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First Eagle Is Who We Thought They Were

There may be a new regime, but it's awfully familiar.

Bridget B. Hughes, CFA, 10/10/2011

Nobody likes the uncertainty that can come with change, particularly when the status quo is pretty darn good. So, when Charles de Vaulx abruptly left the successful First Eagle funds in March 2007, his departure naturally worried the funds' shareholders. They may have breathed a sigh of relief when the funds' advisor, First Eagle Investment Management, brought the funds' previous longtime manager and value legend Jean-Marie Eveillard out of retirement to run the portfolios while a longer-term solution was determined. But the concerns mounted again when a number of other key managers, analysts, and operations folks also departed from First Eagle a few months after dSavee Vaulx had headed out the door. That crew has since founded IVA Advisors, which manages IVA Worldwide IVWAX and IVA International IVIOX

Back at First Eagle, questions abounded. Could the diversified First Eagle funds, including First Eagle Global SGENX, First Eagle Overseas SGOVX, and First Eagle U.S. Value FEVAX, maintain the disciplined and uncommon value approach with a new set of managers and analysts? Would the eclectic portfolios endure? And importantly, would the funds behave as investors expected and be successful overall as they had been for the most part for more than two decades?

Starting (Mostly) Over
Eveillard wasn't the only one left at First Eagle who knew the strategy and the funds. For one, Abhay Deshpande was still there. Deshpande, a former Morningstar fund analyst, had worked with Eveillard as an analyst when he joined the advisor in 2000 but then had moved off the funds into separate accounts and thus had not worked closely with de Vaulx during the latter's tenure as the funds' sole manager. Deshpande re-engaged with Eveillard and the firm's Global Value Team. And Alan Barr also remained as an analyst.

But the team needed a leader to succeed Eveillard as well as more analysts to replace those who had left. More than a year passed before the team would hire another portfolio manager, not surprising given the firm’s cautious style. What was surprising, however, was its choice of a portfolio manager, Matt McLennan, who didn't have a lot of U.S. mutual fund experience. While McLennan had nearly two decades of value-investing experience under his belt, his most recent and most extensive role was as the lead of a global-value team working for Goldman Sachs’ private-wealth group in London. He didn't have a public performance record, nor could investors take a look at the portfolios he had put together. He talked the talk, but would he walk the walk?

Meanwhile, the firm also rebuilt its analyst ranks. A couple, including Kimball Brooker Jr., have since been promoted to the portfolio-management ranks. One interesting and unusual move was the hiring of the highly regarded value-investing author and professor Bruce Greenwald in late 2007. Greenwald, who had long known Eveillard, served First Eagle in a part-time role of director of research and helped primarily with the hiring and training of its analysts. It was a smart move. That Greenwald was well-known and respected probably quelled some nervousness on the part of investors. But the hire wasn't for show: Greenwald shares the fund's investment philosophy and has experience imparting how to think about the important facets of it. And he's seen enough students to help be able to determine who had the temperament to execute it.

Today the Global Value Team comprises six portfolio managers and seven analysts. Both Eveillard and Greenwald officially serve First Eagle as "senior advisors," but their active involvement in choosing investments and portfolio construction is minimal. Eveillard is also the funds' board of trustees since June 2008.

A Familiar Look and Feel
In some ways, the portfolios look different than they did in 2007. For example, the funds' average market cap has increased, and Global and U.S. Value have been moving more into U.S. technology stocks, an area they had previously tread lightly in. There's also more in financials, averaging roughly 11% since October 2007 through September 2011, up from 7% between October 1992 and September 2007. Global's and Overseas' investments in emerging Asia are historically high.

But it's plain to see the value spirit of the funds is still intact. Large-caps, particularly U.S. technology stocks, have been widely considered cheap, and the funds have remained in the blend column of the Morningstar Style Box. Deshpande says that many of these companies, such as Texas Instruments TXN and KLA-Tencor KLAC, had been on the firm's wish list for some time, and that they'd finally reached attractive enough valuations to make it into the portfolios. And while even Eveillard once said "Asia is the future" and while the research team has been looking hard at the region, valuations haven't been overly tempting. In both Global and Overseas, the emerging-Asia stake is less than 5% of assets. Still in character, First Eagle is being patient.

Meanwhile, much of the portfolios should be quite familiar to investors. Several of Global's positions, including top holding Secom SOMLY and Shimano, Pargesa PRGAF, and Sodexo SDXAY, have been in the portfolio for nearly 10 years or more. The funds have also maintained a comparatively heavy commitment to its Japanese stocks--something that sets it apart from its competition. First Eagle has also maintained its long-term orientation, with the funds’ turnover ranging between 9% and 30% since 2008.

The portfolios have also kept up their distinctiveness. Their active share figures (a measure of how different the funds are from their respective indexes) are about 90%--a very high figure compared with other funds. And while some of the portfolios' newer large-cap holdings are household names and widely held, the funds still move off the beaten path. Global and Overseas, for example, are two of fewer than a dozen U.S. mutual funds to put more than 1% of assets in HeidelbergCement.

Beyond Equities
With an absolute-return mentality, Eveillard and de Vaulx had long kept cash in the portfolios. The amount of cash would fluctuate, depending on the opportunities in the market, and the funds weren't afraid to keep large amounts of cash on hand. McLennan and his team have followed in those footsteps. The funds’ cash stakes dipped in early 2009--to less than 10% of assets in both Global and Overseas and less than 15% in U.S. Value--when stock valuations were low and bargains abounded. As the market rallied, cash crept up in all of the portfolios: Global had 15.2% as of the end of July 2011; Overseas had 16.3%; and U.S. Value had 21.7%. (Those numbers have fallen a bit lately, as the managers have been net buyers during the most recent market turmoil.)

Bonds also remain part of the portfolios, if in smaller doses than in the past. Typically, these funds have looked for equitylike returns from their bonds, often homing in on high-yield corporate issues, and Deshpande says the funds’ smaller bond stakes of late are a function of low interest rates and tight credit spreads.

Finally, one of the more unusual attributes of these funds has been their constant inclusion of gold bullion. Eveillard and de Vaulx had long used physical gold as an insurance policy against market meltdowns. Even despite the historically high price of gold, bullion remains in the portfolios, which will typically keep between 5% and 10% of assets in the metal. (As of the end of July, the fund kept between 5% and 7% of assets in gold, reflecting the higher "insurance premium.")

A Performance Check
Clearly, there are some familiar traits among the portfolios, bringing some comfort to shareholders that the funds can continue to behave as expected for the long haul. But how have they performed?

While the past three years is hardly enough time to make an airtight judgment, the tumultuous market has given us a lot to observe, and so far, investors should like what they see. Most important, as one would expect, the funds have held up better than their peers in tough times. In 2008, Global, Overseas, and U.S. Value held down their losses more than most rivals, landing well into their respective categories' best quartiles. Similarly, since the end of April 2011, while all three funds have suffered around 10% declines, their benchmarks have experienced much worse. Thus far, the funds’ resiliency and lower-risk profile appear to have endured.

The funds’ protective stance and lighter losses in down markets have gone a long way in explaining the funds' longer-term success. So, even though the 2009 rally proved a challenge for all three offerings, their annualized three-year returns through Sept. 30, 2011, are strong. Global's three-year Morningstar Rating for funds, which is a risk-adjusted performance measure, is 4 stars; Overseas and U.S. Value have earned 5 stars.

Conclusion and Caveats
Investors seem to be taking notice. While all of the funds suffered redemptions in the wake of the manager uncertainty--and like many others, during 2008's and early 2009's tough markets--they've been taking money in since October 2010, seeing their biggest inflows since early 2005.

That's easy to understand. These remain attractive, well-run funds that have maintained their unusual focus on capital preservation while not sacrificing decent gains during rallies. But caveats do remain. Most important, although individual managers and analysts have experience, that experience came at different places; the team is still fairly new at working together.

And while the recent trends in the portfolios' market caps, along with the highly flexible approaches, suggest the firm can handle more assets, there could come a time when the funds' options are limited--particularly in the less liquid realm of international small caps and high-yield bonds. In fact, maintaining a small asset base and the optionality that goes along with it is one of the arguments that de Vaulx had with First Eagle.

Finally, investors who have been attracted to these funds for their ability to mitigate losses during an uncomfortable time should remember that they are likely to lag if the markets go on a sustained, long-term rally in which more-speculative shares and securities thrive.

That being said, this is one rebuild that has been a success.

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