Screening the World's Bargain Bins
Polaris Global Value illustrates one of the great advantages of a quantitative approach to stock picking: Computers are immune to pressure from fads and indexes. Not to mention they can crank through thousands of stocks like it's nobody's business -- sometimes with marvelous results. Thanks to some timely calls by manager Bernard Horn's computer models, Polaris (PGVFX), which can invest in companies based anywhere in the world, returned an annualized 18% over the past five years through May 31. That put it in the top 10% of global stock funds.
Horn's computers focus foremost on free cash flow, basically the amount of cash profits left after the capital expenditures needed to maintain a business. His quantitative models rank 24,000 companies around the globe on the basis of free-cash generation. "Looking at cash flow removes industry and accounting biases that creep in," Horn says. Securities denominated in riskier currencies must meet higher valuation standards than others.
The screens churn out about 500 names that merit further attention. Horn and his four analysts develop financial models of each company and in many cases meet with executives of potential investments, as well as officials from rivals. Horn brings a cautious eye to the table -- he likes companies that make good buys regardless of future growth. "That's where most investors make their big mistakes, by making heroic assumptions about the future growth of a company," he says. Horn narrows the list to about 75 keepers and weights each holding equally.
Polaris has experienced only one down year since its 1998 inception. The fund beat Standard & Poor's 500-stock index in seven of its eight full years of existence and the MSCI World index (a measure of global stock performance) in six. From its inception through May 31, Polaris returned 12% annualized, compared with 8% for the average global fund and 5% for the S&P 500.
The fund has sometimes been out of step with its benchmark. In the down years of 2001 and 2002, that helped considerably. Polaris eked out small gains those years, trouncing the MSCI World index by 19 and 24 percentage points, respectively. Horn explains that this was a reward for his 1998 decision to move into small and midsize companies, as well as to build positions in shares of materials companies and emerging-markets stocks.
The computers also crank out country and industry valuation rankings. Scandinavia is one of Horn's favorite regions today, although he also sees good values in Japan and Germany. Polaris is underweight U.S. stocks relative to the MSCI World Index, with just 31% in domestic issues. This reflects Horn's belief that U.S. stocks on the whole are overvalued.
Looking abroad, Horn has been increasing his holdings in financial stocks. He recently added Depfa, a Dublin-based bank that provides financing to governments across the world. "There are only about three banks in the world that do this, and Depfa has a pretty strong presence" he says. Depfa trades for nine times estimated 2007 earnings.
At home, Horn favors industrial gas supplier Praxair, figuring that "as companies have more complicated industrial processes they need more pure gases." Praxair (PX) trades for 20 times estimated 2007 earnings.
The fund's assets have ballooned, from $140 million in 2004 to almost $900 million today. "It's not making me nervous yet, but it could," Horn says. He's not a frenetic trader. He holds each security for more than three years on average, so size shouldn't be a hindrance yet. The fund requires a $2,500 minimum initial investment and charges a below average 1.30% in annual expenses.