Investor's Business Daily

"Fund Follows Cash Trail Across Globe"

December 21, 2004

In order to get into the Polaris Global Value Fund portfolio, stocks must clear a hurdle rate set for each, based on expected earnings growth, local economic growth rates and exchange rates, says Fund Manager Bernard R. Horn Jr.   He argues that international markets have averaged about 6% after inflation and as a rule of thumb, if the fund's management can't buy a stream of cash thrown off by a company at a price that beats that particular market, then the management will look somewhere else.

Mr. Horn has learned valuable lessons about how firms operate overseas, providing examples of how earnings can be manipulated. If you really want to get a good picture of a company's profitability, Mr. Horn claims, you should look at cash flow rather than just earnings.  After checking with regional hurdle rates, Mr. Horn and his management team come up with an estimate of how much a firm can produce in cash flow for the next several years.  Usually, Polaris is looking at three- to five-year horizon.  Horn and his team dig into a company's financial statements, talk with rivals and then meet with individual company managements.

(Byline Highlights -- Author Bernard R. Horn Jr.)

• There is little question that foreign markets can outperform the U.S. market for lengthy periods and vice versa. International investments outperformed U.S. investments for most of the 1960s, 70s and 80s, based on the S&P 500 and the Morgan Stanley Capital International – Europe, Australia and Far East Index.  However, the close correlations of the mid 90s/early 2000 are an aberration resulting from fluctuations in the global "TMT" sector: telecom, media & technology.

• Years of outperformance and an abundance of cheap stock picks reinforce the investing argument skewed to foreign bourses. Consider small and mid-cap companies demonstrating better value and dependence on local economies, as well as value stocks with strong cash flow, little debt and simple business models.

• When determining stocks geographically, utilize a holistic approach. Carefully analyze the economic conditions/expansion and government policies of the country, and simultaneously assess how stocks and corporate managements capitalize on developments.  For example, China has benefited from production and manufacturing outsourcing, leading to the prospect of 7% to 8% annualized economic growth.  ASM Pacific Technology of Hong Kong has prospered as they sell equipment to process, package, and test the computer chips manufactured in the new Chinese high-tech factories.

Bernie Horn, president of Polaris Capital Management, discusses the Polaris Global Value Fund's portfolio holdings and current market weightings.  Mr. Horn describes the research infrastructure and the firm's competitive advantage of "scrubbing down" financial statements for top global values.  Among the management team's recent stock picks are: PacificCare Health, which is improving care system efficiencies and controlling costs; Portugal Telecom, which dominates Portugal's fixed line, mobile phone, cable franchise and Internet business; and BHP Billiton, a diversified resources firm that benefits from strong price increase across commodities.

Polaris President Bernard Horn says the best strategy for investing is to take positions in undervalued areas of the institutional marketplace, such as utility companies.  This sector has appeared on Polaris' research screens as undervalued because utilities purchase energy in the form of coal, gas and oil.  As those input costs increase, investors express concern about utility companies' cash flow. Currently, Polaris' management team favors Kansai Electric Power Co. Inc. and Tokyo Electric Power Co. In. -- both of which will are well positioned to prosper on the back of a stronger yen against the dollar and an expected decline in oil prices when supply returns.

The Polaris Global Value Fund racked up admirable returns over the past 1, 3 and 5 year time periods, outpacing the MSCI World Index for the period ended 9/30/04. The Fund management has posted positive numbers using a multi-pronged strategy that begins with a screening of more than 24,000 companies in 40 countries, including the U.S.  The Fund looks for companies with strong, sustainable free cash flow that are trading at discount prices.  The result is a watch list of 250 names and a portfolio that currently holds nearly 75 stocks, most of which are not actively traded on the U.S. exchanges.  In the past few months, management has been finding more opportunities overseas than in the U.S.  Mr. Horn notes the price-to-cash flow ratio for the U.S. market was 12.1 at the end of September, while for the rest of the world it stood at 8.5.  These valuations have led the management team to hold less than 37% of the portfolio's assets in U.S. stocks, and to consider increasing investments in foreign countries including Japan and Portugal.

Smaller investment managers may outperform large competitors due to unrestricted investing options (ability to invest in multi-caps worldwide without certain index requirements), according to Bernie Horn, manager of the Polaris Global Value Fund. These options are tempered by Polaris' strict investment discipline -- that may be contrary to current market trends.  A prime example: during the dotcom bubble, many investors chased companies with very little value and no long-term business plans.  According to Mr. Horn, Polaris didn't chase this market which proved beneficial to the Fund. Currently, the Fund management team is investing extensively in foreign markets, as they view the U.S. market as "richly valued".   

Management for the Polaris Global Value Fund has one goal: to beat the return of the Fund's benchmark, the MSCI World Index, with less volatility.  So Bernard R. Horn Jr. and his team invest in a diversified range of countries and industries -- focusing on 50-75 companies with the largest divergence between share price and Polaris' estimate of future cash flow.  The Fund's management team starts by ranking all of the world's countries and industries according to five valuation factors; next, the team screens financial statements; and lastly, a company specific fundamental analysis is completed.  The Fund's management purchases two to three new stocks per month and tries to keep the portfolio holdings weighted about equal.  According to Mr. Horn, a stock is sold when its estimated future return no longer beats the "global cost of equity" (6%, the long-term annualized return of global stocks historically, plus 2% points, plus some additional percent depending on each country's risk.)

The Polaris Global Value Fund -- recently named to Forbes Semi-Annual Best Buy list -- will invest in companies worldwide as long as the valuation is compelling.  The portfolio currently has investments in the U.S. and 17 other countries.  Mr. Horn and the investment management team have been able to beat the benchmarks by focusing on net cash from operations minus maintenance capital expenditures.  Each year Mr. Horn looks for 20 new good investment ideas from a list of 500 stocks that have already passed Polaris' preliminary screens for valuation and risk.  In 1998 and 1999, Polaris invested in British homebuilders when they were selling of between five and six times cash flow.  The two stocks, traded on the London exchange, have since doubled, according to Mr. Horn, but they still hold similar multiples.

Bernard Horn Jr., manager of the Polaris Global Value Fund, has built a reputation for finding bargain stocks from around the globe.  In June 2001, half of the fund's assets were in U.S. stocks; currently, Polaris' management team has cut U.S. holdings to 40% with additional decreases expected.  According to Mr. Horn, the U.S. stock market currently trades at a price-to-free cash flow ratio of 13, while the rest of the world trades at only 9.  To justify the current U.S. market multiple, earnings of U.S. companies would have to grow 50% faster than companies in other markets.  Mr. Horn believes U.S. growth is likely to outpace that of Europe and Japan but not by 50%, and Asian economies are growing faster than the U.S.  Polaris' management team sees better values in the United Kingdom, Japan, other Asian economies and South Africa.

August 25, 2004

The Polaris Global Value Fund has been in operation since 1998, and has a strong record.  The management team buys beaten-down companies and trades stocks infrequently.  Some of the portfolio's current holdings are in Japan, where many companies are trying to generate free cash flow rather than just grow in market share.  Bernard Horn, manager of the Polaris Global Value Fund, discusses his bullish outlook on British banking firm Lloyds TSB Group, Dutch financial company ABN AMRO, Italian oil company ENI Spa and United Kingdom homebuilders.