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By Jason Stipp | 12-10-2013 10:00 AM

Picking Spots in Emerging Markets

Louis Mendes of Silver-rated Columbia Acorn International says the fund has found value in niche industrial and tech companies, as well as consumer names, while steering clear of regulated companies and low-cost manufacturing.

Jason Stipp: I'm Jason Stipp for Morningstar. It's Emerging-Markets Week on, and today we are checking with Louis Mendes, a manager on the Silver-Rated Columbia Acorn International Fund. He is here to talk about the issues and opportunities facing emerging markets investors today.

Louis, thanks for joining me.

Louis Mendes: Thank you.

Stipp: Your fund Acorn International, a Silver-rated fund by Morningstar analysts. It's a foreign small and mid-cap fund. You are looking for smaller companies. You have a decent stake in emerging markets.

Overall, why small and mid-caps; what advantage do those give you when you're doing international investing or emerging-markets investing?

Mendes: About 25% of the Acorn International Fund is in emerging-markets stocks. Similar to small-cap stocks anywhere in the world, some of the major reasons why you'd want to do that are: one, small-cap stocks by their nature tend to be more focused business models. They tend to have a niche that they are targeting. It's a simpler business model. It makes it easier for us as an investor to understand it.

Two, their managements have a much greater impact on the outcome of the company. Because the managements are involved in a smaller business, they tend to be able to drive its performance.

And three, most importantly is, when you look at a small-cap company, it's often overlooked by most investors. So if we're willing to go in and do the due diligence, get to know the company, find out it's a good investment, we can often acquire a stake in it at a valuation discount to most peers.

Stipp: And when you are thinking about diversification at the portfolio level, a small- or a mid-cap international fund might give you something different than you would see in a lot of the index funds, particularly in emerging markets, for instance.

Mendes: Correct. If you look at a lot of the emerging-markets funds, their top holdings are all the same. They tend to own the large petrochemical companies, the large electronics companies, the large financial institutions. Part of that is that the benchmark for emerging markets is dominated by maybe 15-20 large caps.

In small-cap land, there are no dominant companies. So every stock is an off-benchmark bet. Managers go out, and they are just trying to find great businesses to put in the portfolio.

Stipp: When you're looking specifically at emerging markets or elsewhere at the companies that you want to invest in, what kind of fundamental criteria are you looking for?

You mentioned earlier that management can have a bigger impact on a smaller-cap company. I am assuming that stewardship is going to be one of those.

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