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International Growth and Value in One
PNC International Equity Fund
Interview with: Martin Schulz

Author: Ticker Magazine
Last Update: Aug 28, 12:21 PM EDT
PNC International Equity Fund comprises both growth and value components to gain exposure to a broad swathe of complementary investment opportunities. Martin Schulz, lead portfolio manager of the growth team, seeks companies with accelerating earnings growth, strong management teams, and stable balance sheets, while the value team looks for undervalued streams of free cash flow. The end result is a highly diversified international portfolio that aims to benefit from the best of both worlds.

“We believe investing in international equities enables us to access powerful long-term trends and a varied set of businesses that we couldn’t otherwise find within the U.S.”
Q: How has the fund evolved and what distinguishes it from its peers?

A: One of the defining features of this fund is that we have two separate teams with different philosophies and styles. PNC International Equity Fund was launched on August 1, 1997 and we managed with a growth tilt. In 2005, we partnered with Polaris Capital Management, as we were looking for a more value-oriented manager to balance the overall approach of the fund.

Our dual-manager approach is fairly unusual, as we have a fund that covers multiple bases in terms of style. Not just growth and value; it is also a multi-cap fund. We can invest in companies with market caps of only $500 million, as well as in the biggest mega-caps. However, the actual portfolio consists predominantly of mid-cap names, because that’s where both the value and growth teams tend to find their best opportunities.

In addition to style, we have a wide diversity in terms of geography. Our benchmark is the MSCI ACWI ex USA Index, so we focus on developed markets, but we also have significant exposure to emerging markets and even to frontier markets. The bulk of our holdings is in Europe and developed Asia; we also have investments in Thailand, Egypt and Kenya. So, our universe is the world, outside the U.S.

Q: Why should investors consider this fund?

A: While the growth and value teams are managed fairly independently, both of us share certain core beliefs that guide the way the fund is constructed and managed. We both believe international investing requires a macroeconomic view of all countries in the investable universe, a systematic approach to assessing countries and securities, and a fundamentals-based thesis for all investments that fit within that top-down macro view.

Because we share that common core, and we each stick to our own philosophies and processes, we believe investors might benefit from a highly diversified portfolio of complementary investments. Inter-correlation is almost non-existent and historically there hasn’t been any overlap.

Q: What core beliefs drive your investment philosophy?

A: We believe international equities provide the broadest exposure to companies, trends, and demographics. Obviously, the U.S. has done well recently, but with a broad exposure to both developing and developed markets, we have a much larger opportunity set, particularly in terms of rapidly shifting demographics and longer-term growth trajectories. We can gain access to certain types of companies that we might not necessarily find domestically.

On the value-team side, the focus is on finding companies with undervalued streams of free cash flow. For us, on the growth-team side, our goal is to find companies with sustainable or accelerating earnings growth.

So, speaking for the growth team, we invest in companies with strong balance sheets and clearly defined, disciplined growth strategies. The companies should also fit within our top-down macroeconomic view of various countries.

Q: How important is valuation? What is your price discipline?

A: The value team is naturally more value conscious and has longer holding periods focusing on undervalued streams of cash flow. Conversely, our growth team is looking at earnings growth and is less price conscious per se. It’s all about identifying strong companies with long-term structural growth drivers that are trading at levels underappreciated by the market. Both teams would be happy to find holdings we can keep in the portfolio for a decade or longer.

For the growth team, because of our long-term perspective, instead of diving into only the most recent numbers and quarterly reporting data, we focus on getting to know the companies, their growth drivers, and the markets they operate in. We spend time with company management teams to make sure that they have a deep understanding of their business and industry and the key factors that should drive earnings growth.

Q: What is your allocation between value and growth in the portfolio?

A: We strive to be within one percent of a 50:50 daily allocation between value and growth. As flows come in, they are distributed to maintain the targeted allocation.

Q: Would you describe your investment process?

A: Both teams use a front-end screening process. In the case of the value team, it involves a hurdle rate for free cash flow. On the growth side, we use a top-down framework to help find what we believe are the best growth companies within geographic markets that are relatively undervalued and have the least amount of risk.

The value team uses a global cost of equity approach, looking at long-term returns and using the 10-year government bond of the specific country as the hurdle rate for free cash flow. Then, based on various company valuation screens, the team selects about 250 to 300 names to do additional work on for the value part of the portfolio.

On the growth side, our top-down country allocation framework is based primarily on valuation, risk, growth, and momentum. We identify markets that are undervalued and have the least amount of risk. To estimate the risk, we look primarily at the current account, GDP, and exchange rates. We aim to avoid markets that are overvalued and have a potential downside risk from a currency perspective. The currency in itself is a potential concern. We then fill those market buckets with strong growth companies.

Our team finds securities through a screening process that is focused primarily on growth, both revenue and earnings, but also exhibit strong profitability and positive momentum. And we aim to hold these companies for three to five years.

Both teams travel around the world as part of the research due diligence process because putting boots on the ground and getting out to kick the tires is extremely valuable to selecting investments.

Q: How are the two teams organized?

A: Our growth team is based in Cleveland, Ohio and Polaris is in Boston, Massachusetts. We each manage our portion of the fund fairly independently, but we do compare notes regularly to share our learnings about various countries and companies. We also have combined risk management functions.

On the growth side, our team is organized in a geographic manner, which corresponds with our top-down framework. That means each member of the team travels to their respective region about three times a year to build an understanding of the companies in their universe and to examine the macro factors that may influence companies’ performance.

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