Jason Stipp: I'm Jason Stipp for Morningstar. We're here in California today visiting with Causeway Funds, and we're talking with Sarah Ketterer. She's a manager of Causeway International Value. This is a fund that focuses on developed markets and larger companies in those markets. Thanks for joining us, Sarah.
Sarah Ketterer: Thanks for having me.
Stipp: So, the first question that I want to ask you is more of a broader question. In the rally that we've seen in the last year plus, how would you characterize your mindset about the portfolio today? Are you more in defensive mode now that we've seen securities run up and you're maybe trimming more? Or are you still seeing opportunities in this market?
Ketterer: A bit of both, to give you the ambiguous answer. But there are still opportunities. The upside potential for the international stocks we follow is considerably greater than it was in 2005, 2006, and 2007, but it doesn't hold a candle to where we were a year ago.
So, clearly there's been a big recovery in stocks, especially the cyclicals and in the high-quality cyclicals where we had built a significant position. But some stocks have still been left behind: late cyclical companies or others that are engaged in something that's considered controversial or where there's regulatory problems. This is just an ideal environment for a value investor. This is what we do well is pick through the rubble.
So, we're still finding upside in the cyclical area but also in the defensive stocks. Many of them in areas such as pharmaceuticals or consumer have been left behind. So, any of those. All the opportunities. Disasters. We're looking for stocks as well as just across all industries broadly.
Stipp: So, one of the areas where your fund has focus is in Europe, and you have a good portion of your fund from European companies. And there's been a lot of news speaking of concerns and issues because of some of the sovereign debt issues that we've seen in Portugal and Greece and some of the other countries. How have you accounted for that macro-risk, and has it created some opportunities for you in that area?
Ketterer: It's very definitely created opportunities for us. The more Greek bond yields rise and the more this contagion effect supposedly creates problems for Spain, for Portugal, Italy and the other peripheral European countries enduring a huge amount of strain on their bond markets, the more interesting the equities become.
Now, this may sound a little bit heretical because why would anybody come near these stocks? But underlying many of them are fantastic businesses. There are great Spanish banks, for example, that have significant exposure in Latin America where there is plenty of growth without concerns, at least at present, of big government fiscal spending problems that need to be conquered.
As well, there are fantastic companies with very low risk. For example, utilities in Portugal or companies in the gaming area in Greece that are considered to be crown jewels by their governments and are very unlikely to be affected negatively by the fiscal pressure being placed on the countries.
As a value investor, what we look for is a market reduction. So, this destruction in market cap that's occurring that far exceeds the fair value of the businesses, even under these really tough scenarios of reduced fiscal spending and really slow growth in Europe.
Stipp: Speaking on the individual stock level, your stock selection has helped you overcome a lot of macro headwinds. So, we've seen that stocks in certain areas have gone down, but your fund hasn't gone down as much or has done better. So, how would you characterize the process of your stock selection that has helped you get a boost from the individual security selection?
Ketterer: We have no fear. Where the market fears to tread, we don't. We bought an automotive company in Japan undergoing a huge recall because we did the work. And doing the homework always pays off, especially when investors become irrational. And that's consistently been a very important part of our stock-selection process. And now with these fears overhanging Europe, we're finding several opportunities there.
But I add that Causeway International Fund isn't just about taking risks. We take very calculated, measured risks based on the upside potential we expect to achieve for shareholders.
So, for example, in late 2008 and early 2009, when the investment community was petrified, and investors were selling stocks right, left and center, we moved our fund into the highest-quality cyclical companies we could identify. So, that intersection set of quality, of great balance sheets, fortress-like, with economic sensitivity, so companies that share prices would far discount in advance any upturn.
And so, we took as little risk as possible for the greatest amount of upside. And that is today again the plan that we are pursuing, is to get access to some of this concern about Europe, but do so in a very low-risk fashion.
Stipp: And it certainly seems like quality good news for some investors, what's still on sale into the rally. So, it definitely provided some opportunity there. One question about your fund, you focus on developed markets. But emerging markets are obviously very important even to companies domiciled in developed markets, in several companies domiciled in developed markets. How important is emerging markets exposure to the companies you examine, and how do you think about that even though your fund isn't specifically going into emerging markets?
Ketterer: You can't help but be in emerging markets if you're invested in equities. I mean, it would be awfully difficult to try to confine yourself to only indigenous companies, and we have a preference for multi-national export-related companies that are very globally competitive, whether they're based in Japan or in Europe, wherever they may be. And those companies are seeing, based on our interviews, their marginal growth. That growth at the margin, that very important impetus now while the rest of the world is slowing, that's coming from the emerging world.
I can't tell you how many times in meetings we hear from companies in the engineering fields or who make power generation equipment or heavy rails or whatever it may be that their orders are coming from China. And the rest of the world will recover, but in the interim the emerging world is bridging the growth gap and may supplant some of the growth that came from the developed world.
This is a very healthy development as far as we're concerned. But it doesn't mean to say that our fund is an emerging markets fund. It's still very much, it's fate is dictated by developed markets investors who, I think, tend to be a little bit less volatile.
Stipp: Last question for you, Japan, an area where your fund, I think, has about 17% or so in Japan. This is a country where, I think, a lot of investors just think "value trap" right away. What opportunities have you been finding in Japan, and how did you come to be comfortable with those given a lot of the conditions in Japan and the risks that are there?
Ketterer: Another poor headline risk country, I have to admit. We have a whole collection of them. And, interestingly, Causeway, both in our International Fund and our Global and in all of our institutional portfolios, we have the highest weighting in the Japanese market than we've ever had, and yet we like Japan the least of all of our markets. How do we reconcile that? It's because there are so many high-quality multi-national companies listed in Japan that, again, this power that hangs over the market, this concern about a heavily indebted country, and they seem to operate in an environment of artificially low bond yields, so investors are justifiably nervous.
But, we have found some extraordinary businesses. Companies that, for example, dominate the world of industrial automation, robotics, again, an area very much in demand in China in automobile production, in electronics, that have no debt at all on the balance sheet.
So, we can get companies that have net cash, so no borrowings, huge amount of financial flexibility, pay a dividend, and are extremely well-managed and globally competitive, and they just happen to be listed in the Japanese market. It's a very different proposition than buying a domestic Japanese company whose business is done entirely within Japan. Those businesses, unless they're priced very cheaply, are going to be really tough.
Stipp: Sarah, thanks so much for joining us today and for your insights.
Ketterer: Thank you.
Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.