More Art Than Science

One popular way to diversify equity assets is with international investing; there are plenty of single-country, region, and international funds around, not to mention the closed-end fund and ETF options. But not all investors are comfortable with the concentrated risk of a single country or region, and that’s where an international fund may be just the ticket.

One such fund that has performed well over the long term is Janus Overseas Fund (JAOSX), which has had an average annual return of 14.42% for the 10 years ended December 29 compared to 8.73% for the S&P/Citigroup PMI World Ex-U.S. Index; 19.19% versus 15.52% for the five-year period; 32.21% versus 20.41% for the three-year period; and a hefty 47.21% versus 24.74% for the one-year period. Standard & Poor’s gives the fund four stars across the board. Kate McBride spoke to Brent Lynn, executive VP and portfolio manager of the fund, in early January.

What’s your investment process for this fund?

My investment philosophy is pretty simple. I believe in two things: fundamental analysis, and high-conviction, long-term investing. On a short-term basis, markets and stocks can be very volatile and sometimes irrational, but on a long-term basis we believe stock prices will move with the earnings, cash flows, and fundamental outlooks of the companies themselves.

What do you look for in a company?

I don’t believe there’s a formula to this business, but there are a few criteria that may be common across many of our holdings. I would point to four investment criteria in particular: a sustainable franchise; long term growth potential at the company; value creation opportunities at that company; [and] an attractive valuation.

The single most important characteristic for a company that we invest in is [that it has] a sustainable franchise. It’s pretty basic: the value of any company is the net present value of its future stream of cash flows. The more confidence you have that those cash flows will materialize, the higher valuation you can ascribe to the company. Similarly in the overseas portfolio, especially for many of our larger holdings, I’m very confident in the sustainability of their businesses, competitive advantages, and cash flows. I’m confident that Sony will continue to have a strong consumer electronics and gaming franchise five years from now. I’m confident Samsung Electronics, the big Korean semiconductor company, will remain a dominant player in memory semiconductors five years from now [and] that Roche, the Swiss pharmaceutical company, will be a leader in cancer drugs five years from now. I’m confident that Potash Corp. of Saskatchewan, the world’s leading fertilizer company, will still be the dominant player in potash fertilizer five years from now, even 10 years from now. Because of this confidence in its competitive advantages and the sustainability of its business, I’m willing to pay a higher valuation for that company’s cash-flow stream.

The second criteria is the long-term growth potential–we’re growth stock managers, so we’re looking for companies that have medium- to long-term growth that is at least higher than industry averages. The best kind of growth is when a company is positioned in a growing industry or a growing market and on top of that has the ability to gain significant market share and so grow much faster than the market that it’s involved in. Then what really gets me jazzed is when we see situations for what I call open-ended growth.

Are there examples?

If we’re thinking about the top of the portfolio, say we talk about Li & Fung, Hong Kong’s leading manufacturing logistics company. It provides manufacturing logistics for primarily U.S., but also European, companies. [Retailers] may have their shirts or pants that are made in a factory in China or Vietnam, and they will use Li & Fung as the sourcer for these clothes. With Li & Fung’s very sophisticated logistics network and a network of manufacturing facilities in Asia and around the world, they can get the raw materials, and have them sewn in the right colors, and put that all together and bring them to the U.S. in a very efficient manner. But on top of that, we think there is open-ended upside from making acquisitions of many U.S., New York-based importers, who are much less efficient than Li & Fung, and on top of that there is the opportunity to penetrate some very big retailers like Wal-Mart. There’s also open-ended upside from large deals like one that it recently signed with a leading German department store company.

Your third criteria, value creation?

That, to me, means that management uses the cash in a smart way. The best way that management can use cash is if the company has very high return, organic growth opportunities. [One] company that can do that in a significant [way] is CVRD [Companhia Vale Do Rio Doce], (ADR on NYSE: RIO), the Brazilian mining company that is the world’s largest iron ore exporter. Iron ore goes primarily into the production of steel. Not only is CVRD the low-cost producer today, it also has low-cost mines where the capacity can expand very significantly over the next three to five years. At current iron ore prices, the return is 30%, 40%, 50%, or even higher on investment from these expansions. The key reason is that it already has much of the rail and port infrastructure in place so it’s simply a function, primarily, of expanding the mines and then they get some more rail cars, but it’s much cheaper than greenfield expansions by any of its competitors, so [CVRD's] cost per ton is much lower and therefore its return on investment is much higher. That, to me, is very exciting because they literally can put billions of dollars to work in extremely high-return projects and as investors we’ll take that any day of the week!