R. Burns McKinney is the managing director for NFJ Investment Group, a subsidiary of Allianz Global Investors. As portfolio manager and analyst for Allianz NFJ International Value , he recently answered our questions on the differences between evaluating a foreign dividend-paying company versus a domestic one and addressed the cultural differences that owe to foreign companies' willingness to pay out and maintain dividends versus U.S.-based firms.
3. The fund has a substantially larger emerging-markets stake than the typical fund in Morningstar's foreign large-value category. Why is that? Are you concerned about overheating in emerging markets?
4. The team's outlook for 2011 is optimistic for the long term but also projects "significant short-term volatility." What are some factors that will contribute to instability in international stocks? About the Author Esther Pak is an assistant site editor of Morningstar.com. Contact Author | Meet other investing specialists We believe that the seeds for future volatility could come from burgeoning inflation worldwide. Although inflationary pressures are low right now in the U.S. as a result of high unemployment, the U.S. is exporting this pressure by keeping negative real interest rates low for such an extended period. This forces our trading partners--for example, China--to use their currency to buy dollars and to keep their own currencies from escalating against the dollar, which results in inflation elsewhere. They are forced to adopt our inflationary monetary policies even though they don't have the same levels of spare capacity that we do in the U.S. This is already becoming visible in places like China, India, Brazil, and Indonesia. Furthermore, the supply of low-wage labor may eventually begin to run out in some of these countries, providing additional upward pressure on pricing.
There are two major problems that could be caused by price increases in the developing world. One is social unrest, as we've recently seen in Egypt. Food and energy costs make up a larger share of expenditures in many developing countries than they do here. The second issue is the anticipation that governments might move too far in containing prices. Just recently, in early February, China's central bank hiked rates for the third time in four months, and the same is expected in Brazil. Higher interest rates could not only slow economic growth, but they could also hammer profitability by raising debt-servicing costs.
We also remain skeptical of the European Central Bank's ability to manage the common currency, given the economic disparity of member nations. Many of the recent bailouts have been financed for the next two to three years. Policymakers are forced to set objectives that ensure the survival of the weakest economies--which we believe, despite recent hawkish statements, will hinder their ability to raise rates for the near future.
5. The fund, fortuitously, has been relatively light on European stocks during the past year. You're bottom-up stock-pickers, but what were the key factors that led you to downplay Europe versus other parts of the globe? Did you see any signs of distress before the European crisis began to unfold? Are you continuing to downplay Europe?In a way, it depends on which Europe we're talking about. Southern Europe is something we've been avoiding, not at the macro level but because generally speaking, the financials and price momentum of Southern European companies haven't looked as attractive recently. We have questions about the balance sheets of European banks and financial companies. We're finding better opportunities outside of Southern Europe, particularly in Asian financial companies as well as some in Sweden, Canada, and Brazil. Like we said, we don't need to be in a particular country or region; we just take the best opportunity in terms of valuation and balance sheet strength. There are still some good companies in Europe. The United Kingdom in particular is a significant portion of our portfolio at about 25%, which is overweight versus the benchmark.
In terms of spotting distress, we were underweight the PIIGS (Portugal, Ireland, Italy, Greece, and Spain) nations at about half the benchmark weight. We didn't have direct exposure to Greece or Italy or Portugal. Allied Irish Bank displayPTip('AIB', 'AIB','YTD', '', '', '', '', '', '','msg','P'); was one of the financials that we got out of before it got into serious trouble, thanks to our price-momentum screens. We at NFJ are one of the few value managers that use price momentum to provide an additional level of downside protection. It's always been a favorite of growth managers, but it helps us quantify the tendency of stock prices to continue moving in the same direction and helps us decide if we need to avoid a potential candidate or sell a current holding. Allied Irish was one of those cases where there was information embedded in the way its stock traded that was not necessarily evident from talking with management and examining the financials. It exhibited poor price momentum, so we got out of it and avoided a falling-knife situation.
See More Manager Q&As
Our fund can invest up to 50.0% of its holdings in emerging markets, which is a big difference when you compare us with our competitors. We like to think of Allianz NFJ International Value as a world fund ex-U.S. When we developed it, we didn't handcuff it. We chose a different benchmark--MSCI ACWI ex-U.S.--than many of our peers. So while our emerging-markets allocation might be high compared with our peers, we currently have a weighting that's only slightly above our benchmark's. That's one sign of how significant emerging-markets countries are; they represent about 23.0% of our benchmark and nearly 33.0% of its total market cap. From a global standpoint, developing markets are clearly very important, so we don't feel we're overweight in that regard, either. The way we see it, funds that limit their emerging-markets exposure by benchmarking against something like the MSCI Europe, Australasia, and Far East Index are missing the many benefits of investing in the emerging-markets set.Still, we don't go out of our way to find stocks in developing nations. We are first and foremost bottom-up investors who look for undervalued, consistent dividend payers. Emerging markets are simply part of our investable universe, and we go where the valuations are. And today, there's a great case to be made for valuations in emerging-markets countries. Their stock prices, on average, trade around 14.5 times earnings, while the total global investment universe has P/E ratios of nearly 16 times. Moreover, the International Monetary Fund forecasts that emerging-markets countries will expand their economies at 7.0% this year, which is a far greater rate than what they're forecasting for developed countries. And if you view the global recession to be the result of fiscal promiscuity around the world, and consider that the average 34% debt/gross domestic product ratio of emerging-markets countries is far lower than the 90%-plus ratio of the developed world, emerging markets are attractive on that level, too.
Our emerging-markets holdings also tend to be less volatile, more established names. They must be dividend-paying stocks with market caps of at least $2 billion. As a result, they're industry leaders that happen to be domiciled in developing nations, but they're still cash producers that pay dividends and have long operating histories.
That leads to another important point about our process: We believe our focus on dividends helps mitigate risk in emerging markets, which helps our shareholders. When we buy dividend-paying names within emerging-markets countries, we still get the top-line growth potential of emerging-markets stocks in general, but the presence of dividends also helps us judge earnings quality and earnings transparency. After all, it's relatively easy to fudge reported earnings, but you can't manipulate or restate a dividend. Rather than trying to gauge the quality of earnings in a non-dividend-paying emerging-markets stock, we choose companies paying tangible dividends. I think it's like the old Reese's peanut-butter cup commercials: Dividend-paying stocks in the developing world make a great combination that work well together.
As far as emerging markets overheating, we actively manage risk there just like we do in our entire portfolio, by following valuations at the stock level and then increasing exposure when opportunities look attractive or decreasing it when valuations appear rich. For example, in late 2006 and early 2007, we had just more than 10% in China, and all the pundits were advising investors to get out because China seemed to be overheated. We didn't necessarily disagree. The market was overheated, trading at P/Es of 30 or 40. But the stocks we had were at P/Es of 8 or 9. As a result, we held onto them until they began to run up in valuations, and during the course of 2007, we slowly got out of China until we had nothing there by early 2008. The market may have been overheating, but our stocks were so cheap that we didn't just jump ship. We waited until our names got expensive.
That's the distinction. Because we're always looking for the lowest valuations, our process is going to move us out of overheated countries on a bottom-up, name-by-name basis. As opposed to owning a stock trading at a P/E of 18 or 20, if we can go somewhere else in the same industry and find one with a P/E of 10 or 11, but it still pays a dividend and has a strong balance sheet, we're going to favor the lower-valuation security. Our process keeps us moving out of hot markets and keeps shareholders from having to decide when to go in and out. We believe this is valuable to our clients because emerging-markets countries can be volatile and they do get overheated, but this fund makes that allocation decision for you, as you can see in our shifting allocations over time. Since inception, our fund's emerging-markets exposure has ranged from the upper teens and low 20s to a high of 48%. It's really worked in our favor.
McKinney also discussed the fund's heavy weighting in emerging markets relative to its peers as well as some factors he believes will contribute to future volatility in international stocks. Finally, he addressed the portfolio's position in Europe pre-crisis and where management is finding opportunity in Europe post-crisis.
1. How does the evaluation process of a foreign company's valuation differ from that of a domestic company, if at all? Are there any metrics that you put more emphasis on when evaluating foreign dividend payers than you do when evaluating U.S.-based companies?For this fund, our investment approach is the same as it would be if it were a domestic NFJ fund: We look for low-valuation, dividend-paying securities. That's a mandate across the board at NFJ. We put a large emphasis on financial statements and balance sheets.
One of the things that differentiates Allianz NFJ International Value from many of our competitors is that we invest in the universe of companies that file ADRs. Of course, we're not restricted from buying the regular shares behind the ADRs, but these companies file 20-F forms with the SEC and commonly use U.S. generally accepted accounting principles or international accounting standards. This improves earnings transparency and is very useful for cross-border comparisons. If we're looking at P/E multiples of a company in Argentina and one in France, ADRs help us make sure we're comparing earnings on an apples-to-apples basis.
In terms of evaluating foreign companies differently than domestic ones, we let valuations drive where we're investing. We invest by industry and sector, not by country or region, and we look globally for the best opportunities and the lowest valuations. For example, we might want to invest in telecom, but we don't need to buy a telecom company in China. We can invest in one in Turkey or South Korea if it's trading at a better valuation. Of course, we're not going to just jam something into the portfolio because we want to be in that industry, though we generally want to be diversified and exposed to as many industries within sectors as we can.
In the case of a tiebreaker situation--let's say there are two companies in one industry that we're interested in, but one is in Canada and the other is in Russia--we'll look at the geopolitical risk involved and will expect a greater discount if we see that risk. Or perhaps we'll be looking closely at two otherwise similar companies, but one is in South Korea and one is in Greece. All else being equal, we'd favor the country with the stronger currency.
2. Do you observe any cultural differences related to foreign companies' willingness to pay out and maintain dividends versus what you've seen from U.S.-based firms? Are foreign companies more or less likely to cut dividends than U.S. firms, or is difficult to generalize?There's definitely a cultural difference in terms of paying dividends. It's almost expected that non-U.S. companies will pay out part of their earnings to shareholders. Part of this stems from the fact that in many countries, fixed-income investing has been predominant. So when these investors move into equities, they're more comfortable moving into stocks that pay regular dividends.
Another big difference is that while U.S. companies tend to have a set payment amount of cents per share, non-U.S. companies tend to have a set payout ratio--a percentage of earnings of, say, 50.0% of a dollar. So overseas, investors tend to expect that dividends will fluctuate, whereas if a company cuts a dividend here at home, it's really bad news. Personally, I believe focusing on a fixed payout ratio probably makes better sense from a capital-allocation perspective than focusing on a fixed payment.
As a result of all this, you generally find higher dividend yields outside of the U.S. than you do in the U.S. In terms of the MSCI All Country World Index as of mid-February, the average dividend yield globally was 2.7%, whereas in the U.S. it was only 1.9%. Moreover, in 2010, average dividend growth outside the U.S. was 11.0%, compared with only 5.0% inside the U.S. Internationally, the dividends are there, and they're very important to us--particularly in developing nations, where assessing earnings quality is much harder to do than it is in the developed world. Our focus on emerging-markets stocks that pay dividends really helps us gauge the quality of their governance and the transparency of their earnings, which we believe is a direct benefit to our shareholders.
Return to DiscussNext321PrevBe Seen. Be Heard. Become a Morningstar Contributor.Reach a readership of advisors, professionals, and active investors. Submit your commentaries for publication on Morningstar.com.
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4. The team's outlook for 2011 is optimistic for the long term but also projects "significant short-term volatility." What are some factors that will contribute to instability in international stocks? About the Author Esther Pak is an assistant site editor of Morningstar.com. Contact Author | Meet other investing specialists We believe that the seeds for future volatility could come from burgeoning inflation worldwide. Although inflationary pressures are low right now in the U.S. as a result of high unemployment, the U.S. is exporting this pressure by keeping negative real interest rates low for such an extended period. This forces our trading partners--for example, China--to use their currency to buy dollars and to keep their own currencies from escalating against the dollar, which results in inflation elsewhere. They are forced to adopt our inflationary monetary policies even though they don't have the same levels of spare capacity that we do in the U.S. This is already becoming visible in places like China, India, Brazil, and Indonesia. Furthermore, the supply of low-wage labor may eventually begin to run out in some of these countries, providing additional upward pressure on pricing.
There are two major problems that could be caused by price increases in the developing world. One is social unrest, as we've recently seen in Egypt. Food and energy costs make up a larger share of expenditures in many developing countries than they do here. The second issue is the anticipation that governments might move too far in containing prices. Just recently, in early February, China's central bank hiked rates for the third time in four months, and the same is expected in Brazil. Higher interest rates could not only slow economic growth, but they could also hammer profitability by raising debt-servicing costs.
We also remain skeptical of the European Central Bank's ability to manage the common currency, given the economic disparity of member nations. Many of the recent bailouts have been financed for the next two to three years. Policymakers are forced to set objectives that ensure the survival of the weakest economies--which we believe, despite recent hawkish statements, will hinder their ability to raise rates for the near future.
5. The fund, fortuitously, has been relatively light on European stocks during the past year. You're bottom-up stock-pickers, but what were the key factors that led you to downplay Europe versus other parts of the globe? Did you see any signs of distress before the European crisis began to unfold? Are you continuing to downplay Europe?In a way, it depends on which Europe we're talking about. Southern Europe is something we've been avoiding, not at the macro level but because generally speaking, the financials and price momentum of Southern European companies haven't looked as attractive recently. We have questions about the balance sheets of European banks and financial companies. We're finding better opportunities outside of Southern Europe, particularly in Asian financial companies as well as some in Sweden, Canada, and Brazil. Like we said, we don't need to be in a particular country or region; we just take the best opportunity in terms of valuation and balance sheet strength. There are still some good companies in Europe. The United Kingdom in particular is a significant portion of our portfolio at about 25%, which is overweight versus the benchmark.
In terms of spotting distress, we were underweight the PIIGS (Portugal, Ireland, Italy, Greece, and Spain) nations at about half the benchmark weight. We didn't have direct exposure to Greece or Italy or Portugal. Allied Irish Bank displayPTip('AIB', 'AIB','YTD', '', '', '', '', '', '','msg','P'); was one of the financials that we got out of before it got into serious trouble, thanks to our price-momentum screens. We at NFJ are one of the few value managers that use price momentum to provide an additional level of downside protection. It's always been a favorite of growth managers, but it helps us quantify the tendency of stock prices to continue moving in the same direction and helps us decide if we need to avoid a potential candidate or sell a current holding. Allied Irish was one of those cases where there was information embedded in the way its stock traded that was not necessarily evident from talking with management and examining the financials. It exhibited poor price momentum, so we got out of it and avoided a falling-knife situation.
See More Manager Q&As
Our fund can invest up to 50.0% of its holdings in emerging markets, which is a big difference when you compare us with our competitors. We like to think of Allianz NFJ International Value as a world fund ex-U.S. When we developed it, we didn't handcuff it. We chose a different benchmark--MSCI ACWI ex-U.S.--than many of our peers. So while our emerging-markets allocation might be high compared with our peers, we currently have a weighting that's only slightly above our benchmark's. That's one sign of how significant emerging-markets countries are; they represent about 23.0% of our benchmark and nearly 33.0% of its total market cap. From a global standpoint, developing markets are clearly very important, so we don't feel we're overweight in that regard, either. The way we see it, funds that limit their emerging-markets exposure by benchmarking against something like the MSCI Europe, Australasia, and Far East Index are missing the many benefits of investing in the emerging-markets set.Still, we don't go out of our way to find stocks in developing nations. We are first and foremost bottom-up investors who look for undervalued, consistent dividend payers. Emerging markets are simply part of our investable universe, and we go where the valuations are. And today, there's a great case to be made for valuations in emerging-markets countries. Their stock prices, on average, trade around 14.5 times earnings, while the total global investment universe has P/E ratios of nearly 16 times. Moreover, the International Monetary Fund forecasts that emerging-markets countries will expand their economies at 7.0% this year, which is a far greater rate than what they're forecasting for developed countries. And if you view the global recession to be the result of fiscal promiscuity around the world, and consider that the average 34% debt/gross domestic product ratio of emerging-markets countries is far lower than the 90%-plus ratio of the developed world, emerging markets are attractive on that level, too.
Our emerging-markets holdings also tend to be less volatile, more established names. They must be dividend-paying stocks with market caps of at least $2 billion. As a result, they're industry leaders that happen to be domiciled in developing nations, but they're still cash producers that pay dividends and have long operating histories.
That leads to another important point about our process: We believe our focus on dividends helps mitigate risk in emerging markets, which helps our shareholders. When we buy dividend-paying names within emerging-markets countries, we still get the top-line growth potential of emerging-markets stocks in general, but the presence of dividends also helps us judge earnings quality and earnings transparency. After all, it's relatively easy to fudge reported earnings, but you can't manipulate or restate a dividend. Rather than trying to gauge the quality of earnings in a non-dividend-paying emerging-markets stock, we choose companies paying tangible dividends. I think it's like the old Reese's peanut-butter cup commercials: Dividend-paying stocks in the developing world make a great combination that work well together.
As far as emerging markets overheating, we actively manage risk there just like we do in our entire portfolio, by following valuations at the stock level and then increasing exposure when opportunities look attractive or decreasing it when valuations appear rich. For example, in late 2006 and early 2007, we had just more than 10% in China, and all the pundits were advising investors to get out because China seemed to be overheated. We didn't necessarily disagree. The market was overheated, trading at P/Es of 30 or 40. But the stocks we had were at P/Es of 8 or 9. As a result, we held onto them until they began to run up in valuations, and during the course of 2007, we slowly got out of China until we had nothing there by early 2008. The market may have been overheating, but our stocks were so cheap that we didn't just jump ship. We waited until our names got expensive.
That's the distinction. Because we're always looking for the lowest valuations, our process is going to move us out of overheated countries on a bottom-up, name-by-name basis. As opposed to owning a stock trading at a P/E of 18 or 20, if we can go somewhere else in the same industry and find one with a P/E of 10 or 11, but it still pays a dividend and has a strong balance sheet, we're going to favor the lower-valuation security. Our process keeps us moving out of hot markets and keeps shareholders from having to decide when to go in and out. We believe this is valuable to our clients because emerging-markets countries can be volatile and they do get overheated, but this fund makes that allocation decision for you, as you can see in our shifting allocations over time. Since inception, our fund's emerging-markets exposure has ranged from the upper teens and low 20s to a high of 48%. It's really worked in our favor.
McKinney also discussed the fund's heavy weighting in emerging markets relative to its peers as well as some factors he believes will contribute to future volatility in international stocks. Finally, he addressed the portfolio's position in Europe pre-crisis and where management is finding opportunity in Europe post-crisis.
1. How does the evaluation process of a foreign company's valuation differ from that of a domestic company, if at all? Are there any metrics that you put more emphasis on when evaluating foreign dividend payers than you do when evaluating U.S.-based companies?For this fund, our investment approach is the same as it would be if it were a domestic NFJ fund: We look for low-valuation, dividend-paying securities. That's a mandate across the board at NFJ. We put a large emphasis on financial statements and balance sheets.
One of the things that differentiates Allianz NFJ International Value from many of our competitors is that we invest in the universe of companies that file ADRs. Of course, we're not restricted from buying the regular shares behind the ADRs, but these companies file 20-F forms with the SEC and commonly use U.S. generally accepted accounting principles or international accounting standards. This improves earnings transparency and is very useful for cross-border comparisons. If we're looking at P/E multiples of a company in Argentina and one in France, ADRs help us make sure we're comparing earnings on an apples-to-apples basis.
In terms of evaluating foreign companies differently than domestic ones, we let valuations drive where we're investing. We invest by industry and sector, not by country or region, and we look globally for the best opportunities and the lowest valuations. For example, we might want to invest in telecom, but we don't need to buy a telecom company in China. We can invest in one in Turkey or South Korea if it's trading at a better valuation. Of course, we're not going to just jam something into the portfolio because we want to be in that industry, though we generally want to be diversified and exposed to as many industries within sectors as we can.
In the case of a tiebreaker situation--let's say there are two companies in one industry that we're interested in, but one is in Canada and the other is in Russia--we'll look at the geopolitical risk involved and will expect a greater discount if we see that risk. Or perhaps we'll be looking closely at two otherwise similar companies, but one is in South Korea and one is in Greece. All else being equal, we'd favor the country with the stronger currency.
2. Do you observe any cultural differences related to foreign companies' willingness to pay out and maintain dividends versus what you've seen from U.S.-based firms? Are foreign companies more or less likely to cut dividends than U.S. firms, or is difficult to generalize?There's definitely a cultural difference in terms of paying dividends. It's almost expected that non-U.S. companies will pay out part of their earnings to shareholders. Part of this stems from the fact that in many countries, fixed-income investing has been predominant. So when these investors move into equities, they're more comfortable moving into stocks that pay regular dividends.
Another big difference is that while U.S. companies tend to have a set payment amount of cents per share, non-U.S. companies tend to have a set payout ratio--a percentage of earnings of, say, 50.0% of a dollar. So overseas, investors tend to expect that dividends will fluctuate, whereas if a company cuts a dividend here at home, it's really bad news. Personally, I believe focusing on a fixed payout ratio probably makes better sense from a capital-allocation perspective than focusing on a fixed payment.
As a result of all this, you generally find higher dividend yields outside of the U.S. than you do in the U.S. In terms of the MSCI All Country World Index as of mid-February, the average dividend yield globally was 2.7%, whereas in the U.S. it was only 1.9%. Moreover, in 2010, average dividend growth outside the U.S. was 11.0%, compared with only 5.0% inside the U.S. Internationally, the dividends are there, and they're very important to us--particularly in developing nations, where assessing earnings quality is much harder to do than it is in the developed world. Our focus on emerging-markets stocks that pay dividends really helps us gauge the quality of their governance and the transparency of their earnings, which we believe is a direct benefit to our shareholders.
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Securities mentioned in this article Ticker Price($) Change(%) Morningstar Rating Morningstar Analyst Report With Morningstar Analyst reports you can get our expert Buy/Sell opinions on over 3,900 Stock and Funds Esther Pak does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies. Video Reports Where the Fixed-Income... More Videos... Most Popular Related News Also in Fund Manager Q&A Tech Firms Showing Signs of GrowthBaird's Pierson: Avoiding Red Flags in MunisNygren: Don't Compare Growth With ValueHealth-Care Winners and LosersOsterweis: Get Off the Tracks When the Freight Train's Coming Sponsored Links Buy a Link Now Sponsor Center Please Wait... MUTUALFUNDS USA_AIB,USA_AFJAX E0_USA_AIB FO_USA_AFJAX &primaryKeyword=MUTUALFUNDS 2 {CommentWebService} OAS_AD('Bottom'); Content Partners Site Directory Site Map Our Products Corrections Help Advertising Opportunities Licensing Opportunities Glossary RSS Mobile Portfolio Affiliate Careers Company News International Sites: Australia Canada China France Germany Hong Kong Italy The Netherlands Norway Spain U.K. Stocks by: Title Ticker Popularity Interest Funds by: Title Symbol Popularity Interest Articles by: Title Date Popularity Interest Stock Groups by: Popularity Interest Favorites Title Fund Groups by: Popularity Interest Favorites Title Article Groups by: Popularity Interest Favorites Title Premium Stocks by: Title Ticker Popularity Interest Premium Funds by: Title Symbol Popularity Interest Premium Articles by: Title Date Popularity Interest Independent. Insightful. Trusted. Morningstar provides stock market analysis; equity, mutual fund, and ETF research, ratings, and picks; portfolio tools; and option, hedge fund, IRA, 401k, and 529 plan research. Our reliable data and analysis can help both experienced enthusiasts and newcomers. © Copyright 2010 Morningstar, Inc. All rights reserved. Please read our Terms of Useand Privacy Policy.Dow Jones Industrial Average, S&P 500, Nasdaq, and Morningstar Index (Market Barometer) quotes are real-time. Russell 2000 quote is 10 minutes delayed. var HeaderBox = initBoxQuote("AutoCompleteBox","AutoCompleteDropDown"); HeaderBox.IdleDisplayMsg = ""; HeaderBox.LocalRegion="USA"; HeaderBox.SetPreference('USA','EN',32); var FooterBox = initBoxQuote("AutoCompleteBoxFooter","AutoCompleteDropDownFooter"); FooterBox.IdleDisplayMsg = ""; FooterBox.LocalRegion="USA"; FooterBox.SetPreference('USA','EN',32); //clears all content/image boxes-------------------------------------------------------------------------------------- var imageIDs=new Array('siteDirectoryContent', 'siteMapContent', 'productsContent'); //content boxes .mi_row3{display: none} var _gaq = _gaq || []; _gaq.push(['_setAccount', 'UA-16669347-1']); _gaq.push(['_setDomainName', '.morningstar.com']); _gaq.push(['_trackPageview']); (function() { var ga = document.createElement('script'); ga.type = 'text/javascript'; ga.async = true; ga.src = ('https:' == document.location.protocol ? 'https://ssl' : 'http://www') + '.google-analytics.com/ga.js'; var s = document.getElementsByTagName('script')[0]; s.parentNode.insertBefore(ga, s); })(); var Name = $('meta[name=DC.Creator]').attr("content").split(','); var Title = $('meta[name=DC.Title]').attr("content"); var URL = window.location.href; var Author = Name[1] + " " + Name[0]; var PubDate = $('meta[name=DC.Date]').attr("content"); _gaq.push(['_trackEvent', 'Article Title From Morningstar', Title, URL]); _gaq.push(['_trackEvent', 'Author Name From Morningstar', Author, URL]); _gaq.push(['_trackEvent', 'Article URL From Morningstar', URL, Title + "(by " + Author + " on " + PubDate + ")"]); _gaq.push(['_trackEvent', 'Publish Date From Morningstar', PubDate, URL]); _gaq.push(['_trackEvent', 'Article Title', Title, URL]); _gaq.push(['_trackEvent', 'Author Name', Author, URL]); _gaq.push(['_trackEvent', 'Article URL', URL, Title + "(by " + Author + " on " + PubDate + ")"]); _gaq.push(['_trackEvent', 'Publish Date', PubDate, URL]);There are two major problems that could be caused by price increases in the developing world. One is social unrest, as we've recently seen in Egypt. Food and energy costs make up a larger share of expenditures in many developing countries than they do here. The second issue is the anticipation that governments might move too far in containing prices. Just recently, in early February, China's central bank hiked rates for the third time in four months, and the same is expected in Brazil. Higher interest rates could not only slow economic growth, but they could also hammer profitability by raising debt-servicing costs.
We also remain skeptical of the European Central Bank's ability to manage the common currency, given the economic disparity of member nations. Many of the recent bailouts have been financed for the next two to three years. Policymakers are forced to set objectives that ensure the survival of the weakest economies--which we believe, despite recent hawkish statements, will hinder their ability to raise rates for the near future.
5. The fund, fortuitously, has been relatively light on European stocks during the past year. You're bottom-up stock-pickers, but what were the key factors that led you to downplay Europe versus other parts of the globe? Did you see any signs of distress before the European crisis began to unfold? Are you continuing to downplay Europe?In a way, it depends on which Europe we're talking about. Southern Europe is something we've been avoiding, not at the macro level but because generally speaking, the financials and price momentum of Southern European companies haven't looked as attractive recently. We have questions about the balance sheets of European banks and financial companies. We're finding better opportunities outside of Southern Europe, particularly in Asian financial companies as well as some in Sweden, Canada, and Brazil. Like we said, we don't need to be in a particular country or region; we just take the best opportunity in terms of valuation and balance sheet strength. There are still some good companies in Europe. The United Kingdom in particular is a significant portion of our portfolio at about 25%, which is overweight versus the benchmark.
In terms of spotting distress, we were underweight the PIIGS (Portugal, Ireland, Italy, Greece, and Spain) nations at about half the benchmark weight. We didn't have direct exposure to Greece or Italy or Portugal. Allied Irish Bank was one of the financials that we got out of before it got into serious trouble, thanks to our price-momentum screens. We at NFJ are one of the few value managers that use price momentum to provide an additional level of downside protection. It's always been a favorite of growth managers, but it helps us quantify the tendency of stock prices to continue moving in the same direction and helps us decide if we need to avoid a potential candidate or sell a current holding. Allied Irish was one of those cases where there was information embedded in the way its stock traded that was not necessarily evident from talking with management and examining the financials. It exhibited poor price momentum, so we got out of it and avoided a falling-knife situation.
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Our fund can invest up to 50.0% of its holdings in emerging markets, which is a big difference when you compare us with our competitors. We like to think of Allianz NFJ International Value as a world fund ex-U.S. When we developed it, we didn't handcuff it. We chose a different benchmark--MSCI ACWI ex-U.S.--than many of our peers. So while our emerging-markets allocation might be high compared with our peers, we currently have a weighting that's only slightly above our benchmark's. That's one sign of how significant emerging-markets countries are; they represent about 23.0% of our benchmark and nearly 33.0% of its total market cap. From a global standpoint, developing markets are clearly very important, so we don't feel we're overweight in that regard, either. The way we see it, funds that limit their emerging-markets exposure by benchmarking against something like the MSCI Europe, Australasia, and Far East Index are missing the many benefits of investing in the emerging-markets set.Still, we don't go out of our way to find stocks in developing nations. We are first and foremost bottom-up investors who look for undervalued, consistent dividend payers. Emerging markets are simply part of our investable universe, and we go where the valuations are. And today, there's a great case to be made for valuations in emerging-markets countries. Their stock prices, on average, trade around 14.5 times earnings, while the total global investment universe has P/E ratios of nearly 16 times. Moreover, the International Monetary Fund forecasts that emerging-markets countries will expand their economies at 7.0% this year, which is a far greater rate than what they're forecasting for developed countries. And if you view the global recession to be the result of fiscal promiscuity around the world, and consider that the average 34% debt/gross domestic product ratio of emerging-markets countries is far lower than the 90%-plus ratio of the developed world, emerging markets are attractive on that level, too.
Our emerging-markets holdings also tend to be less volatile, more established names. They must be dividend-paying stocks with market caps of at least $2 billion. As a result, they're industry leaders that happen to be domiciled in developing nations, but they're still cash producers that pay dividends and have long operating histories.
That leads to another important point about our process: We believe our focus on dividends helps mitigate risk in emerging markets, which helps our shareholders. When we buy dividend-paying names within emerging-markets countries, we still get the top-line growth potential of emerging-markets stocks in general, but the presence of dividends also helps us judge earnings quality and earnings transparency. After all, it's relatively easy to fudge reported earnings, but you can't manipulate or restate a dividend. Rather than trying to gauge the quality of earnings in a non-dividend-paying emerging-markets stock, we choose companies paying tangible dividends. I think it's like the old Reese's peanut-butter cup commercials: Dividend-paying stocks in the developing world make a great combination that work well together.
As far as emerging markets overheating, we actively manage risk there just like we do in our entire portfolio, by following valuations at the stock level and then increasing exposure when opportunities look attractive or decreasing it when valuations appear rich. For example, in late 2006 and early 2007, we had just more than 10% in China, and all the pundits were advising investors to get out because China seemed to be overheated. We didn't necessarily disagree. The market was overheated, trading at P/Es of 30 or 40. But the stocks we had were at P/Es of 8 or 9. As a result, we held onto them until they began to run up in valuations, and during the course of 2007, we slowly got out of China until we had nothing there by early 2008. The market may have been overheating, but our stocks were so cheap that we didn't just jump ship. We waited until our names got expensive.
That's the distinction. Because we're always looking for the lowest valuations, our process is going to move us out of overheated countries on a bottom-up, name-by-name basis. As opposed to owning a stock trading at a P/E of 18 or 20, if we can go somewhere else in the same industry and find one with a P/E of 10 or 11, but it still pays a dividend and has a strong balance sheet, we're going to favor the lower-valuation security. Our process keeps us moving out of hot markets and keeps shareholders from having to decide when to go in and out. We believe this is valuable to our clients because emerging-markets countries can be volatile and they do get overheated, but this fund makes that allocation decision for you, as you can see in our shifting allocations over time. Since inception, our fund's emerging-markets exposure has ranged from the upper teens and low 20s to a high of 48%. It's really worked in our favor.
McKinney also discussed the fund's heavy weighting in emerging markets relative to its peers as well as some factors he believes will contribute to future volatility in international stocks. Finally, he addressed the portfolio's position in Europe pre-crisis and where management is finding opportunity in Europe post-crisis.
1. How does the evaluation process of a foreign company's valuation differ from that of a domestic company, if at all? Are there any metrics that you put more emphasis on when evaluating foreign dividend payers than you do when evaluating U.S.-based companies?For this fund, our investment approach is the same as it would be if it were a domestic NFJ fund: We look for low-valuation, dividend-paying securities. That's a mandate across the board at NFJ. We put a large emphasis on financial statements and balance sheets.
One of the things that differentiates Allianz NFJ International Value from many of our competitors is that we invest in the universe of companies that file ADRs. Of course, we're not restricted from buying the regular shares behind the ADRs, but these companies file 20-F forms with the SEC and commonly use U.S. generally accepted accounting principles or international accounting standards. This improves earnings transparency and is very useful for cross-border comparisons. If we're looking at P/E multiples of a company in Argentina and one in France, ADRs help us make sure we're comparing earnings on an apples-to-apples basis.
In terms of evaluating foreign companies differently than domestic ones, we let valuations drive where we're investing. We invest by industry and sector, not by country or region, and we look globally for the best opportunities and the lowest valuations. For example, we might want to invest in telecom, but we don't need to buy a telecom company in China. We can invest in one in Turkey or South Korea if it's trading at a better valuation. Of course, we're not going to just jam something into the portfolio because we want to be in that industry, though we generally want to be diversified and exposed to as many industries within sectors as we can.
In the case of a tiebreaker situation--let's say there are two companies in one industry that we're interested in, but one is in Canada and the other is in Russia--we'll look at the geopolitical risk involved and will expect a greater discount if we see that risk. Or perhaps we'll be looking closely at two otherwise similar companies, but one is in South Korea and one is in Greece. All else being equal, we'd favor the country with the stronger currency.
2. Do you observe any cultural differences related to foreign companies' willingness to pay out and maintain dividends versus what you've seen from U.S.-based firms? Are foreign companies more or less likely to cut dividends than U.S. firms, or is difficult to generalize?There's definitely a cultural difference in terms of paying dividends. It's almost expected that non-U.S. companies will pay out part of their earnings to shareholders. Part of this stems from the fact that in many countries, fixed-income investing has been predominant. So when these investors move into equities, they're more comfortable moving into stocks that pay regular dividends.
Another big difference is that while U.S. companies tend to have a set payment amount of cents per share, non-U.S. companies tend to have a set payout ratio--a percentage of earnings of, say, 50.0% of a dollar. So overseas, investors tend to expect that dividends will fluctuate, whereas if a company cuts a dividend here at home, it's really bad news. Personally, I believe focusing on a fixed payout ratio probably makes better sense from a capital-allocation perspective than focusing on a fixed payment.
As a result of all this, you generally find higher dividend yields outside of the U.S. than you do in the U.S. In terms of the MSCI All Country World Index as of mid-February, the average dividend yield globally was 2.7%, whereas in the U.S. it was only 1.9%. Moreover, in 2010, average dividend growth outside the U.S. was 11.0%, compared with only 5.0% inside the U.S. Internationally, the dividends are there, and they're very important to us--particularly in developing nations, where assessing earnings quality is much harder to do than it is in the developed world. Our focus on emerging-markets stocks that pay dividends really helps us gauge the quality of their governance and the transparency of their earnings, which we believe is a direct benefit to our shareholders.
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Securities mentioned in this article Ticker Price($) Change(%) Morningstar Rating Morningstar Analyst Report With Morningstar Analyst reports you can get our expert Buy/Sell opinions on over 3,900 Stock and Funds Esther Pak does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies. Video Reports Where the Fixed-Income... More Videos... Most Popular Related News Also in Fund Manager Q&A Tech Firms Showing Signs of GrowthBaird's Pierson: Avoiding Red Flags in MunisNygren: Don't Compare Growth With ValueHealth-Care Winners and LosersOsterweis: Get Off the Tracks When the Freight Train's Coming Sponsored Links Buy a Link Now Sponsor Center Please Wait... MUTUALFUNDS USA_AIB,USA_AFJAX E0_USA_AIB FO_USA_AFJAX &primaryKeyword=MUTUALFUNDS 2 {CommentWebService} OAS_AD('Bottom'); Content Partners Site Directory Site Map Our Products Corrections Help Advertising Opportunities Licensing Opportunities Glossary RSS Mobile Portfolio Affiliate Careers Company News International Sites: Australia Canada China France Germany Hong Kong Italy The Netherlands Norway Spain U.K. Stocks by: Title Ticker Popularity Interest Funds by: Title Symbol Popularity Interest Articles by: Title Date Popularity Interest Stock Groups by: Popularity Interest Favorites Title Fund Groups by: Popularity Interest Favorites Title Article Groups by: Popularity Interest Favorites Title Premium Stocks by: Ti Read Full Article »