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VII332

VII332

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H
ad his father's investment companynot employed a big-pictureapproach to identifying attractivestocks, Jay Bowen, armed with an EnglishLiterature degree, probably would havelooked elsewhere for work in 1986. “I'lladmit a bottom-up, number-crunchingapproach probably wasn't for me,” he says.The fit has turned out wonderfully forBowen, Hanes & Co. investors. The firmnow manages $2.3 billion and its longest-lived equity portfolio has generated a com-pound annual return of 14.9% since 1974,vs. 11.8% for the S&P 500.Keying primarily on trends tied to eco-nomic globalization, energy and commodi-ties, Bowen today is finding opportunity insuch areas as chemicals, water infrastruc-ture, coal and railroads.
ValueInvestor
February 29, 2012
Art and Science
Nearly everyone today claims a global approach, but Sarah Ketterer has beeninvesting that way – with considerable success – for more than 20 years.
 
Inside this Issue
FEATURES
Investor Insight: Sarah Ketterer
Scouring the developed world forbargains and finding them in Tesco,Western Union, Babcock & Wilcoxand Tecnicas Reunidas.
Investor Insight: Jay Bowen
On the prowl for prime beneficiariesof key global trends, which todayinclude DuPont, Xylem, CanadianPacific and Teck Resources.
 A Fresh Look: WellPoint
As the company’s business prospectsand performance have evolved overthe past year, so has Jed Nussdorf’sopinion of its stock.
Strategy: Seth Klarman
Insight from an investing legend onhow right-thinking investors can bestmanage through today's “dangerousstate of affairs.”
INVESTMENTHIGHLIGHTS
Other companies in this issue:
 
Seeing the Forest
Top-down investing is more in fashion since the financial crisis, but Jay Bowenand his father before him have been successfully using that strategy since 1972.
The Leading Authority on Value Investing
INSIGHT
 
S
arah Ketterer has a simple answer forwhy stocks in today's hyper-competi-tive investing world can still, reliablyenough, become attractively cheap:“Nobody's patient anymore,” she says.Ketterer's calm in the face of marketstorms has served her investors well. HerCauseway Capital Management now man-ages $13 billion in assets and its globalvalue equity strategy has earned a netannualized 10.5% since inception in 2001,vs. 5.4% for the MSCI World index.Combining quantitative stock screenswith detailed company research, Kettererand co-founder Harry Hartford are uncov-ering bargains today in such diverse areasas money-transfer services, grocery stores,emerging-market capital spending andenergy infrastructure.
 
INVESTOR INSIGHTSarah Ketterer
Causeway Capital Management
Investment Focus:
Seeks companies forwhich actual growth opportunities farexceed the myopic investor expectationscurrently built into the share price.
INVESTOR INSIGHTJay Bowen
Bowen, Hanes & Co.
Investment Focus:
Seeks companieswith the most attractively priced stocks inindustries poised to benefit from what heconsiders key global economic trends.
 
INVESTOR INSIGHT:
Sarah Ketterer
Value Investor Insight 
2
Investor Insight: Sarah Ketterer
Sarah Ketterer and Harry Hartford of Causeway Capital describe how they invest differently in developed versus emerg-ing markets, where they find the worst allocation of capital, how they risk-adjust their share-return expectations, andwhat they think the market is missing in Western Union, Tesco, Babcock & Wilcox and Tecnicas Reunidas.
How has international investing mostchanged since you started out more than20 years ago?Sarah Ketterer:
When I was setting upHotchkis & Wiley’s international equitybusiness in 1990, the most interestingopportunities were in taking advantage of the arbitrage between valuations thatappeared more rational and well-recog-nized in the U.S. and those that were lessso overseas. International stocks were justgenerally less efficiently priced thanstocks in the U.S.That gap between the U.S. and non-U.S. developed markets has closed dra-matically. One reason Causeway hasevolved more into global developed-mar-ket strategies rather than internationalonly is because the opportunity set hasessentially become one. Money nowmoves so fluidly between markets that thehistorical differences between U.S. andnon-U.S. markets no longer apply.
What key inefficiencies remain for you totake advantage of?SK:
The primary inefficiency is one of time frame. Especially in the past fiveyears, with the frayed nerves of investorsafter the 2008 crisis and with the contin-ued rise of hedge funds, ETFs and com-puterized trading, time frames have trun-cated. Our investment horizon is threeyears, give or take, which allows us toinvest with no obvious catalyst otherthan mean reversion and a return to nor-malcy. That works when nobody ispatient anymore.
Harry Hartford:
There are a few types of situations that typically attract us. It maybe in businesses that are cyclical and out-of-favor and the market in our estimationmisprices the stock out of impatience oran unwillingness to accept that the cyclewill mean-revert. It may be in businesseswhere management has erred, say in over-reaching with an acquisition, where webelieve the damage ultimately to beincurred is far less than is currently pricedinto the stock. Often it’s just thatinvestors move in herds and overinvest inone part of the market – say technology,media and telecom stocks in the late1990s – leaving whole industries ignoredand very cheap.In the past couple of years, for exam-ple, we have found opportunity in indus-trial companies – often with businessesthat are energy- or infrastructure-related.These are companies that typically have aheavy orientation to emerging markets inLatin America, Asia and the Middle East,but trade at modest European- orAmerican-market prices.So a company like Siemens [SIE:GR],maybe because it’s domiciled in Europe,maybe because it’s had high-profile run-ins with the authorities over past bribes,maybe because investors consider it anunfocused conglomerate, trades at only10x our earnings estimate two years’ out,when, in fact, we believe it’s geared itself to emerging-market transportation, ener-gy and infrastructure capital spendingand has the capacity to generate signifi-cant growth. It’s well-managed, stronglyfocused on returns on capital, has a veryunderleveraged balance sheet and pays a4% annual dividend yield. That’s the typeof story we find interesting.
How did you respond when investorsdumped European stocks
en masse
lastsummer?SK:
We made the bedrock assumptionthat the euro zone would remain intact,primarily because the cost of a breakupin our view would greatly exceed the costof funding peripheral sovereign debt. Soas investors fled European banks and
Sarah Ketterer
Not Far From the Tree
The daughter of prominent Los Angelesinvestor John Hotchkis, co-founder ofHotchkis & Wiley, Sarah Ketterer was lessthan enthused by her first up-close expo-sure to investment management. “I spentone summer in college filing tearsheets atmy father's firm,”she says. “It was so awfulI swore I'd never go back.”After an Economics degree from Stanford,an MBA from Dartmouth and spending fiveyears in investment banking, Ketterer didgo back in 1990 to lead Hotchkis &Wiley's initial foray into international equi-ties. She held that position through thefirm’s 1996 acquisition by Merrill Lynch,but decided in 2001 to partner with long-time colleague Harry Hartford to launchtheir own international money-manage-ment firm, Causeway Capital.“I'm sure as a kid I had more exposure thanmost to the world of equities, but once I joined his firm my father made a point of let-ting me ascend on my own or hang myself,”Ketterer says. “I had plenty of people to talkto and books to read – which were invalu-able – but given how rapidly foreign mar-kets were evolving, the best way to learnearly on was rolling up my sleeves and try-ing to figure it out for myself.”
 
Value Investor Insight 
3
INVESTOR INSIGHT:
Sarah Ketterer
insurance companies last summer, wefocused primarily on positions wealready held and stress-tested them forthe worst – barring the implosion of theeuro zone – including significant haircutson Greek, Portuguese, Irish, Italian andSpanish debt. Not everything made thecut – we got out of Italy’s Unicreditbecause we found the downside incalcu-lable – but when we concluded theremaining companies had the potentialto survive in any type of apocalyptic sce-nario, as value investors we had to stepup and buy more. That meant adding topositions in banks such as BNP Paribas[BNP:FP] and insurers such as AXA[CS:FP], Munich Re [MUV2:GR] andZurich Financial Services [ZURN:VX].We didn’t bet the ranch on them, but weweren’t afraid of them either. As a pointof reference, many of our competitors atthe time were buying consumer staples’companies.We’re classic value investors in thesense that when share prices are low, wethink risk is low as well. Most people canunderstand that in theory but don’tbelieve it in practice and even act as if it’sheresy. It’s actually when prices are risingand stocks are converging with our share-price targets that we find risk far moreuncomfortable.
Describe your research process in pursu-ing ideas.HH:
Our quantitative team runs a varietyof value screens every week to identifycompanies that are cheap within theircountry or within their industry. Thatoutput is made available to the researchteam on Monday morning, which thengoes about trying to validate if the stocksare really cheap or not.We always assign two people to lookinto each security and the goal of theirfundamental research is to build a finan-cial model that reflects the underlyingrevenue streams of the business, theunderlying costs of generating those rev-enues, the underlying costs of sustainingthose revenues through investments, andany demands on cash flow from financ-ing, taxes and capital allocation. Fromthat model we build a valuation frame-work – discounted cash flow, price tobook, normalized P/E, etc. – for the busi-ness that is independent of its geographyand specific to the industry in which itoperates.That allows us to establish a two-yearprice target for approximately 160 com-panies on which we’ll have done detailedresearch at any given time. We use two-year targets because we think beyond thatyou’re getting further into the realm of speculation and have to start embeddingassumptions that are much harder to jus-tify. We risk-adjust the expected returnsto our price targets, and use those risk-adjusted returns as the road map to buildportfolios that typically hold 50 or sosecurities in our global strategy and 60-70in our international strategy.
How do you risk-adjust the expectedreturns?HH:
We have an internal risk model,which incorporates more than 80 factorsthat contribute to the return profile of asecurity over time, such as its industry, itscountry of domicile, its currency, thecyclicality of earnings, its valuation andthe price momentum exhibited by thesecurity over time. The model allows usto calibrate the expected volatility of anysecurity as a member of the current port-folio, which is how we adjust the returnexpectation to our two-year price target.Our objective is to have a level of portfo-lio volatility at or below the benchmark,with return expectations that beat thebenchmark.All else being equal, in a 50-stockglobal portfolio we’ll be allocating morecapital to the stocks at the top of the risk-adjusted-return ranking and less to thosefurther down the list. That’s usually sub-ject to a maximum holding in any onesecurity at the time of purchase of 5%.
SK:
One advantage of having this type of roadmap is that it constantly adjusts therisk-adjusted returns as share pricesmove. As the price goes up, the returnexpectation decreases and we adjustposition sizes on a regular basis to reflectthat. So while the stock of MolinaHealthcare [MOH], which is a managed-care provider focused on Medicaidpatients, was extremely attractive to uson a risk-adjusted basis last fall, as itsprice has more than doubled we’ve takenprofits and cut the position back dramat-ically. If the stock continues to outper-form, it will continue to move down theranking – a signal for us to sell – untilfinally the stock has a zero weight in theportfolio.
You’ve historically steered relatively clearof Japan. Why?HH:
We have been underweight Japaneseequities since we started, which reflectsour view that Japanese managers by andlarge have been horrible allocators of cap-ital. CEOs seem to have a time frame thatfar exceeds even ours, or believe theiremployees are more prominent con-stituents than shareholders. While thistype of mentality has changed consider-ably in Europe, it’s still a big problem forus in investing in Japan.We will find companies we like there,but they tend to be far more internation-al than domestic. One position of ourstoday is in JGC Corp. [1963:JP], a lead-ing specialist engineering companyfocused on oil refineries and liquid-natu-ral-gas [LNG] plants, with nearly 80%of its revenues generated outside of  Japan. It has an excellent balance sheet,benefits from growing worldwidedemand for LNG, and has a competitivecost base off which to bid on large-scaleprojects. While management isn’t entire-ly Western in its approach, we’re quitecomfortable with its stewardship of shareholder capital.
ON INVESTING IN JAPAN:
We have always been under-weight Japan; Japanese man-agers by and large have beenhorrible allocators of capital.

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