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Equity Perspectives

How Lord Abbett finds under-researched and undervalued international small cap stocks 

Investment Philosophy
Considering that international capital markets are often inefficient in their pricing of small and mid cap companies, Lord Abbett believes that a disciplined, patient approach, based on independent fundamental analysis, can be applied to determine the intrinsic value of a company. We believe that global sector research is the most effective way to uncover companies that are selling at a substantial discount to our bottom-up, fair-value assessment.

Process
We look for well-managed small- to medium-sized foreign companies with improving industry and company fundamentals. Quantitative screens, fundamental research, valuation analysis, and risk management help us select those stocks that we believe have the most attractive risk-adjusted return and appreciation potential. That generally translates into three types of opportunities: 1) "best of breed" companies, which may never develop into large companies, but offer compelling valuations and are expected to continue to dominate their market niche; 2) future market leaders in early to mid-stage industries with the potential for explosive growth; and 3) companies that are out of favor, but poised for a turnaround.

Competitive Advantage
We believe that our global sector approach is critical to analyzing companies within the international small cap core equity asset class. Global capital markets are becoming more integrated, and companies typically are competing on a global scale. Our investment team applies its experience and perspective in the comparison of small cap companies with their global competitors. In addition, our practice of setting price targets provides us with a disciplined approach to support buy and sell decision-making.

Independent Research
Another quality that sets Lord Abbett apart is the fact that 90% of our international small cap core equity research efforts are conducted internally. The majority of the team’s time is spent meeting with company management, their competitors and suppliers, as well as attending industry conferences.  Investment themes are often identified through these meetings and are used to supplement our quantitative research.

Rigorous Stock Selection
From an initial universe of approximately 2,100 stocks, we employ quantitative and thematic research to narrow the investable selection to an eventual portfolio of 80–110 names. Our quantitative tools include screens for liquidity, abnormal trading volume increases, and market capitalization (typically less than $5 billion). We also look at industry-specific valuation metrics, such as price/earnings1, dividend yield2, price/cash flow3, price/book4, earnings growth, and sales growth. Concurrently, we develop a thematic approach to supplement our quantitative screens. These themes are often identified through meetings with company management and discussions with industry contacts. Fundamental research is used to determine potential upside and to clearly identify catalysts that the team believes will likely unlock return potential over the next 12–18 months. We then develop price targets for those stocks that we believe have the most opportunity. Price targets are established using a combination of discounted cash flow analysis and sector-specific valuation methodologies.

Currency Hedging
Currency hedging may be implemented as a defensive strategy on occasion. The firm has a separate team that invests in emerging market currencies. This team analyzes global macroeconomic trends that favor the strengthening of developing local market currencies. Although the currency management team does not make investment decisions for the international small cap core equity product, this team is available as a resource.

Evaluating What Went Right and Wrong
The investment team continually evaluates performance attribution analysis monthly to determine which sectors are outperforming and underperforming their respective benchmarks. The next level of analysis determines which particular stocks are over/underperforming, and the analysts determine the cause. Each stock is evaluated on a risk/reward basis. Our analysis results in each stock within the portfolio being evaluated and a decision is made to continue to hold the stock, sell it, or increase the portfolio’s position. Successes and mistakes are discussed at team meetings so the full team can benefit from lessons learned.

Emerging Markets
The international small cap core equity strategy invests in emerging markets. Maximum emerging market exposure is generally limited to 15% of the portfolio. Investment in emerging markets allows us to diversify the portfolio into new developing markets, which often times have potential for high growth as they are evolving economies. [Note: Emerging markets tend to be less liquid and subject to greater price volatility than those of developed markets.]

Benchmark
We use the S&P Developed Small Cap Ex-U.S. Index5 for performance measurement purposes. We are not, however, limited to just the benchmark index to find investment opportunities. We regularly run screens to search for all companies outside the United States with a market capitalization of less than $5 billion. In addition, we often identify themes through meetings with the management of companies that may not be in the benchmark, and discussions with industry contacts.  

Risk Management
Understanding and managing the level of risk in the portfolio is particularly important for our objective to add value. Company, industry/sector, and country/region risks are managed through our valuation analysis and the fundamental research of our analysts.

On a daily basis, the portfolio is reviewed with respect to its country/sector weightings, as well as the top 10 and bottom 10 holdings. On a weekly basis, the investment team reviews various factor exposures and overall portfolio statistics reports.

Individual stock positions are generally less than 5% of the portfolio’s total market value. At times, we may limit portfolio positions due to liquidity constraints and risk management guidelines. Sector weightings are no more than 25% or 1.5 times the benchmark weighting. Maximum emerging markets exposure is generally limited to 15% of the portfolio. Portfolios are diversified with more than 80–110 positions. In addition, each stock is ranked by their degree of risk.

 

Table 1.  Explicit Risk Ratings Are Assigned to Each Security

 Source: Lord Abbett.

 

1 Price-to-earnings ratio is the ratio of the share price to the earnings per share for the last 12 months. This ratio is one measure of valuation
2 Dividend yield is equal to the dividend divided by the stock price. Dividend yield is one measure of a stock’s value. A high dividend yield may indicate that a stock is relatively inexpensive.
A price-to-book (P/B) ratio helps determine whether a stock is under valued or overvalued. It is calculated by dividing a stock’s price per share by its book value per share.
A price-to-cash flow ratio helps compare a company's market value to its cash flow. It is calculated by dividing a stock's price per share by operating cash flow per share.
5 The S&P Developed Ex-U.S. SmallCap®Index captures the bottom 15% of companies domiciled in the developed markets excluding the United States within the S&P Global BMI with a float-adjusted market capitalization of at least US$100 million and a value traded of at least US$50 million for the past 12-months at the time of the annual reconstitution. Stocks are excluded if their market capitalization falls below USD 75 million, or if the value traded is less than USD 35 million at the time of reconstitution. The index is unmanaged, does not reflect the deduction of fees or expenses, and is not available for direct investment.

 

A Note about Risk: The Lord Abbett International Opportunities Fund invests primarily in foreign small and mid cap company stocks, which tend to be more volatile and can be less liquid than foreign or U.S. large cap company stocks. Small and mid cap companies may also have more limited product lines, markets, or financial resources and typically experience a higher risk of failure than large cap companies. In addition, investments in foreign and derivative securities may present increased market, liquidity, currency, political, informational, and other risks. These factors can affect Fund performance.

Additional Risks to Consider:  Investing in international securities generally poses greater risk than investing in domestic securities, including greater price fluctuations and higher transaction costs. Special risks are inherent to international investing, including those related to currency fluctuations and foreign, political, and economic events. With respect to certain foreign countries, there is a possibility of nationalization, expropriation or confiscatory taxation, imposition of withholding or other taxes, and political or social instability that could affect investments in those countries.  The securities markets of emerging countries tend to be less liquid, especially subject to greater price volatility, have a smaller market capitalization, less government regulation, and may not be subject to as extensive and frequent accounting, financial, and other reporting requirements as securities issued in more developed countries.  Further, investing in the securities of issuers located in certain emerging countries may present a greater risk of loss resulting from problems in security registration and custody or substantial economic or political disruptions. Foreign currency exchange rates may fluctuate significantly over short periods of time.  They generally are determined by supply and demand in the foreign exchange markets and relative merits of investments in different countries, actual or perceived changes in interest rates, and other complex factors.  Currency exchange rates also can be affected unpredictably by intervention (or the failure to intervene) by U.S. or foreign governments or central banks, or by currency controls or political developments.  No investing strategy can overcome all market volatility or guarantee future results.

Diversification does not guarantee a profit or protect against loss in declining markets.

The fund's portfolio is actively managed and may change significantly over time.

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