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Don’t Ignore These Contrarian Buys
06/14/2012 7:30 am EST
Fund manager Andrew Sleeman explains why the insurance sector—even in Europe—offers investment opportunity. He also explains how he gets emerging-market exposure by investing in some developed-market companies.
Andrew, start out with just a bird’s eye view: give us the objective of your fund and describe your investment philosophy.
Andrew Sleeman: Sure, thanks for the time. So, like other Mutual Series funds, we’re bottom-up value investors. We look at investing with a margin of safety—so, downside protection. We think like business owners.
I think that’s a very important aspect of the Mutual Series philosophy. We don’t deliberately go and look for uncorrelated returns, but we love those stories that have a sort of a catalyst which is not market-related or macro-economic in its nature. That’s how we go about things here.
Kate Stalter: Is there any kind of index that you are using as the universe that you’re selecting from?
Andrew Sleeman: You know, we are index-agnostic. I think somebody put it well: We’re aware that there is an index and that we’re going to measure against an index, but we certainly don’t construct a portfolio around an index.
The MSCI World International Index, the EAFE Index, is typically what we would be measured against. But, we construct our portfolios from the bottom up, and every stock has to stand on its own merits in the portfolio.
Kate Stalter: You know, one of the questions in today’s economic and investing climate—with any kind of international manager, Europe has to come up. So is this an area where you are still pretty heavily invested? Have you had to pare back your holdings anywhere from Europe?
Andrew Sleeman: You know, it’s interesting. We are still invested in Europe, and you would be very surprised to see where outperformance in the funds has come from. It tends to be in financials, and specifically European financials.
But, let me just sort of take a step back. You know, if one looks at the cyclically adjusted P/E—what a lot of people abbreviate as the CAPE—it’s at all-time lows in Europe at the moment. Now, there are structural challenges there that they’re working through, and obviously the question at the moment is: Where is the political will to sort these issues out?
But in 1997, everybody gave up on Asia, and from August 1998 when the Hang Seng in Hong Kong was at 7,300, it rallied by March 2000 to 17,400. And before it fell back to these levels of around about 19,000, it actually rallied to 31,000.
Now, we’re not investing in the market as a whole, but it just goes to show you that there are opportunities, and when one thinks about those opportunities, we have to think about businesses that stand on their own merits. Many of the industries, or many of the companies in Europe are global franchises.
I mean, one thinks about some of the names in the portfolio that we have, including BP (BP) and Royal Dutch Shell (RDSA), you know, some of the biggest oil companies in the world. Novartis (NVS), Roche (RHHBY), some of the best health-care stocks in the world.
And Zurich and RSA—Zurich Financial (ZFSVF) and Royal & Sun Alliance Insurance (London: RSA)—are fantastic financial services businesses, trading with dividend yields in the 8%, 9%, 10% range. And what’s interesting is that our financial portfolio in Europe has outperformed and generated some performance for the fund, because we’ve been sort of overweight property and casualty and underweight banks.
And people think about financials as just being banks, but the reality is with Zurich and RSA, property and casualty insurers are paid for taking risk. And in this risky world, that capacity to absorb risk and to price risk should be worth more. And we think that going forward that these guys are going to perform very well, and have done, along with our insurance exposures, have done very well for us over the last three years.
Kate Stalter: Andrew, you mentioned a number of holdings there, kind of in passing. Can we drill down and talk a little bit about some that are some of the outperformers now, or perhaps recent additions? I would just like to hear a little bit about some of these specific holdings that you have at the moment.
Andrew Sleeman: Well, Zurich is a name that I mentioned in passing, but it’s a name that we’ve owned since the inception of the fund. The stock still generates at least an 8% dividend yield as it stands today. It looks that the stock price has declined, but it’s actually quoted in Swiss francs, which has appreciated significantly against the US dollar.
But, what’s interesting about Zurich is it’s a global commercial insurer, and the most interesting part of the business for us is the Farmers Insurance business, which many Americans will be familiar with. They actually own the management contract of Farmers Insurance, so they manage the business for a fee, which they take off the top line. So, they don’t have the balance sheet exposure to Farmers.
Farmers itself works much like a mutual company, and these guys, because they’re taking a fee of the top line—it’s not a balance sheet business—can actually generate significant higher returns on equity than other property and casualty insurance peers.
And again, just to sort of stay on the financial services track, because it has been such an area of outperformance for us, Royal & Sun Alliance is a UK-based insurance company. But most of its profits are generated outside of the UK, specifically in Scandinavia, where the structure of the industry is very consolidated.
They also have a good Canadian business, as well as exposure to Latin America, which is a very difficult exposure to invest in the property and casualty space. But it gives them a lot of growth, and again enables them to generated higher ROEs than many of their UK peers.
Kate Stalter: We only have a couple more minutes here today, and I just wanted to put your fund in the context of an overall portfolio. So for anybody who’s listening to this today, how would you recommended they include this fund in their overall investment strategy?
Andrew Sleeman: Well, many financial advisors have indicated to us that what’s interesting about our fund to them is two things. First of all, it’s our view to protecting the downside and thinking like business owners. And the fact that they can get that investment expertise in offshore markets. So, oftentimes you’ll see them invest directly—financial advisors investing directly in the US and then taking a portfolio approach through an international fund.
I think the other thing that they like a lot about this fund is that it’s a smaller fund. It’s a multi-cap fund. We’re pretty agnostic and quite nimble with respect to the market cap of the businesses that we invest in. So, you can get exposure to some smaller names that are perhaps passed over by some of the larger funds, because we are a smaller fund and a little more nimble in that respect.
Kate Stalter: It sounds like from what you’ve been saying today, that your investments tend to be concentrated in the developed markets rather than emerging markets?
Andrew Sleeman: You know, that’s somewhat true. We have about 36% of our portfolio in Asia. And in Asia, I include Australia and Japan. You know, when you’re investing in Asia these days, it’s very difficult to invest without emerging-markets exposure.
For example, I’d day over 60% of the Hong Kong index is really just Chinese companies. But even within Asia, we invest in companies that might be domiciled in Hong Kong, may have businesses all around Asia, but are really benefiting from the increasing spending power of the Chinese.
For example, we own Mandarin Oriental (MAORF), the hotel group, which is overwhelmingly exposed to the Asian market, and the vast majority of their growth has been from Chinese shoppers who are traveling off shore to spend money.
Another one that we own that’s a Japanese company, Asahi Group (ASBRF), who make beer and soft drinks in Japan, among other places. But one of their great investments outside of Japan has been Tsingtao Brewery, which the way we’ve invested in the business, you know, we’re getting a 10% plus free cash flow yield out of a Japanese brewing business, and we actually get the Tsingtao exposure in China for free. So there are some of the ways that we’re investing in developing markets without investing directly.
Another example is the Jardine Group (LLTHF), and with the Jardines you’ve got a company that’s been in existence since the 1800s, and has contacts throughout the Asia-Pacific region which are second to none, I would venture to suggest. So we get their expertise and their contacts, as well as some wonderful franchises. And because it’s a conglomerate, it tends to trade at a discount to the sum of the parts, a significant discount to the sum of the parts, and we love that.
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