Since it was launched three years ago, the $350 million American Century International Opportunities Fund (AIOIX) has put up some very impressive numbers. For the 12-month period ended July 30, the fund soared 40.2%, easily beating the average international fund, which gained 22.2%. Since its inception, the fund has risen 21.7% on an annualized basis, vs. a gain of just 2.9% for the peer group. As an asset class, international small caps have had a strong run the past few years.
New York-based lead manager Lynette Schroeder and her team of analysts scour the globe for small-cap stocks that can deliver high earnings growth. Since Wall Street largely ignores foreign small caps, Schroeder has no choice but to do her homework, which requires visiting with companies and poring over financial reports and newspaper articles.
Despite the fund's strong performance, overseas small-cap investing poses risks. Liquidity is often low, leading to high
volatility, and corporate governance in non-U.S. jurisdictions can sometimes be questionable. While the fund is just slightly more volatile than the peer group, the annual
turnover of portfolio holdings is around 200%, over double the peer-group average, making the portfolio much more suitable for non-taxable accounts. Management fees on the fund currently run at a high 2.00%.
Based on the risk and return characteristics over the last three years, Standard & Poor's gives American Century International Opportunities its highest overall rank of 5 STARS. However, the fund, which Schroeder has led since its inception in June, 2001, doesn't have a long operating history. Schroeder previously managed the Driehaus European Opportunity Fund.
Palash Ghosh of Standard & Poor's Fund Advisor recently spoke with Schroeder about the fund's investing strategy and top holdings. Edited excerpts of their conversation follow:
Q: What kind of stocks do you invest in?
A: We look for small-cap stocks anywhere in the world that are exhibiting accelerating growth rates on both the top and bottom lines. We want to see some quantifiable evidence of growth. It can come from different sources, such as higher sales volume, better pricing, operating restructuring, or financial restructuring, for example.
Q: What are your thoughts on holdings that grow too large for the fund?
A: We are committed to keeping this a small-cap fund. Once a holding reaches $1 billion in market cap, we will keep it as long as we like the fundamentals, but we won't add to our position. The fund currently has an average market cap of about $600 million. We have a number of micro-cap names as low as $200 million. When the size of the fund reaches $500 million, we will likely close it off to new investors in order to maintain its small-cap nature.
Q: How do you research stocks, given that foreign small caps are largely ignored by Wall Street?
A: Our universe of investable stocks is in the thousands, but our portfolio typically ranges between 85 and 120 positions. We have a team of analysts who follow various global regions. Since there is often a limited amount of information available on these companies, we dig for data, we read a lot, we leverage all of our resources, and we make a lot of visits with companies around the world.
Q: How do you minimize the risks associated with foreign small-cap investing?
A: We control risk by keeping a diversified portfolio. However, we don't make sector or regional bets. For example, we are currently overweight in Japan relative to our benchmark, the Citigroup Extended Market Index, but we are comfortable with our allocation because of the quality of our holdings there.
Q: What are some of the advantages of investing in foreign small caps?
A: They have very low correlation with the performance with the U.S. stock market, so they provide a nice diversification in a portfolio. Most of our companies sell only to their local markets, so they are largely immune to such macroeconomic factors as oil prices or interest rates in the U.S.
More importantly, even if the overall global economy is weak, there are always small pockets of strong performance and high earnings growth somewhere on the planet. This is often found in small- and micro-cap companies, which typically provide only one niche product or service. Companies in our fund usually have limited competition and can dominate a small market niche.
Q: What are your largest holdings?
A: As of June 30, 2004: Tandberg Television ASA, 2.1% [of portfolio assets]; Take And Give Needs Co., 2.1%; Sierra Wireless (SWIR), 2.1%; Okinawa Cellular Telephone Co., 1.9%; Sez Holding, 1.8%; Niws Co. Ltd. 1.8%; SK Electronics Co., 1.8%; Cambridge Silicon Radio Holdings, 1.7%; Accord Customer Care Solutions, 1.7%; Sanei International Co., 1.7%; and Extendicare, 1.7%.
The top 10 stocks represented 20.4% of total assets. Our largest individual positions tend to be 2% or 3%, though we could go as high as 5%.
Q: What are your largest sectors?
A: As of June 30, 2004: Information Technology, 31.8%; Consumer Discretionary, 26.5%; Industrials, 14.7%; Financials, 12.4%; Healthcare, 7.8%; Telecommunication Services, 3.8%; Energy, 1.6%; Materials, 1.0%; and Consumer Staples, 0.5%.
Q: What are your country weightings?
A: As of June 30, 2004: Japan, 34.4%; U.K., 9.4%; Germany, 6.9%; Canada, 6.8%; Taiwan, 5.6%; Singapore, 3.8%; Norway, 3.5%; Switzerland, 3.3%; Denmark, 3.1%; and Finland, 2.2%.
Europe, as a whole accounts, for 41.5% of the fund's assets. Although our exposure to the emerging markets is currently minimal, historically it has been as high as 30%.
Q: Do you have a heavy exposure to Japan because there are so many investable stocks there, or because you particularly like Japanese companies?
A: Japan does have a large number of small-cap companies, but, by our strictly
bottom-up investment process, we are finding a lot of stocks there showing powerful earnings growth. For example, one of our top holdings, Take And Give Needs Co., is a Tokyo-based wedding-planning firm. The company is delivering annual earnings growth in excess of 100%. We bought this stock after our Japan analyst, David Fujisaki, met with company management. He first became aware of it from reading a Japanese newspaper.
Q: What are your sell criteria?
A: We typically sell when we find a more attractive substitute, when we determine that a company will not be able to fulfill its earnings forecasts, or when a company disappoints.
We recently disposed of Jubilee Mines, an Australian nickel-mining company. When we first bought it, we forecast high earnings growth for the company driven by the increasing price of nickel. We started paring back our position after more investors got in, and we deemed there wasn't much upside left in the stock. Although we think Jubilee remains a solid growth story, we determined we could make more money elsewhere.
Q: What about the fund's turnover?
A: Our annual portfolio turnover rate has been quite high: 147% in 2001, 252% in 2002, 214% in 2003, and about 150% this year. This reflects both high market volatility as well as the variable liquidity and corporate governance of many of our holdings. For example, some of our companies only release financial statements twice a year. As a result, if we can't get information in a timely manner on a company we otherwise like, we may temporary trim our exposure to it.
From Standard & Poor's Fund Advisor