The markets of europe, Australasia and the Far East have rebounded after being hit in May and June by interest rate jitters and concerns of slowing growth in the U.S. Although macroeconomic issues persist and geopolitical tensions — such as those in the Middle East — are boiling over, managers of international equity funds say there are plenty of attractive stocks, especially in the small- and mid-cap arenas.

“The correction inserted an element of an appreciation for risk and some fear, which is healthy,” says Jason Holzer, a senior 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 Ltd.

“We had had a very unusual stretch with upward-trending markets and very low volatility,” he says. “You could buy almost anything and it turned out OK. The more risks you took, the more you were rewarded. But things are not that neat and tidy. We’ve had a healthy retrenchment.”

Holzer, who works with co-managers Clas Olsson and Shuxin Cao, took advantage of the volatility in late May and reduced the fund’s cash to about 6% from 10%. They also added to some existing positions. From a geographical viewpoint, about 65% of the invested portfolio is in Europe (vs 53% in the benchmark MSCI EAFE index), 25% in Asia-Pacific including Japan (27%), and 7% in Latin America and 2.5% in South Africa (neither of which are in the index). The fund is not hedged against currency fluctuations.

Bottom-up stock-pickers, the team has lowered the number of holdings in the fund to 110 from 140 a year ago. “We thought we owned too many companies and made a conscious effort to slim down the portfolio,” says Holzer.

From a market capitalization viewpoint, about 40% is in large-caps (defined as companies with market caps of US$14.6 billion or more), 33% in mid-caps (US$3.7 billion-US$14.6 billion) and 27% in small-caps.

USG People NV is one holding that was increased. The small-cap firm is the second-largest temporary-employment firm in the Benelux countries, and the fifth largest in Europe. “Market growth, especially in Holland, has accelerated,” says Holzer. “The Dutch economy had been moribund, and lately has started to pick up. Growth for the industry has been 20%, year-over-year, and USG should exceed the market growth rate because of its focus on small and medium-sized enterprises that are a little later in the cycle.”

USG stock trades at a price/earnings multiple of 11 times 2007 earnings, which, Holzer says, is too low: “Compared with other employment firms, it sells at a nice discount. We’re pleased with it.”

Bought in late 2005 at about 35 euros a share, the stock recently traded at 57.5 euros. Holzer does not set specific targets but, he says, the stock has 50% upside over the next two or three years.

Another increased holding is Petroleum Geo Services Co. Based in Norway, the mid-cap firm is involved primarily in marine seismic services and is leveraged to offshore exploration, which has grown considerably in the past few years.

“Its first-quarter earnings were about 70% above forecasted growth,” says Holzer. Under new management, the company spun off a smaller division recently and is concentrating on seismic services. The stock trades at nine times 2007 earnings. Bought in early 2005 at around 180 Norwegian kroner a share, the shares recently hit 370 kroner. There is another 30% upside over two years, Holzer says.

Although markets have stabilized, “the volatility is not over,” says Gerald Cooper-Key, manager of Mawer World Investment Fund and director of international equities at Calgary-based Mawer Investment Management Ltd.

Three forces are driving international markets, he says: rising interest rates, concerns about the sustainability of economic growth and higher risk premiums applied to stocks. Geopolitical issues such as tensions in the Middle East aggravate matters, he adds, but appear to have less influence.

Even though the markets rallied in late June, “the jury is still out,” says Cooper-Key. “The U.S. Federal Reserve Board’s tightening may not be finished. Combine that with a Japanese rate hike — the first in years — and we could have further volatility.

“It rarely pays to ‘fight the Fed,’ or any other central bank. If rates are perceived as having several more hikes to go, then markets will continue their correction. Whereas if the Fed is perceived to have to finished its tightening mode, the market will look at other issues,” says Cooper-Key. On a positive note, corporate profitability is quite good and valuations are not far out of line.

@page_break@Like Holzer, Cooper-Key has also looked for opportunities in turbulent markets to add to existing holdings. A bottom-up stock-picker, he has allocated about 53.2% of the fund to Europe, 27.1% to Asia, 6.7% to Latin America, 4.2% to Australia and New Zealand, and 2.7% to South Africa. There is about 6% cash.

From a sector viewpoint, the fund is dominated by a 22.5% weighting in financials (vs 29.4% in the MSCI EAFE index), 16.5% in industrials (10.3%) and 10.5% in energy (9.4%).

The top holding in the 50-name all-cap fund is HSBC Holdings PLC, to which Cooper-Key added recently. “It’s truly a global bank, has a long record of profitability and we’ve no reason to think that will deteriorate,” he says. The bank has a market cap of US$200 billion.

HSBC’s trailing earnings multiple is 12 times 2006 earnings. It also has a 4.5% dividend. A long-time holding, the stock was acquired as an American depository receipt on the New York Stock Exchange at an average cost of US$76 per ADR. The ADRs are now US$88.50. Cooper-Key has no stated target price.

Another favourite is Fugro NV. Based in the Netherlands, the small-cap civil engineering firm collects and interprets geological data and specializes in studying seabed data for the oil industry.

“It’s not cheap at about 20 times 2006 earnings, but it has a history of good management and is expected to be highly profitable,” says Cooper-Key. A long-time holding in the fund, its average cost was 14 euros. The stock recently traded at 32.8 euros.

Cooper-Key also favours Samsung Electronics Ltd., the large South Korea-based maker of products such as flat-panel TVs and mobile telephones. “One of its strong points is that it has a significant budget for research and development,” he says. “It’s a global company, with an emerging-market base, and it’s reasonably valued at less than 12 times [2006] earnings.”

The recent correction, Cooper-Key adds, provided an opportunity to add to the holding, as the stock had tumbled to US$210 a unit in June from its all-time high of US$292 in January. The stock recently traded at US$246.

“When you get these volatile periods, it’s an opportunity to add what you believe is a long-term quality company,” Cooper-Key says.

His average cost on Samsung is US$132. The stock trades as a global depository receipt on the London Stock Exchange.

Michael McLaughlin, manager of CIBC International Small Companies Fund, offered by CIBC, is a largely bottom-up and growth-oriented investor; for the most part, he ignores macroeconomic factors . He also continues to favour less well-known, smaller companies within the EAFE markets.

“The small- to mid-cap sector has outperformed consistently for five years,” says McLaughlin, senior investment manager at London-based Pictet Asset Management Ltd. “People ask, ‘Isn’t it about time that trend is reversed because valuations have been compressed?’ Our answer is: ‘Given that we only try to own 100 companies, we are fortunate in that there is no shortage of interesting opportunities. We believe we can get more growth in the small-cap space than in the large-cap. Small-caps are not as cheap as they used to be. Nevertheless, in a universe of thousands of names, you should be able to pick 100’.”

From a market perspective, McLaughlin prefers Japan and the rest of Asia. “Halfway through last year, we began aggressively adding to our positions in Japan,” he says. “Valuations got rich and we cut back a bit. But that market has underperformed this year and it’s offering interesting opportunities.”

The fund is 22% invested in Japan, which is a neutral weighting relative to the fund’s benchmark, the HSBC world ex-U.S. medium/small-cap index. There is also an overweighted position of 16% in Asia and underweighted 60% in Europe.

“We’re not bullish on Europe as a whole; it still has structural problems,” he says. “Germany and France, for instance, are not open, unfettered capitalist economies. They are still rigid and structurally have a lot of impediments.”

One top holding is Prime Success International Group Ltd. The Hong Kong-based firm makes and retails ladies footwear in China. “It is building a dominant market position in China,” says McLaughlin, noting the firm also supplies Wal-Mart Stores Inc. “It has this huge-scale, cheap-shoe business on the manufacturing side. And now that it has the retail platform in China as well, it can capture that much greater retail margin. It’s a well-placed company.”

The firm boasts a 35% return on equity and earnings per share are growing at about 30%-40% a year. Bought in late 2004 at about HK$1 a share, it recently traded at HK$4.50. Its P/E multiple is 23. McLaughlin has no stated share price target.

Another favourite is Nabtesco Corp. A Japanese maker of motion and control systems for industrial robotics, it is a beneficiary of the resurgence in demand for Japanese machine technology and the China growth story. Bought at about 600 yen in mid-2004, it recently traded at 1,150 yen. IE