No. of Recommendations: 12
Last Thursday I attended Polaris Capital Management’s annual review meeting. I then got sick and spent the better part of the weekend resting, so it’s with my apologies that these notes are a few days delayed. Anyway, I’m better now, so let’s jump into these notes.

This is always a fun event, because the folks at Polaris are focused almost exclusively on international investing, though they do run some global portfolios that mix in some US holdings. The ground they cover overlaps quite a bit with what we do here in GG, and some of their holdings now overlap with what we have in GG, too. This is primarily among developed world companies that have substantial sales in the emerging world, because Polaris only dabbles in the emerging world. This isn’t because they don’t believe in the growth potential of these markets but they haven’t had many great valuations to choose from and they have a hard time getting comfortable with the corporate governance practices for many of the companies.

Polaris is run by Bernie Horn, but he shared presentation time evenly with the handful of members on his team. To keep things simple, I’ll refer to them as a group.

If you’ve been with us for a couple of years you probably remember that I’ve attended this event each of the last two years as well. If you’re curious here are the meeting notes for 2008 and 2009:


Looking at three meetings its clear each had its own atmosphere. The 2008 meeting was dark with many angry questions. With the market down 40% and the Polaris fund down closer to 45% investors were understandably upset. In 2009 the performance improved and the tone of the meeting was optimistic, but still quite cautious – this goes for the audience and my read of the folks from Polaris.

Big picture
At this year’s meeting the folks from Polaris mentioned that there are still some sizeable risks in the global economy, but the overall tone was much more upbeat. They don’t see valuations as attractive as they were last year or, of course, at the start of 2009, but they see the occasional fits of volatility providing plenty of opportunity to fully valued companies on the way up and move into others when certain sectors pull back. They think the economic recovery will continue and that it will continue in a similar fashion – slow, gradual, and with occasional fits and starts.

While they see equities as compelling they want nothing to do with bonds here, particularly government bonds. They also aren’t buying that there is a new normal. They see the current market as very similar to the market before 1992. From a stock market perspective I agree with this perspective, but from an economic perspective I think we’re in a pretty abnormal time. The economy and the market are two separate beasts that diverge for long periods of time and occasionally converge and meet, so when discussions characterizing one or the other come up I think they’re worth separating.

A look at the results and portfolio construction
Performance wise 2010 was another good year for Polaris with the international fund up 20.7% and the global fund up 20.85%. This compares to 12.3% for the MSCI World, 8.21 for the MSCI EAFE, and 15.1% for the S&P. Assets under management fell from about $4.2 billion in 2007 to just $1.7 billion at the end of 2008. Performance alone explains most of that lost, but there were substantial redemptions. AUM is now back up to $3.7 billion, so in addition to doing well it looks like Polaris is attracting new deposits again, too.

From a company perspective Polaris runs a very diversified portfolio (50 names or more, I believe), but they do have a heavy weighting toward industrials, materials, financials, and consumer discretionary. From a geographic perspective they’re heavily weighted to Scandinavia, Germany, Japan, and the UK.

From an investment perspective they see two broad global economic trends playing out over the next 5-10 years (or perhaps more). In developed markets they see deflation and pain with pockets of strong demand where shortages exist. So in these markets they’re focused on companies that are deflation beaters – they can either reduce costs or they have brands and pricing power. In emerging markets they see growth and a convergence of living standards with developed markets. The question they have is whether developed market living standards tread water while emerging markets catch up (the theory they hear most from people in developed markets) or if developed market living standards decline as emerging market living standards rise with the pair meeting in the middle (a theory they sometimes hear from folks in emerging markets).

Many of the names they covered in detail are fully valued or close to it. That said, they are holding onto companies like Andritz, Demag Cranes, and Prosafe until they feel there is weakness starting to show up in their order books. For now they feel it’s more likely that these order books grow and that their valuations might prove conservative. Among the most out of favor companies they hold are a couple of UK Homebuilders, US thrifts, CRH, and Showa Denko.

A little Q&A
After the meeting I had some time to chat with the team and asked them a few questions on traveling to visit companies and corporate governance. It turns out they spend about 30% of their time traveling and meeting with companies. In the past they only met with companies that met their valuation and financial metrics at that moment, but they recently decided to start meeting with companies that don’t quite meet their criteria (in case they do in the future they can move quickly) or are very popular in the market and richly valued, but they don’t see the allure.

This change to their travel plans matches up pretty closely with how we run our GG trips, though, admittedly we don’t yet spend 30% of our time traveling. But we do meet with companies that are richly valued if we think they’re interesting and want to know more. These aren’t candidates for striking gold right away, but we have come back to names after trips in the past.

I also asked Bernie about how they vet companies from a corporate governance perspective given the diverse reporting requirements, cultures, and operating environments their broad portfolio has them invested in. The long answer is that they have a checklist of 50-some odd items that they validate, they use resources outside of the filings, have contact with former ambassadors, and at times they hire specialists, including private investigators on occasion if they have new concerns about a holding, to provide additional background info. But the short answer is that Bernie has all of his money in his funds and most of the team does, too. So if a management team doesn’t pass the sniff test they pass on the investment.

I hope you enjoyed the notes! Let me know if you have follow up questions or if something isn’t clear. I’d love to hear how much weight you guys are placing on corporate governance as you build your own portfolios!


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