Is Optimism Fading on International Risk?

Jeremy Glaser: For Morningstar, I’m Jeremy Glaser. We're getting ready for the 25th anniversary of the Morningstar Investment Conference in June. I'm here with Bridget Hughes. She's one of our senior fund analyst who will be moderating an international investing panel. We are going to talk to her a bit about what those mangers are thinking about some of the big international investing topics today.

Bridget, thanks for joining me.

Bridget Hughes: Thanks, Jeremy.

Glaser: Let's start on Japan. It's been an area of really extreme focus over the last couple of weeks with so-called Abenomics, with this multipronged approach to reinflating that economy. When you talk to managers and you've heard from some managers, how are they thinking about Japan. After we’ve had this huge rally and some volatility, how are they placing their bets?

Hughes: People are optimistic about the new prime minister [Shinzo Abe] and what he's been doing in word and deed to try to stimulate that economy. But remember, when you take on tactics that essentially weaken the currency, it really helps your exporters. And, of course, Japan is sort of a dual market. It's got a lot of the exporters that you know are the big companies, and a lot of the smaller companies are more domestically oriented.

So there are different ways, I guess, to play that. If you're really focusing on kind of the macro picture at Japan, you might find some of the managers invested in the big exporters, along with some maybe higher valuations. Some of the managers that we'll be talking with at the conference, this is a really great topic for the three managers on our international panel.

So you have IVA Funds. Charles de Vaulx will be representing IVA on the panel, and they've long been investors in the Japanese market, no matter what's going on with the economics. But what they really focus on are the smaller domestic-oriented companies, and they don't really invest much in the big exporters but always have an overweighting in that area.

Then we've got Rajiv Jain with Virtus Foreign Opportunities, and he really has nothing to speak of in the Japanese market. Something like less than 2% of his portfolio is invested in Japan, so that will be a nice contrast to talk about those two portfolios.

Then, Mark Yockey at Artisan International kind of splits the difference. He's sort of in between. He's underweight the index, but his position is really concentrated in just two stocks: one, Honda, being an exporter, and two, Japan Tobacco, which certainly has a big market share in the Japanese market but is also one of the larger tobacco companies globally.

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Glaser: Turning to China, they've been in focus recently as well with news that their economy might not be growing at quite the same speed it was before. How are these managers thinking about their Chinese investments or thinking about investments in China generally?

Hughes: Again, I mean, I think people are kind of picking their spots, and there certainly is a lot to worry about in China, but a lot of opportunities. So it's sort of opposite of Japan, where Japan has sort of disappointed for such a long period of time that now the fact that something seems to be happening there is news, China is kind of the opposite. It had such strong growth for such a long period of time and had kind of pleasantly surprised investors. Now talking a little bit about slowing is news today. It's a little bit of a concern, though it's still growing.

So in China there are, of course, a couple of different ways to play China through mutual funds. You can certainly buy your China-specific fund, and I would say there are varying ways to invest in China in doing that. So one example, we have coming to the conference is Jesper Madsen from Matthews Asia Funds, and he's a comanager on Matthews Asia Dividend fund, but also on Matthews China Dividend fund. He's actually not on the international panel [at the Morningstar Conference]; he's on a dividend panel. So it's just sort of an interesting way to go about investing in China.

I think one of the concerns with Chinese companies is management, frankly, and that's a big concern all across emerging markets. So, what Jesper Madsen likes to do is look for dividends from these companies and the commitment to growing dividends, and he thinks that with that he gets a more disciplined management team. And that's something that's very important to him in China and the rest of Asia. But also not only do you need to have the desire and the commitment to dividends, but you need to have the wherewithal, too. So these tend to be stronger businesses, franchises with good cash flows and good balance sheets. So that's a way to sort of mitigate the risk of China.

Then as far as our diversified managers go, again, it sort of splits the spectrum here because Mark Yockey has invested in China, and Rajiv Jain, who's not afraid of emerging markets--he's got a very big India stake--really doesn't invest in Chinese companies. And what he is concerned about is politics, sort of how much of those companies are actually still owned by the state and controlled by the state and any sort of interference that might come from the government, and those are sort of other concerns.

Glaser: Turning to Europe, what kind of discourse are you expecting about the attractiveness of European shares right now? Are managers still finding places or pockets of opportunity, or are they afraid of some of the systemic issues that are keeping them from investing?

Hughes: We have three different managers on our panel for the international panel, and they all have substantive investments in Europe; you have to. I mean, otherwise you are all in Japan. A lot of it's in the U.K.; I think that's certainly a favorite market of investors who are investing internationally. What's interesting about the European financial crisis that happened a couple of years ago, many of the managers in the industry like to kind of be opportunistic, and so when there was big sell-off in the market, what they found was really the companies that sold off the most were the ones you didn't want to touch. They were the financial-services companies, and the ones that were of high quality that I think a lot of investors were hoping to get at a bargain price, really didn't come down to that level. So, you were sort of stuck there. You couldn't really take the advantage of the volatility in that market.

Mark Yockey, who is on our panel, actually did go pretty heavy into European financials in early 2010, and it didn't work out. And as it turns out, he kind of reversed course toward the end of that year when more news came out, and he felt like he really just sort of underestimated the potential problems. Since then he's gone back into some financials. Munich Re is one of those, HSBC is another. And Rajiv Jain about a year ago also picked up a number of financials. So, that might be interesting. We'll hear some more talk about what's going on with the European financials for sure because they seem to be maybe the most vulnerable. All the managers though are just kind of picking their spots in Europe, but one common thread is that it seems to be in what would be perceived to be the stronger countries, like the U.K., Switzerland, Germany, and France, and very limited investments in Spain, Italy, and Ireland. So, that's kind of the divide there.

Glaser: Well, Bridget, thanks for your thoughts. We are looking forward to the panel.

Hughes: Me too. Thank you.

Glaser: For Morningstar, I'm Jeremy Glaser.