10 Questions About International Investing: An Interview with John Fenley

John Fenley is the Director of International Research at Denver Investments and a portfolio manager for the Westcore International Small-Cap Fund (WTIFX), a 4-star fund that won the 2012 Lipper Fund Award for its 5-year risk adjusted performance as of December 31, 2011.

What is international investing?

Fenley: International investing is about taking advantage of an opportunity set outside of the largely over-covered U.S. Stock Market. Our international investment fund focuses on smaller companies domiciled in developed and emerging markets outside of the U.S., stocks that range from $100 million – $5 billion in market capitalization.

We look for international investing opportunities in less efficient markets. In general, international investing is accounting for globalization–the opportunities to make money in inefficient markets outside the U.S.

What do you mean by an inefficient market?

Fenley: Efficient market theory says that stocks trade with all available information. As fundamental investors, we feel that every stock has an intrinsic value–what a company is worth based on its existing and future cash-flow. Inefficiency means there’s a big disparity between today’s share price for that company and what it’s truly worth.

In international markets, we believe the inefficiencies are greater, specifically in international small cap, than any other equity asset class, and the reason is logical: Very few managers are chasing the vast majority of stocks out there. There are 11,000 companies in our small-cap international universe and roughly just 60 institutional U.S. managers running dedicated international small-cap strategies.

Contrast that to the hundreds of domestic small-cap managers chasing fewer securities. So, a lot of the companies in our market capitalization range are largely undiscovered and under-covered by investment banks that offer portfolio help. That’s why we believe there are mispricings out there.

Why should international be part of my investment portfolio?

Fenley: Investing internationally and in international small-cap stocks gives you diversification. Their correlation is much lower to the S&P 500 than any other equity asset class, including emerging markets. Low correlation helps smooth out the returns in a portfolio to reduce risk.

Secondarily, international is an opportunity for individual investors to generate high returns in their portfolio because of the inefficiencies.

What do you mean by correlation?

Fenley: Simplistically, correlation is the movement of an asset, in this case a stock, relative to an index or another stock. Low correlation means that small-cap international stocks, in general, move in a different pattern than the S&P 500.

That’s important because conceivably, you’ll have an environment where the S&P 500 is not doing well, but you continue to enjoy some upside in international small cap. The reverse can also be true.

What are the risks in international investing?

Fenley: Risk in international markets center on liquidity, given that these are smaller capitalization stocks. International small-cap stocks typically don’t trade hundreds of millions of dollars a day, so liquidity is a concern–getting in securities and, more importantly, getting out.

Other risks with international investments are the same as in domestic equities. To mitigate those risks, I would look for a fund focused on the qualities that really drive great performance: growth, high returns, strong balance sheets, and free cash-flow.

How have you performed against your benchmark?

Fenley: We took over the fund in November of 2006, so we’ve been running our current process for over five and one-half years. Over that period, not only are we at the front of our peer group, but our excess return on the MSCI EAFE Small-Cap Index is over a thousand basis points. [Editor: As of March 31, 2012, the fund's 3- and 5-years returns are 35.93% and 3.85% respectively, outperforming the index by 11.81% and 1.06% over the same periods.]

You won a Lipper Award for risk-adjusted performance. What does that mean?

Fenley: Risk-adjusted performance takes your absolute performance and incorporates a measurement of risk, defined as the standard deviation–or the amount that your fund will fluctuate–from the median return. You can generate high levels of return with a lot of risk, but your risk-adjusted return may not be as attractive as somebody who generates the same level of return with a lower standard deviation or risk. Risk-adjusted returns are the more generally accepted rates of return because investors want to know how much return they are getting for a given level of risk.

What is your best advice for a potential international investor?

Fenley: International stocks make up roughly half of the world’s equities. Thus, investors should think about starting with a 50/50 percent allocation between international and domestic stocks. According to the MSCI IMI Index, small-cap international makes about 14% of the world equity market, so a generally accepted standard for international small-cap exposure in an equity portfolio is around 7%.

What part of the international world do you focus on?

Fenley: We screen in every country outside of the U.S., both developed markets and emerging markets. Today, our portfolio has less than 5% exposure to emerging markets. We take a bottom-up approach, which means we focus on company fundamentals. We believe that company fundamentals drive great performance over time. It’s not where a company is domiciled or the sector in which it operates or the industry. Rather, its business-specific qualities: management, business model, and other industry-specific factors. The portfolio is a mix of both high-quality names and valuation. Right now, we’re finding a better mix of that quality and valuation in developed markets, so our biggest exposures by country today are the UK, Australia, and Japan.

What attracted you to international investing?

Fenley: Twelve years ago, I dedicated myself to this asset class. I started my career in 1990 as a domestic large-cap manager. In 1997, one of Sir John Templeton’s partners asked me to give international a try. It was not great timing. After seven years of watching my domestic growth stocks go through the roof, all of a sudden I found myself as an international investor right in the midst of the Asian crisis followed by the Russian crisis and Long Term Capital. But I quickly concluded that the best opportunity for outsized returns was in international small cap.

“10 Questions About International Investing: An Interview with John Fenley” was written by Gregory Taggart.

Gregory Taggart

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