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Japan: A Rising Sun for Investors

The Ivy Cundill Global Value Fund (ICDVX) adheres to the classic deep-value investment philosophy of Graham and Dodd, selecting stocks with strong balance sheets, but trading at significant discounts to historical averages and industry peers.

For the one-year period through Oct. 30, the $275-million fund gained 17.5%, outperforming its benchmark, the MSCI World Index, which rose 13.3%. For the three-year period, the find returned 12.1% annualized, vs. 6.1% for the index, and 6% for its peers.

As an added bonus, the fund exhibits lower volatility relative to its peer group, as well as low annual turnover. Expenses, however, run higher, at 2.12%, vs. 1.69% for the average global stock fund. The portfolio is also concentrated, and can assume high weightings in individual countries, which can court country-specific risks. Based on risk-and-return characteristics over the last three years, Standard & Poor's gives the fund its highest rank of 5 STARS.

While portfolio manager Peter Cundill resides in London, his company and the fund's subadviser, Peter Cundill & Associates Inc., are based in Vancouver. The firm manages about $5 billion in total assets, mostly in Canadian mutual funds.

Palash Ghosh of Standard & Poor's Fund Advisor spoke recently with Cundill about the fund's investing strategy. Here are edited excerpts of their conversation:

Q: What's the investment philosophy behind this fund?

A: We look for undervalued stocks anywhere in the world, of any market-cap size, by using the classic deep-value investing styles of Graham-Dodd. We purchase stocks we believe to be trading below their intrinsic values, or below their liquidation values, and that have strong balance sheets.

Our strategy is strictly

bottom-up, and we favor keeping a concentrated portfolio of stocks that we have high conviction in. As a result, we don't buy and trade much. Our annual

turnover rate is only about 10%.

Q: What are your top sectors?

A: As of Sept. 30: financials, 35.1%; consumer staples, 24.4%; consumer discretionary, 24.1%; industrials, 5.3%; and information technology, 3.4%.

Q: What are your top country allocations?

A: As of Oct. 29: Japan, 37.2%; U.S., 7.2%; Hong Kong, 7%; Canada, 3.9%; Malaysia, 3.3%; South Korea, 3.1%; Germany, 2.2%; Italy, 2.2%; and Singapore, 2.1%. We currently have a 33.2% cash stake.

Q: Why do you have such an large cash position?

A: This fund has more than quintupled in size since the end of last year, from about $51 million to $275 million now, due to inflows and price appreciation. As a result, we need cash reserves to keep some flexibility, and we are cautious about the markets. We are simply not finding a lot of bargains out there. In the past, we have had a cash stake as high as 40%.

Q: Why such a large presence in Japan?

A: When the Asian markets melted down in 1997, the Japanese market got hammered, and one could buy literally hundreds of Japanese equities trading at significantly below net cash. However, these companies also had strong balance sheets, and thus became extremely attractive investments. Our exposure to Japan has actually deceased since the end of 2003, when we had a 42.7% stake there.

Q: Do you think Japan has come out of its decade long recession?

A: They have made some progress in restructuring their corporations and rejuvenating their banking system, but they have a long way to go. One of the biggest changes in the Japanese market is how much foreign ownership exists in Japanese companies. For example, Sony (SNE) is 35% owned by non-Japanese shareholders. Japanese stocks are not as cheap as they were last year, on a balance-sheet basis. But the companies are now in a better operating environment, as businesses pay more attention to profitability.

Another major factor that is buoying Japanese corporate profits is the resurgence of China and outsourcing of Japanese manufacturing operations to their giant neighbor. All across the board, Japanese firms are entering into joint-venture deals with Chinese entities, and taking advantages of their lower labor costs.

Q: Have you always had modest exposure to U.S. stocks?

A: When I started my investment career in 1975, there were numerous bargain stocks in the U.S. markets. That is no longer true.

Q: Why no exposure to Western European stocks?

A: They are too highly priced for our deep-value strategy. In the early 1990s we had many European stocks, particularly financial companies in Germany and Switzerland, but we took our profits on them and sold them in the mid- and late-1990s. We are now again looking at Europe as some valuations have become compelling.

Q: What are your top individual holdings?

A: As of Oct. 29: Kirin Brewery (KNBWY), 4.8%; Nikko Cordial (NIKOY), 4.6%; Nippon Television Network, 4.6%; Takefuji Corp., 4.4%; Nipponkoa Insurance (NPPKF), 4.0%; Liberty Media International (LBTYA), 3.8%; Arab-Malaysian Corp., 3.3%; Asatsu-DK Inc., 3.2% First Pacific, 2.7%; and Legacy Hotels Real Estate Investment Trust, 2.5%. The fund currently has 31 holdings.

Q: Can you discuss one of your top holdings?

A: Nikko Cordial is Japan's third-largest stock broker and investment firm, and has a major joint-venture with Citigroup (C). We estimated that if you liquidated the business, it would be worth about 700 yen per share. The stock is only trading at about 450 yen per share. The company just released very strong half-year earnings.

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