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Europe Unit Trust Manager Q&A: 
Small-Cap Values
Author: Manish Shah
Last Update: 9:12 AM EST March 20 2007

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Daniel Geber
  “We are all about buying good businesses at the right price. We focus on management quality and how management is deploying the free cash flow that a company generates. We think about investments as a private equity shop.”
Epoch International Small Cap Fund

Small-cap investing requires a hands on approach and to do this internationally demands an investment process that is scalable. Epoch International Small Cap Fund seeks long-term capital appreciation by investing at least 80% of its assets in small-cap companies outside of the U.S. Incorporating a top-down thematic approach with fundamental bottom-up stock analysis, Daniel Geber, portfolio manager, aims to offer a differentiated investment process in small-cap investing.

Q: What is your investment philosophy?

A: We believe in buying good businesses at the right price. Typically, we focus on management quality and use of free cash flow that a company generates. We also try to invest in industrial sectors with attractive dynamics. We emulate the valuation analysis generally conducted in private equity business.

Our investment style has a heavy bias in fundamental analysis with long term holdings of stocks. Small-cap companies are hard to understand and harder to analyze on a global basis. Our investment approach looks for growth in free cash flow and management’s use of it helps us find companies that meet our criteria.

Q: What are the main criteria that you follow to put that philosophy into practice?

A: Thinking like a private equity investor is how I would characterize our investment style. First, we aim at buying businesses at the right price. That means determining the business value and comparing it to the market value. We are looking to buy a business which is trading at a discount. We also incorporate a top-down thematic approach in our investment process to identify trends and themes to focus our research efforts.

Q: What makes your investment approach unique?

A: What distinguishes our approach is the combination of a top-down and bottom-up approach. We look for themes as a way to focus our resources, and then we conduct conventional bottom-up analysis on each stock idea. Our research team works very closely with a highly centralized decision- making process. Thus everyone on the team knows the portfolio intimately. Everybody is involved in the discussions that lead to an investment decision.

Q: Can you explain the word ‘international’ in the name of the fund?

A: ‘International’ means everything outside of the US but we have very little exposure to some of the more risky emerging markets. The big markets are defined by the benchmarks and are also defined by how we have positioned the portfolio. Western Eu rope is about 2/3 of the portfolio, Asia is the next big market, and the index weightings for the rest of the world are much smaller in size and impact.

Q: What are the benchmarks you measure yourself against?

A: We look particularly closely at the S&P EMI EPAC (Extended Market Index Europe Pacific Asia Composite). That benchmark is relatively heavily weighted in Western Europe, so the biggest market as of the end of last year was the United Kingdom at about 22%, the second biggest market was Japan at around 19%, and then markets like Germany, France, Switzerland, etc. We also can and have invested in Canada. We prefer to buy in the local exchanges rather than restrict ourselves to the ADR trading in the US.

Q: What is your definition of small cap?

A: We rely on S&P’s definition of small cap that is the bottom 20% of the market caps, in each one of the markets where the index is present. In certain Western European markets the bottom 20% of the market caps includes some relatively sizable stocks so that means that there are $15 billion market caps included as part of the benchmark.

From our perspective, this presents both a challenge and an opportunity. The challenge is that we want to make sure that this stays a small cap product, so if you look at how the fund is positioned, our median market cap is slightly over $2.5 billion.

Q: What makes the asset class of international small caps so attractive?

A: It offers a good potential for sustainable superior returns. In international small cap we find many undiscovered opportunities because a lot of the companies are too small to be covered by a large number of analysts. In my opinion, international small cap companies are under followed and under analyzed. The small cap companies in Europe tend to have higher return on investment, lower debt on balance sheet and faster growth than large and small cap companies trading in the U.S.

Q: How many stocks do you evaluate in your international small cap fund?

A: There more than 10,000 stocks and of these stocks we would consider between 2,000 and 3,000 on our investment list. We select approximately 150-200 of these names in our portfolio.

Q: What is your selection process?

A: The first step is to go from the broad investment universe to what we call investment opportunities. We use top-down themes as a screen and we also use quantitative and qualitative screens. We try to identify global trends, sometimes local trends and we try to identify themes that will provide us with an opportunity to narrow down that broad universe to a manageable size.
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