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Thank You for Smoking

Tobacco stocks lit a fire under certain international funds last year.

Gregg Wolper, 01/31/2012

The past year was even rougher for international funds than it was for those centered on the battered U.S. market. While the S&P 500 ended a tumultuous year ahead by 2.1%, foreign markets weren't so fortunate. Most ended up deep in the red, owing to the more direct impact of the eurozone crisis and worries about slowing growth and rising inflation in emerging markets. The effect of weak foreign currencies, when fund returns were translated into dollars for U.S.-based investors, exacerbated matters.

Across the board, foreign-focused categories suffered much deeper losses than U.S.-focused categories did. For example, the foreign large-blend group lost 14% while the domestic large-blend category dropped just 1.3%, and the diversified emerging-markets category plunged 19.9%, more than any domestic group. (The worst U.S. category was the narrowly focused financials-sector category, with a loss of 15.1%.)

Amidst the gloom, though, a light was shining, The glow of a match, one might say, held to the tip of a cigarette. Tobacco stocks, those most reviled of companies in some times and in some quarters, posted strong gains while almost everything else was falling. Managers who owned them in bulk reaped the benefits. When you look at the top international funds of 2011, don’t be surprised if you smell smoke.

No Passing Fancy
For the most part, the managers with substantial weightings in tobacco-related stocks were not simply running for cover, shifting to defensive stocks in a year when riskier options were getting pounded by investors. Most of these managers have had a liking for tobacco, so to speak, for many years.

A prominent example is the team at the helm of Tweedy, Browne Global Value TBGVX, who recently won the Morningstar International Fund Manager of the Year award for 2011. In the fund's September 2011 portfolio, Philip Morris International PM was the second largest holding, at 4% of assets, and British American Tobacco (also known as BAT) BTI was at 2%. Philip Morris rose almost 40% in 2011, and BAT climbed 27%. A smaller position in Imperial Tobacco rose sharply as well. Who said such stocks were stodgy fare?

In a recent interview with Morningstar, the managers of the fund explained what they liked about Philip Morris. Most notably, they pointed to its popular brands, its exposure to emerging markets, and the fact that litigation is much less of a risk outside the United States. In addition, comanager Will Browne praised the decisions made by the company's executives, noting, "they’ve been great allocators of capital."

With stock markets hit so hard in 2011, the performances of those stocks couldn’t keep Tweedy, Browne Global Value’s 2011 return in the black. But they did push the fund into the top decile of the foreign large-value category. Its loss was nearly 9 percentage points milder than the category average.

David Winters of Wintergreen WGRNX has an even deeper connection with this area. Winters has long had huge stakes in tobacco companies, largely because of their powerful, consistent cash flows and the fact they can raise prices more easily than firms in many other fields. In Wintergreen's September 2011 portfolio, Philip Morris International and BAT together made up about 9% of assets, while two other tobacco firms, Reynolds American RAI and Imperial Tobacco, took up around 8% combined. Those stocks soared just as Philip Morris and BAT did. (The fund also owned Japan Tobacco for part of the year.) No wonder Wintergreen beat 90% of its world-stock category rivals last year, posting a slight gain while its typical peer suffered a 7.9% loss.

Gregg Wolper is an editorial director and senior mutual-fund analyst at Morningstar.

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