World values

Q: For more than 15 years you’ve been focused on the international market. Why? A: Many of the world’s top companies are non-North American. You can think of all kinds – BHP, Royal Dutch Shell, Unilever, Honda. And many companies around the world are growing faster than their North American counterparts.
A: It’s also important to recognize that 50% of the world’s equity markets are not North American. Some of these markets have a lower correlation than the TSE does. And from a risk management point of view there is a benefit too.

Q: There are a lot of emerging market companies – how do you decide where to buy?
A: What we’re trying to do is look for great companies rather than focusing on specific sectors or countries. What we’re looking for is world-class businesses and some of them do happen to be in the emerging markets. As an example, a company like Cemex in Mexico or Petrobras in Brazil – they’re world-class companies which happen to be in emerging markets.

Q: So you’ll just buy a company without regard for its location?
A: Well, we have to be mindful of location, but there’s a big difference between being mindful of a location and adjusting risk factors accordingly, as opposed to going out and blindly buying a country or sector. I don’t have anything in Russia for those reasons. I’m concerned about the government and so on.

Q: Do you have investments in China?
A: No. We sold our last position in China in January. The market was becoming excessively over-valued. But, there are other ways to do these things. I would rather have exposure to Chinese growth by investing in some of the high-quality names in other countries than have a material business in the country. Rather than being exposed to Chinese markets and the governments, we get our exposure through companies that are selling things in China. So, it’s on our minds, but we try to mitigate that risk.

Q: What are your thoughts on India? Some say it’s tough to find value there right now.
A: India is probably one of the better BRIC countries, but no country or market is immune to a major slowdown. With overall growth and demand for infrastructure and information technology, it probably slightly mitigates the risk of the underlying economy, which is growing much faster. Recently we’ve seen risk premiums come back into the market, which means that market prices have come down. So perhaps it’s a little more attractive now than six months ago simply on valuation process.

Q: What’s your process, when it comes to choosing a specific company to purchase?
A: We believe we can provide our investors with better than market rates of return together with lower than market levels of risk over economic cycles. That’s our basic philosophy. Our approach, which falls out of that, is to systematically create prudently diversified portfolios of world-class companies bought at discounts to their intrinsic values. Once you have those things down you can start looking at process. With that in mind, then the process becomes much more involved but it has a basis to it. In the process we do a lot of filtering by computer screening and so on. So, what we’re looking for are wealth-creating companies that have a return of invested capital that’s greater than their cost of capital. What this basically means is each day it should become a little more valuable. It’s amazing how many don’t.

We also want companies that have a competitive advantage. The advantage could be as a result of location, or size or anything of that nature. I think too that I would consider myself to be somewhat of a traditionalist. I care very much about what I pay for earnings, for cash flow, for dividends, and for dividend coverage. I do concern myself about balance sheets of companies. I like companies that have a positive free cash flow, particularly in this environment.

Q: What’s your take on the market turbulence?
A: First of all we’re longterm investors, not shortterm traders. However, I am somewhat skeptical about the market itself. I will never know when the bottom is. I believe the market, the conditions around the market, the financial crisis and the U.S. consumer weakness and issues such as that make for a fairly poor earnings outlook in the immediate future. But, sometimes it’s in times of trouble that opportunities are found. I’m not discounting that there could be further weakness in the market, but at the same time we’re long-term investors so we’ll continue to look for wealth-creating companies.

Q: Are you finding opportunities?
A: We are, but I’m more comfortable looking at stocks that are less economically impacted and less exposed to the U.S. consumer – for instance, some of the environmental type of stocks, which tend to be less impacted by the U.S. economy.

One company we’re looking at is Intertech. It’s a company that inspects products for quality. If you think of some of the issues we’ve had with products that have come out of China, there now needs to be more product testing and they do that type of thing.

Q: I know you don’t base your purchases on sectors, but are there any areas that look better than others?
A: We do tend to look at infrastructure stocks, particularly in developing countries. One company is Grasim, which is based in India. It’s a cement company so one of the competitive advantages is that it’s close to where the infrastructure products are needed.

The only auto company I have in portfolio is Honda and that, too, has a clear advantage from the standpoint of fuel efficiency.

Q: And financials?
A: I wouldn’t say we don’t have fi- nancials, it’s simply that I have not emphasized the financials for a good 18 months because of the background and I don’t think the problems are finished yet. That said, some of them are probably getting down to a point closer to write-offs, so we’ll start looking at them again shortly.

Q: Are you sensitive to big cap versus small cap?
A: We are less concerned with cap size than the quality of the company. We don’t try to focus specifi- cally on large cap or small cap – it depends on where the wealthcreating companies are. Just because a company is large doesn’t mean that it’s a great business or wealth-creating.

Q: What are your diversification strategies?
A: Risk management is almost as important as looking at opportunities. I’m looking for prudent diversification. What we’re trying to do is avoid an over-concentration of risk, but not be too overly diversified, because you can diversify all your gains away too. We normally have between 50 and 80 different companies in the international portfolio, though right now we have 62. We don’t try to follow an index. We try to look for good names and the index will follow us.

Another method of risk management is to really know the companies and to care about things like the balance sheet. If you have a great company, that, in itself, is a form of risk control.

Q: What would it take for you to sell a company?
A: If a company is no longer wealth-creating, if we feel the valuation is excessive, if we feel there’s been a significant deterioration in fundamentals and also if we feel there’s a much better opportunity elsewhere. Then we’d bring in another name which could help improve the portfolio, so we’d have to let one of the weaker companies go.

And, part of the process is constant monitoring. Just because a name is going in a portfolio doesn’t mean we forget about it. We have to monitor it all the time and we do it thoroughly.

Q: Is there an example you could share of a company you sold and why you let it go?
A: We recently sold out Korea Electric Power Co. Our primary concerns were, we thought, a deterioration in fundamentals. We were worried about the ramp-up of input prices mainly from coal and other fuels. The difficulty is that the company would have had to pass the cost on to the consumer. So, in our view fundamentals were deteriorating and we decided we’d reduce the stock.

Q: Your turnover is about 15% to 20% a year. That’s pretty low.
A: We are long-term investors, looking for great companies and if we have one we see no reason just to sell it. I think it’s in the process of trying to select great wealth creating companies in the first place.

Q: What is the definition of long term for Mawer?
A: It works out to be, on average, maybe five years. It’s possible one can buy a company and after a year you realize perhaps it wasn’t quite as great as you thought, but then there are other companies in the portfolio that have been around for over 15 years. We’re not traders, so if it’s a great business we’re not going to sell it. If it deteriorates we will.

Q: Has your process changed at all over the 20 years you’ve been managing your fund?
A: I like to say the process has evolved. It’s become, perhaps, a bit more disciplined and a bit more refined. As the technology has improved, the ability to screen has improved. Clearly we’ve become bigger, we’ve had to increase the size of the team.

Q: You appointed David Ragan to comanage the international fund with you. Why did you want help?
A: Because it’s becoming a signifi- cant mandate and it’s a good idea to have a strong backup. He’s been with me for five years. But also, one of the aspects here is our investment philosophy and process are consistent across all our other asset classes. Some of the other analysts who focus on other asset classes contribute to what we’re looking at too. There are a number of people who could have input and bounce ideas around, but they’re not necessarily part of the international team.

Q: You’re 59, still a number of years away from retirement, but have you thought about a succession plan?
A: We’re always mindful of prudent management and we’ve taken care of the transition to the extent that we have a co-manager in here now. We have a very consistent philosophy, approach and process which wouldn’t change if something happened to me. I have no express desire to suddenly run away. I enjoy the business and the team continues to be built. I really don’t know the answer to this, other than I have a strong vested interest in making sure any transition takes place over time and our clients are in good hands, whatever happens.

Q: Manulife is going to sell some of Mawer’s funds, including yours. Why did you partner with them?
A: We’re pretty good investment managers and we think they are very good distributors. [The partnership helps us stay] focused on what we do best, which is manage money and [then we] use their capability to distribute, that works better. [It works because] we’re not predominant in the distribution business and we never can be or would be. Just listen to me, I’m hardly a salesman.

Q: But there are other ways to buy your fund than going through Manulife?
A: Yes. Where we have existing relationships they continue, but otherwise Manulife has an exclusive on the commission-based advisor channel for these co-branded funds. An individual that is not in an advisor-based channel will continue to buy our funds directly.