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Riding Structural Tailwinds
Oppenheimer International Equity Fund
Interview with: James Ayer

Author: Ticker Magazine
Last Update: Nov 30, 2:36 PM EST
Often the market and industry structure plays a key role in determining the long-term performance of many businesses just as the position of a company in a particular industry does. Companies enjoying such structural tailwinds are more likely to reward investors with delivering predictable financial results. James Ayer, portfolio manager of the Oppenheimer International Equity Fund, applies a disciplined process in search of stocks with these characteristics around the globe.

“Rather than constructing a portfolio around a benchmark, we believe in structuring portfolios around themes where we think there is long-term potential or structural tailwinds that help companies outperform over time.”
In this macro environment, where the Chinese and European economies are expanding, and the US economy and Japanese corporate profits are doing well, what we have done over the last 12 months or so is to prioritize more cyclical stocks with operating leverage and financials over defensive utilities, telecommunications, and consumer non-durables which have fallen on our watch list. Macro analysis does affect both watch list prioritization and portfolio construction.

Q: Would you provide an example from another industry and location?

A: For us, a big holding in Japan has been multinational conglomerate Sony Corporation. What impressed me was its management team, which got rid of the former CEO after investors grew tired of him failing to restructure the organization. They extricated themselves from failed businesses like PCs, and reduced their exposure to cell phones, leaving them with their strongest items, like CMOS sensors, a vital component of all cell phone cameras.

For the first time in the company’s history, the new CEO and CFO assigned each division a cost of capital, and management was remunerated for delivering returns above the cost of capital; plus, they cut staff heavily, particularly in some of the nonperforming businesses.

Q: What process do you use to construct your portfolio?

A: There are generally 70 to 80 names in the portfolio. The largest position is 3%, and the top 15 above 2%, but the bulk of the portfolio positions each comprise around 1% to 1.5%, followed by starter positions at maybe 50 basis points.

For us, business falls into four categories: two are defensive (quality companies at a good price, and companies with high, free cash flow yield, high-dividend yields, consumer non-durables, and low beta stocks—what we call stabilizers); plus restructuring and turnaround situations; and cyclical companies with operating leverage.

We look at our aggregate exposure to each of these four categories, two being the more cyclical ones that benefit when the global economy grows, and the other two being quality at a good price and defensive stabilizers, which outperform in deflationary environments and when growth is decelerating. This keeps us from crowding into an area that is highly correlated.

We also have some extreme geographic allocations, such as being overweight France and Japan and underweight the UK, but it’s not like we decide we want to overweight this or that macro region or geography. We view the world as a global marketplace for stocks, and divide it into three categories: developed Asia, Europe, and emerging markets. When I look at macro statistics, I look at the US and China, and that’s what determines corporate profits in Europe and Japan and the rest of the world.

Again, we construct the portfolio around themes, not around country overweight/underweight.

Q: How do you view and manage risk?

A: A primary risk is having a portfolio that we think is diversified, yet the holdings are highly correlated. To get the real benefits of diversification, we must have uncorrelated securities.

We favor defensive stocks in a slowing growth environment, while in an upturn or reflationary environment, like in 2013 and again after the US elections, we favor more cyclical companies with greater operating leverage. But, for us, it boils down to understanding the correlations in our portfolio and managing that risk. We have a good risk management team, with whom we work.

Other risks are volatility versus an index, capital loss, and underperforming an index or peers. A solid long-term track record is achieved by having a lot less downside in a bear market.

I don’t believe in being dogmatic about what we do, as that runs the risk of sustained underperformance. I believe in flexibility, and taking an eclectic approach to money management. I believe in cutting our losses and letting our winners run—unless we have some really good ideas in the watch list that make it attractive to trim some of the past winners.

I like to trade around positions. For instance, there is not much turnover in our top 20 holdings. They are in there for a long time, but I will trade around them. If they get expensive, or the risk is rising, or if I make an investment and it’s not working, I will trim the position. That’s my approach to risk management for long term performance.

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