The markets of europe, Australasia and the Far East have been flat in Canadian-dollar terms so far this year, weighed down by concerns about a slower global economy, persistently high energy prices and the spectre of further hikes in U.S. interest rates.
Managers of international equity funds maintain, however, that there are plenty of attractive stocks, especially in the small- and mid-cap arenas.

“We are seeing a lot of opportunities, much more than we expected,” says Jeff Urbina, a portfolio manager at Chicago-based William Blair & Co. LLC and a member of the team that oversees GBC International Growth Fund, which is offered by GBC Asset Management Inc. of Montreal. “If you look at European small- and mid-caps, there are a lot of very nice companies with very good earnings momentum, good fundamentals and reasonable valuations in Germany, Scandinavia and France, but less so in Britain.”

In contrast, the so-called big industrial stocks that dominate the MSCI EAFE index are restructuring stories that don’t offer the growth dynamics found in smaller
companies, he says.

Overall, from the perspective of interest rates outside of the U.S. or the cost of energy, Urbina doesn’t see a lot of downside risk. Robust growth in Britain, continental Europe and Japan could potentially drive rates up but growth has been far from robust. “Many have unemployment problems. They won’t solve their macro-economic problems by pushing up rates,” he says.

The price of crude oil, he admits, is an open question: “It depends on where China goes:
will it have a soft or a hard landing? Will it
continue to grow quickly and suck up a lot of resources?” He suggests that China is already slowing and pricing pressures will ease as demand for energy softens.

A bottom-up growth investor, Urbina has invested about 45% of the fund in Europe, 21% in Japan, 20% in emerging markets, 4% in Australia, 4% in Canada and the balance in cash. The heavy weightings in emerging markets and Japan indicate where value exists.

One of his top picks in the 100-name portfolio is Aeon Mall Co. A large-scale shopping mall developer in Japan, Aeon is benefitting from the fact that Japan is 20-30 years behind the U.S. and Canada in terms of building malls, says Urbina: “It has a sustainable earnings growth rate of 15%-20% for the next three to five years.”
Bought in April 2004 at about 2,000 yen, it is now 3,920 yen or 24 times 2006 estimated earnings. “Twenty-plus is not a bad number for its kind of growth,” says Urbina, who is reluctant to set any price targets, but intends to keep the stock provided the fundamentals are intact.

Urbina also favours Infosys Technologies Ltd., an Indian computer services outsourcing firm. “It is the best company in that space,” he says, adding that the firm does back-office work and programming for the likes of Goldman Sachs. It has been growing consistently at about 25%-30% a year and boasts a 45% return on equity.
Acquired in mid-2002 at US$25 (it is listed as an American depository receipt), Infosys is now US$76 per ADR. Although its price/ earnings ratio is high at 39 times fiscal 2006 earnings, Urbina defends the position: “I don’t look for cheap stocks, but great growth companies, and this is definitely one of them.”

The market is ripe with opportunities, agrees Jason Holzer, a portfolio manager with Austin, Tex.-based AIM Capital Management Inc. and co-manager of AIM International Growth Class, offered by Toronto-based AIM Funds Management Inc.
“We view the market as one big opportunity set. As long as there are enough individual stocks that are interesting, we are satisfied.
We are bottom-up stock pickers.”

Holzer is clearly reluctant to make any market calls or macro-economic assessments. “We’re believers in what Peter Lynch once said: ‘If you spent 15 minutes each year pondering macro-economics, you wasted 10 minutes.’ A lot of these factors are so unpredictable. At the start of 2005, who would have predicted higher oil prices, lower bond yields and a stronger U.S. dollar? Not many.” More to the point, he says, there is no short-term link between growth rates and market performance. Accordingly, he and colleagues Clas Olsson, Barrett Sides and Shuxin Cao focus on individual stocks.

Running a 140-name portfolio, they have allocated about 70% to Europe, 22% to Asia (including 12% Japan), 3.5% to Australia, 2.5% to Latin America and 1% to South Africa, with the balance in cash. The fund is well diversified: about 33% of the stocks are large caps, 46% mid caps and 22% small caps. From a sectoral viewpoint, however, consumer discretionary and financial services stocks dominate the fund at 22% each, followed by industrials at 16%. The managers favour companies with strong fundamentals, earnings momentum and moderate valuations.

@page_break@One of the leading names is Anglo-Irish Bank Corp. “It’s the bank with the best track record in Europe; it has grown 40% a year for the past five years,” says Holzer, noting that the bank has benefited from the rapidly growing Irish economy and focused on secured lending to small and
medium-sized companies. “It has no branches and is very efficient. The cost/income ratio is about 30%, or about as low as any bank, and its ROE is 30%, which is top class. The model is very focused, conservative underwriting. And it provisions very conservatively, too,” he says. He’d be happy if the bank continued to grow at 15%-20% a year. Acquired in April 2002, at 2.7 euros a share, the bank is now 10.3 euros. The stock is trading at 14 times 2005 earnings, and 12 times fiscal 2006 earnings. While he does not set price targets, he ventures it could be worth 12 euros within 12-18 months.

Holzer also likes Hungary’s OTP Bank. “It has a hammer lock on Hungary, which is a very under-penetrated market,” he says. It boasts a 25%-30% ROE. At 11 times 2005 earnings, it is not cheap relative to banks in developed markets. “But it is cheaper than its Eastern European peers. There has been a lot of excitement because of greater M&A opportunities.” Acquired in April 2003 at 2,365 forints, it is now 7,060 forints. It has the potential to rise another 15%-20% in the next 12-18 months, he says.

“Conditions still favour investors,” says Gerald Cooper-Key, manager of Mawer World Investment and director of Calgary-based Mawer Investment Management Ltd. “Some of the positive drivers include very low interest rates (U.S. rates are rising but are still quite low); tame inflation, aside from some commodities on the energy side; growing profits; and improved corporate cash flow. And by historic standards, we have low taxes. All these are positive drivers.”

On the risk side of the equation, he argues that the fear of rapidly rising rates is probably unfounded: “Europe and Japan do not need to raise rates. Britain is likely to lower rates in the near term.” Second, the drop in the euro against the US$, to a recent US$1.19 from US$1.36, is likely to boost Europe’s export competitiveness. Third, there is a concern about oil prices hurting many companies, but it is a boon to oil producers and service companies. “There are risks, but they are manageable. On balance, the potential rewards should outweigh the risks,” he says.

A bottom-up stock picker, Cooper-Key has allocated about 26% of the fund to Asia.
However, he favours companies in the fast-growing economies of South Korea and India — in which he has 6% and 5%, respectively — rather than Japan, which accounts for 9%. “We prefer the stronger growing economies in Asia, where I can find better value in some world-class companies.” Top names include South Korea’s Samsung Electronics Co. and India’s Grasim Industries Ltd., a leading cement maker.

There is also 54% in Europe, which is dominated by a 23% weighting in Britain.
And he has a 5.5% weighting in Australia and New Zealand, 7.5% in Latin America, 3% in South Africa and 5% in cash. From a sectoral viewpoint, he favours energy, industrials and telecommunications services, and conversely underweights information technology and consumer discretionary stocks.

One of the top holdings in a 58-name all-cap fund is Canon Inc., the Japanese consumer electronics giant. “It has a great franchise,” says Cooper-Key. Acquired more than five years ago, the average cost was US$42 per ADR. It trades at US$53, or about 13 times 2006 earnings (vs 30 times for the Japanese market).

Another large position is HSBC Holdings PLC, one of the world’s largest banks. “Its global scale and expertise make its local operations more profitable,” says Cooper-Key, noting that the firm does a big portion of its business in Asia. IE