A Way to Tap an Overseas Surge
By Amey Stone
David Herro is one of the mutual-fund world's stars of international investing. But as he commented at a recent conference, for the past few years he felt like he was stuck on the "Island of Lonely Toys" -- where the toys no child wants to play with are consigned. He joked that he had plenty of company that day at the conference, where presentations were also being given by managers of high-yield bond, large-cap growth, and other out-of-favor funds.
However, unlike his fellow fund managers, Herro's style of investing has recently been more positively regarded. International markets had been roiled for the past four years by economic crisis in East Asia, Japan, Russia, and, more recently, Argentina. A remarkably buoyant dollar has also hurt U.S.-based funds that invest abroad.
But this year, international stock funds -- particularly those with exposure to small companies in emerging markets -- are among the hottest-performing mutual funds around. Herro's strict discipline of buying small, cheap stocks is paying off particularly well. With the upturn in his funds, he quipped at the conference that he hopes to soon be moving from the Island of Lonely Toys, to the "Island of Closed Funds."
He's well on his way: On May 10, he shuttered his small-company fund, Oakmark International Small-Cap (OAKEX ) to new investors. The fund, which he co-manages with Michael Welsh, is up 18% so far this year (on top of a 13% gain in 2001). It was closed because new money was flooding in, endangering its strategy of seeking out tiny stocks. (Funds with large asset bases can't buy enough shares of small, illiquid companies to make a difference in their returns without driving up the share price). Now, with about $500 million in assets, the fund can maintain its small-cap focus.
However, a good opportunity to invest with Herro and Welsh still exists. Oakmark International (OAKIX ), which has the same management team, is up 17% this year and is open. With $1.3 billion in assets and an average market cap of $11 billion, it's a bigger fund stocked with larger companies. But unlike most broad international funds, it still has a healthy portion of small-cap names, and its median market cap is much smaller than most. The fund also has about 15% of its assets in emerging markets (down from as much as 30% when emerging-market shares were lower).
Of course, Oakmark International isn't for everyone. "People should understand this is not your typical core holding," says Morningstar senior analyst Bill Rocco, noting that the fund is more aggressive than many and varies widely from the sector and country weightings of broader international index funds. For example, even though Herro has bought a few Japanese companies lately, the fund is still underweight the country relative to the "EAFE," the Europe, Australia, and Far East Index from Morgan Stanley Capital International.
"You can expect good long term results, but there will be some volatility when its style is out of favor," Rocco cautions. He also warns investors against chasing hot funds. Indeed, value-oriented funds like Oakmark International have already enjoyed a considerable rise.
Herro, however, believes that the upturn in international investing is just getting under way. For one thing, international companies still trade at a discount to U.S. stocks. The American market trades at 15.2 times cash flow, compared to the 10.7 times that the EAFE trades at. Also, the former is at 3.2 times book value, while the latter is at 2.1 times. "That's close to a 40% discount" for international stocks, Herro says.
He also thinks foreign markets will get a boost from improved corporate governance and a new emphasis on investing in stocks for the long term. Finally, he figures that foreign currencies will continue to strengthen against the dollar, giving U.S. investors an extra lift.
Herro favors companies trading at a steep discount to what he determines to be their intrinsic value. Some of the fund's recent stock picks include Ericsson (ERICY ), the downtrodden Swedish telecom equipment maker, which he thinks is competitive enough in its main business to make it through the current downturn.
He also owns Televisa, a Mexican media company that's out of favor with investors lately. Herro likes its strength in the international market for Spanish-language programming. And he likes Hong Kong-based Giordano International, a leading clothing retailer in the Pacific Rim that he credits with highly efficient operations.
"I think international as an asset class will outperform in next three to five years," says a confident Herro. "There will always be periods of time when we're out of sync," he notes, but his value discipline provides solid returns that exceed most of his peers over time.
So, rather than mourn the closing of Herro's small-cap fund, investors can give Oakmark International a try. Herro says the larger-cap fund has plenty of room for new investors. But they shouldn't dally. Given the fund's recent strong performance, it could be moving to that mythical Island of Closed Funds sooner than Herro expects.
Stone, an associate editor for BusinessWeek Online in New York, covers the markets and investing
Edited by Thane Peterson