Top fund managers predict Japanese stock comeback

BOSTON — It could have resulted in a clash of egos: pair a renowned U.S. stockpicker with a top investor in overseas stocks. Get them to manage a mutual fund with half of its investments at home and half abroad.

Yet it has worked well at Oakmark Global Select, co-managed by Bill Nygren and David Herro.

Investors have earned an average annualized return of nearly 12 percent over the last three-year period. That places it in the top 1 percent of the world stock funds that Morningstar tracks.

Some of Herro’s recent stock picks, however, require a good deal of patience. He insists that long-suffering Japanese stocks are poised to rebound, even though he isn’t venturing a guess when.

Three of the fund’s top six holdings are Japanese. Semiconductor manufacturer Rohm, automaker Toyota and brokerage Daiwa Securities make up nearly 19 percent of the portfolio. None of the stocks has recovered to their levels before the March earthquake and tsunami that triggered a nuclear crisis, and sent the Japanese market tumbling.

The managers say they rarely disagree, and Nygren has stuck by Herro’s conviction about Japan. They’re not afraid to hold on to their favorite stock picks, even when they lose favor.

It’s a key reason why both are past winners of Morningstar’s fund manager of the year award in their respective categories. Herro was also named top international stock fund manager of the past decade.

They were honored for their performance working separately at Chicago-based Harris Associates, adviser to the $40 billion Oakmark fund family. They joined forces in 2006 to launch Global Select (OAKWX), with Nygren running the North American stock portion and Herro the international side. Both also continue to run other funds, most notably Nygren’s Oakmark Fund and Herro’s Oakmark International.

They see a bright long-term outlook at home and abroad for the large-company stocks they favor — one reason their portfolio currently has a near 50-50 split. U.S. and international stocks have performed quite similarly lately. The Standard & Poor’s 500 is up about 3 percent this year, while a comparable international stock index is up 2 percent.

Below are edited excerpts from an interview this week with Nygren and Herro:

Q: What’s your take on investing during crises like the one in Japan, and the risk that Greece will default on its debt?

Nygren: The crisis du jour always seems like it’s unsolvable, and the market almost always overreacts. The recent exception has been the U.S. housing market crisis, which has persisted. But usually, the crisis gets solved. We’re long-term investors, and by the time five years pass, people don’t even remember what crisis they were worried about when the market fell.

Q: Japan’s economy has been languishing for more than two decades. Why do you believe Japanese stocks will come back?

Herro: We’re fully confident that our Japanese stocks will become a positive at some point for the fund — who knows when.

Japan is the cheapest among the developed markets. Dividend payments are rising in Japan, and corporate performance has improved. Foreigners don’t care. Japan is kind of depressed. The yen is strong against the dollar. At some point, these things will ease up, and people will rediscover Japanese stocks.

There are only two real risks. If the yen continues to strengthen, that will make it difficult for corporate Japan to continue becoming more profitable. And there’s a trend toward Japanese companies putting their cash holdings to work, rather than sitting on them. If that reverses, then all bets are off.

Q: Your top holding, Japanese semiconductor maker Rohm, is a company few American investors know about. Why do you like the stock?

Herro: Rohm is a perfect example of the Japanese companies that have dramatically improved their capital allocation. Rohm used to sit on 60 to 70 percent of its market cap value in cash. It had a payout ratio (the portion of a company’s profits used to pay dividends to shareholders) of just 5 percent, and it never bought back stock. It just sat on the cash.

Rohm has bought back 12.5 percent of the company over the last five years, and their payout ratio is about 30 percent. They’ve made a couple acquisitions, and they’re starting to do things with their cash. Among specialty semiconductor companies, they’re a global leader.

Q: Besides the Japanese holdings, the fund’s overseas portfolio is entirely in European stocks. Are you worried, given the risks that Greece’s debt troubles pose to other European countries and banks?

Herro: It’s certainly a big problem. It’s going to be very difficult if not impossible for Greece to pay the debt back. That’s the bad news. The “more bad news” is that Europe is so wedded to this idea of a single Europe with a single monetary system. They don’t want their little empire to fall apart.

Some of the stronger European countries don’t want to extend further support to Greece. But if their leaders refuse to provide more help to Greece and other weak countries, the idea of a single unified Europe could be in doubt. Although there’s economic pressure for a split, the political pressures to stay together are so strong that they may usurp the economic pressures. You’ll probably get some form of a debt restructuring, but there will be more of a bailout than a restructuring.

Q: There are currently no small-cap stocks in your portfolio, and just a couple mid-caps. Small-caps have outperformed large-caps for the better part of a decade. What’s your thinking?

Nygren: When we prepared to launch this fund, we believed large-cap stocks offered a very good long-term investment opportunity. The size advantages that larger companies have over small ones will become more important, especially on a global playing field.

But domestic large-cap is the most hated space now in the investment world. Small-caps have done better lately, and we think the value of large-cap has become more compelling as time has gone by. It’s rare to get to the point where we are today, where you have to pay a big premium to buy a small-cap stock, based on price-to-earnings ratios. You’re giving up the strengths larger companies have: liquidity, scale, a global platform and greater access to capital markets.