Approaching international growth with a valuation focus: where ClearBridge sees opportunities

Dec 13, 2017 @ 12:01 am

ELISA MAZEN Managing Director and Head of Global Growth ClearBridge Investments

Growth investing provides attractive returns, but high valuations of growth stocks can also bring volatility. The international growth team at ClearBridge Investments, led by Managing Director and Head of Global Growth Elisa Mazen, looks at international growth investing across market caps and classifies growth stocks with an eye to controlling risk. The 31-year investment veteran, who serves as portfolio manager of the ClearBridge International Growth Fund, recently joined Evan Cooper, executive editor of the arjuna-design Content Strategy Studio, to discuss her outlook and her team's valuation approach to growth.

arjuna-design: Investing internationally has been challenging for a while. Where do we stand now?

MAZEN: It's true, at the end of 2016, people had practically given up on international investing because performance was challenging for its two basic components: local currencies and local markets. The US dollar was very strong for an extended period, largely due to higher interest rates in the US. By 2017, the dollar's strength started to wane and we began to see strength in the euro. Market valuations for the US were also high in comparison with overseas markets.

In addition, past political problems including Brexit, the Greek and Spanish debt problems and Italian banking crisis all seemed to have played out in 2016. Emerging markets also appeared to have reached the bottom. As these fear factors resolved, the big negatives were no longer there. Political and economic resolutions helped change the tone of the market environment, while real policy changes were also providing economic stability in Europe, making this an attractive time to be re-evaluating investing in international markets.

Today, we have political and business leaders who want to realize growth, not just keep things from catastrophe, that, combined with supportive central banks, have a good chance of success. Emerging markets have gone from terrible economic performance and political troubles, to not-so-bad, to looking very good as they recover from their problems. We see this as the beginning of a very long positive stage, and we're finding plenty of attractive opportunities in terms of valuation. We think growth could last for a few more years.

IN: Let's look at some countries and sectors. Which do you like?

MAZEN: We're growth managers because we believe in the power of compounding, but since we always look at the risk associated with that growth, there are certain sectors we're favorably disposed to and others that we're not. For example, we like information technology and have a reasonably large allocation to it across a number of segments. We are probably neutral in financials overall, but very overweight European banks, where we see low valuation and multiple legs of earnings growth from a very low level. We're also overweight stock exchanges, primarily because we see a transformation at many of these companies as they move from just equity trading to derivatives, and to becoming index and data providers and more tech-like. We have a good allocation to consumer staples as well, where we see very good long-term secular trends. We're underweight in utilities, telecom and sectors where we really don't see good long-term growth characteristics such as energy, which will have to deal with the decline of the internal combustion engine.

Since our fund is benchmarked to the MSCI EAFE [Europe, Australasia and Far East] Index, we like to be relatively neutral in terms of countries. We aim for two-thirds or more of our fund's performance to come from selecting stocks, not from picking currencies, sectors or countries. Valuation has to be the reason to buy a particular name, and then, of course, its growth prospects. We look for good growth that's been mispriced while being very careful about risk; we like our risk profile to look about the same as the benchmark's.

IN: What about China and Japan?

MAZEN: We have a 4%-5% position in China through several tech investments. China is not as bad as some people think; there are enormous opportunities there and we quite like the Chinese market. Japan is interesting too, although historically it has not been a growth market. Overall market returns and return on equity are on the low side, its businesses are inefficient, although improving and growth stocks there tend to be expensive as there are less of them than in, say, China. We have traded that underweight in Japan holdings for growth stocks in China, which has worked out very well.

IN: Tell us how your team is structured and how it finds opportunities.

MAZEN: We have a dedicated team of four experienced people. I've been in the business for 30-plus years and many of my colleagues have been doing this for 25 years and more. We are organized as portfolio managers and analysts, so we wear two hats, and have structured ourselves in our analytic work as sector specialists. Our team typically covers about 80% of the stocks in our portfolios directly as analysts, with ClearBridge's 13 central research analysts who also have a sector specialization, helping us with the rest.

To find ideas, we use a proprietary model that looks for inexpensive stocks on a valuation basis with good quality metrics, rising earnings and price momentum. The model helps us find underpriced growth stocks. We run the model every month on 6,000 non-US names, by sector, country and market cap. Since it's a very data-rich product, we can see globally where earnings are rising, where they are falling and where there are valuation disparities. It's not a stock-picking tool, but a way to systematically identify ideas that will shape our priority list for research. Once we have decided on the name, we will do the fundamental work of understanding the company, its industry and coming up with a point of view that's different from the market's. We believe that if you want to generate alpha, you have to have a different point of view than the market. In doing this, you have to understand where the consensus is, where you are different, and why you are right.

IN: Is growth all about new products and new markets, or are there other growth criteria you look for?

MAZEN: We've bracketed growth into three groupings, each with its own risk levels and growth characteristics. Our first is what we call our emerging growth stories. These are the very-high-growth companies, showing 20% to 50% top line growth, typically disrupting large market opportunities. Earnings growth generally does not follow that top line growth as they invest for future growth. When that happens, often earnings can trend negative or sideways, which the market often doesn't like, causing a lot of price volatility. This is our riskiest category and we size positions and our overall weight here for that risk. You have to be very careful about valuations here, but we want to own those companies as they can be significant stock performers. ASOS PLC (an online only retail platform for people age 15 to 30) is one of our holdings in this emerging bucket, where we will invest up to 20% of the portfolio.

The second bucket, and always the largest part of the portfolio, are our secular growth story companies. These are high-quality, not particularly volatile companies with smart managements that are taking out costs and growing at twice to three times the market growth rate on both the top line and EPS. Names such as Rentokil (pest control) and Temenos (banking software) are in the group.

The last bucket is what we call structural growth companies, which are going through some sort of a change that the market doesn't quite understand. We love these stories, and one of the largest stocks in our portfolio, Shiseido, is an example. This cosmetics company had a huge cost base they never effectively tackled. Then, a very forward-thinking CEO was appointed, a Japanese executive from Coca-Cola Japan. He cut costs, changed compensation, rationalized unprofitable products and business lines, prioritized corporate governance and returns. He has also been a leader in putting women into senior leadership roles. The stock is up significantly since we bought it because profitability has gone from zero to over 15% in Japan and overseas profitability is on that same trajectory. That's a big change, and the market's only now just waking up to it.

IN: What sets you apart from peer-group funds?

MAZEN: It's probably our emphasis on risk. We take great pains to make sure investors are getting growth characteristics in a portfolio that is conservatively constructed, conservatively managed and not particularly volatile versus our benchmark. We also have a very strict sell discipline. If we think a stock is fully priced, we'll sell it. I guess you can say we're a growth manager with a pretty conservative approach.

Past performance is no guarantee of future results. All opinions and data included in this commentary are as of November 23, 2017 and are subject to change. The opinions and views expressed herein are of the portfolio management team named above and may differ from other managers, or the firm as a whole, and are not intended to be a forecast of future events, a guarantee of future results or investment advice. This information should not be used as the sole basis to make any investment decision. The data have been obtained from sources believed to be reliable, but the accuracy and completeness of this information cannot be guaranteed. Neither ClearBridge Investments, LLC nor its information providers are responsible for any damages or losses arising from any use of this information. This is a sponsored special feature, developed by the arjuna-design Content Strategy Studio, and supported by ClearBridge Investments

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