By Tom Bradley

I recently had the chance to spend some quality time with Sandy Nairn, the CEO and founder of Edinburgh Partners (EPL is the manager of our Global Equity Fund). We had an extended lunch in downtown San Francisco.

We spent a lot of time discussing the firm’s personnel (stable; continuing to invest in the next generation), philosophy (unchanged; based on 5-year valuations) and decision-making process (unchanged; ten smart people in a room; still crisp).

We also talked frankly about the fund’s sub-par performance. Sandy and his team are well aware of the returns to-date and he was more than willing to drill into their strategies.

The biggest drag on returns has been the fund’s lack of exposure to U.S. stocks. Indeed, it has been a double whammy - the American market has solidly beat other developed markets and the U.S. dollar has been the world’s strongest currency. For Canadian investors, the U.S. has been the place to be.

U.S. stocks have come down from 25% of the Global Equity Fund a year ago to just over 10% today. This shift resulted from a consistent pattern of selling U.S. stocks that have moved up and are getting pricey (Illinois Tool Works, SanDisk, Cisco Systems) and replacing them with cheaper stocks from elsewhere in the world.

EPL is well aware of the dynamics that have seen the U.S. economy recovering nicely while Europe and Asia struggle to grow. The lack of U.S. exposure is the result of company by company ‘bottom up’ research and a cautious macro view.

During the lunch, Sandy added some color to the Global Equity Strategy:

  • In his view, the U.S. market is expensive. The EPL team keeps coming across companies that are achieving record profit margins and trading at above-average price-to-earnings multiples. High margins and P/E ratios are a bad combination.
  • There are more over-looked companies in Europe, the UK and Japan. Because of the economic cloud over these regions, they can buy global franchises at fair prices.
  • For EPL’s strategy to work out, the U.S. market doesn’t have to go down. If their analysis is correct, U.S. stocks’ ascent will slow while other parts of the world will garner more investor attention.
  • Corporate reforms in Japan are finally taking hold. Investment managers have been predicting change for a decade now, but today it’s actually happening. There’s plenty of examples of asset sales, restructuring and share buybacks. Profit margins are at cyclical lows and have plenty of room to improve while still not threatening the heady level of corporate America. Combining better corporate governance with a weaker Yen, the chance of positive earnings surprises in 2015 is increasing. (To understand EPL’s thesis on Japanese stocks, see our August 21st blog.)

Sandy emphasized that there are still attractive investment opportunities, but after a stretch of strong market returns, it’s key to avoid expensive stocks. The composition of the fund reflects this, and is much different than the broad global market.