International Equities - Opportunities If Investors Pick Wisely - Morningstar Conference

Charles Paikert

21 September 2020

International equities outside the US have languished compared with the pre-pandemic bull market, but fund managers specializing in the asset class say resolute investors can still be rewarded.

“International stocks are full of opportunity if you know how to look and are disciplined,” Rupal Bhansali, chief investment officer and portfolio manager of international and global equity strategies for Chicago-based Ariel Investments, said. She was speaking at this year’s virtual Morningstar Investment Conference.

China Mobile, for example, is tapping the world’s largest consumer market to offer investors a “huge subscriber base” as well as an attractive 6 per cent yield, Bhansali said.

Despite its COVID-19 problems, Brazil also offers an ample source of opportunity for international investors, she said.

Identifying growth traits is critical for international investors, according to Rezo Kanovich, portfolio manager for Milwaukee-based Artisan Partners Non-US Small-Mid Growth Strategy.

For example, M-Systems, an Israeli company specializing in computer memory, has grown six-fold in the fast few years, said Kanovich, another featured speaker at Morningstar’s “International Equites: Moving Beyond a Lost Decade” session.

What investors should look for
Smaller companies need to be innovative, idiosyncratic and nimble enough to out-maneuver and disrupt markets of larger competitors, he said. M-Systems, Kanovich noted, has been able to take market share away from the US networking and tech giant Cisco Systems.

Investors seeking to diversify internationally should be more concerned with where a company’s sales are coming from, rather than where it is domiciled, said the sessions’ third panel member, Rob Lovelace vice chairman of Los Angeles-based Capital Group.

“Where a company is based is no longer a good proxy,” explained Lovelace, who is also an equity portfolio manager for Capital Group. “Investors need to look at a company’s economic exposure through its source of revenue.”

Around 30 per cent of the revenue for companies in the S&P 500 come from outside the US, he noted, while around half of revenues for European corporations come from outside the continent. “Almost any fund you buy now is a global fund,” Lovelace said.

All of the portfolio managers conceded the importance of China when considering international investments.

“The world has changed dramatically since the late 1990s and it’s been driven by the rise of China,” Lovelace said. “China has its own Internet, is the world’s fastest-growing market and is the major driver of where so many companies are doing business.”

Openings for international companies
The fund managers also agreed that companies involved in healthcare, telecommunications, e-commerce and biotech have caught the attention of international investors.

“Investors must be able to identify where small companies can do what larger companies can’t to carve out industry niches and disrupt supply chains,” Kanovich said.

Fashion and automobiles, for example, are two industries where smaller international companies have been able to take advantage of changing market conditions, Kanovich said.

The demise of in-person retail shopping due to the pandemic and the rise of “fast fashion” customized on the internet has means that emerging market companies don’t have to be as capital intensive or carry such a large inventory, but they can still produce higher margins.

Innovative companies have also been able to take advantage of the declining demand for combustible engines in cars and the growing need for semiconductors in the auto supply chain, Kanovich pointed, to establish themselves in a mature industry where even five years ago such an intrusion wouldn’t have been possible.

Red flags
But investors need to proceed with caution, the managers warned.

Valuations based on price-earnings ratios “in a world awash with debt” should give way to analyzing the enterprise value of companies, according to Bhansali. “Investors should pay for free cash flow, not earnings,” she said.

Ariel also looks for dividend yield and avoids companies with excessive debt.

The COVID-19 pandemic has been an accelerant for higher debt levels around the world, Bhansali said. The actions of the US Federal Reserve have misled investors, she argued. “Investors think the Fed will save them but they forget that the Fed only buys debt of solvent companies.”