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Online Extra: "Everything in the U.S. Is Expensive"


Charles De Vaulx is "a citizen of the world," which gives him the perfect credentials to run a global mutual fund. Born in Morocco and raised in France, De Vaulx, who is the co-manager of the A-rated First Eagle Global Fund, lives in the U.S. At the end of the year he'll take sole responsibility for the $6.8 billion portfolio after his legendary co-manager, Jean-Marie Eveillard, retires. BusinessWeek Personal Business Editor Lauren Young recently spoke by phone with De Vaulx while he was attending a family wedding near Burgundy, France. Edited excerpts from their conversation follow:

Q: How do you view the investment landscape right now?

A: We are value investors, which makes us very sensitive to prices and valuation. That also makes investing around the world difficult -- with the U.S. market as the true problem. It trades at a very high multiple, and 14 times aftertax cash flow.

If you look around at respected U.S. value investors, they're all struggling to find cheap stocks in the U.S. Many of us have 20% to 40% in cash. Everything in the U.S. is expensive -- small stocks, value, growth, you name it. In our global fund, we've never had as little a weighting in U.S. stocks as we do right now. It's something close to 20%. A more normal weighting has been closer to 40%.

Q: So where are you finding better values?

A: The European markets offer decent values -- stocks are trading at nine times cash flow after taxes. They aren't cheap, but they're reasonable. Smaller European stocks are a better deal than they are in the U.S. Small stocks trade at a 10% to 20% discount to large caps. There are still some pockets of opportunity among those names.

The cheapness of the small stocks in Europe comes from the fact that there's still an institutional bias against small companies -- they're somewhat illiquid, and European money managers like to trade a lot. Also, European money managers are more obsessed with benchmarks, so even if small stocks look cheap, they won't bother if it's not relevant to an important benchmark.

European stocks have higher dividend yields. The yield isn't the reason we hold or buy stocks, but it's nice to get paid something while waiting for value to get recognized. Within the Global fund, a little more than 35% is invested in European stocks.

Q: What's your next biggest position after European stocks?

A: About 30% is in Asia, in particular in Japan and South Korea. The Japanese market has rallied over past year after a 13-year bear market. Despite the one-year rally, it remains cheap: It's trading at nine times aftertax cash flow.

There are signs things are changing for the better in Japan. It doesn't have a culture of hostile takeovers, but now we've seen several mergers among small Japanese drug companies, including Yamanouchi Pharmaceutical and Fujisawa Pharmaceutical. In Japan, we also own some of the larger companies such as Secom and Mitsui Sumitomo Insurance, as well as some smaller ones like Shimano Inc., a bicycle-parts company.

South Korea, which did well in 2003, has come down quite a bit since mid-April. We own Samsung Electronic, but we own the preferred stock as opposed to the voting shares. Many small companies in South Korea are very cheap. Some run their businesses very well, but they forget to pay dividends. Instead, they let cash pile up on the balance sheet. As a result, those stocks languished. But I don't think they'll stay cheap forever. Some of the smaller ones we own include Daeduck Electronics and its sister company Daeduck GDS.

Q: How much do you have in cash?

A: We always leave room for high-yield securities, but now it's hard to find anything of interest there. That's why we have 20% in cash as a hedge, along with 5% in gold and gold-related securities. It's definitely a defensively positioned portfolio. We would rather hold cash than buy overvalued securities. We focus on capital preservation as opposed to being a go-go fund.

Q: With so much cash, do you have any plans to close the fund?

A: If, in the next 12 months, the stock markets around the world were to shoot up, and if along with that we had significant inflows making it tough to find bargains, we would consider closing the Global fund. In early 1994, we closed the fund for 18 months when cash reached 35%. So far, we've been able to put money to work in Japan and Europe.

Q: What's your economic outlook?

A: In a high p-e, low-rate world, where there's growing competition in many industries, especially with the emergence of China and India, the returns of capital are about to be subdued. During the next five to eight years, investors should expect very modest returns.

Q: How will Jean-Marie's retirement affect the fund?

A: I've been working with him for 18 years, so I think people are comfortable with me running the fund alone. We're on the same wavelength. Nothing will change. Incidentally, I have all my financial savings in the funds I manage.


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