How A Pest Control Company And A Cosmetics Maker Became This Five Star Fund’s Top Two Holdings

As passive investing grows in popularity, it’s been difficult for mutual fund managers to justify a relatively costly active-management strategy.

The ClearBridge International Growth Fund’s excellent track record makes the case for carefully including active management in a diversified portfolio.

The $503 million ClearBridge International Growth Fund LGGAX, >+0.48% LMGNX, >+0.49%  is rated five stars by Morningstar (the financial-data firm’s highest rating), and has trounced its peer group of funds and its benchmark, the MSCI EAFE Index 990300, >+0.27% this year and over the long term, as you can see below.

In an interview on Aug. 1, Elisa Mazen, the head of head of global and international growth at ClearBridge Investments (a subsidiary of Legg Mason Global Asset Management), explained that she and her colleagues managing the fund look to beat the index by identifying stocks of growth companies that are underappreciated by other investors.

Mazen and her team have been running the ClearBridge International Growth Fund since September 2013.

Legg Mason Global Asset Management
Elisa Mazen, head of head of global and international growth at ClearBridge Investments.

“When companies invest for growth, generally what you see is earnings can go sideways or down. The market doesn’t like that,” she said. “Growth can be volatile. We adjust for that by having a valuation focus. We buy good companies at moments when we think the market is missing the bigger picture.”

Here’s a look at the top 10 countries represented in the ClearBridge International Growth Fund and how those concentrations compare to those of the benchmark index:

Both the fund and the index are heavily weighted toward Japan and the United Kingdom, but Mazen said the fund’s concentration in those countries was not by design, but came about “through stock picking.”

One way the fund is differentiated form the MSCI EAFE Index is that its managers can move up to 10% of the portfolio into emerging-market stocks. The fund sticks with that limit because of higher volatility for stock in emerging markets.

Mazen pointed out that among publicly traded companies in China, “about 70%-plus are state-owned enterprises.” So she is most interested in companies such as Alibaba Group Holding BABA, >+2.03% Baidu BIDU, >+0.47%  and Tencent Holdings 0700, >+4.09% TCEHY, >+1.25%  — the fund holds shares in all three — because they are “part of the dynamism” of non-state-owned companies in China.

Types of growth

Mazen said that identifying various types of growth companies “allows for participation in different market environments.” Here are three categories of growth she described, along with an example of each held by the fund.

Emerging growth

These are companies Mazen calls “disrupters,” which can be of any size. “Alibaba is actually an emerging growth stock,” she said. Those stocks tend to have high valuations and price volatility, so the fund limits them to 20% of the portfolio. The fund also limits the size of individual investment positions to control risk, Mazen said.

Asos PLC ASC, >-0.03% ASOMY, >+0.01% is an online retailer that has “an interesting heritage with social media,” Mazen said. Through its website, the company helps people (mainly millennials) select clothing (and other items more recently, including cosmetics) by offering its own products and those manufactured by other companies.  

“[T]hey are very far ahead of their peers,” Mazen said, and with investments in new markets and distribution capabilities, she believes the company “can grow for a very long time.”

Secular growth

The largest portion of the fund (40% to 60%) is made up of companies that have established business models and are what Mazen calls “sustainable long-term compounders with consistent returns.”

Rentokil RTO, >+0.24% RTOKY, >+0.64%  a U.K.-based provider of commercial and residential pest-control services that operates internationally, was the fund’s second-largest holding as of June 30, reflecting very strong performance for the stock.

Mazen said Rentokil’s industry is becoming increasingly important because of global warming, bed bug infestations in recent years and because of the growth potential in emerging markets, including India, where Rentokil made a recent acquisition.

The company is growing at “a nice, steady rate,” she said, and it has been “making small acquisitions and putting them on their platform.”

Mazen called Rentokil “a long-term secular compounder.”

Structural growth

These are companies “where we see an evolving story that the market doesn’t yet recognize as being a growth stock,” Mazen said. Those stocks have attractive valuations and “tend to be really outsized performers.” They make up 20% to 40% of the fund.

Shiseido 4911, >+1.91% SSDOY, >+1.53%  was the largest holding of the ClearBridge International Growth Fund as of June 30, but Mazen was quick to say this wasn’t by design but “because it grew there.” The company makes cosmetics and last year completed a restructuring led by new CEO Masahiko Uotani, who pushed hard to bring the company’s expenses under control.

Mazen likes the cosmetics industry, which she said has a steady 5% growth rate.

But Shiseido still trades at valuations well below those of L’Oreal SA OR, >+0.93%  and Estee Lauder EL, >+3.40% because of lower profit margins, Mazen said, presenting an opportunity to buy the shares in anticipation of growth.

“We think the driver for performance will ultimately be earnings,” Mazen said, because Shiseido’s profitability “is less than half their peers.”

“There is no reason it cannot catch up to those levels. The market does not believe that can happen. We do,” she said.

Performance and top holdings

This table shows the excellent performance of the ClearBridge International Growth Fund’s Class A and Class I shares against Morningstar’s Foreign Large Growth category, the benchmark MSCI EAFE Index and the MSCI All Country Ex-U.S. Index:

Total return - 2017 through July 31

Average annual return - 3 years

Average return - 5 years

Average return - 10 years

ClearBridge International Growth Fund - class A LGGAX, >+0.48% 6.2% 10.0% 10.9% 6.1%
ClearBridge International Growth Fund - class I LMGNX, >+0.49% 6.4% 10.2% 11.1% 6.4%
Morningstar Foreign Large Growth category 1.2% 6.9% 7.0% 4.6%
MSCI EAFE Index (U.S. dollars) 0.0% 5.5% 6.4% 3.9%
MSCI All Country non-U.S. Index (U.S., dollars) -1.1% 6.5% 6.1% 3.6%
Sources: Morningstar, FactSet

The class A returns exclude any sales charges (which are often waived, depending on how shares are purchased) and are net of annual expenses that are currently 1.15% of assets. The current expense ratio for class I shares is 0.90%.

Here are the top 10 equity holdings (of 58) of the ClearBridge International Growth Fund as of June 30:

Company

Ticker

ADR

Country

Industry

Share of fund

Total return - 2018 through July 31

Shiseido Co. Ltd. 4911, >+1.91% SSDOY, >+1.53% Japan Household/Personal Care 4.5% 51%
Rentokil Initial PLC RTO, >+0.24% RTOKY, >+0.64% United Kingdom Miscellaneous Commercial Services 3.5% 8%
ASML Holding NV ASML, >+0.93% ASML, >+1.07% Netherlands Electronic Production Equipment 3.4% 28%
SAP SE SAP, >+0.55% Germany Packaged Software 3.3% 8%
London Stock Exchange Group PLC LSE, >+0.34% LNSTY, >-0.56% United Kingdom Investment Banks/Brokers 3.1% 17%
Diageo PLC ADR DEO, >+0.46% United Kingdom Beverages: Alcoholic 2.8% 2%
Icon PLC ICLR, >-1.21% Ireland Pharmaceuticals: Other 2.8% 24%
Hoya Corp. 7741, >+0.23% HOCPY, >+0.25% Japan Medical Specialties 2.8% 20%
Umicore UMI, >+0.41% UMICY, >+0.38% Belgium Other Metals/Minerals 2.8% 27%
Suncor Energy Inc. SU, >+0.97% Canada Integrated Oil 2.8% 17%
Sources: Morningstar, FactSet

The fund tends to purchase shares traded in local markets. However, shares of Icon PLC ICLR, >-1.21%  and Suncor Energy SU, >+0.97%  are publicly listed in the U.S., and the fund holds American depositary receipts (ADR) of Diageo PLC DEO, >+0.46% If there are ADRs available for stocks the fund purchases outside the U.S., the ADRs are listed in the table.

Don’t miss: These 10 companies have recently raised their dividends by at least 10%

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Philip

van Doorn

Philip van Doorn covers various investment and industry topics. He has previously worked as a senior analyst at TheStreet.com. He also has experience in community banking and as a credit analyst at the Federal Home Loan Bank of New York.

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