Q: How has the fund evolved and what distinguishes it from its peers?

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?

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?

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?

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?

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?

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?

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. 

Q: How important are dividends in your investment process?

Dividends don’t have any bearing on the growth team’s view and outlook as we prefer our companies to reinvest in growth. The focus of the value team is finding the most undervalued streams of free cash flow anywhere in the world, so a dividend would be just a byproduct of both teams’ processes. 

Q: When searching for value, do you also need to see a catalyst?

The value team is definitely patient. Often they will invest early, but with the understanding that there is some future catalyst. They wouldn’t invest in a company just because it’s cheap; they need to see a company and a management team that has the understanding of an undervalued stream of free cash flow and, more importantly, has a long-term growth potential as well.

Q: Would you highlight your process with a few examples?

On the value side, I would use the example of Samsung Electronics, the Korean multinational electronics company. It has been a holding for our value sleeve since 2005. The key aspect is that Samsung historically was a commodity-like chip-making company, as it threw off a lot of free cash flow. Over time, Samsung has been moving from a commodity-like company towards having a consumer-oriented focus in smart phones and other spaces. Importantly, the company still has the free cash flow generation ability through its technology and brand name.

On the growth side, I would use the example of Tencent Holdings Ltd., the technology investment holding company. Our top-down analysis suggested we should look at Hong Kong because of lower valuations and risks, solid growth, and good momentum. On the security screening side, Tencent Holdings had gone public in 2004 and was showing up on our screens as a fast-growing company. Based on our meetings with management in Hong Kong and later in New York, we concluded that it had competent management and understood its industry well. 

Since then, the company has been able to expand into other fast-growing areas of the tech industry. For example, when Tencent initiated the WeChat platform, it had a long-term vision about monetizing the communication platform. They were able to use their experience within the gaming industry and then branch out to continue to generate growth.

Q: How does your research process work?

For the growth team, our initial top-down approach to countries and securities determines where we look to add or eliminate holdings. When we aim to add in a certain location, the analyst is responsible for identifying potential names. Then each analyst works with the portfolio manager to drill the selection down to one or two names that are suitable for investment. The selection process involves meeting with company managements at least once a year. 

We don’t necessarily have to meet them prior to our investment, but we would aim to at least have a conference call before following up in person. We focus on the ability of the company management team to understand its business and its long-term growth prospects.

Q: What is your portfolio construction process?

Since the fund has two different managers that look at the world in different ways, the end result is a portfolio that strives to capture the best of both worlds. Because we fish in different ponds, the result is a highly diversified portfolio.

While both teams use top-down frameworks to whittle down the investment universe, bottom-up fundamental analysis also plays heavily into the portfolio construction process. Due to the types of characteristics each team seeks, our resulting sector exposures often differ. The allocation also depends on where we are in the business and economic cycle. 

Q: What is your sell discipline?

On the growth side, we sell an investment if our top-down analysis tells us that we need to reduce our exposure to a certain part of the world. From a fundamental perspective, if something material changes or we’ve made a mistake, or if the management team acts differently than what we expected, we would sell the stock. We would also sell if we have achieved our price target or if the investment thesis is no longer intact. Finally, the sell discipline is a function of relative growth rates.

On the value side, the sell discipline is all about target prices and whether the free cash flow is still available at the prices that they are willing to pay. Any negative changes in that respect would be a reason to sell a company. For example, many U.K. homebuilders were big, staple, long-term holdings of the value team and were doing well in the portfolio. However, recently this group of stocks reached the point where valuations exceeded expected free cash flow, so they decided to sell.

We seek to keep turnover fairly low and focus on the long-term investment horizon. 

Q: How do you define and manage risk?

There is an overarching risk control process as it relates to individual position size, industry concentration, and geographic exposures that is governed by our risk management team. We meet monthly with the risk management committee and we follow restrictions in terms of those constraints. 

However, each team also has their own risk parameters related to their process. The growth team is primarily focused on the risk related to the potential growth rates of the companies and on concentration risk. For the value team, downside risk is the primary issue, and they aim to limit downside risk in their portion of the portfolio. Of course, we also have certain overall limits and guidelines related to risk management.