Q&A: Escape from the Ivory Tower

Economics training pays off for Oakmark International's Herro

Investing is academic, really. Just ask David Herro. The money manager once thought he would be an economics professor. But halfway to his PhD, he became disenchanted with theory and decided to put his education to more practical use: his "first love," investing. Herro's economic acumen has paid off: His $1.3 billion Oakmark International Fund has returned 12.7% a year since its inception in 1992 and is up 14.4% so far this year. BusinessWeek's Brian Hindo spoke with Herro in New York.

Q: You say a change in mind-set is creating value in many companies outside the U.S. What do you mean?

A: In the past, many foreign companies didn't have the same profit-oriented culture as in the U.S. This has been changing. You have more private pensions, which means more involvement and broader ownership in equities. You have companies using their stock as capital to expand their businesses. In Europe [where the fund has a 66% weighting], people are realizing that restrictive labor policies, high tax rates, and a high social safety net are impediments to the increased standard of living they've witnessed in the U.S. and, to some degree, Britain. The change is just starting--there's a long way to go.

Q: What European stocks are you excited about?

A: Ericsson [the Swedish telecom-equipment maker] is one of our newer stocks. Its balance sheet is far better than any of its competitors. It's not flush with cash, but it's O.K. And it's the clear leader in the wireless-infrastructure industry. At some point, phone companies will start spending again. It's not going to be in the short term, but the company is trading cheaply. It will have the financial strength to go somewhat on the offensive. Three to five years from now, it could be double or triple where it's selling now.

We're also optimistic about media companies. It's a growth industry but they're at depressed prices because of the recession. A Swiss company called Tamedia, which has a monopoly on German-speaking print and radio, trades at seven or eight times EBITDA [earnings before interest, taxes, depreciation, and amortization]. Aegis Group, based in London, is near a five-year low.

Q: Your fund's biggest country weighting is Britain. What makes it a good place to find value?

A: Britain has a corporate-governance system that helps ensure that companies are, in fact, run for owners of the business. There is clear agreement that businesses have to be run to make money. The Netherlands, for example, still has built-in poison pills against hostile takeovers, which just protects mediocrity. Also, Britain has a large number of private pension funds that make sure that if a company is sleepy for too long, some changes will be made. That tends to keep management focused on returns.

Q: Are you invested in emerging markets?

A: We have somewhere around a 14% exposure to emerging markets, [including] South Korea, Israel, Mexico, and Brazil. The beauty of what's happening in the global economy is that political decision-makers have less power than ever before, vs. the power of supply and demand. That's causing a lot of discipline in emerging markets these days.

Q: Your fund has an 18.9% weighting in the Pacific Rim. What's your take on that region?

A: Japanese stocks are undervalued, but it's a challenge to find quality. We've added Takeda Chemical Industries. Takeda has some very good compounds, and instead of remaining insulated in Japan, it went out and did deals with foreign companies to get distribution in Europe and the U.S., and it's selling at a low price.

More interesting than Japan is Hong Kong, where we like clothing retailer Giordano, and South Korea, which has gone through a dramatic economic transformation. The small and midsize companies are extremely competitive, very profitable, and very high-growth. We added to our South Korea exposure when stocks were at fire-sale prices in 1997-98. We've been trimming lately, just because of the sheer amount of appreciation these companies have had. We're still at a 5% or 6% weighting, but that's off from 8% or 9%. And Australia is a very high-growth country. There is almost a guaranteed flow of money into the equity markets because of their private pension scheme.

Q: Why so many smaller companies in your portfolio?

A: The stocks that fit our criteria tend to be more in the mid-cap range, but we don't target it. I've always believed that it's tough to find a good, high-quality business that has $100 billion a year in revenues. Everyone knows about it, so it's not exploitable. I mean, how cheap could Coca-Cola Co. ever get?

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