The third quarter was a time for defense, according to the leading international equity managers.
Active international money managers who used a variety of self-described defensive strategies finished ahead of the pack at the end of the summer months, according to Pensions & Investments' Performance Evaluation Report.
International equity portfolios saw returns drop precipitously as major international markets fell in the third quarter. The median rate of return for a managed international equity account in the PIPER universe was -15.4 in the third quarter, down from 1.5% for the second quarter.
For the year ended Sept. 30, the median was -8%, according to PIPER, which covers data from 173 portfolio managers.
In comparison, the leading international equity index bested the median manager by 130 basis points.
The Morgan Stanley Capital International Europe Australasia Far East index posted a drop of 14.1% for the quarter while showing a return of -8.1% for the year.
The leading managers, while managing to beat the index, still posted negative returns in the quarter.
From first to fifth place, the managers were: Pyrford International PLC, with a return of
-5.5%; Standard Life Portfolio Management Ltd., -5.9%; Lexington Management, -9.2%; PW Trust Co., -9.5%; and Philippe Investment Management Inc., returning -10%.
The returns for 12 months were better. For the year ended Sept. 30, Lipper & Co. LP finished at the top of the heap with 18.6%.
Rounding out the top five for the 12-month period were: Waddell & Reed Asset Management Co., 12.2%; Driehaus Capital Management, 4.5%; Philippe Investment, with a return close to 4%; and Standard Life Portfolio, with a gain of 3.3%.
The leading managers for the quarter stressed they had defensively positioned their portfolios. They held noncyclical, large-capitalization stocks with strong earnings and also selectively overweighted a variety of European markets in portfolios. Some also maintained high cash positions.
These active managers pointed to such defensive moves as providing insulation from the fallout of Russia's default on debt in August, which sent world markets spiraling downward through the rest of the quarter.
Pyrford International's investment strategy was -- and still is --"incredibly defensive," said Bruce Campbell, chief investment officer and managing director for the London-based firm. Using a top-down, country style approach, Pyrford held large-cap, liquid stocks, and "nothing in the banking sector."
Mr. Campbell admitted, however, it was "stocks more than markets that provided the most important returns" during the period. The manager was heavily overweighted in the United Kingdom against the EAFE. It held a 34% U.K. weighting, while the index was 25%, he said.
Mr. Campbell also stressed he was "seeking liquidity" through investing in large-cap stocks that reflect the firm's top-down view. "If we're expecting slow growth and deflation, we avoid cyclicals and buy large caps," he said.
British stocks in the portfolio included: Boots Co. PLC; Glaxo Wellcome; Marks & Spencer PLC; The Greenalls Group PLC; Norwich Union; Orange PLC; Reuters Holding PLC; Scottish Hydro-Electric PLC; Smith & Nephew PLC; Tomkins PLC; Unilever PLC; and United Utilities PLC.
"The United Kingdom offered the best relative value when compared to other European countries," Mr. Campbell said.
AN 'UNUSUAL' YEAR
Driehaus Capital Management Inc., Chicago, weathered a tough quarter, underperforming the EAFE index by more than 500 basis points. But the firm, which is a bottom-up stock picker, maintained a positive return of close to 4.5% for the 12 months through Sept. 30.
"This has been a very unusual one-year period," said William Andersen, senior vice president and international portfolio manager. The first and second quarter of this year were very good, while the last quarter of 1997 and the third quarter of 1997 were very bad.
The default by Russia's government on local debt spread to other emerging markets and became a worldwide financial crisis, Mr. Andersen said. The result was "a big credit contraction that led to a fear of slowing economic growth," he said.
Driehaus "manages for the long run. That sometimes means you have volatility on the downside,"he said, adding that, during the third quarter, "we were in some stocks that had corrections" greater than their markets. But, Driehaus "did so well on the up quarters, it more than mitigated the poor quarters."
In the first part of the year, the biggest gains were in European technology and financial services, Mr. Andersen said. Both suffered in the third quarter, he said. Tech stocks retreated as "valuations were stretched" and financial services companies were hammered by the global financial crisis.
RELYING ON GROWTH
Money managers who were positioned defensively were "hit the least," said Kenneth Lipper, chief executive officer of Lipper & Co. LP, New York. Like Pyrford International, Lipper's idea of defense in international markets rested on owning large-cap, liquid stocks.
"A lot of our companies are growth companies, so prospects transcend" a market downturn, he said. He pointed to Britain's Vodafone Group and British Telecommunications, and Sweden's Telefonaktiebolaget LM Ericsson as exemplars of European, liquid large caps.
In Switzerland, it owns Nestle S.A., Roche Holding AG and Novartis, while the portfolio has Nokia Corp. in Finland. The portfolio has "companies with more predictable growth rates in earnings over different economic cycles than the market on average," he said.
Another long-term defensive move for active managers was shying away from Japan. "We are very much underweight in Japan," said Michel Raud, managing director and portfolio manager with Philippe Investment in New York. Its portfolio had a 6.6% position in Japan, vs. 21% for EAFE. "Stock selection in Japan is very defensive," he said, adding the firm held "cash generating companies."