Wed, 4 Jan 2012
The Tweedy, Browne team, winner of Morningstar's 2011 International-Stock Manager of the Year Award, discusses the role of process and time horizon in the fund's successful long-term track record.
Bridget Hughes: Hi, my name is Bridget Hughes. I’m one of the analysts here at Morningstar, and I’m here this morning with the winners of our International Fund Manager of the Year Award for 2011. They are the portfolio managers of Tweedy, Browne Global Value, as well as the three other Tweedy, Browne mutual fund offerings. And we’ll start here with John Spears, Bob Wyckoff, Will Browne, and Tom Shrager. Thanks, guys, for coming in this morning, and congratulations on the award.
Just to kind of summarize what happened this year, the Global Value Fund did drop about 4% in 2011, but that’s about a third of the loss of the MSCI EAFE Index, and foreign large-value funds on average dropped also about more than 12%. So, you held up well in a tough and rocky, volatile environment, so congratulations on doing that.
I know you don't build the portfolio, construct the portfolio, based on the kind of macro events that drove a lot of the returns in 2011, but what is it about your strategy that sets the fund up nicely time and time again for these times of strife? This isn’t the first time that the fund has been resilient.
John Spears: We’ve always used the same strategy. We’ve been using this same strategy since we ... Will and I have been partners together since the 1970s, and the whole idea is that we are buying shares in a business, not a piece of paper, and if you and I own the whole company, what’s the business worth? We value companies by looking at what similar businesses have sold for, and then we try to buy in at big discounts to that value--typically a third, 40%, sometimes 50%, or less, of that estimated value. And those stocks are often in the lower deciles and quintiles on statistical measures that have been correlated in various empirical studies, stocks that tend to do better like low P/E, low price to book, high dividend yield, ... enterprise value to EBIT, EBITDA, that kind of statistical measure is related to doing better than average.
William Browne: And I'd add to that, I think one of the biggest difficulties anybody has in decision-making, whether it's investing, love, eating, is temperament, and you've got to find some way to deal with temperament. Temperament ... works at cross purposes with good decision-making. I saw a statistic the other day, which said that the average mutual fund, correct me if I am wrong, but over 20 years ending in '08, compounded at about 8%, the average investor in the fund compounded at less than 2%--that's temperament.
And you have to find some way to anchor yourself in some more objective, if you will, measures, so that you can be more rational in your decision-making, and that comes out to process. Process gives you an anchor off from which you can work and make your decisions.
The other thing, I think, that we have which helps us is, we come at this with a very different time horizon than a lot of people. Some say "Well, you did this last year, what are you going to do next year?" I don't know. What's next year going to bring? Not sure. But we do have a sense, one, that some time over the next several years, things will probably begin to get better, but in the meantime, I think it's important to bear in mind that behind every stock price is a business. As John was saying, you focus on how the business is doing. Last year stock prices tracked our businesses a bit better than some other businesses, and we happened to think we were in some pretty good business.
Hughes: So let's talk about one of those businesses. One of the biggest contributors to the fund's performance last year, actually, it wasn't a stock that just held up better, it was a stock that was up almost 40%, and that's Philip Morris International. You bought that very nicely, it looks like, near it's all-time low since the spin-off in early 2009. So what attracted you in the first place to that company and then since the stock has averaged above a 25% return over the past three years, what do you say about its valuation?
Bob Wyckoff: Well, it's a terrific company. It has seven of the most popular cigarette brands in the world. It sells those cigarettes all over the world. It does something north of 40% of its sales in faster-growing parts of the world, the emerging markets. It's the international segment of what used to be the old Altria. It spun out in 2008, and there's less litigation risk associated with cigarette sales outside the United States.
Browne: They've been great allocators of capital. They haven't made foolish decisions. They pay it out to you or they buy in their stock. So there are a lot of things about it that are attractive: very sustainable business. All that being said, you're absolutely right. That's probably one of the more fairly priced securities we have in our portfolio, and if things continue to track the way they have been, you will probably see us trimming that off and selling that off as we go on, because it is fairly reasonably priced. But the business is certainly still intact.
John Spears: That gets back to what Will was saying about process. I mean when people call us up, they often ask about our buy list. But part of the process is the sell list, too. It's when things attain sort of fair value or you find better choices, you make a switch.
Hughes: So, we've talked about some of the good news in the portfolio. There's always some other areas of the portfolio that aren't firing on their cylinders. Let's talk a little bit about the financials. It looks like you've been swapping a little bit out of CNP Assurances and into Munich Re, and Zurich is a fairly new holding. I wonder if you can talk about that analysis and then maybe contrast the ... European insurance companies with the European banks, which you don't own.
Shrager: We have been trimming CNP and Munich Re. We bought a little bit of Munich Re at the beginning of the year. The main difference between insurance companies and banks is funding. You don't depend on wholesale funding that can disappear tomorrow.
Spears: You don't depend on borrowing money. You've got money from your policyholders that just stays with you, and they are not moving around. It's not hot money.
Shrager: In addition to that, life insurance companies at least, you are tied into a longer-term contract. So the probability of premiums coming in every year is relatively high.
The main risk you have with the insurance companies that we own is the portfolio of government bonds, and if Greece goes, nobody will notice. The big problem is Italy. But if Italy goes, and Italy blows up, there is no place to hide. It's like a Lehman event. But on average, we believe that at this moment in time, there are better businesses. In the case of CNP, it's the number-one life insurance company in France. It has a tremendous business in Brazil. It's at 6 times earnings. It has an 8% yield, pretty good numbers.
Spears: 75% of tangible book value
Shrager: 75% of book value, maybe 60% of embedded value with good embedded value growth over the last 10 years.
Browne: The raw statistics--if you just looked at statistics, which we don’t; we go beyond statistics--they are really very attractive statistics in terms of yields between 6% and 8%, depending on which security you pick. Below their embedded values, low P/Es.
When we started investing in these securities, Greece was an issue. But we hadn’t seen people's concerns metastasize to Italy and Spain. Now I happen not to believe that Italy and Spain should end up in the same soup that Greece is in, but you've got a lot of emotion in markets today. And as we looked at that, and we looked at the exposures, and one of the nice things about insurance companies is that they are far more transparent, from a balance sheet point of view, than a bank is, in addition to how they fund themselves.
We said, well, just maybe we are better off owning a little bit less of them than we had originally owned because of a low-probability, but indeterminate, risk if those things ended up becoming a huge problem.
It's interesting. The companies have actually done analyses: If they were forced to take 30% or 40% write-offs, for instance, on Italian bonds, they would still have adequate capital. But all things being equally said, we are going to own a little bit more than we had originally wanted to own because this issue developed.
Hughes: One of the more unusual traits of the Global Value Fund is the currency hedging policy--which 100% of your economic exposure to foreign currency is hedged back into the U.S. dollar, and you have since introduced Global Value II, which doesn’t hedge. But I am curious as to how much of your 2011 performance you can attribute to the currency policy on Global Value, and what's been your experience over the long term in terms of how that’s helped or hindered the fund, and what do you expect from that policy in the future?
Wyckoff: The hedging actually helped very little in 2011. Most of the major currencies that we're invested in basically started out the year at a price and ended up pretty much near the same price. So, whether you were hedged or unhedged, you tended to come out at the same place.
And one way of looking at it is, we always compare our performance to the EAFE index, hedged and unhedged, which is sort of a proxy for the developed markets. And the return, as I recall, for the one year for EAFE hedged was I think negative 12.10%, and the return for EAFE unhedged was negative 12.14%. So there was a four-basis-point differential between the hedged and unhedged index, which suggests that the money we made--or didn't make, actually, but we were a third of the index loss--occurred in our stocks.
Shrager: So the yen strengthened, the Swiss Franc and British Pound were about the same, and that the euro weakened. So overall it was a wash.
Wyckoff: But over longer measurement period, you do see some differentials between hedged returns and unhedged returns. For instance I think the three-year results for EAFE hedged and EAFE unhedged is somewhere between 200 and 300 basis points in favor of the unhedged EAFE index.
But over very-very long measurement periods in the developed world, currency seems to be a wash when investing outside the United States, from the perspective of a U.S.-based investor. And you can see that, again, in the long-term compound of EAFE and EAFE hedged, which are within, I think, 20 basis points of each other. We have had the good fortune of outstripping both of those indexes by about 500-plus basis points since inception. But the hedged and the unhedged were right in line. So at the end of a long day, whether you are hedged or unhedged doesn't seem to matter a whole lot, at least looking backwards. In terms of where we are going in the future, and what currencies are going to do, it's any one's guess.
Browne: That being said, to me it's a little bit like the Vietnam War. There really isn’t an answer, and the debate will go on forever. We found that in so many instances when we spoke with clients, so much of the time we had with them was taken up on whether does one hedge or not hedge. So we said, why don’t we provide an alternative? So we can talk about how we try and capture the local market return in the share price.
Wyckoff: So we leave it our clients.
Hughes: Well, thank you again and congratulations again on the International Fund Manager of the Year Award for 2011.
Spears: Thank you.
Browne: Thanks. I appreciate your interest.