Kathryn Spica: I'm Kathryn Spica, mutual fund analyst at Morningstar. I am here today with Sarah Ketterer of Causeway Funds, and we're going to talk about the Causeway International Value Fund.
Sarah, thanks so much for being with me.
Sarah Ketterer: Thanks for having me.
Spica: So just to start off, could you give us an introduction to the fund and tell us about how your fund differs from other international value funds.
Ketterer: Gladly. Causeway International Value Fund, we launched it in 2001. It's a carryover from what our team has done since 1990. So we have tons of experience.
We are predominantly a developed market international fund with a very distinct value approach, and at Causeway we blend both fundamental investing, serious in-depth research, with quantitative risk control, and the two combined lead to the outcome of our fund returns that are risk-modulated.
Spica: Could you talk a little bit about how those teams come together, the fundamental research and the quantitative sides?
Ketterer: Well, we are not big on star system at Causeway. We prefer to have a collaborative team of portfolio managers. There are six fundamental portfolio managers at Causeway working closely with two quantitative portfolio managers, and we meet every week where the fundamental side produces stocks with significant upside potential. My quantitative colleagues, they have both built a multifactor risk model for us and through that model, determined the marginal or that extra amount of risk each stock will add to our portfolio. So our international portfolio, our attempt is, and that's our fund, to maximize return and minimize risk, to achieve the largest Sharpe ratio we can at all times.
Spica: That sounds like risk, as you mentioned, is a really integral part of the process. Could you go a little deeper into how you look at risk, and why that's an important part of your approach?Read Full Transcript
Ketterer: So we define risk as volatility, and we believe strongly that if we can keep volatility at the lowest level possible with a fully invested fund, we can deliver more consistent performance.
So my quantitative colleagues determine the perspective volatility, and over the next 12 months, how volatile will our fund be versus the benchmark, the Developed Markets International Index?
And when we believe, we our fundamental team, believe the upside potential is so significant that we want to take risk because we are convinced our fund shareholders will be paid for it, then we bump up the risk level, relative to benchmark.
And conversely as we are today in an environment where the rewards aren't nearly as attractive as they were a year and half ago, we're taking risk down. So we can do all this. We don't need to raise cash, time markets, become tactical wizards, we don't know how to do that. But we can change the mix in the fund to ensure that we keep volatility at benchmark levels of risk whenever possible.
Spica: And is it always company-specific or sector-specific. Do you do currency management or look at currency as a way to manage risk?
Ketterer: Interesting question, because until a year ago, our team hadn't hedged a single currency since 1997--that does sound like a rather large gap. And the reason why we are doing it today, and we've been hedging euro versus U.S. dollar over the last 12 months, is because my quantitative colleagues at Causeway have shown us, the fundamental portfolio management team, that euro, our large 1,200 basis point overweight versus benchmark, the euro is adding volatility without the commensurate return.
So that's a pretty rotten deal for fund shareholders, and that's why we are hedging that euro exposure versus benchmark. We brought euro way down in order to keep volatility as low as possible. Where there is risk, there better be return, otherwise we are going to eliminate that risk.
Spica: And you mentioned at the beginning that your fund is focused on developed markets, and a lot of managers are going to emerging markets, and sometimes that can cause more volatility, but you're focused just purely on developed. What drove that decision?
Ketterer: Well, we're value managers--we're the cheapest people you've ever met, and we're more than keen finding companies that have been mispriced--something has gone wrong to drop them into our value net, and all they need is to be recognized for the undervalued property on the balance sheet, and something to do with real estate or could be other physical assets or could be that they're generating cash flow from their new expansion in the emerging world that nobody will recognize, even though they're headquartered in Europe. Whatever it may be, there is a misperception about the business. We want to get there first. That's value investing, and I think I'm certain it's most effective in mature markets. When you're talking about nascent markets where investors are just learning how to value equities, those investors are often more keen just to go for earnings momentum. So, that's why Causeway uses a very different approach in the emerging world.
We're happy to buy stocks that are expanding in the emerging world, like Akzo Nobel, one of our largest weights on our international fund, is one of the world's largest in paints and coatings. This company does 40% of their revenues in the emerging world, with a very significant market share in Latin America. We'll gladly take that growth, but we want to buy the cheap European prices.
Spica: It looks like you have recently added Chinese companies, which are considered part of the emerging markets, but they are listed on the Hong Kong Exchange. Could you talk a little bit about that difference?
Ketterer: Yes. So, the world definitely isn't neatly siloed, as I referred to earlier, and for Chinese companies, indigenous Chinese companies, we will only consider them if they trade in Hong Kong. And generally, we are interested in the more larger-cap companies, well regulated and well scrutinized by Hong Kong Stock Exchange officials. So, we don't want any monkey business in these companies. We're not interested in buying them in the local markets where they trade in a more casino-like fashion. But in Hong Kong, they stride the fence; they are both emerging and developed, and then appropriate for this fund.
Spica: You talked a little bit about sectors, so industrials and material sectors are pretty heavy in the fund. Can you talk about how you look at those two sectors?
Ketterer: Yes. So, first glance, the Causeway International Value Fund looks like this cyclical fund, that's just got this massive weight--30%-plus in a combination of capital goods and materials, but if you look beneath the surface, the stocks we have in capital goods are not necessarily very cyclical, and they don't really compete with each other geographically. They are often specialists, say, in electrical goods or in gas refining facilities, they operate in the Middle East, they are operating in Japan, they are in Continental Europe.
So, we look at that capital goods component as very diversified at low risk. As well, the materials weight in the portfolio, the second-largest weighting we have, is in companies that are largely in specialty chemicals, flavors and fragrances, which is very economically defensive.
Industrial gases, another area that we like a lot that has produced very consistent return for fund shareholders, and very little of that material weight in metals and mining, an area that we're more concerned about of late.
Spica: So, speaking about where your concerned of, of late, what's your outlook for the fund? What should investors expect going forward?
Ketterer: The expected return on the fund as we measure it, because we have a two-year price target and every single stock in that fund at all times, we also know the income, because we were tracking the dividend yields. Those returns have come off from a year ago, but they are still low double-digits, they are still really attractive.
So, we are optimistic. We just have seen such a strong run year-to-date in 2012, that we're happy to take off some risk, because we think there is no reason to be sticking one's neck out at present. We've put more diversification in the fund, a few more holdings, we're now roughly around 65 stocks, and that's one way to ensure we've protected the downside if there is a market pullback.
But the most interesting areas now, it used to be just Europe a year ago as investors couldn't wait to get rid of those stocks. Now, Asia is opening up for us, because there are concerns about Chinese growth slowing, and for us as value managers, that's a gift. Because we can get high-quality companies in infrastructure like ports or in energy that otherwise would have been too expensive.
Spica: Great. Sarah, thanks so much for being with me today.
Ketterer: Thank you.
Spica: For Morningstar, I'm Kathryn Spica.