When the markets are as volatile as they were in January 2008, with news about ratings agencies, banks, broker/dealers, and the bond insurers growing darker by the day, some clients may be feeling a tad emotional. Bothered by the uncertainty, they may not feel content to stay with their advisor’s well-crafted financial plans, may reach for yield at just the wrong time, or worse, maybe they just can’t stand the roller coaster sensation of being in the markets to any degree at the moment. Emotion can complicate investing, and while a mattress filled with cash may be a comfort during uncertain markets, it doesn’t constitute a great retirement plan. While so much is still unknown about domestic companies’ prospects, perhaps it’s an opportune time to look outward, internationally, in terms of clients’ equity allocations.
One portfolio manager, Scott Snyder, takes the style boxes and emotion out of international investing with a quantitative system he uses with an industry focus, but as an example of his approach, the Greenwood Village, Colorado-based manager of the $271 million Icon International Equity Fund (IIQIX) says, “even though we’re focused on industries, we’re still buying companies to populate the industries–we’re not out buying a steel ETF.”
Standard & Poor’s ranks the fund’s I shares as four stars overall, with four stars for its three-year ranking, and five stars for the one-year ranking. The fund had an average annual total return of 24.56%, compared with 17.18% for the equity international peer group for the three years ended December 31; and 22.58% versus 12.42% for one year.
We spoke by telephone with Snyder in late January.
What’s your investment process?
The whole premise with the fund, as well as with every fund within Icon, falls back to our quantitative, systematic investment approach. We’re a bottom-up manager and we focus on industry rotation. What we’re looking for first and foremost is industries that are trading at discounts to their intrinsic value, so we use a modified Benjamin Graham model to come up with our estimate of intrinsic value. We group these based on 147 different industries as classified by S&P and MSCI, and from there we can get the whole gamut in terms of the broad market to see which industries would be giving us the most value as opposed to the least value. We’re tilted toward the higher discount; the ratio [we use is called] the value-to-price reading [VP], just your intrinsic value divided by where the stock or industry is trading right now. We’re looking for the high VP stocks and industries. Value investing always has an early bias so we’re also looking to combat the early bias, a bit, and also employing a relative strength metric to capture that. We’re looking for stocks that are, first, cheap, and they’re also on sale–trading at a discount to their intrinsic value–and this value is starting to be recognized by the marketplace. The prices are starting to get bid up and the relative strength is moving in their favor, so we view those industries as being in the sweet spot: they’re cheap; they’re on sale; and they’re really starting to move now. That’s where we focus our investments.
How is the fund different from its peer group?
Our differences stem from our unique approach. First, we’re a quantitative system so we’re not out chasing news stories and trying to outguess one person or the other in saying, “I think company XYZ is going to come out slightly less than this quarterly number,” or saying that, “Interest rates in the U.K. are going to be this versus that.” What we do is stand back and take the non-emotional approach. The reality is, we’re operating in an emotional marketplace here, and we just have to recognize instances when stocks get pushed in one direction or another, either far too optimistic and they bid the prices up far too high, or far too pessimistic where you start trading these stocks a lot lower.
The industry focus has been a unique approach across the peer group especially within the international marketplace, our ability to really take active bets across industries, and…we basically toss out the style box. That’s a unique approach unto itself. There are times when this fund can take on a small- to mid-cap growth tilt, or we can start moving to the larger-cap blend or value side of it. We’re not making the top-down decision to do that, it’s just wherever the market drives us. We have the ability to go wherever we need to. Internationally, it hasn’t been as big an issue, but it still comes up; if you look at the Lipper categories and the Morningstar categories the style box creeps in.
No one can ignore what’s happening in the financial sector. Does it affect your models?
This is the perfect example of the integration of these economies. Internationally the financials haven’t been immune to the struggles that we’ve seen within the U.S. In the shorter-term weakness over the last six months or so, financials certainly have been a weak spot globally. First and foremost we do see plenty of value there, so while our individual intrinsic valuations on the stock levels have come down with these write downs–with these decreases in forward-looking earnings, and forward-looking growth rates–it has certainly been detrimental to the individual valuations of these groups. Yet what we’ve been seeing is [that] the market’s been taking it way too far in the other direction. Granted, value has come down, but the market has overly punished these stocks.
We’ve been underweight financials for quite a while, and it wasn’t some prophetic view of me being able to outguess the next guy down the street; it was a strict adherence to our overall investment system. Much of it was [that] the relative strength component of [the financials] started to work against itself there, so from an opportunity-cost standpoint, there were better places to be within the market; we took away from our financials positions quite a while ago and moved to those better industries.
So the models came through for you?
Are you seeing in your modeling that the international financial sector’s getting to the point where you’d possibly nibble, or does it still indicate weakness?
Right now it’s really at that pivot point–it’s certainly made up quite a bit of ground. Right now, financials as a whole are middle of the pack relative to the other industries. We’ve seen some emergence of financials. In the short term we’ve seen a more pronounced rebound within the last week-and-a-half since the first Fed rate cut [on January 22]–financials have certainly been one of the leaders off of that. We have a six-month relative strength in place–it’s the best of both worlds, as we say–we’re not going to get whipped into short-term head fakes as often. Kind of taking a very, very short-term view here, but even with that, it’s certainly moved up to be on average, on pace, so that said–and we did have quite an active underweight–we have been moving towards nibbling, taking some more selective positions as these groups have started to show some strength in the short term right here.
Is there a holding that worked out better than anticipated?
We’re not company focused, we’re more focused on industries…[however] one of the longer-term holdings and one of the ones that’s a perfect segue [from] what we were just talking about within the financials–one that’s held up very well and still had very good returns–is the National Bank of Greece. It’s been one of the largest holdings and it’s also been one of the largest holdings within our European Equity Fund. Within the group–we’ve been underweight the diversified banks industry for quite some time within this fund–it happens to be the largest industry within the fund and within the benchmark, yet relative to the benchmark, [we] had an underweight position there. This is really showing how we can still capture country themes within industries.
A lot of times when you’re looking at the 120 or 130 names within this industry you’re going to get some winners, and some losers, and some overpriced names, and some underpriced ones. From a top-level view, things can cancel out a bit, but when you look a little deeper and start looking country by country the banking industry within Greece has certainly been a sweet spot. [It's] had some current short-term volatility within this month, but then, again, who hasn’t? But the long-term growth rates on this as forecasted on the Street could be well over 20%, and we’re still taking a much more conservative viewpoint on their earnings growth rate; we’re looking at them to grow about 16% over the long term here.
What’s your sell discipline?
Our sell discipline revolves around our two main metrics: the first is the value-to-price reading. Our guideline is that we’re going to sell industries that fall into the bottom decile of our value-to-price reading. So the interpretation of that would be, simply, profit-taking–the prices have moved far beyond where we’re estimating the intrinsic value to be in these groups, so we’re taking profits there and moving back up to the top of our industry list. The second one is based on relative strength, which is more of an opportunity cost. When we initiated the position we had value in the group, and the market was showing indication that it was recognizing it through a higher relative-strength reading. For one reason or another, relative strength may have deteriorated…and you basically have to cut your losses rather than sitting on the loser month after month.
Who would be the typical investor for this fund?
It’s going to come down to their risk-return tolerances and objectives that they have for their portfolio but…if you look at the world now, and certainly this decade, with the stellar overseas returns relative to the U.S., you can’t ignore international equities, and the whole stigma of the unknown has really been torn down. If you look at a world benchmark, over half the world’s market cap–last time I checked it was 54% or 55%–is outside of the U.S. From an asset allocation perspective, just on size alone, [it indicates] a healthy exposure to the international markets.
Do current market conditions change the international allocation?
We have a global product [at Icon]…and we’ll manage the U.S.-international tilt within that; we’ve been slightly overweight international, to slightly underweight the United States. As value investors we’re going to break down our allocation based on valuations. This morning, our value-to-price [VP] reading, (so this is your barometer: when our VPs are high, stocks are really cheap to us and we get excited), the VP for the U.S. is a 1.34, so, in essence, stocks are worth about 34% more than where they’re currently trading right now in the U.S. Internationally it’s a 1.35, so you’ve got about value parity across the globe, and it’s really almost arguing for a neutral stance.
Senior Editor Kathleen M. McBride writes regularly about mutual funds. She can be reached at firstname.lastname@example.org.