International equity markets have been hit hard this year, beset by worries of slowing global growth, rising inflation from record-high commodities prices and challenging credit conditions. Although some fund managers are taking a defensive approach, others are finding value amid the debris.

In the former camp is Manraj Sekhon, manager of Mackenzie Universal International Stock Fund, offered by Mackenzie Financial Corp., and head of international equities at London-based Henderson Global Investors Ltd. He considers the return of an inflationary environment, after years of deflation, a major test.

“Investors have a real psychological challenge in appreciating and understanding what an inflationary environment means for economies and individual business models,” says Sekhon. “It is playing out already and will continue to play out.”

At the beginning of the year, Sekhon saw the risk of rising inflation and concluded that companies needed to have strong franchises, pricing power and operate in parts of the economy in which they could add value and pass on cost increases. At the same time, he looked to de-emphasize consumer discretionary companies that were at risk because they would have difficulty passing on rising costs.

Today, Sekhon argues, we are moving into the next phase. “Evidence is emerging that some of these cost increases are resulting in demand retrenchment,” he says. “Companies down the value chain cannot take it anymore. It’s becoming more challenging.”

Surging oil and gas and steel prices are having a damaging effect. Moreover, interest rates in Europe are on the rise, increasing the cost of capital.

“If you have a business model based on certain assumptions,” he says, “your spreadsheet may have looked great six months ago. But it is not looking so clever today.”

Markets are reflecting these pressures, as measured by the year-to-date 15% drop in the benchmark MSCI Europe Australasia and Far East index.

A growth investor, Sekhon is taking an approach he describes as defensive growth. “Overall earnings growth is going to be very different from the past few years,” he says. He expects to emphasize companies that are not economically sensitive.

From a geographical standpoint, Sekhon sees better opportunities in Asia and emerging markets, which represent 26% of the fund. There is also a neutral 20% weighting in Japan (vs 21% in the index), an underweighted 50% in Europe and 4% cash.

One relatively new holding in the 44-name fund is Vodafone PLC. The Britain-based global telecommunications player has been hit by regulatory concerns in Europe, but Sekhon believes this represents a buying opportunity. The stock recently traded at 150 pence a share, but Sekhon sees about 20% upside in the next year or so.

Another favourite is Lonza SA. The Switzerland-based firm is the world’s largest producer of active ingredients for major pharmaceutical firms, such as GlaxoSmithKline PLC. “Its business has evolved from commodities-oriented ingredients to high-end specialist ingredients,” he says, “which means margins have gone up.” The stock recently traded at 18 times earnings; earnings are growing by 17%-18% a year.

Lonza is an indirect play on the pharmaceutical industry, without the risks associated with drugs going off patent and regulatory hurdles, which have plagued drug-makers. Although the stock was recently 35 Swiss francs a share, Sekhon believes it could rise to about 160 SFR a share within 12 to 18 months.



Global markets have been rattled by the liquidity crisis in the U.S. and concerns surrounding the housing slowdown and credit tightening. David Ragan, portfolio manager at Calgary-based Mawer Investment Management Ltd. who co-manages Mawer World Investment Fund with Gerald Cooper-Key, honorary chairman of the firm, says we are at stage three in the financial crisis.

“The first stage revolved around the derivatives losses in the subprime market,” says Ragan. The second stage involved the seizing-up of money markets and the crisis that swept through U.S. monoline insurers.

“We’re getting into the third and, probably, final stage,” he says. “Normal mortgages are having difficulty getting approved, consumer spending is slowing and receivables are having losses. These are all normal problems, and we’re getting there — finally.”

Looking around the world, Ragan notes that real estate markets have been contracting in Spain, Ireland and Britain as well as other countries.

“There’s no sign of a slowdown in Europe, but we are expecting slowing growth for 2008 and 2009,” he says. As for Japan, its economy is not improving, largely because its political leadership is in flux. “You are not likely to see any political moves to help remedy Japan’s problems,” says Ragan, adding that its GDP growth will continue to be very weak.

@page_break@Meanwhile, he believes that the so-called BRIC countries (Brazil, Russia, India and China) will see a moderation in their GDP growth, as mature economies slow.

On a positive note, Ragan argues there are lots of opportunities for stock pickers. “It’s an uninspiring economic outlook. But as an investor, you have to look at the valuations,” he says. “Some of the companies that used to look expensive are looking attractive. So, we’re averaging in.”

The fund has about 7.6% in cash, but that’s dropping to around 6.5% as some money goes into new holdings.

“Liquidity has improved,” Ragan adds, noting that many central banks have lowered interest rates. “We’re more bullish than six months ago, but we’re definitely still cautious. We’re concerned about investor sentiment and how the U.S. housing crisis will affect consumers. As home prices fall, consumers will be less inclined to spend their money.”

From a geographical viewpoint, Ragan favours Europe, which represents 59% of the portfolio’s assets. There is also 6.6% in Australia, 8.7% in Latin America, 3.3% in South Africa and 15% in Asia (including China, Hong Kong and India). The most significant underweighting is the 6.5% weighting in Japan.

“We are bottom-up investors,” Ragan says. “So, Japan’s underweighting is a byproduct of our process. Only four Japanese companies make the list.”

Adding to the 60-name fund, Ragan recently acquired Britain’s Rathbone Brothers PLC. The small-cap firm is a leading independent investment manager that oversees portfolios for high net-worth individuals and foundations. It has about £13 billion in assets under management.

“The market has been very hard on financial services stocks. But this one is different,” Ragan says. “It has very stable long-term cash flows. Some of its clients are the third generation.”

The stock’s multiple fell recently to 10 times trailing earnings from a high of 16-17 in 2007. “The business model may suffer a little,” he says, “but we don’t think it will suffer as much [as the market contends].”

Once market sentiment improves, Ragan expects the stock will move upward: “Meanwhile, we will collect a 5% dividend, and its earnings will grow over time. We expect to benefit at all levels.”

Rathbone Brothers shares recently traded at 830p each, but Ragan believes the price could go back to 1,000p a share over an unspecified time frame.

Another new holding is Intertek Group PLC. The British firm specializes in testing, quality assurance and certification for manufacturers around the world.

“It works with companies from start to finish — designing, testing and checking for quality” says Ragan. “The cost for its services is relatively minuscule compared to the problems that can arise with recalls and reputational damage.”

The firm is one of three global players. Thanks to acquisitions and organic growth, its revenues are expected to grow 26% from 2007 levels. He has acquired the stock in stages since this past September.

“At 17 times earnings, the stock looks expensive on a price/earnings basis,” says Ragan. “But it’s not so on a discounted cash flow basis.

Intertek also has low capital requirements. He believes there is about 30% upside on the stock price, but has no target date.



Markets may be highly volatile, but there are plenty of buying opportunities, argues Don Reed, manager of Templeton International Stock Fund and president of Toronto-based Franklin Templeton Investments Corp.

“It’s especially good for Canadian investors,” says Reed. “All assets are cheaper because of the strength of the Canadian dollar. That creates some opportunities. And valuations are lower — considerably lower than a few years ago. So, you’re getting more for your buck even if the exchange rate didn’t change.”

A bottom-up stock picker, Reed is reluctant to say whether he is bearish or bullish on markets. “The issue is, can we find good value?” he says. “The answer is: ‘Yes’. There is a lot of value out there.”

From a geographical viewpoint, Reed has a slightly underweighted 67% in Europe (vs 68.3% for the MSCI EAFE index) and a modestly underweighted 23.8% in Asia.

But within the latter component, there is a very underweighted 5% in Japan (vs 21% in the index), which is offset by an overweighted 6% exposure to Hong Kong and 4% in China (compared to nil in the index). There are also single-digit weightings in Latin America and South Africa and 3.4% in cash.

From a sector viewpoint, Reed likes the telecommunications and energy industries; conversely, he underweighted the financial services sector long before the credit crunch hit last summer.

One favourite name in the fund with 75 holdings is China Mobile Ltd. The firm boasts 380 million cellphone subscribers and is growing at the rate of more than five million new subscribers a month.

Reed bought the stock in 2001 and watched it peak at HK$160 a share this past October. It’s down now to around HK$105 a share, largely because of the meltdown in the Chinese market and the re-structuring of the domestic telecom industry.

“The balance sheet is clean and management works hard [to create] shareholder value,” says Reed, adding that he has no stated target. “There is still upside potential.”

A more recent favourite is Sasol Ltd. The South African firm is known for liquefying coal. “It has the largest scale project in the world,” says Reed, noting that Sasol has set up pilot plants in markets such as China and the U.S. that have oil shortages.

Bought in the summer of 2007, the stock has risen 70% to a recent 43,376 South African rands. It trades at around 15 times earnings, and earns a 2.1% dividend yield.

In a similar vein, Reed likes Gazprom OAO. Controlled by the Russian government, the firm is the world’s largest natural gas producer. “It supplies about 55% of Europe’s natural gas needs,” says Reed. Its former CEO, Dmitry Medvedev, is now president of Russia.

“The company has done a very good job of opening up various markets ” says Reed, “and has proven to be quite efficient.” IE