The world can be a scary place for investors and, for more than a decade, that perspective has held sway as U.S. markets have outperformed overseas stock indices.
Whether the U.S. markets’ dominance continues or not, there is a strong argument for more foreign diversification as Canadians are notoriously overinvested in their home country. Add in the prospect that you may be buying at the bottom of a 10- to 15-year trough depending on the region – with the caveat that international markets could still go lower.
Doomsday news headlines about wars, pandemics, and political upheavals will never disappear, but foreign equities make up more than half of the world’s securities and offer plenty of value today and future growth potential, top-performing international fund portfolio managers say.
“One of the exciting things about managing international money is there is always something to worry about. You open the paper every day and there are scary headlines,” says Jed Weiss, Boston-based portfolio manager of the LSEG Lipper Fund Award-winning Fidelity International Growth Fund – Series F for 10-year performance. (The LSEG Lipper Fund Awards track performance for various periods ending July 31, 2023).
His mandate is simple: find long-term growth stories that have a combination of pricing power, financial strength and growth potential “at attractive valuations,” – or bargain prices to the rest of us. Those scary headlines and market volatility – turnoffs to most investors – show the Fidelity manager where to look for undervalued blue-chippers.
There is no shortage of international hunting grounds after years of underperformance. “Valuations are cheap versus their own history and versus their U.S. counterparts on almost any metric you use, whether it’s P/E [price to earnings], or price to book value, or EBIT or EBITDA [earnings before interest, taxes, depreciation and amortization] or dividend yield or free cash flow yield.”
For example, he points to the investor exodus that came with the United Kingdom’s Brexit referendum, which has resulted in years of outflows from U.K. mutual and exchange-traded funds. Instead of getting bogged down on the minutiae of the crisis, he identified an underpriced homegrown champion.
U.K.-based InterContinental Hotels Group PLC (IHG Hotels & Resorts) had a small fraction of its business in the U.K., yet its stock was pummelled along with the rest of the market. In crisis, Mr. Weiss saw opportunity.
“At the time … only three per cent of its business is in the U.K., two-thirds of it is in the U.S.; it is Holiday Inn, Holiday Inn Express, and yet the stock is down 15 per cent in a few days because people just want out of the U.K., and they are selling everything they can. Those are the kinds of opportunities that I tend to look for.”
The COVID-19 pandemic ushered in “massive change” on an international scale that varied from country to country. One constant for Mr. Weiss regardless of geography: “If you are able to keep a cool head in the downturn, you are able to gobble up some attractive franchise businesses on the cheap.”
These days, the Fidelity portfolio manager is eyeing oft-avoided markets such as Japan for small and mid-sized bargain stocks, Taiwan (some “irrationally” cheap stocks) and India, “a small mid-cap market which is a happy fishing pond for [stock market] inefficiency.”
A similar approach has worked for the Desjardins Overseas Equity Fund – Class F, a 2023 Lipper Award winner for the best five-year performance among international funds.
Montreal-based fund manager PineStone Asset Management Inc. takes a picky, research-based approach to select just 25 to 35 large-cap equity positions in developed markets in Europe as well as Japan, Australia and Taiwan.
The fund’s successful strategy has allowed investors to invest in sectors underrepresented in the high-flying U.S. market, says Maxime Brochu, Desjardins’ product manager for the Overseas Equity Fund.
Mr. Brochu argues that this is the time for investors to consider increasing international holdings and diversification, rather than turning to “expensive” U.S. markets.
“It is not top-heavy [technology] like the U.S., you have exposure to tech, but also industrial, financial, and other sectors. You have a lot of companies that are well known with operations across the world,” he says, citing fund positions in the likes of luxury goods maker LVMH Moet Hennessy Louis Vuitton SE, semiconductor manufacturing giant Taiwan Semiconductor Manufacturing Co. Ltd., and makeup behemoth L’Oreal SA. The fund’s largest holding is with Danish global health care company Novo Nordisk.
International markets are best characterized as providing “individual and idiosyncratic” returns which is “good for stock pickers,” says Jeffrey Germain, a portfolio manager of the Brandes International Equity Fund – Series F, which topped the Lipper Awards three-year performance category.
The San Diego-based manager’s fund, which seeks to buy into companies it sees as undervalued due to their financial strength and growth potential, has invested in value-oriented plays in sectors including aggregate construction materials, aerospace and food retailing.
By country, investment is dominated by France (17.3 per cent), the U.K. (17.2 per cent) and Japan (14.1 per cent) with smaller holdings in companies in Germany, Switzerland, Italy and Brazil among others. It takes a big basket approach, holding positions in up to 85 companies. Its largest holdings include Japan’s Takeda Pharmaceutical Co. Ltd., U.K. aerospace and defence company Rolls-Royce Holdings PLC and China’s Alibaba Group Holding Ltd.
The Brandes portfolio manager sees the “growth over value” dynamic in international markets giving way this year to the value-based stock pickers’ approach as the headwinds of higher inflation and interest rates benefit stronger companies that are undervalued compared to competitors.
“We have had a pretty good relative performance period, but I think given where valuations are in international markets in absolute [terms], and especially relative to the U.S., for valuations on a relative basis to kind of get back to the historical average, there is quite a bit of potential upside in the general asset class.”