NEW YORK -- Why buy foreign stocks?
One of the main reasons commonly offered is that foreign stocks make a portfolio more balanced. That's because of a concept called diversification: Foreign stocks can rise when U.S. stocks fall -- and vice versa -- and the difference in performance can help stabilize a portfolio.
But James Doyle says that foreign markets offer less diversification than in the past. He was a nominee for Morningstar's 2013 International-Stock Fund Manager of the Year award, along with the other managers of the Causeway International Value fund (CIVVX). It returned 23.9 percent last year, including dividends, ranking in the top 15 percent of its category.
Doyle says markets from the United Kingdom to Australia increasingly have been moving in greater unison. In industry parlance, the correlation between them is tightening. Doyle says investors still have reason to consider international stocks, but diversification isn't the main one. He also says he hasn't seen such little potential from stocks since the end of 2007, when the Great Recession was starting. Below are excerpts from a recent conversation, edited for length and clarity:
Q: Stocks in Brazil, Indonesia and other emerging markets fell last year, when the U.S. was surging. Isn't that a sign that foreign stocks still offer diversification?
A: Emerging markets are the last bastion of uncorrelated stocks. They have different capital flows, different currency issues and political factors that can drive differentiated returns. But the United Kingdom, Australia, developed Asia, European stocks: The correlations are getting tighter and tighter.
Q: If they're offering less diversification, don't U.S. investors have less of an incentive to invest in international stocks?
A: It's a fair question, but I'd turn that around and say: What a client should want are the best companies around the world. I completely agree that you don't want to invest in international markets for the diversification alone. International investing is about finding opportunities to outperform.
You want to allow your manager the opportunity to say, "I think a European energy service company is cheaper than its U.S. peer, or a Hong Kong-listed integrated energy company is cheaper than its U.S. peer or a French-listed pharmaceutical company is cheaper than its U.S. peer."
Q: You look for cheap stocks. Are any left following last year's big run for stocks in the U.S., Europe, Japan and elsewhere?
A: A lot of undervaluation has been driven out of the market. In our process, we come up with an estimate of fair value for every stock that we own. So we can come up with the expected return for our portfolio, and we have that data going back through time.
Q: Is your expected return now at its lowest level of all time?
A: It is not the lowest, but it's the same level it was at the end of 2007: mid-single digits. Now, I would say that our process was not designed to come up with a forecast for equity markets. So I wouldn't look at that number as an absolute reference. But a mid-single-digit return is pretty unimpressive.
Q: Can you put into context how low that is?
A: In 2008, 2009, it was 30 percent-plus. In 2001, 2002, it was in the high 20s and low 30s.
Let's face it, the macro is not great. Europe has normalized, albeit at a fairly low level of activity. Japan has done some things right, but those have primarily been the easy wins. The hard things -- the structural reforms that are required in that country -- are more or less untouched. The U.S. has probably done almost everything right from a policy standpoint that we can do, and the best we can generate is middling levels of economic growth. And we still have this specter of increasing rates in the U.S. and other markets. And emerging markets have their particular struggles that vary from country to country.
Q: Is there anything worth buying?
A: We recently added Nikon to our portfolio. Its business that makes tools used to manufacture semiconductors and LCD has historically been a good business, but for a variety of reasons, it's not so hot, nor will it be. On the consumer side, Nikon has two main products. The compact camera is not doing so well, because we have our phones.
So, OK, we're oh-for-two. What's the opportunity? Well, the other product they have is the digital SLR, a sophisticated camera with a separate lens. It's a market that has been growing, and this is a market -- unlike the compact camera business -- that is dominated by just Canon and Nikon.
The SLR business is so profitable that Nikon can still have a lot of earnings momentum. This isn't an easy story. This isn't a no-brainer. But these are the kinds of opportunities we're seeing in 2014.
Q: So what would you tell the retail investors who are just now coming back to stocks after the financial crisis? To stop?
A: Where were you guys three years ago?