Quick Take: Vanguard International Value Fund (VTRIX) rode the wave of strong performance from foreign equity markets last year. The $1.7-billion portfolio soared 41.9%, versus a gain of 38.6% by its benchmark, the MSCI EAFE Index, and a 37.4% return from the average international equity fund. For the five years through January the fund rose an average annualized 4.7%, versus 2.3% for its peers.
Launched in May, 1983, the fund was taken over by Hansberger Global Investors in July, 2000. Ajit Dayal is part of a four-person management team from Hansberger that oversees the portfolio. Thomas Hansberger, Ronald Holt and Aureole L.W. Fong round out the team.
The fund, ranked 3 Stars by Standard & Poor’s based on a three-year period, takes on slightly more risk than the peer group, but features substantially lower turnover. Over the five years, the portfolio carries a 4-Star rank. Typical of Vanguard funds, this portfolio has a relatively small expense ratio of 0.62%.
The Full Interview:
S&P: How do you select stocks for this fund?
DAYAL: We are “value” investors, seeking companies that are out-of-favor with the market, and inexpensive relative to historic and peer valuations. We emphasize factors such as cash flow, earnings growth and asset value. We like companies with solid businesses, and good outlooks that are being punished by the market for some near-term concerns. We prefer to invest in companies with a market cap of at least $1 billion, and with a decent free float.
S&P: What types of comparisons do you make?
DAYAL: Hansberger believes that sectors matter more than countries. The stocks we select meet our research and investment criteria based on their sector comparisons. Having selected attractive companies in different sectors, we identify the catalysts that will allow the stocks we own to be re-rated by the market.
S&P: How did you change the way the fund is run from the previous subadviser?
DAYAL: From a portfolio perspective, we reduced the number of stocks from around 130 to about 80, giving us a larger exposure to fewer names that we liked. We typically own between 70 to 80 stocks. At the end of 2003, we had 82.
S&P: What made 2003 such a powerful year for foreign stocks?
DAYAL: At the start of 2003, many large international markets had valuations about 30% lower than U.S. markets. In hindsight, the weakening U.S. dollar compelled American investors to add more foreign stocks to their portfolios, and assisted in overall outperformance for overseas stocks.
Foreign stocks also benefitted from continuing reforms at the company level, where shareholder value gained focus, better financial discipline, and cost control. Also, the growth in the U.S. economy helped many foreign companies export more goods to the U.S.
S&P: What do you attribute the fund’s 2003 out-performance to?
DAYAL: Many of our stocks performed well last year. We had over 70 stocks that had positive returns, and only nine posting losses. Our exposure to consumer discretionary, industrials, materials, and telecom sectors — some of which were in the emerging markets — did well. Our longer-term view allowed us to look beyond the “double-dip” fears that gripped investors in late 2002/early 2003, and permitted us to buy and hold on to some better-managed businesses that were hit by near-term concerns.
S&P: The fund suffered three consecutive years of losses starting in 2000, but still outperformed the benchmark.
DAYAL: The benchmark was probably hurt by its exposure to many of the internet, telecom, and media stocks that inflated its performance in 1999-2000. As value investors, we had few investments in those sectors, although we added to those sectors over the years, at lower valuations. Also, our decision to buy stocks in the materials and consumer discretionary sectors helped. Our exposure to emerging market stocks also helped since these markets have done relatively better than the benchmark over the past few years.
S&P: What is the fund’s current geographic profile?
DAYAL: As of Dec. 31, 2003, we had 67.1% invested in Europe, 18.3% in Asia-Pacific, and 14.7% in emerging markets. Our emerging markets exposure has typically ranged between 12% and 15%.
Once we have chosen our stocks, based on their sector valuations, we ensure that we have representation across four broad currency blocs: the euro (Europe), the British pound (U.K.), the yen (Japan), and U.S. dollar denominated emerging markets and Asia-Pacific.
The geographical layout of our portfolio is strictly a by-product of our bottom-up, sector-based, stock selection process. However, our risk controls require that we are at least 70% of the index weight for that currency bloc. For example, if Europe (ex-U.K.) represents a 44% weighting in the MSCI EAFE Index, we will always have at least a 31% equity stake in the euro area.
S&P: What are your top holdings?
DAYAL: As of Dec. 31, 2003, our top ten were Total SA (TOT); HSBC Holdings PLC (HBC); ENI Spa (E); Sumitomo Trust & Banking Co. Ltd.; Aventis SA (AVE); Samsung Electronics Co. Ltd.; Kookmin Bank (KB); GlaxoSmithKline PLC (GSK); TietoEnator Oyj; and DBS Group Holdings Ltd. These ten holdings represented 18.7% of the fund’s total assets.
S&P: Can you discuss one of these stocks?
DAYAL: Total, the French-based energy company, is a long-term holding. Total has the strongest production growth prospects among the major oil companies, with output expected to increase by more than 5% annually through 2007. That growth rate stems from one of the most geographically diversified and lowest-cost portfolios of oil and gas assets in the industry. The company has a clear strategy, strong balance sheet, high-quality management, and an excellent track record of meeting its targets.
S&P: What are the fund’s top sectors/industries?
DAYAL: We currently like the consumer discretionary and industrial sectors, given our assumption of decent consumption in this year, and the start of some capital expenditure plans by companies.
S&P: Relative to the benchmark, in which sectors are you significantly overweight? Underweight?
DAYAL: We are underweight the utilities and energy sectors, and we are overweight stocks in the consumer discretionary and industrial sectors. We ignore what the weights in the Index are, and how they change over time. However, we ensure we have representation across the 10 sectors in the MSCI Index, although we have no qualms about being absent in many of the 61 industries that make up these 10 sectors.
S&P: What are your top country allocations?
DAYAL: As of Dec. 31, 2003: UK, 19.8%; France, 13.6%; Japan, 13.4%; Germany, 6.8%; Switzerland, 6.6%; Hong Kong, 4.7%; Netherlands, 4.6%; Korea, 3.9%; and China, 2.6%.
S&P: Given that emerging markets have surged recently, does that make it a less attractive area to invest in, given your value approach?
DAYAL: The valuation differential between emerging market stocks and stocks of the developed world narrowed in 2003. However, the economic and earnings outlook for the emerging markets are looking better than they were a year ago. In that sense, P/E in the emerging markets remains more attractive than in the developed world.
S&P: What are your sell criteria?
DAYAL: The fund has a modest turnover rate of 28.0%, so we don’t trade too much. We sell a stock once it has reached its “full valuation,” and we see no further upside based on long-term fundamentals of the business. We also sell a holding if we can find a better replacement; i.e., if there is another opportunity where the similar long-term business potential and risk-adjusted return exceeds the one we own.
In addition, we dispose a stock because it was a mistake to buy it: either the business was not as good as we thought, or we misjudged the management.
S&P: How does the weakening U.S. dollar influence your stock picks, given that this will hurt the big exporting companies in Europe and Asia?
DAYAL: The weak dollar works in two ways: It hurts exporters in Europe and Japan and means that overseas companies show lower earnings when they “translate” their dollar profits back into their stronger currencies. However, a weak dollar also forces these foreign companies to shed any excess fat they have and become more efficient.
S&P: Looking at 2004, what regions (or sectors) of the world are you most bullish on? Where might you be avoiding?
DAYAL: We do not really have any strong geographical likes or dislikes, but we do recognize that stock markets, globally, had a tremendous run in 2003, and global liquidity, personified by low interest rates, may not be that supportive in 2004.
– Palash R. Ghosh