By Thomas Streater
Emerging Markets are supposed to offer high growth and high
returns. Yet since the global financial crisis, it is developed
markets, with the help of global central banks, which have managed
to outperform. Even so, Robert Secker, an emerging markets
investment specialist at M&G Investments, believes that has
created many opportunities in emerging markets, especially in
Asia.
Secker, a CFA charter holder, had worked for T. Rowe Price for
10 years before joining M&G in 2010. He travels regularly to
kick the tires in emerging markets, and concentrates on the
microeconomic details of businesses he examines, leaving the more
macro ruminations to his fixed income colleagues sitting across
from him in the London office. On a recent trip, he stopped by
Barron's Asia's Hong Kong office to talk broadly about those
opportunities he sees.
Barron's Asia: What's your big-picture market outlook at the
moment?
Secker: Emerging markets have underperformed developed markets
substantially for three or four years. That lets you buy Asia on
attractive valuations today. Emerging markets trade at book values
of 1.5 times, that's pretty much historic lows, and it has only
typically been that cheap during periods of crisis. The discount to
developed markets has only been wider during the dot-com boom, when
developed markets were very inflated. Asia is cheap but there's a
huge variation within the asset class.
A lot of this divergence between emerging and developed markets
is driven by sentiment. Also, if you look at the U.S. market, there
have been share buybacks every year since 2007, so there's less
equity year after year.
Q: Where do you see low and high valuations within Asia?
A: Indonesia and the Philippines are the most expensive, trading
at just over 3 times book value, and given the corporate governance
and the types of businesses that you can buy in those markets, it's
not warranted. But people love to chase a story, and Indonesia
grabs attention because the country is doing well, thanks to its
resources.
On the flip side, China is about as cheap as it has even been.
Korea is a market that has historically traded at a discount, but
ultimately as every other market around Korea is re-rated, Korea
looks even cheaper than it has historically.
The Indian market in our eyes has probably run a little bit too
fast and too high. We started buying there last summer when all the
talk was of the "fragile five" [countries of Brazil, South Africa,
India, Indonesia and Turkey], and when India was very weak. Modi's
election in March is potentially a bit of a game changer for the
economy, but we are equity investors, not a macro fund, and some of
the companies we owned have gone up far too strongly this year, so
we have been selling into that strength.
Q: Do you think the reforms in Korea could eliminate the Korea
discount?
A: Taxing the companies' retained earnings and incentivizing
them to pay dividends shouldn't be too much of a stretch. But the
sprawling nature of some of the businesses will still remain in
place, so they probably would still trade at a discount. The
discount potentially can narrow once they adopt dividend policies.
Korea has the lowest payout ratio of any market. Companies are
beginning to talk about adopting dividend policies, which is a step
in the right direction.
Our investing is driven by bottoms-up analysis, and finding
companies with decent valuations. Among the companies we like are
some banks, a couple of car companies, Samsung, and retailers.
Q: What's your strategy for investing in China?
A: With China you've got many businesses that are run the wrong
way and run to achieve social aims. But then, on the margin you do
have a handful of companies that are focused on moving up the value
chain. So they're investing more in R&D and branding. There are
more patents filed annually in China than in any other market in
the world, which suggests there's a bit of an attitude change
taking place.
Companies are beginning to realize that if you want to be a
sustainable business you can't just compete on cost. Companies that
make low-margin products don't have the ability to pass on rising
costs. But if you move into high-margin products you become a price
maker rather than a price taker, and you're able to feed rising
costs through to the consumer.
So the types of companies in China we look for are primarily
those ones that are moving up the value chain and that are going to
be around in 10 years from now. These businesses aren't going to be
wiped out if the exchange rate goes against them.
Q: Do you avoid buying state-owned enterprises?
A: Well, there are different types of SOEs. The banks, for
example, we would struggle to own because they are not designed to
be run for profits but are run for achieving economic goals.
Typically we prefer privately-run businesses where management
teams are incentivized to run those businesses for the same
interests that we have as shareholders. We've got quite a big
overweight actually in the Asia Fund in China.
Q: That leads us nicely to the Shanghai-Hong Kong Stock Connect.
What do you make of it?
A: We're waiting to see how it starts. In theory, it gives us to
access to 568 new names [in Shanghai]. It gives us access to what I
believe is the second most liquid market in the world. The majority
of current investors are retail so I expect you're going to get
inefficiencies in the market. It's going to be an active stock
pickers' market, which is good for us.
But you have to be very selective. None of those businesses
really have had exposure to international investors before, so
disclosure is going to be bad in many instances. Companies'
attitudes towards international investors initially are probably
not going to be ideal.
We never buy a company without speaking to the management team.
That's crucial when you're investing but particularly in emerging
markets because it comes down to trust. You need to be confident
the managers are going to run the business in the way that you
think they should.
Q: What do you think about Taiwanese stocks?
A: You've got broadly three parts to that market: The financials
are a big element but they're some of the least profitable banks in
our universe. Then you've got some fairly low value-add tech names,
and then some chemical businesses, which are in commoditized
industries. What the Taiwanese dollar does will impact the success
of many of these businesses and you don't necessarily want to buy
shares in a company where the success of that company is going to
be based on an exchange rate.
Ultimately though, you can find a decent company if you look
hard enough. We have been buying a little bit more recently because
we've uncovered some better companies and it comes down to relative
valuations again.
Q: You implied that Indonesia was "a story", can you
elaborate?
A: We don't buy stories. We buy shares in companies and
Indonesia is trading at three times book value.
A lot of the companies there are essentially operating in
oligopolies based on the industry structure, and will those
industry structures remain in place? You're going to have reforms
now to make industries more competitive. A business that's reliant
on its industry structure is going to come down to politics, which
we're not going to try and second guess. Corporate governance is
not great in Indonesia, certainly not in relation to some of the
valuations.
If you think of the emerging market consumer story, it's a hell
of a story. It's billions of people getting wealthy and consuming
more, but investors are overlooking valuations.
Q: Can you explain how you look at value creation?
A: In essence: Can a business earn a return on capital above its
cost of capital? If it does that, it creates value.
We look to construct a portfolio of businesses that are perhaps
low return on capital today, but because there is a change in
strategy, they will become value creating in the future. And those
types of business we normally have about 50% of the fund in. They
are typically your risk-on trade.
You can make a lot of money by buying a business that doesn't
make money if it is restructuring the asset base and selling assets
that aren't worth its keep. If it gets that right, it starts to
grow profits and return on capital.
If a business is breaking even, what does it need to do? It
needs to continue to focus on how it uses its assets. It needs to
start thinking about margins and profitability. Once it gets that
right, then it becomes value creating.
Finally, what drives the future success of a value-creating
business? It's sustaining those returns and then it's growing them
so you get the compound effect. So if you think of a business that
earns a 20% return on capital, every dollar that gets put back in
to the business becomes $1.20 and that gets reinvested and becomes
$1.44 etc. etc. The company continues to grow its book value.
Philosophically, that's what we're looking for.
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Email: thomas.streater@barrons.com
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