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  • When it comes to investing in international equities, the forecast for 2011 finds a mix of challenges and opportunities on the horizon. Turmoil in Europe, and inflationary concerns in emerging markets may pose risks, but consumption spending and prudent companies offer a promising outlook.

    What remains consistent is the overall consensus among investment professionals that the Canadian market represents only a small portion of the investment world, and that investors need to diversify beyond our borders.

    Stephen Way, a senior vice-president and head of the global team at AGF Investments in Toronto, considers investing outside of Canada an important means of lowering risk through greater diversification.

    “I think people don’t really appreciate the inherently volatile nature of the Canadian stock market, given its focus on materials, financials and the energy sectors,” he says.

    According to Way, while the Canadian stock market has had a good 10-year run, it is now selling at historically high valuations relative to the rest of the world. “People remember the recent past, but they forget the underperformance that Canada witnessed from 1985 to 2000,” Way adds. “So those are some of the reasons why global investing still makes sense.”

    As well, the Canadian stock market is under-represented in sectors such as health care and consumer staples – areas that can offer more predictability in terms of stability and profitability. Those two sectors represent about 6% of the Canadian market and about 30% of the world market.

    Considering risk management paramount for 2011 and beyond, Way’s global team is focusing on companies that have pricing power. Dividends and dividend growth are considered key to overall returns from international investments.

    Country allocation is considered more important than ever. “Just look at Europe: Ireland and Portugal versus Germany,” says Way. “There are big economic divergences taking place because of different budget and debt situations and economic policies coming out of the financial crisis.”

    That means the earnings of different stocks in different countries are going to diverge much more than they have in the past. “So we think that’s leading to some very good opportunities, particularly in core Europe,” says Way.

    Hans van den Berg, CEO and lead portfolio manager at Echo Point Investment Management LLC, located on the outskirts of Philadelphia, anticipates a slow growth environment moving forward. He and his team manage the $604-million TD International Growth mandate.

    “Most of the developed world,” says van den Berg, “is in a very slow, somewhat volatile recovery mode.” In the U.S. and Britain, the economic recovery is very “ho-hum.” Then in Europe, Germany is doing just fine, but the so-called PIIGS markets – Portugal, Ireland, Italy, Greece and Spain – are in even slower recovery.

    To capture opportunities and to mitigate risk in a sluggish environment, the emphasis is on companies with sound balance sheets that don’t have to seek financial aid. As well, businesses are sought with superior attributes, such as lower costs of production, better technology, or better distribution, that can grow faster than the average economic growth would allow. Add to that, a management team with a sound business strategy to develop fast growth for many years, is considered critical.

    “We do find those opportunities,” says van den Berg, “but in the developed market they can be far and few. In emerging markets, they are a little bit more prevalent, and we do find them in all sectors and in all regions. Over the past few years, consumption in emerging markets has grown dramatically.”

    For example, total consumption spending in emerging markets combined has now surpassed total consumption in the U.S. “In the past, it was always thought that if the U.S. was to go into a recession, the emerging economies would tank,” adds van den Berg.

    He considers the car market in China a good example of consumption growth. Car sales in China have grown from 2 million vehicles about five years ago to about 14 million on an annualized basis, compared to the U.S. at about 11 million.

    Van den Berg echoes Way’s views on the potential of international sectors, such as health care and information technology, that represent a much smaller weighting in the Canadian market.

    In 2012, for example, it is foreseen that there will be a peak for drugs that are coming off patent, and when that occurs, there will be a new opportunity for generic drug manufacturers.

    “There are new players that will benefit from this future off-patent period,” says van den Berg, “and it is those new players that we have been investing in. So even in this slow growth climate, there are fantastic growth opportunities.”

    That’s not to downplay the challenges that lie ahead in global investing. With faster growth in emerging markets over the past couple of years, there has been rising inflation. If central banks tighten monetary policy gradually, van den Berg thinks the economies will continue to grow and the equity markets will continue to rise.

    But if inflation is not successfully contained over the next 12 months, financial markets might get concerned that interest rates would go much higher and that would hurt equities.

    In the developed markets, the outlook is that inflation is very much under control, and that interest rates will stay low. “Economic growth will be slow,” says van den Berg, “but for some smart companies, they’ll still grow earnings that are double-digit based, so that could provide some very attractive opportunities.”

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