Ajit Dayal of Vanguard International Value Fund

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.