International equities markets have been recovering since early March, as confidence has been restored to the banking sector and the world-wide fiscal and monetary measures take effect. Although stocks are not as cheap as they were in the first quarter of this year, fund managers believe there are still plenty of attractively valued opportunities.

“Since March 9, investors have been increasing their risk appetite,” says David Ragan, a portfolio manager with Calgary-based Mawer Investment Management Ltd.who oversees Mawer World Investment Fund with Gerald Cooper-Key, honorary chairman of the firm. “It’s less about good economic news and more about less bad news. To use the tunnel analogy: we may not see the light, but it’s not getting darker.”

Ragan adds that investors have been dumping U.S Treasury bills and driving up riskier investments and currencies, including those in emerging markets.

Ragan believes that the market recovery is linked to the stabilization of the financial services sector. “Banks are lending again, to consumers and each other,” he says, also noting that the spread on the London interbank offer rate (which refers to the short-term interbank lending rate in the Eurodollar market) has narrowed from its peak of 3.44% in October 2008 to 0.369%.

“Corporate bond issuance has also picked up. This is what we need to see for a recovery,” says Ragan. “It’s not turning a corner, because there is more bad news to come out. But these are typical signs of a recession, and not the insanity we saw last year.”

Still, investor sentiment is fragile, and volatility remains high — although not at last fall’s levels.

“We will see some ups and downs. But, generally, valuations are reasonable. We are staging in [reducing] cash and suggest that other people do that, too,” says Ragan, noting that stocks in the benchmark MSCI EAFE index are trading at 13.5 times trailing earnings. “They look like a good investment.”

Cash represented about 10% of the Mawer fund’s assets under management going into last fall’s correction, as there were few attractive stocks with reasonable risk/return profiles at the time. “This has changed materially,” notes Ragan, “and we’re down to about 4% cash.”

From a geographical standpoint, about 61% of the fund’s AUM is in Europe, 15% in Asia (including 6.6% in Japan and 3.2% in South Korea), 7.7% in Australia, 9.9% in Latin America and 3.2% in South Africa. The most significant underweighting is in Japan, which accounts for 23.5% in the MSCI EAFE index. “We’re not finding good investments in Japan,” Ragan says, “particularly relative to other Asian markets.”

Running a 54-name fund, Ragan recently acquired Bureau Veritas SA. One of the top three firms in the world that specialize in testing, inspection and certification, the French company has 700 offices and laboratories in 140 countries. “It has high returns on capital and it’s in a fragmented industry that is consolidating, so there is lots of growth to go around. We’re not seeing intense competition, with returns being driven down,” says Ragan. “With increased regulation and concerns about materials and products, testing is on the increase.”

Acquired in late March at 28 euros, the stock is now trading at 34.9 euros. Ragan has no stated target, although he maintains the stock is still “cheapish.”

Ragan also likes Halma PLC, a firm based in Britain that designs and assembles safety and detection devices for equipment such as elevators. “It has a very stable business model,” he says. “The management team is one of the best that we have in the portfolio. It’s created a range of products that earn a fairly steady, high return on capital. It’s been able to do this for years.”

Ragan initiated a position in February 2008, when shares were 180 pence each, but added on weakness this past winter. Shares are now trading at 197 pence each.

“It’s not a screaming bargain,” he says. “But it’s still a very high-quality company that, over the long term, should provide good returns.”



Markets have turned a corner, agrees Don Reed, manager of Templeton International Stock Fund and president of Toronto-based Franklin Templeton Investments Corp. “I believe we will see growth in the economy in 2010. I don’t know if the World Bank numbers are right or wrong — they could be revised downward or upward several times over the next six months,” says Reed, referring to the World Bank’s recent forecast of minus 2.9% global economic growth in 2009 and 2% in 2010.

@page_break@Because Reed believes that EAFE economies are dependent on developments in the U.S., he argues that there are several positive factors that will have an impact.

First, the so-called “Obama Factor” will bolster economies: “We need to see confidence develop in the financial system. It’s clear to me that Obama has promoted a lot of confidence through his leadership. When he went to the G-20 meetings in Europe last April, they couldn’t get enough of him.”

Second, the collaborative efforts at the G-20 meeting have been critical to an economic turnaround. “They are agreeing,” says Reed, “on how to move forward.”

Third, central banks around the world are generally in lockstep on lowering interest rates.

Fourth, investor sentiment has improved, and this is reflected in rising stock markets (the benchmark MSCI EAFE index increased by 16% for the three months ended May 31, in Canadian-dollar terms).

In addition, Reed notes that commodities prices have recovered, with crude oil now at US$64 a barrel after bottoming at US$34 last December.

More has to happen to get markets moving ahead: price stabilization in the U.S. housing market, reduced levels of U.S. housing inventory and consumers continuing to replace government spending.

“We are seeing some of that. But we need to see more,” says Reed, noting that these trends have to be apparent in EAFE markets, too. “It’s a worldwide phenomenon.”

A bottom-up stock-picker, Reed is a value-oriented investor who does not adhere to index weightings. As a result, 73% of the fund’s AUM is overweighted in Europe (compared with 66% for the MSCI EAFE index). Of this allocation, about 25.8% is in British stocks, compared with 20.8% in the index, largely because British stocks are trading at a price/earnings multiple of nine, vs the long-term average of 16. There is an underweighted 20% of AUM in Asia, single-digit holdings in Latin America and South Africa, and 1.5% in cash.

From a sector viewpoint, Reed favours telecommunications (12% of AUM), energy (12%), industrials (19.8%) and consumer discretionary (11%).

One favourite telecom stock in the 68-name fund is Vodafone Group PLC. The largest cellphone company in the world by revenue, it boasts 200 million subscribers, second only to China Mobile Ltd. (which is also in the portfolio). Reed bought the Vodafone stock in July 2004 and watched it peak at 190 pence in late 2007. The stock is now trading at about 118 pence.

“Sales have grown at 11.4% compounded over the past four years,” says Reed, noting that Vodafone is the leading provider in Britain and Germany but is also well represented in emerging markets. The stock has a 6.6% dividend yield. Reed, who has added to the holding on weakness, has no stated target.

Although the Templeton fund is underweighted in financials, Reed likes several real estate firms that are included in the sector. One favourite is Hang Lung Group, a Hong Kong-based developer and owner of residential, office and hotel properties that has expanded into China. Revenue growth has been erratic, Reed admits, as sales were up by 120% in 2008 vs 2007, while 2006 sales were 44% lower than those in 2005. But the stock is very reasonably valued at 11 times earnings, he notes. Acquired in July 2004 at around HK$12 a share, the stock peaked at HK$43 a share in late 2007. The stock is now HK$38 a share; it pays a 1.8% dividend yield.



Although Jason Holzer is reluctant to make market calls, the co-manager of AIM International Growth Class Fund believes there are definitely more opportunities than there were a couple of years ago. “With a severe two-year underperformance of small-caps, that segment has become very attractive again,” says Holzer, a portfolio manager with Austin, Tex.-based Invesco AIM Capital Management. “From a market-cap standpoint, we are taking a barbell approach. We are finding lots of attractive large-caps and small-caps, but less so the mid-cap segment.”

Currently, about 51% of the AIM fund’s AUM is in large-caps (categorized as companies with market capitalizations of US$8.5 billion or higher), 16% in mid-caps (market caps of US$3.6 billion to US$8.5 billion), and 33% in small-caps (less than US$3.6 billion).

“We’re finding a lot of high-quality companies, with strong balance sheets and free cash flow yields of 8% and up,” says Holzer, who works with portfolio managers Clas Olsson, Barrett Sides and Shuxin Cao.

“We have no idea about the trajectory of the economic recovery,” says Holzer, adding that although credit conditions have improved, he doesn’t anticipate a dramatic turnaround by yearend. “We are looking for companies that can weather a variety of environments. Whatever shape the recovery takes, these companies are well positioned.”

Given the tough economic environment, Holzer and his team are focusing on companies that are less vulnerable to the economic cycle and have better balance sheets. From a sector standpoint, the top weightings are in industrials (18.6%), consumer discretionary (18.1%), health care (16.4%) and consumer staples (14.7%). There are smaller weightings in areas such as energy (6%) and cash (9%, down from 11% in April).

Geographically, 72% of the invested portion of the portfolio is in Europe, 19% in Asia, 5% in Latin America and 4% in Africa and Middle East.

Running a 74-name portfolio, Holzer favours small-cap names such as Paddy Power PLC. The firm operates the leading gambling bookmaking chain in Ireland and boasts a 30% return on equity. “Its shops are more profitable than its peers,” says Holzer, noting that the company has expanded into telephone and online betting and into the wider British market. “It punches above its weight, in terms of advertising and brand recognition. A lot of the competition does not have the kind of balance-sheet strength that Paddy does.”

Acquired in early 2008 at about 20 euros a share, the fund’s managers added to the holding on weakness last fall. Shares are now 16.6 euros each, or 11.1 times trailing earnings. Holzer has no stated target, although he generally expects 50% upside.

Another small-cap favourite is DCC PLC. Based in Ireland, the firm has five divisions but is best known for energy distribution (both oil and propane).

“Historically, its return on capital has been close to 20%, and was 18% last year, a tough year,” says Holzer, adding the firm has emerged as the leader in oil distribution and is the No. 2 company in liquefied petroleum gas distribution in Britain.

Acquired in the fall of 2008, at about 10 euros, the stock is now 14.7 euros. “It was simply too cheap,” he says, adding that the stock trades at nine times earnings.

“A lot of small-caps went down last year,” he says, “probably much more than they should have.” IE