Meet the Street: Go East, Says Fund Manager

For an analysis of the world markets, Meet the Street sat down to chat with Jeff Everett, the globe-trotting manager of the (TEMWX)Templeton World Fund and the (TEMFX)Templeton Foreign fund.

While his funds are down for the year, they have done well relative to the international market indices. Templeton World fund is down 9.5% this year through November, while its benchmark Morgan Stanley Capital International (MSCI) Index is down more than 17%. The Foreign fund, meanwhile, was down about 9.8% through November, while its benchmark MSCI EAFE (Europe, Australasia and Far East) index is down 21% for the same period.

Everett is particularly enthusiastic about China, which he believes will usher in a strong bull market in Asia in the near future. He also justifies some of his other stock picks and describes why he especially likes the insurance industry.

TSC: What is your assessment of this past year, relative to your investing experience historically?

Everett: I must tell you that this market has been much more normal than in 1999. This is a controversial statement. I am not saying it's easier or less painful. But this market makes more financial sense. Valuations, earnings and dividends now matter. And these criteria have always been important to us.

TSC: How have the funds performed?

Everett: They have done well. We are down single-digits, percentagewise, this year, despite the fact that we have seen tremendous dislocation in the market. The S&P is down about 13%; Europe on average is down 20%, and Japan is down 30%. I feel that we have protected our investors' capital very well this year.

TSC: What is your perspective on which countries and which sectors are doing well now?

Jeff Everett, Manager, Templeton World Fund

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Everett: The issue that people are missing is this: People seem to want to talk about Japan when they refer to Asia. But while Japan has been in a huge bear market, China will be the driving engine of growth and development in Asia for the next few years. Australia and New Zealand have also done well this year.

Asia is a region with very disparate performances. You have to know your companies and management. The Asian market is not too dissimilar to Latin America: Argentina is shaky and its spill-over effect has made Brazil come down. Yet, Mexico was up 13%. Some of the best-performing stocks in our funds are Mexican stocks.

I believe that China winning the Olympics was just the beginning. This paves the way for where they are headed for the next few years. The government is talking about a lot of new interesting initiatives in Hong Kong, such as setting up a free-trade zone with Hong Kong companies. Another interesting thing is that Hong Kong is going through a real estate market price correction. The sentiment overall is weak.

Yet, the Chinese government is taking steps to boost liquidity and investor sentiment in Hong Kong. The government is considering a proposal whereby qualified, domestic investors from the mainland would be allowed to invest in Hong Kong. Right now, mainland investors are not allowed to invest offshore.

TSC: How much confidence do you have regarding the Chinese markets' liquidity and the transparency in the financial reporting practices of Chinese companies?

Everett: Last May, they appointed a Western-educated female official named Laura Cha at the top of their SSRC [Chinese Securities Regulatory Commission], which is their equivalent of the SEC. Her job is to reform corporate governance. This shows that the government is taking reforms seriously. We were also invited to speak to the officials about what steps are involved in improving corporate governance.

We also know that the World Bank has submitted to the government numerous proposals about improving the capital markets. I am told that the Bank has received very positive feedback from Chinese Premier Zhu Rongji's office, which treated the project on accounting reform as a top priority.

Plus, here is a very tangible number to cite: How many Chinese ADRs are listed on the New York Stock Exchange? There are China Mobile(CHL), China Unicom(CHU), PetroChina(PTR), CNOOC(CEO) and Legend. These are five new Chinese companies that came public [within the last] 18 months. The point is that they have intentionally been listing these major market-cap offerings in the U.S., where they have to abide by the stringent rules of the NYSE. I see this as a government's message to Chinese corporations that they have to be clean.

We had zero exposure in mainland China in the beginning of this year. Now we have about 3% exposure in the World Fund and Foreign Fund through stock picking through our bottom-up approach, and not by indexing. That I think gives you a sense of our comfort level.

TSC: Can we talk more in detail about the companies and sectors you like right now? I see that your top holdings are Cheung Kong and PetroChina.

Everett: Cheung Kong has one of the best managements in Asia, if not in the world and sells at a very low valuation. But let's look at Li Ka-Shing [Cheung Kong's founder and chairman of fellow conglomerate, Hutchison Whampoa] and his performance. From 1990 through November of this year, he has done nearly well as Warren Buffett by putting up 21% returns annually, according to Bloomberg, while Berkshire Hathaway(BRK.A) has put up 22%. The S&P 500 by comparison has put up 13%.

Right now you're paying less than six times earnings for this performance for Cheung Kong.

TSC: How about for Berkshire?

Everett: It's 85 times earnings. It looks like you're paying 23 times earnings for Cheung Kong, but in fact it owns a big chunk in Hutchison Whampoa, which inflates their earnings. If you look at Cheung Kong's earnings themselves, it's trading at a single-digit PE. That's what you're paying for this management with a long track record of delivering great returns for its shareholders.

Another point is that Li Ka-Shing is known as a shrewd trader of businesses. If you believe as I do that there will be a great bull market in Asia for the next 10 to 15 years, wouldn't you want to be with a man who's going to see opportunity there first and foremost? It's not going to be Warren Buffett, it's going to be Li Ka-Shing.

TSC: How about PetroChina?

Everett: We like PetroChina, although not as much as we used to. We have split our holdings between PetroChina and CNOOC, which is Chinese National Offshore Oil Company. CNOOC is the oil driller, and PetroChina is the oil refiner. For PetroChina, you're getting a 10% yield and you're paying five times earnings. Even by Chinese standards, it's cheap.

This is no Exxon-Mobil(XOM) by a long shot, but Exxon is selling at 16 times earnings and has a 2% yield. Even if you doubled PetroChina, it'd be half the [average] global valuation.

TSC: What's your outlook on the global economy?

Everett: OK, please remember that I am not a global economist. What companies are telling us is that things are not going gangbusters. But we have some real estate companies that tell us that they still enjoy a great ability to increase rents, and there is no shortage of tenants. We're also investing in insurance companies all over the world.

TSC: Why do you like insurance?

Everett: This is an area where there'll be significant earnings growth next year. First of all, we have always had a bias for the industry. It is a phenomenal, wealth-creating industry. In order to see this, you should look no further than the Forbes 400.

Look at the fortunes made in the insurance industry: You have Maurice Greenberg, the CEO of AIG(AIG); Warren Buffett; Peter Lewis at Progressive(PGR); and Eli Broad, who used to run a company called SunAmerica that he then sold to AIG.

Interestingly, many of these insurance companies have recently set up operations in Bermuda, which has multiple benefits. Bermuda is not subject to the U.S. court system. Instead, insurance claims there are handled by the Privy Council in London. This is a big factor because these companies do not want to be involved with the U.S. courts. Second, they are able to compound their investment gains tax-free. This offers them a huge competitive edge.

So we have been partial to the companies with operations in Bermuda. And to that extent, we have XL Capital(XL) and Ace(ACE) both in the World and Foreign funds. As mentioned, we have AIG and we also have Zurich Financial in the Foreign fund. We have AXA(AXA).

I'd point out that not a lot of earnings estimates for 2003 have been put forward by the sell-side community. This is because companies are not providing extensive forecasts in the wake of 9/11. It is a question of what insurance rates are going to be like. We have no doubt here that there is still a lot of value on the table for a lot of these names. But investors seem caught up in this gap of information. That presents an opportunity for us.

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