Times are tough right now for international stock fund managers.
High inflation, supply-chain issues, a lingering pandemic, and Russia’s war with Ukraine are hitting markets globally and across sectors.
Despite the uncertainty, Haicheng Li and Jesse Flores, portfolio managers of the $480 million
Chautauqua International Growth
fund (ticker: CCWSX), are sticking with their long-term strategy and favored stocks.
The duo identifies sustainable trends and seeks high-quality companies with strong balance sheets, conservative accounting, and a competitive edge in their markets. These traits will help the fund eventually weather the current volatility, they say, even as the market rout has dented shares of fundamentally strong companies.
“When we look five years out, despite all the uncertainty that we’re facing today in the world, we think these businesses are going to be a lot bigger and stronger,” Flores says.
Although the fund is down 12.7% year to date, it’s still outperforming its foreign large-growth peers, and ranks in the category’s top 13% for the past five years. It has beaten its foreign large-growth peers and index, MSCI ACWI ex-U.S., with an annualized return of 11.8% over the past three years and a 10.8% annualized return over the past five. Morningstar rates International Growth a four-star, bronze medalist fund, but considers the fund’s expense ratio of 1.05% above average.
Co-lead managers Li, 49, and Flores, 37, run the strategy along with co-manager Nathaniel Velarde and investment team partner David Lubchenco. Co-lead manager Brian Beitner, who founded Chautauqua Capital Management in 2009, will step down at year’s end.
While they all have M.B.A. degrees, the Boulder, Colo.—based team credit their nonbusiness backgrounds as a key to their success. Li holds two masters degrees—in medical science and medical research—from Harvard Medical School, while Flores received a bachelor’s of science engineering degree from Cornell University. Velarde has a master’s of information and data science from the University of California, Berkeley. The team puts those backgrounds to use, reflected in the fund’s sizable positions in technology and healthcare, at 34% and 17%, respectively, which are larger allocations compared with the fund’s benchmark and peers.
The managers pursue opportunities in long-term global trends such as health, aging populations, and productivity and efficiency.
No. 2 holding
Novo Nordisk
(NVO), which the fund has held since its 2016 inception, reflects both the health and aging trends. The Danish drug company is known for its diabetes research, which targets the disease’s large molecules, a different approach than competitors
Merck
(MRK) and
Pfizer
(PFE). It has the scale to market and sell insulin drugs, and was the first to create an injectable pen, the managers say. Last year, the Food and Drug Administration approved Novo Nordisk’s once-weekly drug targeting chronic weight management in adults with obesity, which Li says is a huge opportunity for unmet medical needs.
“The company has evolved, but they’ve always stayed focused on this area [of obesity], so I think their competitive advantage actually widened,” Li says, noting the firm’s return on invested capital is more than 60%, gained mostly through internal growth.
While Li and Flores are bottom-up managers, they do watch top-down macro factors, especially in countries where government intervention is high, such as China. International Growth has cut holdings of some Chinese companies over the past couple of years, citing both high valuations and the tough regulations imposed on certain sectors. The team exited educational firm
TAL
) by June 2021 because of the regulatory crackdown on private education, and last year gradually reduced its positions in
WuXi Biologics (Caymen)
(2269.Hong Kong), partly because of rising U.S.-China tensions.
Despite the heavy government regulations, they’re maintaining a slight overweight in China versus the index, at 8.5%, saying it’s too big of a market to ignore. “Every market has its own risk,” Li says.
International Growth still owns some Chinese healthcare companies, as the sector is in line with the government’s goal to reduce wealth inequality, partly through removing some of the healthcare burden, Li says. Holdings include state-owned enterprise
Sinopharm Group
(1099.Hong Kong), a domestic firm which made China’s Covid-19 vaccine, and American depositary receipts of
BeiGene
(BGNE), which Li believes has best-in-class leukemia drugs and could eventually rival Pfizer.
BeiGene is one of five U.S.-listed Chinese companies the Securities and Exchange Commission is considering delisting because the company hasn’t met auditing requirements under the Holding Foreign Companies Accountable Act. According to news reports, however, BeiGene recently took steps to change its auditor in an effort to comply with the law. In either case, Lubchenco says the fund can switch to the company’s Hong Kong shares if needed, but he is hopeful that U.S. and Chinese regulators will make progress on the issue. “We are constructive that regulators will find a solution that prevents delisting of identified issuers,” he adds.
The fund’s biggest country exposure is Canada, at 18.6% versus 7.9% for its peers, but the team isn’t targeting the U.S.’s northern neighbor specifically, Flores says. Rather, the fund’s No. 3 holding
Constellation Software
(CSU.Canada) and No. 4 holding
Waste Connections
(WCN.Canada) happen to be based there.
Constellation Software is a holding company owning more than 500 independently managed businesses that provide mission-critical software to a variety of sectors, including hospitality, education, and transportation. Flores says the company has largely been growing through mergers and acquisitions. These buyouts are self-funded and Constellation imposes strict return criteria on deals; it earned an average return of 32% from 2018-20, according to the managers. With a “rock-solid” balance sheet and strong management, Flores expects Constellation to have a long growth path.
Meanwhile, garbage-collections company Waste Connections is an inflation play, Li says, since most of the costs are borne early on and landfills often operate for decades, making it a high-margin business. In addition, the initial costly capital requirements as well as regulatory approvals to create landfills create high barriers to entry for competitors.
Similar to the pharmaceutical business, trash pickup is an essential service. But landfills can have a much longer usable life because they can expand and accept more trash once permitted, whereas drugs eventually go off patent. “A landfill is priceless,” Li says.
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