Multinational company portfolios are earning spectacular returns for internal money managers at the Novartis AG and PKE pension funds.
In 1997 alone, as large multinational stocks started to dominate index returns, PKE chalked up an eye-popping 61.9% return -- 3,565 basis points above its benchmark.
During the eight years the portfolios have been managed, returns have consistently outperformed the Morgan Stanley Capital International World index (reinvested in Swiss francs).
The funds' successes dovetail with recent discussions at Bacon & Woodrow, Barclays Global Investors and FTSE International to create a multinational company index (Pensions & Investments, Feb. 8).
At Basle, Switzerland-based Novartis, Andre Ludin, head of portfolio, currency and risk management, has earned a compound-annual return of nine percentage points above the Morgan Stanley Capital International World index (measured in Swiss francs) during the eight years ended Dec. 31.
Similarly, Franz Winkler, head of portfolio management at Pensionskasse Schweizerischer Elektrizitetswerke, Zurich, has bettered the bogey by 11 percentage points during the same time period.
What Messrs. Ludin and Winkler do is essentially throw modern portfolio theory out the window.
The two internal managers -- who share investment research with each other but make separate stock picks -- invest huge chunks of their respective pension funds into concentrated multinational portfolios of 30-odd stocks.
At Novartis, the 8 billion Swiss franc ($5.4 billion) multinational company portfolio comprises 44% of the company's 18 billion Swiss franc pension fund.
For PKE, its portfolio represents three-quarters of the 5.8 billion Swiss franc fund's equity exposure, and about 30% of total fund assets.
The multinational portfolios represent all of the Novartis fund's international exposure, and most of PKE's. That's because the portfolio managers believe the multinational stocks provide internationally diverse sources of earnings. An oft-cited example is Nestle SA, where foreign earnings comprise 98% of sales.
But the same is true of many multinational stocks, particularly in pharmaceuticals. "Novartis is not a Swiss stock," Mr. Ludin said. "We do not look to nationalities because all the big companies are active worldwide." The company's exposure "is mostly in the dollar and the euro, so it's stupid to say we're a Swiss franc company."
Mr. Ludin said the key to his portfolio is that it is invested on the basis of cash flow returns after depreciation. Traditional valuation methods, such as price-to-earnings ratios, come a distant second.
Low level of risk
Despite the high degree of concentration, the portfolios have a relatively low degree of risk. PKE's Selection portfolio has a beta of 17.36, compared with 17.74 for the MSCI World index.
"What astonished us is the volatility was lower than the index," Mr. Winkler said.
What also makes the portfolios stand out is the ability to invest for the long term, with little in the way of benchmark constraints, and the ability to make large shifts as economic and financial conditions change.
The size of the portfolio does not remain constant. Total equity weightings (including the Selection portfolio), can be as high as 60% of assets. Now, for the first time, the weighting has fallen below the norm to about 35%.
"I think the market is tremendously overvalued," Mr. Winkler said.
If markets continue going up, he said, he might reduce equities to 25% to 30% of total assets.
PKE's Selection portfolio invests in six major industry sectors. About half of the portfolio now is invested in just two of those sectors: media, telecommunications and technology stocks; and pharmaceuticals stocks. That gives the portfolio an enormous tracking error of 7.5 to 8 percentage points against the index.
Given current high valuations, he has taken profits on some of his technology and pharmaceutical stocks, selling off holdings in Cisco Systems, Sun Microsystems, Merck & Co. and Pfizer Inc., reducing exposure to those sectors to 50% from 60%. Mr. Winkler said he will reduce them to 40% if the market keeps going up.
"I also sold all the financial services, which I think are ridiculously overvalued," he said. Instead, Mr. Winkler has moved into defensive stocks, such as consumer stock Phillip Morris Cos.; capital goods companies ABB Asea Brown Boveri Ltd., Siemens AG and General Electric Co.; and some utilities.
Nimble during nosedive
Mr. Winkler also proved to be nimble last year when global markets took a brief nosedive. He cut back on equities last summer, to 40% from 55% of assets, just before Russia hit a financial crisis, dragging down stock markets around the world.
When the correction proved to be severe, he bought back the same stocks at half the price for which he had sold them. For example, Mr. Winkler had sold shares of Cisco in the low 80s, buying them back at 42 or 43. The stock closed at 109 1/8 on May 26.
Similarly, he purchased shares in United Bank of Switzerland and Zurich Group at half their previous levels.
But current prices make him antsy. "At the moment, a lot of people are not looking at risk," he said. "We are in a nirvana world" of low inflation.
Mr. Winkler said the success of the Selection portfolio is his ability to take a long-term approach. He warns against "the sickness of the industry" in focusing on monthly performance. "I have a long-run focus on the money."
The portfolio manager also preaches against the "second sickness" of indexation. "It means the bigger something gets, the more and more you have to buy."
Funds that are 80% passively invested and 20% invested in very active approaches end up paying too much in fees, he said. PKE's total cost structure is eight basis points, he said.
Despite PKE's rapid shifts, Mr. Winkler said, the portfolio has a very low turnover, noting it had owned Cisco for years before selling it off.
Mr. Winkler also deprecates conventional asset allocation studies and separate allocations to such areas as emerging markets.
"I'm completely against it," he said. "I would drop it out, but the consultant and others want it."
In the past two years, Mr. Winkler said, PKE's consultant PPCmetrics, Zurich, and board members have forced him to take on external money managers who run small-cap, emerging market and Asia-Pacific portfolios.
Ten percent of the fund is run by external managers, 3.5% of fund assets are allocated to emerging markets.
But he thinks investment in multinationals provides more than enough international diversification. "The natural exposure is global companies," he said. "If Dell sells in Asia, we have Asian exposure." However, Mr. Winkler said, the new portfolios will be given five to six years to see if they can catch up with in-house performance.
Pressure on PKE's managers is even keener because investment performance for both internally and externally managed portfolios is posted on PKE's Web site, www.pke.ch.
Mr. Winkler boasts the site gets 30,000 visitors a month, with an average 20 hits per entry. Roughly half of the visitors are from the United States and half from Europe, with a sprinkling from Asia.