Bernie Horn is president and portfolio manager of Polaris Capital Management, and manager of the Polaris Global Value Fund (PGVFX). The Fool's David Meier recently had the opportunity to interview Horn via email. Read on to see what Horn had to say about value investing, new investment opportunities, and concerns regarding China.
David Meier: How did you get started in the money management business and what prompted you to become so worldly?
Bernie Horn: As an undergraduate at Northeastern University, I gravitated to accounting and finance coursework. I conducted an independent study on options securities, which proved analytically fascinating and I decided to pursue this study further. I obtained my Master's from MIT's Sloan School of Management after an intensive study of finance, investments and capital markets.
In the late 1970s and early 1980s, few U.S. investors would consider overseas stocks. As I researched these markets, I saw dramatically low correlations with the U.S. market. For instance, from 1969 to 2004, the correlation of monthly returns of the MSCI-EAFE Index versus the S&P 500 is just 0.56.
As I contemplated the benefits of international diversification, I was working with my graduate thesis advisor, Fischer Black, who frequently wrote about exceptions to market efficiency -- value investing being one such exception.
Upon graduation, I founded a money management business that incorporated both of these concepts. The basic global value investing premise remains in place today -- 25 years after I started my first business, through years as a money manager at other institutions, and with the launch of Polaris Capital Management, LLC in 1995.
Meier: Value investing comes in many different flavors. How would you describe your firm as one made up of value investors?
Horn: At Polaris, we employ an unconstrained pure value equity selection process that is characterized as an active, all-capitalization investment approach. We are considered a deep value manager; we believe that the best way to generate above average risk-adjusted returns is to wait for market fluctuations to produce undervalued companies.
Our clients appreciate the tenets of value investing. They identify with our basic philosophies and strategies, and they want diversification in their portfolios. Although we are coined "value investors," our real strategy is to invest in companies that are priced to give us a proper rate of return. From our perspective, this is not just value investing: it is correct investing.
Meier: What are some countries you find most interesting today in terms of investment opportunities and why?
Horn: We have seen declines in Japanese domestic companies, U.K. homebuilders and U.S. regional banks that seem to grossly exaggerate the near and long-term issues facing these companies. This market environment presents an unusually good buying opportunity for the Fund. We are seeing more Japanese small cap companies on our screens. The Irish market was down nearly 30% in 2007, and close to 50% off its high, so extraordinary values exist there. We started buying Anglo Irish Bank, which we think is ridiculously cheap at eight times earnings -- this is one of the best-run banks I've seen in my career. And even the U.S. is starting to be a little bit better value.
We continue to conduct local research, meeting with management teams and local competitors to determine the strength of company fundamentals. These research activities indicate that business and company fundamentals remain compelling in spite of dropping stock prices attributed to 2007 market volatility.
We intend to continue taking advantage of these depressed valuations going forward. In making such investments now, we are preparing for potential success when markets return to a focus on fundamentals.
Meier: How do you work through the multitude of accounting and financial reporting standards around the world? For instance, as a value investor, when scrubbing financial statements, how do you get comfortable with what a non-U.S. company reports as operating cash flow, and how this might compare to the figure they would report under U.S. GAAP?
Horn: As a Northeastern co-op student at Gillette from 1974-1978, I worked in financial reporting. That involved consolidating the company's financials, including foreign subsidiaries. When you see how international financial reports are put together -- the latitude in estimates and differences in accounting standards -- you quickly learn to scrub down the statements. Today, although there is a strong move to have international accounting standards, there are still many differences. In fact, many companies are de-listing from U.S. exchanges to avoid Sarbanes-Oxley reporting requirements.
To avoid the pitfalls of relying strictly on earnings as a measure of value or company comparison, we focus on cash flow. Free cash flow is more consistently calculated and is harder to manipulate than reported earnings. We believe that if we can find the best sources of free cash flow -- no matter where in the world or in what sectors -- and buy them at a low price, we will see admirable performance.
The focus of the Polaris process is on free cash and the use of the Polaris Global Cost of Equity to discount those cash flows to determine if the investment offers an attractive rate of return. The approach utilizes bottom-up research to uncover the most undervalued streams of free cash flow in the world. We use a discount rate to value each portfolio investment in the course of this fundamental analysis. We apply the discount rate to extremely conservative estimates of future cash flows to determine the fair value of the investment.
Read the second part of our interview to learn about Horn's best and worst investments, along with some of his opinions about China and specific stocks.
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