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Algy's Investment Podcast
Glen Finegan: Investing in Emerging Markets - Risks, Rewards & Realities | #20
01:08:44
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- [00:00]
A
Do you think emerging markets are suitable for all investors, big or large?
- [00:05]
B
I do. I think it's different types of growth. If you're heavily invested in US or global equity, there's a large bias in your portfolio today.
- [00:13]
A
How will Trump's trade policies affect your universe?
- [00:18]
B
They've had limited impact on us so far. I mean, the domestic businesses that we own continue to invest, continue to execute on long term.
- [00:26]
A
Are there any golden rules which is sort of imprinted on your brain, which
- [00:30]
B
you still adhere to today, not compromising on governance?
- [00:34]
A
What are the three biggest country exposures in the portfolio at the moment?
- [00:39]
B
Currently, we would have India as the largest country exposure, followed by Taiwan and then Mexico.
- [00:45]
A
In today's episode, my guest is Glenn Finnegan from Skerryvoor Asset Management. And Glenn has a vast amount of experience in managing money in global emerging markets. But what are your risk controls in terms of stock sector and country level?
- [01:02]
B
So we have some rules. No more than 50% in a single country and no more than 50% in a single sector.
- [01:07]
A
How do you define risk? What is risk to you?
- [01:10]
B
For us, risk is losing money, permanent loss of capital.
- [01:13]
A
How many stocks in your portfolio do you think today have got the potential to double over the next three years? Welcome to Algae's investment podcast. And in today's episode, my guest is Glenn Finnegan from Skerryvoor Asset Management. And Glenn has a vast amount of experience in managing money in global emerging markets. I think probably it's going to be the next hot subject for investors to be looking at and I'm going to ask him a whole range of questions about why investing in emerging markets and also most importantly, how he and his team run their global emerging market strategies and portfolios at Scoville. So, Glenn, welcome and thank you so much for joining me today.
- [02:02]
B
Thank you, Ali. Very nice to be here.
- [02:03]
A
So I've got to ask the first obvious question. What on earth is an emerging market?
- [02:10]
B
As an asset class? Today, it represents 80% of the population of the world.
- [02:16]
A
Wow.
- [02:16]
B
Very diverse set of countries. There's almost 50 plus countries across emerging and frontier market benchmarks. And that creates a interesting universe of stocks that one can build very diversified portfolios that are hopefully benefiting of companies that are hopefully benefiting from the spending power, increasing consumption of 80% of the world's population.
- [02:42]
A
Well, I think actually answering that question, you've almost answered my next question. Because my next question is what are the main characteristics of emerging markets?
- [02:53]
B
Again, a very diverse range. It's very hard to sort of link the shining Skyscrapers of Shenzhen with much more emerging parts of the globe. But there are large growing middle classes with increasing consumption of products and services that you and I take for granted in the developed world. And many of these are still at quite early stages in emerging markets. So it is possible to find good long term compounding types of businesses that can hopefully deliver a kind of different form of growth to what investors have been exposed to in the developed world recently, which is quite tech focused.
- [03:34]
A
Well, that would be very much welcomed by the likes of Warren Buffett. Strong long term compounding businesses. That is something ready to aim for in our chat today. Do you think that emerging markets are higher risk than developed markets today? If they are, why are they?
- [04:00]
B
I don't think they necessarily have to be. I think through stock picking you can manage many of the emerging market risks. I think the main perceived risk in emerging market investing is weak rule of law and we fully accept that. And I think as an emerging market investor you have to have your eyes wide open and your stock picking should fully reflect the fact that you may not have appropriate protections in the event of some sort of governance failure. And when identifying companies to invest in, you really must spend a lot of time understanding the history of the people behind the businesses and understanding whether or not they've demonstrated high levels of integrity over long periods of time, that they've treated all stakeholders and their businesses fairly. And that is really the best way to lower the risk of investing in emerging markets. I think you'll probably ask about currencies later.
- [04:55]
A
I will do definitely.
- [04:56]
B
Well, we can come on to how do you protect yourself from inflation later. But first and foremost, governance. High levels of alignment between us as minority shareholders and ultimately the people in control of capital allocation and companies is absolutely crucial.
- [05:14]
A
And so are emerging market equities. Are there returns highly correlated to the developed market? Equity markets like the US and Europe,
- [05:31]
B
they haven't been so obviously US and particularly US tech has had a very good 10, 15 years. The opposite has been the case for emerging markets. It's been a poor place to invest. Part of that I think is the governance challenge. If you look at some of the headwinds that have hit the emerging markets asset class, the wiping out of the Russian stock exchange, clearly a pretty significant failure of governance there. The kind of realization, I suppose, that a lot of very large state owned enterprise simply don't exist to benefit their minority shareholders. Big scandal in Brazil around the Petrobras state owned oil company. Hundreds of billions of dollars of political bribery and corruption and many of the state owned enterprise in China also delivering poor returns. So many of the headwinds for the asset class at the top level have been governance related to. But there are plenty of bright spots. Mid cap India, private businesses have performed very well. Some private Chinese companies have performed very well. So if one is very selective, so
- [06:41]
A
there's lots to go for if you're selective.
- [06:43]
B
Very much so.
- [06:44]
A
And then in terms of valuation, between global emerging markets and the developed markets, are equities in emerging markets generally cheaper or more expensive than the developed markets?
- [07:02]
B
Our portfolio is probably a better way. We don't use the benchmark. So our portfolio is cheaper than the S and P, has better earnings growth than the S and P, stronger balance sheets than many of the businesses in the S and P as well. So I do think after a long period in the wilderness, if you like, EM does offer a decent valuation opportunity.
- [07:21]
A
And of course in the 1990s, I remember when I used to be involved in managing money, we made some incredible returns out of emerging markets. And then we had the Mexican crisis and then we had the Asian crisis, but even after that they recovered pretty quickly. Do you think that the state of the finances of the countries where you're investing is as strong as it's ever been before?
- [07:55]
B
Without a doubt. The whole world is starting to resemble. Many parts of the developed world are starting to resemble what feels like the definition of an emerging market. Sort of erratic policymaking, fiscal issues, tariff and trade war, things like this. And actually in many ways the argument that EM should trade at some sort of a discount feels like it's going away. So I do think that the opportunity to make good absolute returns from emerging markets from here look reasonably good. And you must remember it's after a long period of doing quite poorly. But you're right, there have been some very good periods in EM, the 90s, the early 2000s. They came out of the financial crisis in 2008 very, very strongly as well. So there's been, you know, 10 year periods where Em has delivered great returns for investors. Just not the last 10 years.
- [08:49]
A
Just not the last 10 years. So this is really why we're talking how do currency movements affect the returns for investors in emerging markets?
- [09:01]
B
So I think weakening currency is a fact of life. It's a headwind that you sail into as an emerging markets investor. And again, like governance, it's better to embrace and accept that this is a risk and look to only invest in businesses that have demonstrated strong pricing power over a long period of time. Weak currencies leading to inflation isn't necessarily a problem so long as the business you're invested in can increase its prices in line or ahead of inflation. So we look to own businesses that have demonstrable track records of strong pricing power. And that leads us into some sectoral biases. We own strong brand owning consumer companies like Coca Cola bottling operations in emerging markets. We own very efficiently run retail operations that have a very strong, very strong ability to pass inflation through their top line. We also lean quite heavily into sort of intellectual property based businesses where you can point to a long track record of investing in R and D that gives you confidence that the businesses will be able to price in line or ahead of inflation. Other sectors we have biases against. We don't trust emerging market politicians and we try to stay away from businesses that are overly reliant on them or in any way. So we find it very difficult to buy regulated utility companies because ultimately it's a ministerial decision as to what price they can charge for their goods. And we also avoid very politically exposed groups, groups we think are benefiting from political relationships.
- [10:40]
A
That is very reassuring to know. And what about the performance of emerging markets? Recently there's been a big uptick in the absolute performance of emerging markets. What's caused that?
- [10:55]
B
Yeah, so the last couple of years emerging markets have, at the headline level have done, or a year and a half anyway, they've done a little bit better. I think part of it is one of the big headwinds over the last five years was the bursting of a bubble in the China equity market. The China equity market represented over 40% of the EM benchmark at its peak. It's enormous. And it was because the underlying stocks had become extraordinarily expensive. We were constantly seeing PEs of over 100 on stocks. These prices that really didn't make sense. So what you've seen is a sort of three, four year period of the Chinese equity market gradually derating, companies slowly growing into their multiples. And I think you could argue that market, we went into the China peak with zero, almost zero exposure to China. Our weightings in China are closer to 10% now. So we have taken advantage of the deflating bubble there. So that sort of, that bubble deflating I think created a bit of a floor perhaps under EM as an asset class. So things have done a little bit better since then.
- [12:09]
A
I think looking at your portfolio, your time is quite contrarian, which is great to see because I read an article last night and this investor had done a lot of research into negative or positive commentary about China. And last year, 595 of the 600 comments he'd seen written about China from investors was negative. And that surely that is the canary in the coal mine for potentially increasing exposure to China.
- [12:44]
B
Yes, but very selectively so you have to bear in mind the Chinese political system is what it is and therefore there is a lot of political influence over a lot of that economy. So you won't see us investing in Chinese state controlled banks or in fact state controlled enterprise anywhere in China or anywhere else for that matter. We're looking for strong founder led franchises or founder or owner manager type situations where you can point to very high levels of alignment. And we've been able to add China's leading pharmacy chain to the portfolio for the last couple of years. We've been able to add a leading manufacturer of medical devices, a kitchen equipment company. But these are all businesses where the founders remain heavily involved and heavily invested in the same shares that we can own. So the rules around alignment are even more important to get right in China.
- [13:42]
A
I find this absolutely fascinating. Do you think emerging markets are suitable for all investors, big or large?
- [13:53]
B
I do. I think it's different types of growth. I think if you're heavily invested in US or global equity, there's a large bias in your portfolio today driven by the fact that AI theme, AI infrastructure exposed businesses have become so flavor of the month and there's potentially a bubble formed there. And I think having some more diversification in your global asset allocation makes sense. And we can own the leading soft drink bottling businesses in West Africa, we can own leading convenience store operators in Latin America. And these are businesses that should be able to grow irrespective of whether or not there's a bust in expectations around very large AI investment. So it is a nice diversifier, I would say, for any type of investor with a sensible time horizon, with a
- [14:53]
A
sense of time horizon. I'm going to touch on that actually, because you said sensible time horizon. For you with all your wealth of experience, what is a sensible time horizon?
- [15:04]
B
So when we're valuing companies, we look for a 10 to 12% return over what we assume will be a five to seven year holding period. So ultimately, I think investing in an EM fund such as ours or a strategy such as ours, one should really have that five to seven year time horizon in mind.
- [15:22]
A
That's very important for people to understand. Where are the political risks in emerging markets? The. The lowest, not the highest, but the lowest.
- [15:36]
B
I mean, political risks seem to be rising globally with the tariff and trade wars and what have you been initiated in the US and inevitable sort of countering of that elsewhere. Geopolitical risks exist. Our new forms of geopolitical risk exist for companies that have been very used to very open multinational trading. We look to protect ourselves a bit from that by leaning more into domestic consumption focused businesses. So, for example, in April, when the tariffs were originally announced on Liberation Day, our funds went up when markets went down very substantially. So there is a, a degree of protection from rising geopolitical risks that comes from owning very strong domestic franchises in markets that are somewhat uncorrelated with the US in terms of where political risks are high or low. There are some countries where we have never invested and there are some countries where we have taken a pragmatic decision to disinvest. So we've never invested in Russia. We couldn't find companies in Russia that were run by people who we felt would put our interests on the same level as their own. We have disinvested from our only holding in Egypt. The military government there has exhibited a tendency to start interfering in the boards and they removed the chairman of a bank that we quite like in Egypt and what have you. So when we start to see increasing political interference in businesses, it can make us quite nervous about countries we don't currently have any investment in. Turkey, it's very hard. We want businesses with pricing power that can beat inflation. But when currencies are devaluing at the rate of the Turkish lira, it's hard to find anyone who can really keep up with it.
- [17:40]
A
If I could sort of put you on point and ask you, what is your strategy's exposure to domestic consumption across your range of companies as a sort of moistened finger in the wind?
- [18:01]
B
We would have about 45% of the strategy invested in what are known as consumer businesses. That's your soft drink retailers. It includes pharmacy chains. I always feel they should be included as healthcare, but they get called consumer companies. There's about 10 or 12% of the 45 would be pharmacy, which is more linked to healthcare spending. We also own a number of leading private banks in emerging markets. We own the leading mortgage bank in India where you only rent. 6% of the Indians have mortgages and there's plenty of Runway for that to compound in the long run. We are in a leading private bank in Indonesia where credit penetration remains very low. Private credit penetration remains very low. So direct and indirect exposure across the portfolio is pretty high. It could be up towards 60%.
- [18:51]
A
And so how will trump's trade policies affect your universe.
- [19:00]
B
They've had limited impact on us so far. I mean, the domestic businesses that we own continue to invest, continue to execute on long term growth plans that they have. We do invest in some businesses, particularly in China, which have become successful multinationals over time. So there's quite a number of Chinese businesses now that dominates whole niches globally. We've recently added a business that manufactures medical devices in China. The China market slowed down for the reasons that the bubble there bursting, the property bubble bursting, local governments who fund hospitals being cash strapped meant that demand for medical devices in China softened. But this business is 50% exposed to everywhere else and it's growing quite rapidly overseas. And it's not relying on access to the US market. You know, it's selling medical equipment to Indonesian hospitals, to Brazilian hospitals. And it's doing exactly what successful multinationals should do. It's investing in capacity in places like Mexico and what have you to diversify its global footprint. So there are a number of emerging multinationals coming out of China who if they were overly exposed to the U.S. i guess the tariffs could be a headache. But many of them are really more trading with the rest of the world. At least those are the ones that we're interested in.
- [20:27]
A
Very good answer. Well, some commentators out there are concerned about China's relationship with Taiwan. What has China got to benefit from invading Taiwan?
- [20:48]
B
I mean, there doesn't really seem to be any benefit for anyone for this to descend into a full blown conflict. It's a very hard thing to price as an investor. It's one of those sort of binary outcomes. We were able to avoid the fallout of Russia, Ukraine because we couldn't find Russian or Ukrainian businesses where we felt the governance models were strong enough to protect us. So that as a very governance focused investor, avoiding the fallout from that conflict wasn't particularly difficult. China, Taiwan is different because some of the Chinese businesses we look at are global leaders in their field. Taiwan is full of global leaders. We don't have a lot of exposure to domestic Taiwan. We are more invested in leading businesses that have built strong niches in particular technologies. And there aren't so many of those are in other emerging markets. So businesses with very strong intellectual property available to us in Taiwan. So it's very difficult for us to say we just will avoid Taiwan or we'll avoid China because actually there's some really good quality businesses that we think our clients will benefit from being exposed to. And we'll just have to monitor the developments and cross strait relations. You Would like to think that there'll be some form of accommodation before a full blown conflict, but it's just one. We have to. It's one of those risks that's out there and you have to live with it.
- [22:14]
A
And are there any restrictions for foreign investors when they're looking to invest in emerging markets? Are there any countries that create restrictions?
- [22:25]
B
Oh, yes, less than there were over the years there have been many markets have had things like foreign investor limits or a foreign board that investors might have to pay a premium for their shares and what have you. A lot of that is going away. The market with the most significant restrictions, the most important market with the most significant restrictions is China. Whole sectors of the Chinese economy are technically off limits for foreign investors. Internet, media and education are technically out of bounds for foreign investors, which sort of begs the question as to how on earth some Chinese Internet companies can be the biggest index constituents. And this comes to questions around alignment as well for us, in the sense that the very large Chinese Internet businesses, the Alibabas, the Tencents, Metuans, they've accessed foreign capital through legal structures called vies, which are variable interest entities. It's a legal mechanism that was actually designed originally by Enron to hold assets off balance sheet and not consolidate them. And the lawyers have helped these companies divide these structures in order to access foreign capital. And the index providers have been happy to overlook the obvious weakness in the structure and that you don't actually own the underlying company. But we've never been prepared to overlook that. We've benefited over the long run by not compromising on governance structures where alignment isn't sufficiently strong.
- [24:00]
A
Goodness, I never knew that. I never knew that. So that's going to lead me onto my next question, which is how do you define risk? What is risk to you?
- [24:14]
B
Well, it follows on from that answer. For us, risk is losing money, permanent loss of capital. And in my experience, governance compromises in emerging markets are the quickest way to experience a permanent loss of capital. And therefore, from our perspective, it's just not worth making those compromises.
- [24:40]
A
We've spoken about AI, talked about tech to some degree. I read the other day that I think the population of India is nearly one and a half billion people and that is the same size as the population of north and South America and Europe combined. What is it that really attracts you about India as a place to invest?
- [25:14]
B
Yeah, so I mean, obviously the headline numbers in India are staggering and for that reason investors have a bit of a habit of extrapolating very strong growth for A very long time and paying very high multiples for Indian companies. So that can be a bit of
- [25:28]
A
a challenge we try not to do
- [25:30]
B
and that can be a bit of a challenge. But there's no doubt the Runway for growth of many products and services within the context of a growing middle class is very robust for a long time to come. Trying to find ways to access that at reasonable valuations has been challenging. Although the mid cap part of the market has been experiencing some sort of a correction. We have a large position, as I mentioned, in Indian Mortgage bank which has a very, very long Runway to grow. We have a large position in a leading healthcare business there that manufactures medicines. And of course a feature of a growing middle class is better access to health care and that's driven a very nice long term domestic growth trend for this business that we own there. So looking for oblique ways to get exposure to this that doesn't involve paying very, very high multiples, that some of the names have is sort of our challenge, but the opportunity is real. There are some sustainability risks that I think it's clear that India has to manage. Things like water scarcity risks. It's certainly at the forefront of those types of things. And thinking about that as an investment risk in the types of businesses that you own is important too.
- [26:56]
A
Can emerging markets perform even during periods of high inflation, especially commodity price inflation?
- [27:09]
B
Again, it cuts both ways. I mean, Latin America loves high commodity prices. India and China obviously benefit from low commodity input prices. So again, it's a very diverse asset class. African markets performed very, very well about 10 years ago when commodity prices were high and they've had an awful decade since. So there's natural diversification across the wide range of countries that we look at.
- [27:41]
A
Well, Glenn, now let's move onto your business, Scarryvore Asset Management. Firstly, where did the name come from?
- [27:49]
B
So Skerryvoor is the name of the tallest lighthouse off the west coast of Scotland. It's about 150 years old. It was designed by the Stevenson family based out of Edinburgh and it stood the test of time. It marks a very significant rocky reef off Tyre. I do a little bit of sailing myself and I know it's very treacherous out there and prior to this lighthouse being constructed, you know, it was a dangerous place to navigate. And of course the lighthouse has enabled people to just to safely navigate this very rewarding but sometimes dangerous place. We quite like that. It's sort of an analogy for an investment philosophy that if you believe that emerging markets can be sometimes difficult to navigate, the idea of a sort of guiding light in the form of a lighthouse. We sort of felt summed up our approach.
- [28:42]
A
I love the name. And you founded the business in 2019. What does it look like today?
- [28:48]
B
Yeah, so we've evolved a lot from when we first started. We started as eight founders, we're now 17 people. We're based in Edinburgh and we have pooled vehicles available in Australia, Dublin, UCIT's vehicle and some funds in the US as well. We've got a very diverse client base, a mix of institution and sort of wholesale type clients. A growing number of endowments and foundations coming into the funds as well. So yeah, quite diversified, but emerging markets only investment boutique.
- [29:26]
A
And how long have you managed this strategy yourself?
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B
So I joined a firm called first state back in 2001 and there was a gentleman there called Angus Tullock who's retired now, but he was running. He's been running essentially this philosophy since 1988. I joined him in 2001 and I worked together with him until the end of 2014. I formally took over lead management around about 2007, I think. So yeah. Quite a few years of implementing it
- [30:01]
A
and First State is a very well known company. Angus Tullock is one of the legends of our industry. He was so lucky to have worked for Angus and I'm going to ask you a bit about him in a second. But before I do so are you allowed to tell me about what your long term track record is as a fund manager?
- [30:19]
B
Yeah, I am. It's differentiated in the sense that we've delivered better returns than the benchmark and peer group over the long run, but at much lower levels of volatility than the benchmark as well. So it's a different type of track record. I think if you talk in terms of upside, downside, capture, which people like to look at, we don't get all the upside because the conservative approach to governance and also valuation, meaning that we're often selling out of hot parts of the market maybe a little bit before other people, but that's protected us when markets have had tricky periods. So there's been very, very few down markets where the funds haven't done very well. So it's a different type of track record, a different type of approach and it appeals to longer term investors who aren't so focused on the one year performance number.
- [31:10]
A
I really like that because one of the best attributes of active fund management, if you lose less in the downturns, is that you keep the investor in the strategy and they don't bounce Themselves out.
- [31:28]
B
Yeah. It leads to a better franchise. Certainly that was our experience at first aid coming through the global financial crisis. Keeping people invested was important because there were super returns to be earned following it. So. Yeah, I totally agree. I think it's for any kind of long term. Our approach is rooted in trying to generate absolute returns over the long term.
- [31:51]
A
That's a very key word. So you're not a relative return investor over the long term, you're an absolute return investor.
- [31:57]
B
I think that's why on earth would one take the additional. Why would people put their assets into emerging market equity if it wasn't to generate an acceptable absolute return? Yeah.
- [32:11]
A
You can't spend relative returns at test scares, can you?
- [32:13]
B
No.
- [32:15]
A
So going back to Angus Tullock because I learned an awful lot from Angus just being a client of his for many years. Are there any golden rules which he taught you which are sort of imprinted on your brain which you still adhere to today?
- [32:39]
B
Yeah, Angus, as you say, I mean phenomenal track record over his career and I learned an awful lot from him. What I would say the golden rule that we very firmly continue to stick to today is about not compromising on governance. Angus, he had a very, very strong ability to identify people with integrity meeting hundreds and hundreds of management teams around Asia and emerging markets. He was very good at filtering out groups where you really felt that they viewed you, the minority shareholder as an equal owner of the business alongside them and your rights would be, you know, taken into account when any kind of capital allocation decisions that they're making. And he was extremely good at that and good at avoiding many of the banana skins which are, as I've said, normally governance related in emerging markets. So he's. We very much stick to that rule today.
- [33:40]
A
Fantastic. And focusing the limelight on you just for a second. What are the skills which you individually have, you yourself that you think bring the most to the team?
- [33:59]
B
We run a. And I'd say this comes from Angus as well I think is we run a very non hierarchical team. So really there's no owner of the truth on any holding that we have. And one has to be quite thick skinned I think to we've got very experienced investors on our team. I think the average Investment experience is 22 years or thereabouts. So there's no point in having such an experienced team if you're not prepared to be fully challenged by them. Yeah. So having a bit of a thick skin is an important part of it. And then I think the other thing that I've brought was over. My career is I enjoy investing. I get excited when I find an opportunity that appears to be of good quality and reasonably priced. I should get quite excited about it and enjoying going around looking for those sorts of opportunities. Hopefully drives a sort of a flywheel of decent ideas coming onto a watch list and keeps the portfolio sort of fresh.
- [35:06]
A
So you've touched on the team's experience, which is pretty incredible. But what makes your team so special in your eyes?
- [35:23]
B
There's a few, obviously experience is a huge part of it, but I think there's a few things we don't pay anyone based on one year relative returns. Everyone on the team is invested in the strategy personally. So essentially run their own money alongside client money and we run the funds with this absolute return goal, which is exactly how we would wish our own assets were run. So I think that drives certain behaviors, such as the willingness to say, I think maybe TSMC is getting quite fully priced and it might be the largest stock in the index, but if you don't see material upside to owning it, we won't hold it. So we're able to be very, very different to the benchmark. The boutique ownership structure is quite important as well. So the investors also own the business and the business was established to invest in this way. So the ownership structure and the investment philosophy are completely matched together. You don't get, as you do in bigger firms, a new CEO or a new CIO appearing and bringing their changes and what have you. There's a consistency of approach that comes with having a very aligned ownership model. The team is an interesting group of people in the sense that many of us have had jobs before we became investors. I worked in the oil industry. I was a geophysicist for a few years before I started working with Angus. And many of us have had careers before investing, which I think leads to a broader perspective.
- [37:06]
A
And does that help avoid group thinking?
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B
I think it does, yeah. It certainly. I mean, we have one investor who had worked at one of the very large consultancies before, and not only does he bring a certain amount of knowledge about IT and the IT consultancies, but but also a very different perspective to someone who studied engineering and geophysics and things like that. So I think it does bring broader perspectives.
- [37:32]
A
And if there's one thing you as a team are striving to get better at, because I can tell you're all very competitive to do a great job, what is it that you at the moment are striving to get better at?
- [37:48]
B
So when we describe our philosophy we say that there's three to four extremely important elements to a business being considered good enough to own on behalf of clients. The first is the history of governance and alignment. We've talked a lot about that. The second is a franchise that has pricing power in order to keep up and beat inflation. And the last is a very strong balance sheet. So it doesn't have to be net cash, but. But many of the companies that we invest in, in fact, the majority of companies that we own have no debt. And then finally it has to be behaving sustainably. So that's not to confuse it with sustainability targets, but to say if a business is knowingly polluting the drinking water of people around its factory, it goes all the way back to the beginning. That's telling you something about the integrity of the people running the business. And why do you think they would ultimately treat you any better as a minority shareholder if they're prepared to treat other stakeholders poorly? So those are the four things that we're looking for. We've done a good job over the long run of not making governance mistakes. So that sort of golden rule we've adhered to very well. We've never had a company go bankrupt on us so that the balance sheet side has held up. Okay, We've had all of our consumer companies got hit with COVID but none of them went bankrupt. None of them got into financial difficulties because of the balance sheet element. Where we've made the most mistakes over our careers is buying franchises that haven't been strong enough. So that is, they may have had pricing power, but the pricing power is sort of deteriorating over time. It might be because of new competition, it might be because of a lack of investment in innovation. And we've been, historically, I feel we've been a little bit too slow to get out of franchises that are withering on the vine a bit. And that's certainly an area that we're striving to be better. Being more ruthless, if you like, if companies are failing to meet what are our hopefully conservative assumptions over one year, one and a half years, not sitting there and hoping for the best, but actually saying, look, let's get this out of the portfolio and own a business that's actually demonstrating strong pricing power. I think that's probably the area where we've made most mistakes.
- [40:08]
A
What a wonderfully honest answer. You've touched it already. But could you, in a nutshell, give me your investment philosophy?
- [40:22]
B
Yeah, this is it. We protect our watch list from poor quality businesses by studying the history of Governance and alignment, studying the history of returns, margins, pricing, power, reinvestment and innovation or intellectual property development in order to really, we want honest people running strong businesses and then a deep study, deep understanding of balance sheets as well. So that's essentially how we build our watch list. We've got about 300 and over 300 businesses on the watch list that we've identified over the 25 years or so that we've been looking at emerging markets and obviously there's turnover in the watch list. Things change and companies leave and new companies come in. Within the watch list we have a very like our highest priority part of the watch list, which is probably about 20 of the 300 or so companies where we feel valuations are becoming quite interesting and they're close to competing for capital as a holding in the actual strategy. And then we have the portfolio itself which is where that subset of around about 45 holdings today trade at a valuation that we can credibly prove to ourselves that 10 to 12% per annum absolute return is realistic over a five year period.
- [41:47]
A
And what percentage of stocks in your portfolio are actually listed on developed market exchanges?
- [41:55]
B
It varies. 10 to 15% has been the historical sort of average. There's kind of two different types of companies that trade on developed world exchanges and we look at both. The first is an emerging market business that's chosen to raise capital in the developed world. So I think a good example of that would be the Coca Cola bottler for West Africa and Eastern Europe. It's a Greek family controlled business. They were very nervous about Greece and falling out of the euro back in 2008 so they moved the primary listing to London. So if you want to buy soft drink consumption in West Africa, you can buy a London based share and get some very high quality exposure. So that's an EM business, that's access capital in the developed world.
- [42:41]
A
Is there an advantage of having some of your portfolio listed on developed market exchanges? In terms of as long as the
- [42:52]
B
quality of the business is sufficiently good, then yes, it gives you a broader universe of stocks to pick from.
- [43:04]
A
How important do you think it is to trust company management?
- [43:09]
B
I mean it's at the heart of everything that we do. I mean there's two elements of trust. There's trust that they will treat stakeholders fairly and then there's trust that they can actually execute on the strategy. So there's two elements to that and we're looking for both in large quantities. So we're looking at, we like looking at long track records because assessing trust you can't go on to Bloomberg. There's no price to trust ratio, there's no price to integrity ratio. So all you can do is study history and say, we were looking at a Chinese company just a couple of weeks ago and we noticed that in 2012 there'd been a rights issue. And when we investigated the rights issue, it turned out that the chairman, it was a discounted rights issue to his own family. So that's just a straight disadvantage of minorities. And apart from that, we couldn't find anything wrong with the company. It looks like a great company, but because he's done that, it's a no. It's a no. And he can't make it. It can't progress through our process.
- [44:12]
A
So what percentage of the companies in your portfolio have significant founder shareholder holdings in them?
- [44:19]
B
A large number. There's different types of governance models that we look for. And a founder. So the actual founder still being involved and invested in the same equity is one that we quite like, so long as they're a proven executor. Families of founders where they act as a sort of steward of capital. We quite like those. We've got quite a number of those types of companies where at the board and shareholder level you'll have a family, but the business is run entirely professionally and the family acts to protect the interests of all the shareholders. So the management may want to leverage up the balance sheet, but the family will say, well, actually we don't want to leverage up the balance.
- [45:03]
A
Not on my watch.
- [45:03]
B
Not on my watch, exactly. So we like those types of governance structures, but we also own businesses where they are ownerless. Some markets have more ownerless corporations. The South African market, for example, a lot of companies there with very strong boards and governance models, but there isn't necessarily an identifiable owner. So it's really about assessing the strength of a governance model and long track records. The longer the track record, the better, because then you can take.
- [45:33]
A
Is it funny though? Is it so true? Isn't it? The further you go back in history, the easier it is to look forward.
- [45:40]
B
Exactly.
- [45:41]
A
In terms of trying to work out what might happen in the future. So what. What's the longest you've held a company for.
- [45:52]
B
So we had a look at this yesterday for you. We think it's a South African pharmacy chain called Clicks, used to be called Nuclics and now it's called Clicks. And anyone who's been to South Africa will see it essentially looks like Boots of South Africa, the leading pharmacy operator down there. And I met this company all the way back when I first started working in the industry in the very early 2000s. And we went to their headquarter building and in the lobby there was a sign. And it was before people really had access to stock market data on telephones or anything like that. And it said, today's share price is 14 random. Tomorrow's share price is up to you. And we just say it gives a window into the culture of the company that, you know, that people were. It was about value creation. And obviously we asked the management team about the origin of the sign and yes, all our.
- [46:48]
A
So how long have you owned the company for?
- [46:50]
B
Since all the way back then. So over 20, 25 years.
- [46:54]
A
Fantastic. And what is the oldest company that you own in your strategy?
- [47:00]
B
So we had another look at this. We own a. It's a good example of a developed world listed company that we've identified in Lisbon, Portugal. We own a company called Girono martins and it's 350 years, I think it's just over 350 years old. And it started with a single war in Lisbon, but it's now the leading discount retailer in Poland. It's building a chain of stores in Colombia. And obviously it has its legacy Portuguese business as well. It's got a controlling family, the dos Santos family, who've owned it for generations. It's got no debt and it's got an excellent track record of managing inflation in the markets where it operates. So it sort of ticks all of our quality metrics. Yeah. And 350 years to look at.
- [47:52]
A
And what is your average stock holding period? Because you did mention earlier on when you were going into a stock, what you're looking for it to do. In reality, things change a little bit.
- [48:02]
B
Yeah. So the turnover of the fund would suggest we hold stocks for five to seven years, 20% turnover thereabouts. But turnover goes up and down. When Covid hit, we added six new companies to the portfolio. This is the nice thing about having a watch list of quality companies that when they drop, you can act quickly to get them into the portfolio. So the turnover can be. In falling markets, our turnover goes up because names become attractive.
- [48:35]
A
They pop up and wink at you.
- [48:38]
B
Yes.
- [48:40]
A
And what is the scope of number of holdings you're prepared to hold in the portfolio at the moment? You said you hold 40.
- [48:50]
B
Yeah, in the mid to low 40s.
- [48:53]
A
Mid to low 40s. And that number just is the sweet spot for the strategy, is it?
- [48:58]
B
I think you want a certain amount of concentration. A strategy such as our one should have the conviction to back its strongest ideas. So we're quite comfortable having the top 10 holdings but been anything up to 50% of the portfolio and with a tale of interesting names then from there on down and we have written within the rules of the strategy we can be up to 80 holdings but I think that would be unlikely that we would. I think this sort of 40 to 50 number is probably about, is about
- [49:33]
A
the right one for you. And if I was listening to this conversation we're having today, I'd also want to know whether or not I'm going into a smaller company fund or not fund portfolio or I'm going into a large cap portfolio. Through your strategy, where do you sit in terms of the range of market capitalizations within the portfolio?
- [50:03]
B
Yeah, so the median market cap in our portfolio is about US$18 billion which I would say puts us as mid cap investors. The smallest company we hold is only about $800 million market cap and the largest company that we've been producing but continue to own a bit of is TSMC with over a trillion dollars of market cap and that throws the average up to more like $80 billion. But I think the median is a more illustrative number at 18. So it's the mid cap and this is where we find these founder family led firms or businesses that still have long runways to keep growing. We're certainly not a mega cap fund by any means.
- [50:49]
A
Cheeky question here, which I asked you to look up the answer for me before our conversation today. How many stocks in your portfolio do you think today have got the potential to double over the next three years?
- [51:08]
B
So looking across the. We have five year price targets for all of our holdings. And looking across the portfolio today, based on our assessment of what these companies might be worth in five years, that 10 to 12% hurdle that we set ourselves looks achievable maybe not in the most expensive technology stock that we've discussed, but across the whole portfolio and we reduce names or we think that it's not going to be possible. So yeah, mathematically doubling your money on a sort of five year view maybe rather than three year view should be realistic.
- [51:48]
A
But that's a wonderful return for somebody who wants to keep their head above water versus inflation.
- [51:57]
B
I think so. I've certainly been buying the fund personally because I think the same thing. We are in a world where there's no doubt the gold price is telling you something about what investors are thinking about government's fiscal positions and things like that. A basket of very well governed strong franchises that should Compound even in an economic downturn with balance sheets that can weather recessions, feels like a good place to be.
- [52:35]
A
How does a new investment get into the portfolio?
- [52:41]
B
So we're constantly meeting companies, hundreds of companies a year, teams, how many people,
- [52:45]
A
how many people in the team?
- [52:47]
B
So we're 17 people across the firm and seven of us full time.
- [52:50]
A
Seven years. Full time.
- [52:51]
B
Of course, full time stock picking. Yeah. And so we're meeting, we meet up 200 plus companies every year. Everyone's a generalist, so everyone has the freedom to, you know, say I, you know, I've met xyz, Chinese industrial, I'd like to do some more work on it, you know. If the team broadly agrees that it's a sensible area for us to spend effort, then a team member will go away and produce a very in depth due diligence document which studies history. It's all about the history of who the people are, how capital has been allocated, how stakeholders have been, how stakeholders have been treated. And then this document is discussed. At our regular investment team meeting we do a written Q and A. In the past we always had a sort of a quick fire question and answer in the meeting, but we found that it's too easy to duck the difficult questions in those situations. So we now have written Q and
- [53:49]
A
A where the analysts nowhere to hide
- [53:51]
B
and there's nowhere to hide. You actually have to answer the question and everyone agrees, actually answering the question, the written Q and A is often harder than writing the actual original report. So yeah, at that point a decision would be made that a company is good enough quality and then we would start to discuss valuation. So we very much put valuation at the end of the process and I think that helps us not get. We'll never start looking at something just because it's cheap, because I think we need to look at it because it's very good. And then is it cheap enough? Would be the question, Might you earn 10 to 12% per annum?
- [54:27]
A
When will we sell a stock?
- [54:32]
B
Well, generally speaking there's two types of sells and one is where the thesis is played out and you've achieved your 10 to 12% perhaps a little bit ahead of time. Oftentimes the market can give you the returns a bit sooner than your nice linear model assumes. So selling on valuation grounds and moving it back to the watch list and keeping an eye on it and hoping to get another opportunity to win it in the future. And then there's the less good sell where the investment thesis hasn't played out and there's different ways that can happen. I mean, you could have an emerging governance concern. So I mentioned in Egypt we had the government step in and remove the chairman of a bank that we held and had long admired. And that, you know, that was an event that we couldn't, we couldn't justify continuing to own the business. So a change in the governance model led us to exit the holding and actually remove it from the watch list. Because, you know, if the government's choosing the chairman, it's not, it's not what we invest in.
- [55:33]
A
It's not good, is it?
- [55:36]
B
And then there's this emerging franchise concern, you know, where you're getting quarter after quarter of deteriorating results and your belief that the company had sustainable pricing power is ultimately being eroded. And trying to be a little bit quicker to recognize those and get them out of the portfolio is another sell decision.
- [55:57]
A
And so as a team, you're set up to be better buyers or sellers of stocks.
- [56:07]
B
I think history would suggest we've been better buyers. And I think this is linked to the philosophy when, if you buy a little bit too early or you buy ahead of an event, so long as you've maintained conviction in the integrity, honesty, governance structure, the fact that the business is suddenly 30% cheaper only makes you want to buy more of it. So the conviction to add when things fall is higher because of the level of work we've done building confidence in the people behind the businesses. So I think, yeah, we've proven to be quite good at buying in downturns. Historically, selling is a different discipline. There's different types of sell mistakes. 1 are selling too early, hanging on too long, but we try to keep it rooted in valuation. Are you going to earn an acceptable absolute return from here?
- [57:10]
A
Do you trade around a position to take advantage of short term market volatility or do you just sit in your hands and let the company do its own magic?
- [57:27]
B
We do. As companies approach price targets, obviously your perception of what you might earn from holding it, obviously it's a shrinking return. So we might have a company that's performed a little bit better than we might have expected and you're only seeing an 8% likely return for the coming five years. That to us is probably at the margin of a reduce. And similarly we have examples where nothing's really changed other than the price of the stock and you're looking at a sort of 15, 16% expected return. And we're going to add to those types of positions as well. So it's linked to our view of what the absolute return potential is.
- [58:08]
A
I Love this question. When I was thinking what to ask you, which sectors are just too difficult, too dangerous or just too goddamn boring to invest in?
- [58:24]
B
There are biases in the fund. Anyone who looks at the fact sheet will see some of these biases. We're biased towards really well run, inflation protected consumer type businesses and businesses that have a long history of generating strong IP because that gives us conviction in what's hopefully going to be sustainable pricing power. And there are sectors that simply don't lend themselves to pricing power having pricing power. So regulated utilities, we don't own any sort of regulated electricity generation companies because ultimately they're not in control of their own destiny. Our Coca Cola bottlers have endless revenue management levers they can pull shrinking pack sizes, fiddling with the recipe, all the things that they can do to manage their margins and manage inflation. When a government is setting the price of the electricity or the water or whatever utility is, that's just not a form of pricing power that we're confident in. Similarly, we have no exposure to oil and gas or mining businesses today, directly to mining businesses today. And that is a bit of a feature of em. The best natural resource assets around EM exist in the worst governance structures. Brazilian oil fields are very valuable, but Petrobras is very hard to say that it's run for the benefit of its minority shareholders. Gas problems, Gas fields are valuable but clearly worth nothing to foreign investors. So it's hard to find top tier assets inside governance structures in those industries.
- [60:04]
A
Which sectors give your investors the best risk reward in your universe?
- [60:12]
B
It's a myriad, everything across very strong brand owning consumer companies, very efficiently run retailers. We own some E commerce businesses. We own a leading ecommerce e commerce business in Latin America where very unusually for that industry it's one share, one vote. So we actually sit alongside the founder in this business without and they don't have super voting rights or anything like this which is a feature of those industries. So we can find E commerce type businesses where there isn't a governance compromise to be made either away from China. But so yeah, sectors where you believe that both the ability to grow and have sustainable pricing power so not have growing with deteriorating margins.
- [61:06]
A
And then you mentioned it earlier on. But what are your risk controls in terms of stock sector and country level?
- [61:18]
B
Yep, so we have some rules. No more than 50% in a single country and no more than 50% in a single sector and we're not allowed to have more than 10% in cash, although in reality we run cash fairly close to zero because we believe our investors are, they want us to allocate their money to leading emerging market firms, not sit on their cash. So yes, those rules are designed to create some diversification in the portfolio, but also give us a lot of freedom to express where we think the best ideas are.
- [61:54]
A
And how does the concept of sustainability feature in your portfolios?
- [62:02]
B
Simply put, if a business is not acting sustainably, it won't be able to carry on. So we think of sustainability and investment as they're just two sides of the same coin. So a business that generates, if it's pricing power, the source of its pricing power is not treating its waste. At some point that's going to become a financial problem for you or if it's modern slavery type issue, it's going to become a boycott issue or a financial penalty issue. So yeah, simply businesses that are not acting sustainably are likely to be poor investments.
- [62:41]
A
And what are the three biggest country exposures in the portfolio at the moment?
- [62:51]
B
Yeah, so currently we would have India as the largest country exposure, followed by Taiwan and then Mexico. But I guess what's somewhat interesting is some of our Indian holdings are very global in nature. Our Chinese businesses, sorry, our Taiwanese businesses are extremely global companies and the names we hold in Mexico actually have Pan Latin American franchises in many cases. So the headline country weights don't really give you a true picture of how diversified the sort of sources of cash flow that the portfolio enjoys.
- [63:32]
A
Of course. And let's just touch on the active fund management versus passive fund management and ETF index trackers. What do you think are the pitfalls or dangers that are potentially involved for investors going into index trackers in emerging markets?
- [64:01]
B
Yeah, so this comment, I'll caveat by saying this is specifically about emerging markets. So if you compare an emerging market index to a US or developed world index, the large companies making up a developed world index are generally speaking businesses that have been very successful and have built their market cap by growing a huge franchise. If you look at the emerging markets index, it's really quite different. There are, of course there are some of those that have grown under very strong leadership and built huge franchises. But there are many listed bits of government say Petrobras is the Ministry of Energy in Brazil. The Chinese banks are an extension of the Ministry of Finance in China and you know, will be directed by the Ministry to achieve whatever aims it wishes. There's a very large state owned banking sector in India which I would, you know, not, I would, would not claim was run for the benefit of all shareholders. It's A, you know, it's a, it's a politically driven sort of sector but because these are big, they, you know, they're also represented in the index. So to buy an EM index fund exposes you to some of these very good names but also lots of these names where I think if you looked at it standalone you'd probably rather not be exposed to it.
- [65:26]
A
Fascinating. Which of course brings you to my next question which you may be able to give me some sort of indication on is what is the active share? That is the percentage of your portfolio that is not, not replicated by the index.
- [65:45]
B
Yeah, we've always run very high active share portfolios and we're in and around 95 I believe at the moment.
- [65:52]
A
That's a proper active fund, isn't it?
- [65:54]
B
It's very different.
- [65:55]
A
Very, very different indeed in this AI driven world that we are living and breathing in today. Do you think active fund manager management has got a bright future?
- [66:12]
B
I mean, I hope so. I think that AI, we were using it ourselves as a sort of a productivity improvement tool. We use it across the firm and clearly it should bring efficiencies to businesses, you know, in our portfolio that potentially help them with returns. We, I've mentioned Coca Cola bottles a few times but you know, they're utilizing all sorts of AI solutions to help with their revenue management system and what have you to make sure their distribution can be even more efficient. So I think, you know, there's no doubt there's some useful tools emerging. I'm not sure that AI will ever be particularly good at assessing integrity in the way that we go about looking for governance models, which is a very subjective activity. What is acceptable ultimately judging integrity is about operating in the gray.
- [67:10]
A
Absolutely.
- [67:11]
B
And I'm not sure that AI is there just yet.
- [67:16]
A
I think that's a brilliant answer. How will you judge yourself in terms of how successful you've been when one day you decide to retire?
- [67:30]
B
Yeah, I think to look back over one's sort of whole track record and, and it would be very pleasing to see that we'd sort of, we, we'd done or, or even beaten the hurdle that we set out for ourselves after 10 quite poor years for em. I'm a little bit off the pace at the moment. My annual return is just sub 10 at the moment.
- [67:52]
A
10%?
- [67:53]
B
Yeah. Since I began running the fund. So you know it's, and we can, we have our long term track record. So yeah, to achieve the hurdle rate that we've set ourselves over the rest of my career would be, I think you could look back on and say you've done a reasonably good job for clients.
- [68:14]
A
Well, Glenn, I've thoroughly enjoyed talking to you this morning. I've learned so much and I can see that actually investing in emerging markets is so to do it successfully is so dependent upon making sure that you are investing in management that you can trust and great businesses which are sustainable. Thank you very much.
- [68:38]
B
Thank you.