this, I’d probably be a buyer. So finally there was an insider who was willing to sell down a little bit, and I’ll probably get that 100,000 shares.

What initiates a buy order from you? My starting point is that there’s nothing like getting cash in the mail, so I really like dividend-paying stocks. The good news is that these markets believe that’s one measurement of success of a company. Right now the Aussie dividend yield is about 3%, and we think it’s going to be almost 3.8% to 4.0% by next year. That’s a decent score.

The other thing I look at is price-to-book. For the Aussie 300, it’s probably less than two. Our average P/Es are in the low teens, going lower next year based on the current year and forecasted earnings. Now if you go a step further, you start finding some very interesting situations. For example, one company we’re looking at acquiring right now is selling at a P/E of less than seven, yet the market has a P/E of 15. We’re looking at a dividend yield of close to 8%.

And here’s the other reason to consider these markets: They are truly local markets. The people who are buying these stocks are more influenced by whether the cows had big production this week than they are by what’s happening in the U.S. I’m not suggesting that when you have a calamity like we had here on September 11 that all markets don’t hiccup. But over time, what you will find is that that’s not necessarily the case with respect to the local small-cap stock. They will move based on other factors. That’s one of the great buying opportunities you have in these markets–and one I try to take advantage of.