Benjamin Segal

Neuberger Berman International Fund

by Marla Brill
MFI Publisher

About two years ago, Benjamin Segal was traveling abroad when he began to notice that thanks to a strong dollar, being an American spending money overseas had become unusually easy on the pocket. “I’ve done a lot of traveling, and I wasn’t used to feeling rich in expensive places like Europe or Japan,” says the 35-year-old manager of the Neuberger Berman International fund. “To me, it was a red flag that U.S. currency was overvalued.”

As it turns out, Segal’s intuition proved correct as the dollar began its descent against the euro and the yen soon after his foreign jaunt. Among the beneficiaries of the trend have been overseas investors who gain both from share price appreciation, and the kicker from currency translation. In 2003, the MSCI Europe, Australia, Far East Index rose 39.1 percent, and was up another 15 percent in the first eleven months of 2004. Foreign funds shot up as well, with the boost even more pronounced for those investing in small and mid-sized companies. The average fund in Morningstar’s foreign small and mid-cap growth group posted a gain of 53.8 percent in 2003, and was up another 18.3 percent through November of 2004.

Yet foreign small and mid-cap funds remain a relatively small corner of the investment universe. They received some $4.5 billion of inflows for the ten months through October 2004, compared to  $37.6 billion for large company foreign stock funds, according to Financial Research Corporation.

As an all-cap offering with a small cap tilt, Neuberger Berman International is one of the few foreign funds to cross size lines. Segal looks for companies with outstanding stock worth at least $400 million, and the portfolio has a median market capitalization of $1.9 billion.  Since 2002 its asset base has more than tripled, from $70 million to  $266 million.

Segal prefers not to prognosticate about whether small and mid-sized European companies will continue to outperform other corners of the stock market in 2005. As a fundamental analyst, he says, he prefers to stick to picking superior stocks with reasonable valuations, healthy growth prospects, and the potential for 50 percent appreciation over a three-year period.

But he does have some opinions about a further weakening of the dollar against other currencies.  Although a widening trade and budget deficit, lackluster economic growth, and high oil prices often foreshadow such a move, Segal says he’s not banking on it.

“The argument for further decline of the dollar is less powerful today than it was a year ago. Washington does not want that to happen and will take steps to prevent it. If the dollar does decline this year, I think it will be a modest one.” He also believes that foreign markets are generally less of a bargain in comparison to those in the U.S. than they used to be. “Two years ago, foreign stocks were trading at a 20 percent to 25 percent discount to their U.S. counterparts. Today, I’d put the discount at around 10 percent to 15 percent,” he says.

A further decline in the dollar would generally tilt the balance in favor small and mid-sized companies over large multinational companies based abroad, which face a decline in earnings when U.S. sales are translated from dollars into their home currencies. They also face weaker sales if they are forced to raise prices to adjust for a weaker dollar, and American snap up fewer foreign goods.

Segal says that because foreign small and mid-sized companies usually have a strong presence in their local economies, and limit the geographic scope of their businesses, the fluctuation of the dollar affects their businesses less.  “In the U.S., small and mid-sized companies are usually focused by areas of business specialization, rather than geography,” he says. “Small European companies tend to differentiate themselves by country rather than product. It is possible for a company to be small, but to also be the dominant player within its home country.”

But even without the backwind of a weaker dollar and narrower discounts, Segal cites several reasons for investing in small and mid-sized foreign companies. Because they are under-followed by analysts and less efficiently priced than many stocks, he is “still coming across really good companies with undemanding valuations.” They also offer diversification, and have a lower correlation with the U.S. market than larger multinationals.

While Morningstar analyst Bridget Hughes acknowledges that foreign funds that invest in small and mid-sized companies make sense for investors who want to diversify beyond traditional large company fare, she’s concerned about the group’s recent run-up. “We think the performance of these funds in the next couple of years is likely to be more subdued than in the past couple of years, and we’d encourage investors to invest gradually and keep the funds to a smaller portion of their portfolios,” she noted in a recent report.

Beyond the possibility of a pullback lie some inherent risks involved with investing in this space. If the dollar strengthens unexpectedly, smaller foreign stocks could get left behind. Because it takes less muscle for a small foreign company to become a dominant player in a local market, the barriers to entry are typically lower than they are for small companies in the U.S. A high level of family ownership can mean a significant cache of stock that is concentrated in the hands of a few family members, whose interests may or may not align with those of other shareholders.

Segal believes his training has prepared him for scratching beneath the surface of guarded foreign companies that fly below the radar screen. Born in London, he graduated from Cambridge University and later earned a graduate degree in business from Wharton. He started his career in international finance and consulting, which included multi-year assignments in Asia and South Africa. In 1997, he moved to the buy side as an assistant portfolio manager at another firm before joining Neuberger Berman six years ago. He began co-managing Neuberger Berman International in late 2000, and become its sole manager in 2003.  

Unlike many international fund managers, who take a top-down approach by picking the countries they want to be in first and then focusing on companies within those countries, Segal favors beginning with a stock-by-stock analysis. “I’m aware of studies have shown that when it comes to international investing, most return comes from country selection,” he says. “The problem is that very few people know how to be in the right country at the right time. I prefer to stick to fundamental analysis.”

Besides, he says, approaching things from the bottom-up often leads to conclusions about what’s going on from a macro-economic standpoint. “If you can’t find any interesting cheap companies in Japan, that tells you something about the country’s economic situation,” he says. The fund is currently has an underweight position in Japan relative to its MSCI EAFE benchmark.

Segal’s analysis focuses on finding companies that have a return on equity of 15 percent to 18 percent, and a healthy growth rate. “I like to see earnings growth of at least 5 percent, but 20 percent or 30 percent is our maximum,” he says. “Anything beyond that is probably not sustainable.” The 92 stocks in the portfolio have an average price-earnings ratio of 14, according to the firm’s latest fund fact sheet.

Although the fund is free to invest in companies of all sizes, Segal’s criteria often leads him toward small and mid-sized companies in both in established European and Japanese markets, as well as in less trodden territory such as Greece, Canada and Ireland. At 19.1 percent, the United Kingdom represents the largest country allocation, followed by Japan at 17.3 percent, France at 12.3 percent, Ireland at 8 percent, and Canada at 5.8 percent.

Segal says that Anglo Irish Bank, which has long been the fund’s single largest holding, “has a clear focus on what it is good at.” Instead of extending loans to a broad swath of the public or to companies, the bank specializes in lending and other services to high net worth professionals. It has limited advertising, and gets most of its customers through word-of-mouth in professional communities. He adds that smaller local bank holdings in Spain, France and the U.K. have been outpacing their larger investment-banking oriented peers, especially those in Germany. At 18 percent of assets, banking and financial services companies represent the largest fund sector.

Another top five holding, Pubic Power Corp., is Greece’s largely unregulated electric power monopoly and the fund’s only utility sector holding. Segal says the company should benefit from an economic boost that came from hosting the Olympics and from its use of the mineral lignite for power production, which insulates it from higher oil prices.  Canada’s Talisman Energy, which would benefit from such an increase, is the fund’s sixth largest holding. Segal says the company is attractively valued compared to its U.S. competitors, and that  “a smaller company like Talisman is more focused on delivering value from its assets that a global U.S. oil producer.”

Neuberger Berman International Fund At-A-Glance 

Assets: $266 million  

Top five holdings:  Anglo Irish Bank, C&C Group, Vodafone Group, Public Power Corporation, RPS Group.  

Contact information:  800-877-9700;  www.nb.com