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Saturday 15 September 2012

As Pat English likes to say about his investing style, "We're in the rejection business."

Over the course of a year, the CEO and chief investment strategist, along with Fiduciary Management's seven other investment analysts and portfolio managers, will sift through hundreds of companies looking for what might amount to just a handful of new holdings. "At the initial stage, 95% of what we look at will be rejected," says English, who joined the Milwaukee firm in 1986 when it was just two founding partners managing $300 million in assets. As the firm's first director of research, English was instrumental in honing Fiduciary's ultra-selective, highly concentrated value approach.

"Our culture is very contrarian in nature, and that's a testament to Pat," says Andy Ramer, who took over as director of research in 2010. The team isn't "contrarian just for the sake of being contrarian," he adds. "But we're always asking what can go wrong."

Enlarge Image

Kevin Miyazaki for Barron's
Andy Ramer (left) and Pat English take a highly focused value approach to their targeted portfolios.
That skepticism has helped deliver superior results for the $15 billion the firm manages in separate accounts and three mutual funds. The firm's oldest fund, the $1 billion FMI Common Stock (ticker: FMIMX), which holds small- and medium-sized companies and is closed to new investors, as of Aug. 31 has posted 12% average annual returns since its 1981 inception; the Russell 2000 averaged 9.94% a year over that period. The $6 billion FMI Large Cap fund (FMIHX) has earned a 9% annual return over the past decade, better than 98% of its peers, according to Morningstar. At the end of the year, it too will close to new investors.

Now the team is looking to repeat its performance overseas with the FMI International Fund (FMIJX), which it launched at the end of 2010. This is Fiduciary's first official foray overseas, though English says it's all familiar territory. During a 2010 test run, the fund posted 17% gains. That success continued after it went live. It's up 26% in the trailing 12-month period, beating 99% of its peers, and returned 24.2% in 2011, also beating 99% of its peers.

Despite those results, the fund is tiny, with just $64 million in assets. English isn't surprised. "The consultants like to see a three-year track record," he says, referring to professionals who recommend funds to 401(k) plans. "But the strategy has a 30-year track record." FMI International has an expense ratio of 1%.

The international fund follows the same playbook as the two other funds FMI manages, the only exception being that holdings are domiciled outside of the U.S. Like all FMI funds, this one is concentrated, with just 27 holdings, though the team makes a concerted effort to spread that risk among many sectors. Country selection isn't a big priority, says English, since most of the companies are multinationals, though the fund does hedge for currency risk. "We don't want our stock picking diluted by currency moves," he says.

Given that the team may add just a handful of new investments a year and holds them for three to five years, the barriers to entry are high. Before even considering a company, the team screens for factors such as debt ratios, operating margins and return on invested capital. "It's shocking how many companies don't earn their cost of capital," notes English. They'll troll through company filings, listen to several years' worth of conference calls and look at management's track record. If a company makes it over those hurdles, "then the real research begins," says English.

Fiduciary Management

FMI International Fund

Total Returns*
YTD 1-Yr 3-Yr
FMIJX 14.4% 25.6% NA
MSCI EAFE NR USD 11.2% 15.9% NA
% Of
Top 10 Holdings Ticker Portfolio**
Compass Group PLC


Brookfield Asset Mgt


Henkel AG & Co


Accenture PLC




SMC Corporation


GlaxoSmithKline PLC


Fairfax Financial Hldg


Rolls-Royce Hldg PLC


Adecco SA


Total: 42.5%
*All returns are as of 9/12/12; three and five year returns are annualized.
** as of 6/30/12 NA= Not Applicable
Source: Morningstar; company reports
While the team will try to research every last detail up front, it avoids companies that require too much upkeep. "You won't see any opaque financial enterprises or biotech firms in the portfolio," says English. Nor will you see luxury-goods companies such as Richemont (CFR.France) or Burberry Group (BRBY.London). Fiduciary sticks with what English calls "necessary businesses."

If the team finds a company it likes but thinks it too expensive, the team will set the company aside and wait for a buying opportunity. "We're always going to be attracted to businesses that are under a cloud," says English, "but we spend a great deal of time analyzing the cloud."

Japanese companies have been socked in for 20 years, says English, who chalks it up to a weak economy and a culture that doesn't value outside shareholders. But there are bright spots in Japan, he says, including $11.3 billion SMC Corp. (6273.Japan), which the fund has owned since January 2011. SMC is the world leader in compressed-air components used in manufacturing. "It's a phenomenal business that nobody knows about," says English, noting that SMC's return on invested capital has averaged in the mid- to high-teens for the last decade when most industrial companies are "barely in the double digits."

Sometimes the business is sound, but management is not. English and his team believed that was the case with Henkel (HEN.Germany). The $31 billion German company is a global leader in consumer and industrial adhesives (i.e. glues and polymers), laundry and home care, and cosmetics and toiletries. It also has a strong foothold in emerging markets, which account for more than 40% of sales. Yet previous management struggled to control costs and focus on the most lucrative parts of the business. FMI initiated its position in May 2011, a few years after Henkel brought in a new CEO. "There was a turnaround in place but it wasn't visible because of the downturn," says English, adding that the new executive team has already shown success in improving operating margins but "we think there's still plenty of room to improve."

The Swiss-based $9.5 billion professional-staffing company Adecco (ADEN.Switzerland) has also been hidden in an economic haze. "People are assuming it's going to be awful in Europe forever," says English. The fund made its first investment in July 2011 and have since added more. As the largest such company in the world, Adecco is globally diversified and half its business comes from industrial staffing, where qualified labor is in short supply. "You're buying a superior business in a cyclically weak period," he says, adding that the company is currently earning more than its cost of capital. "We think it will survive and then thrive when economy picks up."
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