Just about every finance textbook contains at least one chart illustrating the benefits of international diversification.

Applying this theory takes some patience, however, as there are long stretches during which this kind of diversification doesn’t seem to accomplish much at all. Despite its recent drop, the rampaging Canadian dollar has managed to erase virtually all the gains earned by funds that invest outside the country, prompting some investors to conclude stronger returns may be found closer to home.

But for investors who take a contrarian view and still want to maintain some exposure overseas, international funds that steer clear of both the U.S. market and the greenback, although not widely held among Canadian fund buyers, could be the way to go.

With this in mind, two small funds to consider are Mawer Investment Management Ltd.’s $123-million Mawer World Investment Fund and AIM Funds Management Inc.’s $85-million Trimark International Companies Fund. Like most of their peers, both have been little more than break-even propositions over the past five years, although each has enjoyed a rebound recently. The Trimark fund was named International Equity Fund of the Year at the 2004 Canadian Investment Awards.

Mawer World Investment has been a consistent performer throughout its lifetime.
It posted first-quartile returns for the 2001, 2002, and 2004 calendar years, staggering a bit in 2003 with a modest 9.7% annual return against the benchmark MSCI Europe Australasia Far East Index’s 13.8% return.
Year to date, the fund is up 4.5%.

Over all 12-month periods since its launch, the fund has beaten the index more than 60% of the time, whereas the median international equity fund has been able to beat the index only 35% of the time.
Moreover, the fund’s 10-year average annual compound return is 8.6% — more than twice that of the median fund in the category and the benchmark. As a result, the fund receives a five-star, risk-adjusted rating from Morningstar Canada.

The Trimark fund’s average annual compound return for the five years ended April 30 is 2.1% — well ahead of the EAFE index’s 3.5% loss. At the same time, in periods during which the index has had positive 12-month returns, the fund has outperformed by an average of 1.8%, generating more positive periods than the index since its inception in 2000. As a result, it also receives a five-star Morningstar rating.
It has lagged the Mawer fund sharply in recent months, posting a 1.2% return year-to-date.

Trimark manager Judith Adams got her start at Confederation Investment Counsel, initially managing a Canadian small-cap fund. She joined Sceptre Investment Counsel Ltd. as a manager of European equities, later switching to Trimark Investment Management, a predecessor company of AIM.

Adams looks at company-specific factors such as quality of management, market share and growth opportunities. She then conducts a valuation analysis, looking at the growth and cost of the company vs the market. Adams’ bottom-up approach determines the fund’s sector and regional allocations, neither of which looks much like the index. For example, the fund has no exposure to energy, telecom or utilities, and it has consistently underweighted Japanese companies. Instead it’s tilted toward sectors that benefit from global economic recovery, such as industrials, financials and technology.

In terms of country exposure, the fund has about 45% of its money in Britain and Ireland, 25% in Continental Europe, 11% in Japan, and 6% in Mexico with the balance scattered among smaller European countries. Cash is currently 12%, which is higher than usual.

Gerald Cooper-Key, manager of this Mawer fund since its inception in 1987, is a traditionalist. A veteran of 30 years in the investment industry, including a long stay at Royal Trust, he relies on standard ratios such as price/book, price/ earnings, and price/cash flow, as well as return on equity, to drive his decisions.

Currently, asset weights are 28% in Britain and Ireland, 36% in Continental Europe, 10% in Japan, with 5% in Australia and the remainder divided between Latin America and Asia ex-Japan. Cash is 6%.

The fund’s exposure to Japanese equities is less than half the weight of the EAFE index as Cooper-Key believes that Japanese companies remain overvalued. The fund’s correspondingly higher exposure to other Asian countries enables it to gain increased exposure to China and India, areas Cooper-Key favours but is reluctant to invest in directly because of concerns about corporate governance.

@page_break@Both offerings are narrowly based for foreign funds. Mawer World Investment currently contains less than 60 stocks, compared with about 30 for Trimark International Companies. The Mawer fund generally plants about 28% of assets in its top 15 holdings while limiting sector exposure to a maximum of 20% of the portfolio, whereas the Trimark fund has about 40% of its assets in the top 15. These two funds have few common holdings among their major bets.

A year ago, about 40% of the Trimark fund was in smaller-cap stocks but that amount has subsequently dropped to about a quarter of the fund. In general, the Mawer fund favours larger-cap companies. Trimark International Companies is the more volatile of the two with a standard deviation of 15.8, while the Mawer fund has had a 14.0 standard deviation for the past five years. Of the two, only the Mawer fund has registered less volatile results than the median fund and much of this volatility is largely attributable to high returns in rising equity markets.

The funds’ respective Sharpe ratios suggest Trimark investors have been slightly better rewarded over the five-year period. Mawer supporters, however, have been equally well served over the long term.

Both funds are strong contenders. With a solid long-term track record and a skinny management expense ratio of 1.4% (120 basis points lower than the median fund), the Mawer fund has proven a good source of diversification for Canadian investors. In this instance, at least, it seems to be the better choice, given the price difference. The Trimark fund costs are in line with the median fund, however, and it has also delivered on its promise since its inception. IE