Tweedy, Browne Global Value: More Graham Than Buffett

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Tweedy, Browne Global Value's transition away from quality has been rocky, but it also shows discipline. Although the results have not been there, management will see this through. Its long-term perspective and patience undergird this fund's Morningstar Analyst Rating of Silver.

This fund's shift away from quality to value stocks shows its price discipline. Management prefers companies with strong franchises and economic moats (a la Warren Buffett), but that preference isn't divorced from price. Coming out of the credit crisis, high-quality companies were relatively cheap and management loaded up, especially on branded consumer staples names. But that became a popular trade, and by mid-2013, when 90% of the fund's equity assets were in companies boasting Morningstar Economic Moat Ratings, management started cutting back.

Since then, the portfolio has taken on more of a value (Ben Graham) tilt. As of June 2016, cheaper, no-moat stocks made up 30% of equity assets, triple the stake of three years prior. The portfolio's average price multiples reflect this shift. Its average P/E ratio was above that of the MSCI EAFE Index for most of 2012 and the first quarter of 2013 but has been below the index's since then. Management achieved this by trimming popular consumer staples stocks in favor of cheaper energy and financials issues.

So far, as is often the case with value investors, this makeover has been early. Although the fund has smoked most of its foreign large-value peers during the past three years, it has lagged its MSCI EAFE 100% Hedged Index by 3 percentage points annualized through August 2016. Quality growth stocks have continued to lead the market. Management has made some unforced errors, too, such as its foray into Asia-focused banks such as Standard Chartered. Its energy positions have also been a mixed bag, but management is sticking with it.

Such patience has been a hallmark of this fund and the key to its success. It has been early before and has endured its share of dry spells, but the fund's long-term record is a testament to management's conviction.

Process Pillar: Positive | Kevin McDevitt, CFA 09/09/2016 It will buy deep-value names, but this fund's team prefers to own quality stocks with strong franchises over the long term. The managers often invoke Ben Graham, but their style also incorporates Warren Buffett. They will happily pay a fair price for a good firm such as Nestle. They hold such positions for years, using a long time horizon to their advantage and earning the fund a Positive for Process. Turnover is typically below 15%, partly in an effort to minimize capital gains. The team opportunistically buys lower-quality stocks selling at depressed multiples, too, but these are quickly unloaded once they recover.

The fund's all-cap approach gives another edge. Rather than sticking to the large-cap universe, the team will go up or down the market-cap ladder depending on where it finds the best values. In the late 1990s, more than half the portfolio was in mid- and small-cap stocks. As small- and mid-cap valuations rose over over time, the combined weighting has fallen to 17% of assets.

The team's valuation consciousness and willingness to hold cash have helped make this one of the foreign large-value Morningstar Category's least-volatile funds. The team builds sizable cash stakes when it can't find attractively priced stocks. Hedging the portfolio's perceived economic foreign-currency exposure (sibling

Although it lets its winners run more than some value managers do, this fund's team has been showing its value leanings. The team has trimmed the huge consumer staples position, which had served shareholders so well, from 32.0% of assets in December 2011 to 15.9% in June 2016. Some of the proceeds have been reinvested in banks and insurance companies, giving the fund a 19% financials weighting on par with the MSCI EAFE Index. But with global equity prices choppy, the team has moved cautiously with cash at 18.8% of assets as of June 2016, although that stake has fallen following $400 million in outflows over the past 12 months.

With less invested in high-quality consumer staples stocks, purchases the past three years have been more value-leaning. The fund began building its energy stake in mid-2011, including integrated majors Total and Royal Dutch Shell, which now stands at 7% of the portfolio. Although the team likes companies with strong brands and pricing power over more-commodity-oriented businesses, it will buy the latter when valuations become compelling. The team believes there's a sufficient margin of safety even as oil and gas prices have fallen sharply since June 2014, as many such stocks trade below 1 times sales. Partially offsetting this foray into energy, the team has reduced the fund's positions in cyclical sectors such as industrials and consumer discretionary firms.

Performance Pillar: Positive | Kevin McDevitt, CFA 09/09/2016 This fund's results must be framed by its hedging policy. Management hedges the portfolio's perceived economic foreign-currency exposure. This means the fund hedges about 75% of its nominal foreign-currency exposure. Few peers do the same, and it leads to huge differences in relative returns. (It has also given the fund a strong tailwind over the past five years.)

But the fund's hedging policy hardly explains its long-term success, which earns it a Positive Performance rating. During the trailing 15 years, the fund's 6.5% annualized gain beats its MSCI EAFE 100% Hedged benchmark by 2.6 percentage points as well as the unhedged MSCI EAFE Index by nearly 1.6 percentage points through August 2016. It has also beaten the foreign large-value category average by 2 percentage points.

Its record looks even better on a risk-adjusted basis. The fund owns the category's lowest Morningstar Risk scores for the trailing three-, five-, and 10-year periods. The fund had one of the category's best showings during the 2008 financial crisis, and it outperformed again during 2011's choppy market and the 2015-16 bear market.

But dry spells come with the territory, and the fund tends to lag during robust bull markets, although it outperformed in 2009 and 2010. The fund's willingness to hold large cash stakes can hold it back during rallies (as in 2005 and 2013), as can its currency hedging when the dollar weakens.

People Pillar: Positive | Kevin McDevitt, CFA 09/09/2016 This fund has one of the more experienced management teams in the category and earns a Positive People rating. While comanager Chris Browne's retirement in mid-2009 was certainly a loss, Will Browne and John Spears have both been comanagers since the fund's 1993 inception. Bob Wyckoff and Thomas Shrager were added in 2005, but both have been with the firm for years. The team takes a collaborative approach to managing the portfolio, as they tend to see the world in a similar way. In conversation, the managers often finish each other's sentences.

The management team is supported by a deep bench of nine analysts, including several career analysts. That depth may be called on in the years to come as some of the principals finish out their careers. Will Browne is 71 and Spears is 67, although the other team members are in their late 50s and early 60s. The firm laid the groundwork for future succession when it promoted analysts David Browne, Roger de Bree, and Jay Hill in July 2013 to the investment committee. Those three were also added as comanagers, although the four senior managers retain final authority.

However, David Browne left the firm in May 2015 to start a hedge fund. (Analyst Will Browne left the firm in May 2016 to join him.) Longtime analyst Frank Hawrylak took his place on the investment committee. The firm strengthened its bench when it hired two new analysts in May 2016, Amelia Koh and Andrew Ewert.

Parent Pillar: Positive | Kevin McDevitt, CFA 10/28/2013 Tweedy, Browne has done much to align its management team's financial interests with those of fundholders. Manager ownership of fund shares is very strong. Each of the firm's funds has at least one manager with more than $1 million invested. Current and retired principals, directors, and employees have about $800 million invested across the firm's portfolios as of June 30, 2013.

Transparency and shareholder communications are also excellent. The team writes thorough annual and quarterly letters, addressing shareholders as partners. The managers also tend to be candid about their mistakes. As these attributes suggest, Tweedy is not a marketing-directed firm. It has been around since 1920 but offers only four funds (and only three distinct strategies). The firm further demonstrated its fiduciary commitment by closing Tweedy, Browne Global Value and

Such excellent stewardship makes the above-average costs on the firm's four funds--as determined by Morningstar's Fee Level measure--that much more disappointing. With $8.5 billion in assets (as of September 2013) across these U.S.-based funds alone, the firm should do more to share economies of scale with shareholders.

Price Pillar: Negative | Kevin McDevitt, CFA 09/09/2016 This fund's high expenses are a major disappointment for an otherwise fundholder-friendly firm. Its 1.37% expense ratio is 33 basis points greater than the foreign large-cap, no-load peer median, despite having one of the category's 10 largest asset bases. The firm clearly could do a better job sharing economies of scale with shareholders. On the other hand, its low turnover does limit trading costs. The fund's 2016 brokerage commissions were just 0.01% of average net assets.