Fri, 14 Jun 2013
After a nasty 25-year bear market, Japan is still far cheaper than both U.S. and European equities, despite its huge rally, says IVA CIO and portfolio manager Charles de Vaulx.
Bridget Hughes: Hi, I'm Bridget Hughes, one of the analysts here at Morningstar, and I'm at the Morningstar Investment Conference. I'm here today with Charles de Vaulx, who joined us for our International Opportunities panel.
Thank you, Charles, for joining us.
Charles de Vaulx: You're welcome.
Hughes: I wanted to start by asking you about Japan, because you're one of the few international global investors that actually has had a meaningful commitment to Japanese stocks, and has had so for a long time.
It's one of the best-performing markets this year. How do you feel about the story in Japan? And then, how do your stocks kind of fit into that story, or are they distinct from it?
De Vaulx: You're right. We had a pretty high allocation to Japan over the past few years. We have taken advantage of this huge rally that started mid-November last year to trim some positions. In fact, we're down to around 8% in Japan in our worldwide fund, down to around 16% only in our pure international fund.
But because the severe correction has taken place over the past three weeks--I think the market is down 20%-22% over the past few weeks--over the past few days now we've become net buyers again in Japan. So, at the right price we would be happy to own more in Japan as opposed to keep trimming.
What truly intrigues us with Japan is not so much Abenomics, the new policies, the desire to inflate your way to devalue. What really piques our curiosity is the fact that we think corporate Japan has finally changed in terms of capital allocation. They used to hoard cash. Now we've seen more and more companies in Japan willing to raise the dividends, more and more companies willing to buy back their own stocks, when they feel the stock is undervalued, and we're even seeing some corporate activity, friendly mergers or maybe not-so-friendly things.
Recently an American investor, Dan Loeb, took a stake in Sony, suggesting some radical changes, and interestingly enough, the company seems receptive. So, I think better capital allocation going forward for Japan is what piques our curiosity. Also, from a valuation standpoint, despite the huge rally, Japan after a 25-year nasty bear market is still far, far cheaper than both U.S. and European equities.
Hughes: So, whereas Japan has been one of the better-performing markets this year, and the U.S. has been strong as well, Europe has not been as strong. So, are you finding opportunities in Europe?
De Vaulx: Well, Europe has not been quite a strong this year, nor has it been as strong since the markets bottomed in March of '09. And so you may believe that Europe, as a whole, offers a lot of opportunities. Unfortunately, that is not the case, or at least not for us. We think it's a two-tiered market. On one hand, you have the banks, the insurance companies, the utilities that look dirt cheap, but probably for a reason are not safe enough; the banks remain notoriously undercapitalized.
But if you look at the high-quality companies, those we tend to care for, they are as expensive if not more as similar U.S. companies. So, unfortunately … we have been net sellers in Europe for the past few months, and we're finding virtually nothing new to buy there.
Hughes: And then finally, just to round out the world, the developed world anyway, you also have a global portfolio [in addition to] an international portfolio. In the global portfolio, are you finding a lot in the United States?
De Vaulx: No, we've been net sellers there as well, because the market has done well in so many sectors. We've trimmed some of our names in the technology field, for instance. We've even started to trim Berkshire Hathaway, which has been a good stock for us and was a large position, and still is.
One sector that's been lagging over the past year or two is energy. So, we've been adding a little bit in the exploration-and-production companies. But it's hard for us to find things that are truly compelling.
What we see in the U.S. is not so much … we don't see many stocks been grossly overpriced. We see most stocks to be fully valued, and as a value investor, we typically insist on a margin of safety, and it's hard for us to justify buying for the first time or holding on to a stock whose price equals our intrinsic value estimate.
Bridget Hughes: So, hearing everything about these three regions, cash is on the high side?
De Vaulx: Is higher than ever before. We're only 52%-53% invested in equities, because on one hand we believe that equities remain the best house in a bad neighborhood. Equities still make more sense than cash yielding less than zero after inflation. High-quality bonds after inflation don't offer much return either. So on one hand, equities are the best house in a bad neighborhood, but then again that's a relative argument.
We think that stocks can go higher, but only as long as interest rates remain ultra-low, and we do not believe in the tooth fairy. We believe that at one point, whether it's a year or two or three years from now, interest rates will have to normalize, and that's when there will be some trouble.
Also we noticed that the smart money, whether it's Warren Buffett, Seth Klarman, and many others, tend to be quite bearish. We see a lot more insider selling than insider buying at various companies, so that's not a very healthy sign, either.
Hughes: Your portfolios tend to be among the more unusual. These names are sort of off the beaten path. [Could] you generalize a little bit about your strategy and … the things that you're looking for? When you say you're a value investor, what does that mean to someone at IVA?
De Vaulx: Well, we're a value investor in the classical sense that we only buy things that trade at a discount to what we think the real value of the company is.
I think what distinguishes us, though, is that we're willing to be very eclectic. We're willing to look at tiny companies. Most of the companies we own in Japan are smallish companies, because that's where we think the best bargains are today. Then again, we're willing to own Microsoft or Google that are very large companies.
We're also willing to sometimes buy high-yield bonds when they offer equity-type returns. As we discussed earlier, if nothing piques our curiosity, we're willing to hold cash and just sit and wait. We're willing to use gold with the hope that, more often than that, gold is willing to be inversely correlated to stocks. Sometimes gold is willing to go up, when stocks go down.
The recent market peak was May 21-22. I think the world index is down 4%-5% since then. Guess what, gold is up a little bit since. Gold had dropped before that, but since then it's up. So, it has acted in an inverse correlated manner.
As value investors, we have a bias towards better businesses. We're more in the Warren Buffett camp than the Ben Graham's net-net and cigar butts. We also have a clear bias toward owning stocks in companies with a significant insider ownership. Our experience around the world, including Japan, is that companies with significant insider ownership, that includes Berkshire Hathaway by the way, tend to be better managed for the long run and tend to deliver much better returns for shareholders. And of course, we're believers that eating your own cooking for us, portfolio managers, also tends to sharpen the focus and more often than not produces good results for mutual fund shareholders.
Hughes: Well, Charles, thank you very much for your time. Thanks for coming to the conference.
De Vaulx: You're welcome. Thank you.