Jan. 23, 2004 — The $179-million INVESCO International Core Equity Fund (IIBCX) uses a proprietary model that ranks international stocks based on parameters such as return-on-equity and price-to-book to construct a portfolio of attractively valued companies poised for growth. The fund’s value approach fell out of favor last year when foreign markets surged in a bullish frenzy. Still, the portfolio, which is team managed, gained 30.2% in 2003, versus 38.6% for its benchmark, the MSCI EAFE Index, and 37.4% for the average international equity fund.
The fund is the successor to INVESCO International Blue Chip Value Fund, which merged with AIM International Core Equity Fund last November. The previous funds were managed by the same investment team using the same philosophies and strategies. Atlanta based Lindsay Davidson is one of the managers on the portfolio.
Although the fund’s mandate does not limit it to large-cap stocks, Davidson and the team typically do not consider companies below $1 billion in market cap. “Ideally, we want a company with a minimum of five years of operating history,” he said. “We like larger, well-established, blue-chip names with above-average financial strength, stable earnings, and high-quality management.” Davidson said that while the fund has a “value bias,” the team is flexible and follows a bottom-up approach to pick profitable companies with attractive valuations.
Davidson and the team of eleven portfolio managers analyze about 3,000 international companies and apply a proprietary modeling system to evaluate each stock’s valuation and growth prospects. The methodology emphasizes discounted cash flow, price-to-book, return-on-equity, and historical track record. Buy and sell decisions are initially based on how the stocks rise or fall in their ranking system. Though the portfolio management team is divided up by sector responsibilities, buy and sell decisions are made by consensus.
INVESCO International Core Equity currently has 68 stocks. The fund typically holds between 55 and 70 stocks. As of Dec. 31, 2003; the ten top holdings were Endesa (ELE), 2.92%; Nestle, 2.87%; Novartis AG (NVS), 2.71%; Fuji Photo Film (FUJIY), 2.59%; Societe Generale, 2.51%; BP Plc (BP), 2.50%, Total S.A. (TOT), 2.49%; ING Groep (ING), 2.38%; Danske Bank, 2.32%; and Michelin, 2.18%.
One of the fund’s standout performers from last year was Endesa, the Spanish electric utility. “Its stock price was hurt in prior years because of the negative sentiment towards Latin America, particularly Argentina, where the company has significant operations,” noted Davidson. “But as Latin American economies improved last year, this negative bias disappeared.” Also, Endesa’s Spanish operations were able to raise prices due to a tariff increase. Endesa’s stock price soared about 50% in 2003, but its p/e remains a very moderate 12, Davidson notes. It remains an attractive holding, and the team has no plans to trim or eliminate it anytime soon.
Another top performer, Total S.A., the French-based integrated oil and gas company, benefited from robust oil prices and finding additional oil reserves. “They’ve been more fortunate than players like Royal Dutch Shell, which recently had to downgrade its reserves,” Davidson noted. “Total is one of the cheaper, second-tier oil stocks.”
While the fund uses the MSCI EAFE Index as its principal benchmark, Davidson and the team do not seek to match its country or sector allocations. However, they look at the tracking error relative to the index, and try to limit the tracking error to about 7.5%. To control risk, no individual holdings make up more than 5% of the fund’s assets.
The fund has heavy representation in Western Europe. As of Dec. 31, 2003, the fund’s top countries allocations were the U.K., 19.5%; Japan, 18.8%; Switzerland, 11%; Netherlands, 8.2%; France, 8.1%; Finland, 4.3%; Spain, 3.4%; Germany, 3.4%; Sweden, 2.7%; and South Korea, 2.4%.
The fund’s investment style is not restricted by geography, and can emerging markets exposure up to 20%. But at the moment, the only holdings in the region are two stocks in Korea and Telefonos de Mexico SA de CV, the Mexican phone giant. Earlier this year, the team sold two Brazilian stocks, including Petrobras, which became overpriced. The fund’s two biggest country weightings, the U.K. and Japan, are actually underweight relative to the index, Davidson noted. However, the fund is overweight in Finland, Switzerland and Denmark.
Davidson concedes that the fund’s exposure to Japan actually hurt performance last year. “Although the Nikkei rebounded in 2003, our Japanese stocks really lagged,” he noted. The fund was invested in blue-chip exporters like Sony, which have been hurt by the weak dollar. The portfolio was also hurt by investments in chemical producer Kao, drug maker Takeda, and Fuji Photo. “The one sector we really missed in Japan was the resurgent banking and financials sector,” noted Davidson.
While financials represent the fund’s largest sector (22.9%), the portfolio is diversified. As of Dec. 31, 2003, the largest weightings after financials were consumer discretionary, 13.0%; energy, 11.9%; materials, 9.6%; health care, 9.4%; and consumer staples, 8.9%. Though the team likes to keep the fund diversified, the sector allocation results from its bottom-up process. “We are currently substantially overweight in energy, and we’re underweight in industrials, where we’re not finding much value,” Davidson noted.
The management team are buy-and-hold investors: The fund’s annual turnover rate was 44% last year, versus 89.2% for its peers, according to Standard & Poor’s data. “Since we usually buy stocks when they are out-of-favor in the market, they don’t turn around too quickly unless we are lucky,” Davidson said. The team typically sells a stock outright when it has become fully priced. According to their screening model, this happens when a stock falls into the bottom 15% of the model’s ranking system. But it’s more common for the team to trim a position rather than sell it outright. Holdings are also disposed of when the team’s fundamental analysis reveals that its initial investment premise no longer applies.
Two recent outright sales were in the surging European banking sector, San Paolo IMI (IMI) of Italy; and Banco Popular Espanol SA of Spain. However, Davidson explains that the fund has always had a significant exposure to European banks, reflecting the team’s focus on return-on-equity. “Banks in Western Europe, and particularly in Britain, generate relatively high ROEs.”
Because of the fund’s conservative style, it tends to lag in strong bull markets, and somewhat outperform in bear markets. The fund often invests in sectors like energy and consumer staples, which perform well during bearish periods, but are typically ignored when stock markets are surging, noted Davidson.
– Palash R. Ghosh