There has been a great deal of discussion lately about the importance of a higher allocation to international securities. A larger participation in international assets may make sense when you think that, as of the end of 2006, the U.S. portion of world market cap was 43%, according to Morningstar. Overseas operations accounted for 48% of the operating revenues of the S&P 500. The World Bank’s GDP forecast projects 2007 and 2008 GDP in developing countries to be about triple the GDP for the U.S. That said, not everyone wants to have an all-equity allocation to international.
One fund that can provide “best-of-breed” portions of international equity as well as fixed income is the $280 million Ivy International Balanced Fund, (IVBAX). Templeton Investment Counsel is sub-advisor to the fund, and, E. Tucker Scott, based in Geneva, Switzerland, runs the equity portfolio, while Michael Hasenstab runs the fixed income portfolio.
The fund has a long record of solid performance, with average annual total returns of 9.36% for the 10 years ended April 30, versus 9.17% for its peer group of hybrid global funds; 15.74% compared with a peer group average of 11.24% for five years; and 16.81% as opposed to 13.80% for three years, according to Standard & Poor’s. S&P ranks the fund three stars overall, with a 10-year style rank of three stars; five-year rank of five stars; three-year rank of three stars; and one-year rank of five stars.
Scott spoke with Investment Advisor by telephone from Geneva in April.
How much money do you manage overall?
Round numbers about $8 billion; [in this fund] $280 million.
What’s your benchmark?
Because this account is normally it is 65% equity and 35% fixed [income], we’ve created our own customized benchmark, which uses the MSCI All Country (Ex U.S.) because we don’t invest in U.S. securities, for 60%, and [for the other] 40%, the J.P. Morgan Non U.S. Government Bond Index.
What’s your investment process for the fund?
I co-manage this [fund]. I manage the equity portion of the fund, and a fellow by the name of Michael Hasenstab manages the fixed-income portion. I manage the equity side as if it were a normal equity portfolio that I’m managing day to day. We are value oriented, our marketing people use the term “core value” I think that’s descriptively correct, in the sense that we’re not deep-value people, and when growth becomes cheap in the market–as I think it is today–then we’re able to buy companies that might not traditionally be labeled as value stocks.
We have a low turnover, it’s typically 20% to 25% per year, so we really do what we say we do, and that is we’re long-term investors and we tend to hold securities until we think that they are fully valued. We don’t want to eat up our returns in trading too much.
How do you select the companies you buy for the fund?
I operate as part of a team, I think we’re 34 people today, located around the world but very much part of a seamless organization. We’re primarily a research organization. I’m a portfolio manager, with oversight over a number of portfolios, but with regard to the value that I’m providing to the entire group–and this works in both directions–we all have research responsibilities. What I mean by that is, I follow forest products and paper on a global basis; commercial services; and within those industries it’s my responsibility to be aware of which companies are getting close to the parameters that we’re looking for, and then recommending those to the group. Then all portfolios’ [managers] consider buying the stock that I’m recommending. It really is a group effort.
So how do I go ahead and make decisions on the fund? It really is a bottom-up process in the sense that the analysts, wherever they’re finding value–no matter what country or what industry–go onto what we call our bargain list, which is our stocks that we believe are the most undervalued that we can find in the world–and that’s where I go when I want to add a new security to the portfolio. I’ll look across there and try to find the ones that make the most sense to me.
How does volatility in oil or resources around the world make a difference in your investment process?
Well, our whole approach to valuation revolves around the idea of normalization, so when it comes to commodities, especially, we think in the long run that’s a very sound process to take. You need to think about the incremental cost of adding capacity, and that tends to, over time, be roughly where the commodity price should settle out. So if you get a big disconnect, i.e. the commodity price is selling well above the cost at capacity–and I’m talking about a unit of capacity here–then people will add capacity because it’s very profitable to do so. Conversely, when the commodity price is well under that, they are not going to add capacity, so you have this self-correcting mechanism, which, over time, works. So volatility, to the extent that it’s influencing asset prices above or below what we think is justified by our normalization analysis, provides us opportunities to buy or sell. But, it really doesn’t impact per se how we view the world–commodity prices are going to fluctuate and they’re very hard to predict in the short run, but in the long run you have pretty good ability to predict where they’re going to average out.
So you don’t let that noise affect you?
Exactly. If anything it’s just going to provide more opportunities to buy or sell at advantageous prices, the way we view the world.
What about interest rates or currency fluctuations–how do they affect what you’re doing?
Well, certainly the way we approach valuation is on a company-by-company basis. So these are inputs that go into the company analysis, and in many cases, certainly with regard to currencies, when we’re dealing with a multi-national organization they’ve already matched up their currency exposures, usually, as well as they can, and then it’s really an issue of a translation effect as opposed to a real mismatch in the currency where you can get some big changes in the value of the company based on that, so you want to make sure that the company is well-matched. In that case then, the currency is not going to be that big of an issue. Conversely, I follow the paper business. Currencies are a very important part of the analysis that I do on paper companies. The Canadian paper producers have been getting killed because the Canadian dollar has gotten expensive, so I need to take a view on that. The way I do that is by, typically, looking at where it’s traded historically; I look at purchasing power parity; and I make my best estimate–and it’s just that, I don’t have any special insights into currencies. I’m just using a common sense, long-term, value-focused way to project them and when I do that, in those cases where it is important, and as I say that’s a minority of cases, that’s how we approach currencies. We don’t hedge currencies on top of our portfolios; we try to take it into account at the company level.