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September 30, 2003

Hedgies for the Pros

By Kathryn M.Welling

Well, our Web site [] explains our methodology very quantitatively and explicitly for the sake of transparency to our clients. But what it all comes down to philosophically is the recognition that analysts make errors. So we try to use the consensus numbers, along with lots of others, to identify where analyst error may be taking place. We are absolute return managers, but any valuation is going to be relative to stocks in its region and in its sector. So when looking, for example, at a retail stock in Japan valuation-wise, like Yamada Denki Co., I don't care what its absolute multiples are. I do care what its multiples are versus its peers, though. Its sector is out of favor, so the whole thing is cheap. But this stock is cheap even versus its sector. So we like it as a long. Our thinking is, if Yamada Denki is trading at a discount to its regional peers, which it is, and if they report a positive earnings surprise, which we are hoping they do, won't analysts say, "Hey, these guys are delivering yet trade at a discount, so a re-rating is in order?" So it's not like we just pick stocks trading at P/Es of less than 10 times. What matters to us at any point is how a stock is trading versus its regional peers.

Nor do you do a lot of after-hours trading in mutual funds, I trust.

No. We focus on the fun stuff. Finding ideas before other people and exploiting them. That's why I'll be in Japan soon, looking at all these retail trade companies. There are a couple of dozen. I am just going to visit all of them. The retail traders, department stores, apparel stores, mail order stores, catalog companies. Their poor industry has been in the tank for eight years.

So what macro signs are you seeing?

What we are seeing in a few charts are early signs - nothing conclusive yet - that the trend is changing in terms of household income, retail sales, and home consumption expenditures in Japan. It's no surprise at this juncture that Japan's macroeconomic position is improving. Everybody loves Japan's macroeconomics here. And analysts on balance earnings revisions tend to closely track trends in macro forecasts. But what may be happening below the surface hasn't gotten much attention.

You think this recovery in Japan is for real? Not another head fake?

We do. I have been involved in the Japanese market for the last 13 years. But it's only in the last six-seven weeks that we have really increased our net exposure in Japan as well as our exposure in Japan's retail trade space, based on information we've gotten from the companies we have talked to. We will be topping off that research effort in the next four weeks with a trip there. Still, whether this will be a one-month thing, a six-month thing, or a two-year thing, we just don't know yet.

Japan's retail stocks weren't the first to catch investors' eyes