Speaker 1: Welcome to Inside Active, a podcast about active managers that
Speaker 1: goes beyond sound bites and headlines and looks deeper into
Speaker 1: the processes, challenges, and philosophies and security selection. I'm David Cohne,
Speaker 1: i lead mutual fund and active Research at Bloomberg Intelligence.
Speaker 1: Today my co host is Marvin Chen, Senior Asia equity
Speaker 1: strategist at Bloomberg Intelligence. Marvin, thank you for joining me today.
Speaker 2: Hi David, thank you for having me.
Speaker 1: So you recently published a note pretty interesting on you know,
Speaker 1: emerging market and so, you know, I just want to
Speaker 1: see what's kind of driving the markets right now.
Speaker 2: Yeah, David, So, you know emerging markets is, emerging markets
Speaker 2: are having a pretty good year, one of the best
Speaker 2: since I think around twenty seventeen. And what we like
Speaker 2: to do is, you know, we like to break down
Speaker 2: the returns of emerging markets in terms of currency change, valuations,
Speaker 2: and the earnings outlook. And what is interesting is that
Speaker 2: we're noticing that, you know, a lot we've seen some
Speaker 2: valuation rerating, particularly in you know, China, some of the
Speaker 2: North Asian markets such as Korea and Taiwan. But what
Speaker 2: has been the main driver this year is the currency
Speaker 2: change you know, the weaker dollar has helped drive returns
Speaker 2: in some of the best performing markets. If we look
Speaker 2: at some of the top performing markets such as Korea,
Speaker 2: some of the Latin American countries, you know, the currency
Speaker 2: gains have accounted for maybe ten to thirty percent of
Speaker 2: the returns. So the outlook of the dollar is quite important.
Speaker 2: I think we think going forward, you know, it has
Speaker 2: been a big driver in the first half of the year,
Speaker 2: but uh, you know, things will be changing going forward
Speaker 2: with the expected fed rache Chet cycle beginning again.
Speaker 1: Be something to watch. And speaking of emerging markets, I'd
Speaker 1: like to welcome Robert Marshall lead to the podcast. Rob
Speaker 1: is the founding partner and chief investment officer of Kusana Capital.
Speaker 1: Rob thank you for joining us today.
Speaker 3: Thanks David, it's a pleasure to be here.
Speaker 1: So let's talk about the Kasana's emerging market strategy. Your
Speaker 1: sword and shield approach is really a unique framework you
Speaker 1: kind of unpack how that philosophy shapes your portfolio decisions.
Speaker 4: I started investing in emerging markets in about nineteen ninety nine,
Speaker 4: and at that point I was a chartered accountant beforehand,
Speaker 4: and I just started investing it. I was a utilities
Speaker 4: analyst Newton Investment Management now part of BNY Mellon, and
Speaker 4: I was there at the very early stages of the
Speaker 4: kind of the industrialization of China, and it was a
Speaker 4: fascinating place to invest, and a lot of companies did
Speaker 4: very well through that that industrialization boom, which led to
Speaker 4: a commodities boom. I ended up being a mining analyst
Speaker 4: as well, and as a time, you can make ten
Speaker 4: times of money in mining sector. During my experience since
Speaker 4: ninety nine, you know, I became progressively aware that there
Speaker 4: were some very, very value generating companies in emerging markets,
Speaker 4: but they were kind of being offset by a whole
Speaker 4: bunch of companies which kind of go violently sideways or
Speaker 4: even violently down. And so when you look at the index,
Speaker 4: all you see is the combination of those two effects
Speaker 4: going on. So the compound is being offset by the
Speaker 4: value destroyers effectively, and Henry Besenbind has done some really
Speaker 4: good work on that which highlights that in pretty much
Speaker 4: any stock market over time, it's a relatively small number
Speaker 4: of companies that generate most of the returns. And that's
Speaker 4: something I kind of observed over my own experience, you know,
Speaker 4: over the first ten years of investing globally, but with
Speaker 4: you know, with a significant amount of emerging market experience
Speaker 4: in twenty eleven, and I had the fortunate ability to
Speaker 4: set up an emerging market strategy from scratch, having been
Speaker 4: a global port value manager for the a number of
Speaker 4: years before that, and because of my experience, and because
Speaker 4: I didn't have any pre existing clown promises, I could
Speaker 4: think hard about what I was trying to achieve. And
Speaker 4: what I realized is you don't want to be tracking
Speaker 4: the index. You don't want to be measuring the risk
Speaker 4: relative to an index which is not your friend. So,
Speaker 4: for example, if you've got thirty percent of the index,
Speaker 4: which is state identities, which is broadly the number, those
Speaker 4: companies are not run for shoeld of value creation. So unlike,
Speaker 4: for example, the US market, which on the whole is
Speaker 4: quite eva centric, that is absolutely not the case for
Speaker 4: large swathes of emerging markets. So although you might have,
Speaker 4: you know, for example, a commodity boom and things like this,
Speaker 4: there are some parts of the market which are creating
Speaker 4: value and a whole load of others which are destroying value,
Speaker 4: even if they have good years every now and then.
Speaker 4: So rather than chasing those ups and downs of the
Speaker 4: oil price or whatever is driving those swings back and forwards.
Speaker 4: It's much better to understand whether value creation is really happening.
Speaker 4: And there are some great companies in emerging markets with
Speaker 4: some very long, strong underlying growth pinnings. But it's understanding
Speaker 4: what attributes you're looking forward doing that and then being
Speaker 4: able to construct a portfolio which captures those without worrying
Speaker 4: about all the swings in the index. So all that
Speaker 4: kind of sign is kind of obvious, you know, where
Speaker 4: if the crazy risks from state identities and olig ar
Speaker 4: coned oil companies in Russia and those kind of things
Speaker 4: at the same time as created, you know, for example,
Speaker 4: investing in the brilliant consumer franchises in India. So you
Speaker 4: think it's well, of course, you know, why doesn't everyone
Speaker 4: do that? But the difficulty comes because everyone's kind of
Speaker 4: weighed against an index on an annual basis. You get
Speaker 4: annual bonuses within a large investment house. The market convention
Speaker 4: from media and so on is to focus on the
Speaker 4: last twelve or eighteen months or rolling three years even
Speaker 4: and if you stand out from the crowd and do
Speaker 4: something different, you can look really silly for a period
Speaker 4: of time. So if all those state owned Chinese banks
Speaker 4: rally by fifty percent like they did in mid twenty fifteen,
Speaker 4: and you don't own them because you don't want to
Speaker 4: earn them, then you look a little bit foolish for
Speaker 4: a while. And the question is can you stomach looking
Speaker 4: foolish for a while, or do you lose your job
Speaker 4: or do you use your cliants because you haven't given
Speaker 4: them reason to understand that you're going to do something different.
Speaker 4: But stepping back, you know, over the period since twenty eleven,
Speaker 4: the strategy that I started at that point and have
Speaker 4: run since then and at Kusana since twenty two has
Speaker 4: generated something like three or four times the index return
Speaker 4: cumulatively over time. So the index has gone up a
Speaker 4: little bit, you know, each year, but it goes violently
Speaker 4: up and down on in a given calendar year. But
Speaker 4: stepping back from that, you know, we've had stots which
Speaker 4: have generated here multiples of return over a sustained long
Speaker 4: term period with a much larger position size, and so
Speaker 4: you actually generate a much higher return with a lower
Speaker 4: level of absolute growth. So stronger corporate governance, high return
Speaker 4: on capital, businesses, strong balance sheets. These are the things
Speaker 4: that protect your capital. And it's a bit like when
Speaker 4: we look at the US mag seven it's a similar
Speaker 4: kind of effect. There are certain number of companies which
Speaker 4: actually generating those returns.
Speaker 1: So if you know the majority of companies in the
Speaker 1: index are value destructive, you know, how do you find
Speaker 1: the ones that aren't? Like what is your process?
Speaker 4: It's having a clear idea on the attributes that you're
Speaker 4: looking for and the warning signs or the kind of
Speaker 4: not even the warning signs, just the you know what
Speaker 4: mediocre looks like. Most businesses out there are not competitively advantage.
Speaker 4: They'll have the moment in the sun. You know, it's
Speaker 4: a steel company makes really good profits one year. Guess what,
Speaker 4: someone comes to builds another steel plant next to you,
Speaker 4: and supply demand corrects, and then you probably make really
Speaker 4: bad returns the next year. That happens with shipping the
Speaker 4: whole time, airlines. You know, that's the kind of the
Speaker 4: lower quality businesses, and it's most of the businesses, to
Speaker 4: be honest. Or in Brazil you have the corporate governance
Speaker 4: set up. The incentive structures for most management teams are
Speaker 4: focused on sales growth and EBITDAR growth, so They're focused
Speaker 4: on P and L growth, not value creation. So if
Speaker 4: I'm a manager in Brazil, what do I do? I
Speaker 4: raise capital, I do lots of M and a lots
Speaker 4: of roll ups. I get paid, and I'm not creating
Speaker 4: any sustainable growth. So the shelters will go up and
Speaker 4: down and up and down. Actually they don't, you know,
Speaker 4: they don't have a long term good good journey.
Speaker 5: So what we look for is is well managed businesses,
Speaker 5: normally founder lead, so I think sixty five plus percent
Speaker 5: of our portfolio is founder led businesses in China and
Speaker 5: India and.
Speaker 3: Brazil, et cetera.
Speaker 4: We look for high incrementalt on capital into a structural
Speaker 4: growth opportunity. So we're looking for a long one way
Speaker 4: for growth. We want to own stocks ideally for ten
Speaker 4: years plus, and we want the compounding effect of reinvesting
Speaker 4: in the growth at a high incremental return to be
Speaker 4: the core dry of our returns over time. It's far
Speaker 4: more predictable, it's lower risk. But you can find those
Speaker 4: great business franchises which actually they don't have mean reversion.
Speaker 4: They have something which is unique, which is their proposition
Speaker 4: to their customers, which they're able to charge for often
Speaker 4: with capitalized businesses with big barriers to entry.
Speaker 3: It could be network effects.
Speaker 4: So for example, we have make my Trip, which is
Speaker 4: like the booking dot com of India. It has sixty
Speaker 4: percent market share. The next peer is at ten percent.
Speaker 4: But you have very strong network effects and a high
Speaker 4: return business model. And that's when you can you can
Speaker 4: start kind of banking on the kind of the sustained reinvestment.
Speaker 4: And it is a completely different perspective on value. If
Speaker 4: you think you've got a cash earnings per sure which
Speaker 4: is companning at twenty percent, it's got a very different
Speaker 4: value from the mediocre which is compounding at four or
Speaker 4: five percent if you're lucky.
Speaker 1: So you mentioned governance, you know, and gave an example
Speaker 1: in Brazil. You know, in emerging markets governance can be opaque.
Speaker 1: So how do you vet the skin in the game?
Speaker 1: You know, where managers have their interests aligned with other shareholders?
Speaker 5: Is behavioral?
Speaker 4: I mean, really you try and to judge companies over
Speaker 4: as long a period as possible. You should buy IPOs
Speaker 4: very very warily because you didn't have that kind of
Speaker 4: track record. We look for alignment of interest. Sometimes it's clear,
Speaker 4: sometimes it's a little less clear. You can have a
Speaker 4: really good professional management team which is doing all the
Speaker 4: right stuff. So, for example, TSMC was effectively a founder
Speaker 4: led business and has become effectively a professional management but
Speaker 4: they're reinvesting wisely for the long term. They're trying to
Speaker 4: do the best for their customer base and the industry
Speaker 4: as well as making very acceptable profits for themselves. So
Speaker 4: that's a kind of a nice, you know, a nice
Speaker 4: symbiotic relationship. We like founder led businesses, but ones that
Speaker 4: don't rip you off, which is kind of in stark
Speaker 4: contrast to you know, I don't know a Russian steel
Speaker 4: company owned by an oligarch who will be buying a
Speaker 4: shipping port for ten million dollars and then selling it
Speaker 4: to the LISCO for one hundred million dollars, extracting value
Speaker 4: at your expense. And the obvious thing to do to
Speaker 4: look for that is look at return on capital and
Speaker 4: return on equity and cashlow measures of that on a
Speaker 4: through the cycle basis, so you can often see what
Speaker 4: warning signs things that don't make sense. So we had
Speaker 4: we looked at a fast moving consumer goods company which
Speaker 4: made choco pies in South Korea, and we can't understand
Speaker 4: why it didn't seem to be profitable enough, and it's
Speaker 4: because they would make really nice cash flows, and then
Speaker 4: every now and then they go and buy a related
Speaker 4: party company an elevated valuation, so the effectively disenfranchising the
Speaker 4: minority investors. So we're looking at a whole raft of
Speaker 4: different things. We have what we call the investment checklist,
Speaker 4: which is really all the learning points of my career
Speaker 4: since nineteen ninety nine as an investor and actually even
Speaker 4: before that was a chartered accountant, thinking about what are
Speaker 4: the things that allow us to have confidence in those businesses?
Speaker 4: What are the warning signs? We won't get over perfect.
Speaker 4: But what we're trying to do is cut out nineteen
Speaker 4: ninety five percent of the market and focus on the
Speaker 4: top five or ten percent in order to identify the
Speaker 4: best twenty five or thirty opportunities for us to invest
Speaker 4: in with a five year horizon.
Speaker 1: So what does the typical holding period look like? You know,
Speaker 1: how often do you reassess thesis?
Speaker 4: So the way we work is because we're trying to
Speaker 4: give that compounding effect enough time to manifest itself, we
Speaker 4: inherently go and win with a five year horizon.
Speaker 3: So everything we're doing in terms of.
Speaker 4: How we're assessing the backdrop, how we're thinking about the company,
Speaker 4: how we're thinking about its reinvestment of earnings. We want
Speaker 4: to have the ability for it to be recycling capital
Speaker 4: through the business and understanding the power of that. So
Speaker 4: we find that five years is a period which is
Speaker 4: long enough to allow the compounding to become the material driver.
Speaker 4: So you're a one year investor, it's kind of eighty
Speaker 4: percent about the multiple, which is that kind of the
Speaker 4: voting mechanism in Buffett's peak, versus twenty percent the kind.
Speaker 3: Of the earnings power. Whereas if you.
Speaker 4: Take the compounding of effect forward, then it becomes more
Speaker 4: like twenty percent multiple move and eighty percent about the earnings.
Speaker 4: So although you might think further out, it becomes less certain.
Speaker 4: In many ways, it becomes more certain. The difference between
Speaker 4: the good ones and the bad ones becomes clearer. And
Speaker 4: so when we're we're valuing the companies, when we're assessing
Speaker 4: the different scenarios that we see before us, everything we're
Speaker 4: doing is with a five year view, and therefore, inherently
Speaker 4: that tends to kind of tie in pretty well with
Speaker 4: our typical holding period. Now, because in the real world,
Speaker 4: share prices don't follow a nice classic compounding curve, even
Speaker 4: of the earnings per share and the cash earnings per
Speaker 4: shure moved in a perfectly smooth fifteen percent compound.
Speaker 3: Growth rate curve.
Speaker 4: There's always different stuff happening in the markets. There's always
Speaker 4: a lot of noise around, which encourages people to trade
Speaker 4: backwards and forwards, and that means the share price is oscillate.
Speaker 4: So the kind of the anchor of the share price
Speaker 4: is effectively that cash earnings perssure curve, but the share
Speaker 4: price will re rate and derate depending on the views
Speaker 4: on risk reward around the broader market, and that presents
Speaker 4: us opportunities to trim backstocks which are done well and
Speaker 4: ad to stops which are done less well. So we're
Speaker 4: using a time advantage. If we're assessing things on a
Speaker 4: five year view and everyone else is working on a
Speaker 4: twelve eighteen month view, which is the kind of the
Speaker 4: typical in our view in the market, and perhaps even
Speaker 4: shorter in places like China. Then we find great stocks
Speaker 4: on sale periodically, and sometimes they get bid up to
Speaker 4: crazy prices, like internet companies did in late twenty twenty.
Speaker 4: So we want to be taking money off the table.
Speaker 4: The risk reward is less good than other.
Speaker 3: Opportunities that we have.
Speaker 4: So bringing all of that together, what we're trying to
Speaker 4: do is optimize from today with a five year view.
Speaker 4: Every single day we're trying to optimize our capital allocation
Speaker 4: in terms of our view on the balance of risk.
Speaker 3: Rewards for the next five years.
Speaker 4: And so some stocks will be an eight percent position,
Speaker 4: some might be a one position, some will be going
Speaker 4: out sometimes. And actually, when we're performing very well, our
Speaker 4: turnover tends to go up because we have to recycle more.
Speaker 4: And when our performance is lagging the market, which actually
Speaker 4: did earlier this year, then actually our turnover tends to
Speaker 4: drop back. Because we're pretty happy with our positions, we
Speaker 4: don't need to change much. We might concentrate it more
Speaker 4: into our top holdings, for example, and that's a sign
Speaker 4: of confidence and a sign of a steady temperament. Every
Speaker 4: now and then there's a reason why you need to
Speaker 4: change things more. So when we came to the end
Speaker 4: of twenty twenty, it was we moved from an deflationary
Speaker 4: period into an inflationary period. That does kind of cause
Speaker 4: you to want to kind of make some adjustments. So
Speaker 4: we shouldn't be afraid of managing. We don't manage to
Speaker 4: a turnover level. But at our name term turnover, which
Speaker 4: is kind of reflective of how we invest, is around
Speaker 4: twenty percent. And then we have a kind of a
Speaker 4: topping entailing within the portfolio, as I said, trimming the
Speaker 4: kind of the strong performance and topping up some of
Speaker 4: the weaker ones. And that is so the actual turnout
Speaker 4: is more like forty or fifty percent.
Speaker 2: So rab bit upon the macro outlook. I mean, we've
Speaker 2: talked about how em is having one of the best
Speaker 2: years since you know, twenty seventeen. I guess the big
Speaker 2: question now is it sustainable? And you know, how does
Speaker 2: the FED outlook and expectations for you know, the race cycle.
Speaker 2: Will that be the next catalyst for emerging markets in
Speaker 2: the near term?
Speaker 4: Yes, I mean I think I guess I'm not the
Speaker 4: kind of the ultimate expert on macro. I'm a stock investor,
Speaker 4: but the macro is still is important in supporting the
Speaker 4: best franchises. And I have some observations. So generally the
Speaker 4: emerging markets tend to outperform in a very correlated fashion
Speaker 4: against the Dixie so the trade weighted US dollar, and
Speaker 4: of course that gets moved around by you know, fed
Speaker 4: rates and and so on. So you see this year
Speaker 4: with moving to more dissinflationy backdrop, and there's money exiting
Speaker 4: the US dollar from very extended levels after a ten
Speaker 4: year bill market. We're clearly seeing the dollar trading often.
Speaker 4: That tends to be very good for emerging market relative
Speaker 4: performance at the index level. Some of the reasons behind that.
Speaker 4: So you know, when the currency drops, it improves the
Speaker 4: kind of purchasing power within the emerging markets. Cost of
Speaker 4: capital tends to drop. So we've seen bond yeals in
Speaker 4: many emerging markets going way below developed market bond yeals.
Speaker 4: It's a particularly interesting time actually, you know, I think
Speaker 4: the developed world is sort of hitting the limits in
Speaker 4: terms of fiscal affordability, you know, with aging populations and
Speaker 4: immigration and excessive promises, and so the market is done
Speaker 4: to call time on that by raising the cost of capital, just.
Speaker 3: Like we see in an emerging market.
Speaker 4: So like Brazil in twenty fourteen, things like this, you know,
Speaker 4: the country lives beyond its means. The market will enforce
Speaker 4: discipline through the currency and through the cost of capital.
Speaker 4: And I think we see that happening in the US,
Speaker 4: but also in Europe.
Speaker 3: And Japan.
Speaker 4: But if for emerging markets, you know, you have a
Speaker 4: slightly different situation on the whole.
Speaker 3: So we have.
Speaker 4: A shift from an inflationary period into a disinflationary period.
Speaker 4: We see that very clearly, and quite a lot of markets,
Speaker 4: China really into kind of pretty much on the edge
Speaker 4: of deflation, which is perhaps a little kind of worse
Speaker 4: in a way, but it's just bright teetering on the edge.
Speaker 4: But broadly, we seeing cost of capital going down and
Speaker 4: bond yields moving down. That of course reduces the cost
Speaker 4: of money for people, and it reduces the cost of
Speaker 4: capital when you're valuing the equity market. It can stimulate growth,
Speaker 4: that can stimulate investment, that can stimulate earnings growth. And
Speaker 4: when you see more earnings growth coming through, particularly on
Speaker 4: domestic oriented companies, then the multiples tend to go up
Speaker 4: as well. So you end up having the current see
Speaker 4: and the earnings growth and bond yules and hence multiples
Speaker 4: all kind of moving together at the same time. So
Speaker 4: most of the market is intend to have a very
Speaker 4: short term memory, so everyone kind of thinks about what's
Speaker 4: happened over the last ten years. When the US market's
Speaker 4: done well and emerging market's done relatively poorly, But if
Speaker 4: you look at the decade before that, people kind of
Speaker 4: forget that emerging markets did a two hundred and fifty
Speaker 4: percent dollars a turn in the ten years up to
Speaker 4: twenty eleven, and then it's only since twenty eleven that
Speaker 4: there's been a kind of a tougher relative period, whereas
Speaker 4: the US market has done well where it did not
Speaker 4: so well in the previous decades. So these things do
Speaker 4: tend to go in kind of waves, and arguably, you know,
Speaker 4: there's a there's a pretty strong possibility that we're in
Speaker 4: kind of one of those ways of transition.
Speaker 1: Great.
Speaker 2: Yeah, So, I mean you mentioned, you know, China. China
Speaker 2: has been one of the you know, market says has
Speaker 2: divided investors over the past couple of years. I mean,
Speaker 2: you know, it's been called an investible what's your take
Speaker 2: on China and how do we find the value and
Speaker 2: the opportunities in that market?
Speaker 4: Yeah, China is complicated, but it's got some amazing companies
Speaker 4: as well. The way I characterize China is that the
Speaker 4: market is probably eighty percent plus not very attractive, but
Speaker 4: there's probably a ten percent or so core of very attractive,
Speaker 4: you know, high quality growth companies, perhaps even more than that.
Speaker 4: And given it's a very large, deep market, that presents
Speaker 4: a very interesting opportunity set. And here I'm not talking
Speaker 4: about the big banks or the big steel companies or
Speaker 4: the property companies who should have been going pop. I'm
Speaker 4: talking about the founder lad entrepreneurial growth companies, often technology
Speaker 4: and scale and efficiency leaders that have been moving up
Speaker 4: the value spectrum. And whereas historically China would import a
Speaker 4: lot of high quality or high technology goods, these days
Speaker 4: they're competing in the global market, so that Chinese are
Speaker 4: really world classed. And I was at in Shanghai back
Speaker 4: in January and just traveling around the Yangti Delta, you know,
Speaker 4: two hundred and fifty million people, an incredible manufacturing complex.
Speaker 4: It's very very hard for the Japanese or Koreans and
Speaker 4: Europeans and US to compete. They're so efficient, they're so good.
Speaker 4: And then going to Malaysia and finding out everything there's
Speaker 4: a cost thirty or forty percent more. That's kind of
Speaker 4: one of the China plus one places. They just they
Speaker 4: kind of hold the Chinese in are in terms of
Speaker 4: how good they are. So we tread carefully with China,
Speaker 4: but we do see significant opportunities. It's worth kind of
Speaker 4: bearing mind where we've come from. So you know, Chinese
Speaker 4: starts presented a huge opportunity. Over the ten years to
Speaker 4: twenty twenty, we did phenomenally well. Our holdings did really,
Speaker 4: really well. So I'm thinking stops like ten Cent compounding
Speaker 4: at thirty or forty percent for a ten year period,
Speaker 4: so we have the same comparable value creation, in fact,
Speaker 4: probably ahead of a lot of the US market up
Speaker 4: to that point. And then I think you had something
Speaker 4: of the power of large, large numbers, So likes of
Speaker 4: ten per cent of Ali Barbar became very large, and
Speaker 4: I think, you know, Jack Mark kind of overstepped the
Speaker 4: mark and that led to something of a clampdown to
Speaker 4: make sure they knew who was boss, you know, the
Speaker 4: Chinese Communist parties in charge and president she kind of
Speaker 4: you know, asserted that in the market, and I think
Speaker 4: you had a hunkering down of certain companies. So the
Speaker 4: likes of ten you know, ten Cent, for example, is
Speaker 4: still a very good company, but its growth rate decelerated.
Speaker 4: It it really kind of managed down its profitability. It
Speaker 4: was less you know, it's competing less in the market
Speaker 4: whilst it's trying to keep a low profile, and of
Speaker 4: course the growth rates and profitability went down a bit
Speaker 4: in the short term, so it's not the underlying businesses bust,
Speaker 4: it's just that they decelerated, and at the end of
Speaker 4: twenty twenty they've been overly you know, over highly valued
Speaker 4: with an extrapolation of the twenty twenty kind of internet
Speaker 4: technology boom that we saw through the COVID period. So
Speaker 4: that led to you just plot a chart of the
Speaker 4: Chinese market against other markets globally, they'll see China had
Speaker 4: raced ahead and then are a very substantial pullback through
Speaker 4: twenty one, twenty two to twenty three, so you had
Speaker 4: a de rating period. We never thought China was oninvestable,
Speaker 4: but we were quite selective through that period. In fact,
Speaker 4: we invested a lot more in electric vehicle supply chain
Speaker 4: and solar companies for example. And where we are today,
Speaker 4: I think there's been market repair, so the government realizes
Speaker 4: that it needs private enterprises to flourish, particularly as you're
Speaker 4: coming out of a property market correction, which is quite
Speaker 4: severe after a ten year bubble. So that property market
Speaker 4: is steadily deflating. It's leading to a lot of excess
Speaker 4: supply and all sorts of stuff, particularly basic materials and
Speaker 4: basic manufacturing, which is then flooding the global markets. I'm here,
Speaker 4: I'm thinking cement and stuff like that. So you don't
Speaker 4: really want to be invested in those areas, and the
Speaker 4: government's trying to kind of sort that out. But when
Speaker 4: the government gets involved, you're probably best avoiding those kind
Speaker 4: of areas. At the same time, you know, you've still
Speaker 4: had these high quality, compounding businesses and they're being able
Speaker 4: to function again, and that's why those companies are really doing,
Speaker 4: you know, quite well. So they're being allowed to re
Speaker 4: rate back to a more normal level from a very
Speaker 4: depressed level. The currency is strengthening against the dollar and
Speaker 4: against other things. You know, there's there's we're not expecting it,
Speaker 4: you know, a huge kind of macro boom off to
Speaker 4: the races, but it's there. There's certainly a market repair
Speaker 4: story going on, and and and investors who've shied away
Speaker 4: from China kind of are rethinking that one and have
Speaker 4: been coming in at the margin, which is obviously been
Speaker 4: driving prices up. And then of course that gets domestic
Speaker 4: investors excited, and Chinese investors have a notorious casino mentality,
Speaker 4: so they get overly pessimistic and overly optimistic as well.
Speaker 4: So I don't think we're into the full over optimistic thing,
Speaker 4: but the government's starting to get a little bit queasy
Speaker 4: on that, so it might start doing a little intervention
Speaker 4: to of hold the market back a little bit after
Speaker 4: some very strong rebounds. So in that kind of context,
Speaker 4: what do we do. We have something like twenty six
Speaker 4: percent or something of the portfolio within a benchmark agnostic
Speaker 4: strategy invested in China, but our holdings look very little
Speaker 4: like the index. We're very select on the type of
Speaker 4: companies that we hold.
Speaker 1: So what does a typical holding period look like? You know,
Speaker 1: how often are you reassessing your thesis for different companies.
Speaker 4: So in order to allow the compounding effect, to which
Speaker 4: we think is the core driver at value creation, for
Speaker 4: our clients to actually manifest itself and for us to
Speaker 4: make the right investment decisions, then we invest with a
Speaker 4: five plus year horizon. So everything we do allows that
Speaker 4: because most of the market operates on something like a
Speaker 4: twelve eighteen month horizon. In certain markets like China, it's
Speaker 4: arguably even shorter. You know, when we're in meetings with
Speaker 4: Chinese investors, they're talking about the next month, maybe three months,
Speaker 4: whereas we're looking at about how a company is going
Speaker 4: to be changing and creating value over the next five
Speaker 4: plus years. It gives a very different perspective on risk reward.
Speaker 4: It gives us a huge advantage if we have the
Speaker 4: temperaments and the process and the ability to understand value
Speaker 4: by looking further ahead than the market, because everyone else
Speaker 4: is kind of crowding around, making the short term very efficient,
Speaker 4: but the long term is much less efficient, particularly in
Speaker 4: emerging markets which are highly irritational. So if you're investing
Speaker 4: in a one year of view, something like eighty percent
Speaker 4: of your equation is about the multiple, which is, as
Speaker 4: Buffett would say, a kind of a voting mechanism. So
Speaker 4: share prices are wabbling up and down depending on sentiment
Speaker 4: and perception on growth, Whereas if you're looking out five years,
Speaker 4: the compounding effect for good companies can really differentiate them,
Speaker 4: so you can grow through multiples quite quickly. So you know,
Speaker 4: if you think back to Apple in two thousand and four,
Speaker 4: it was training at one hundred times multiple. It turns
Speaker 4: out that was cheapest chips. You know, if you bought
Speaker 4: those shares and to sat with them. You've made four
Speaker 4: or five yeah, something four hundred times your money since
Speaker 4: then because it's compounded at a very high rate. But
Speaker 4: the media at the time will be saying, oh, that
Speaker 4: stops really expensive, there's a bubble, and all that kind
Speaker 4: of stuff. But the key is what is the sustainable
Speaker 4: growth rate of that business? Why will some companies go
Speaker 4: up one thousand percent and somewhill go down fifty percent
Speaker 4: from the same Starling multiple. And everything we're doing is
Speaker 4: trying to understand which are the good ones, which ones
Speaker 4: are going to be trying to invest in for the
Speaker 4: next five to ten plus years, and which ones to
Speaker 4: avoid like the plague. And so the attributes that we're
Speaker 4: looking for are thinks like corporate governance, economic modes, the
Speaker 4: things that give us conviction that the company is generating
Speaker 4: a high return on capital when it's recycling its capital,
Speaker 4: and everything we're doing in terms of valuation is consistent
Speaker 4: with that. So we were trying to really understand the
Speaker 4: evaluation scenarios the companning of cash earnings per share out
Speaker 4: for the next five or ten years. What is the
Speaker 4: market going to be thinking when it's looking at the
Speaker 4: company in five years time, when it's looking forwards and
Speaker 4: it's a different way of thinking, it takes a different approach.
Speaker 4: It's actually much lower risk because we own good companies,
Speaker 4: not rubbish companies we think are just going to bounce
Speaker 4: over the next three months. We're never going to guess
Speaker 4: what's going to happen over the next three months. Only
Speaker 4: better than the market, we don't think. But we have
Speaker 4: a dramatic advantage in understanding the difference in compounding rates
Speaker 4: and understanding which of the great companies in that kind
Speaker 4: of context.
Speaker 1: So in your materials you talk about you know there's
Speaker 1: different buckets. You're looking at classic compounders narrowing in wide jaws.
Speaker 1: Could you give our audience kind of an overview what
Speaker 1: they are and how you size positions among them.
Speaker 4: Yes, So if you a classic compounder to us would
Speaker 4: be a company like TSMC or Tencent, you know, a
Speaker 4: stot that we might have held since twenty eleven when
Speaker 4: we started the strategy, and a stop like TSMC we've
Speaker 4: probably held in a five percent plus position through most
Speaker 4: of that fourteen year period, when it's companning at twenty
Speaker 4: twenty five percent year after year. Now there's still going
Speaker 4: to be cycles through that, but it's the stain compounding
Speaker 4: rate which is the real driver. A steady state business
Speaker 4: which is generating say a twenty percent return on capital
Speaker 4: or twenty percent ROE if it didn't pay any dividends out,
Speaker 4: its sustainable growth rate is defined by that steady return
Speaker 4: on equity, So the internal compounding of per share basis
Speaker 4: would be around twenty percent. Now, you can use the
Speaker 4: capital to buy back shares or pay out dividends and
Speaker 4: things like that, but effectively, that's the internalized growth rate.
Speaker 4: If a company starts at a twenty percent ROI and
Speaker 4: goes to zero, you're going to lose a lot of money.
Speaker 4: And if it starts at what is optically a low
Speaker 4: return on equity and goes up a lot, you will
Speaker 4: make dramatically more than that compounding rate. So and then
Speaker 4: hopefully you're going to you know, tail off at that
Speaker 4: companding you know that twenty percent in five years time.
Speaker 4: So those will be the best return companies, but they
Speaker 4: tend to be higher risk, so you might not want
Speaker 4: to be sticking your neck out too far on some
Speaker 4: of those situations. And in between, there's what we always
Speaker 4: called the narrowing GRS company, So it might be a
Speaker 4: ten percent row which is becoming a twenty percent hour awe,
Speaker 4: or which has a wider range of different scenarios around it.
Speaker 4: So historically, a fast moving consumer goods company like hindusan
Speaker 4: Unilever something like that, like a Procter Ammal in the
Speaker 4: US would be compounding get maybe ten to fifteen percent rate,
Speaker 4: which is quite an attractive return for a very low
Speaker 4: risk investment. I don't think those FMTG companies as attracted
Speaker 4: these days. They've been structurally disadvantaged, but they would have
Speaker 4: been a classic, classic steady compounder, but not vastly exciting
Speaker 4: for everyone who's trying to make a quick buck. The
Speaker 4: best compounders over the last ten years have really been
Speaker 4: those online platforms, so Google and Meta and companies like that,
Speaker 4: which have been capital like businesses with strong growth runways
Speaker 4: and pretty well managed and that's a lot and wide
Speaker 4: economic modes around them, and that's allowed them to protect
Speaker 4: their profitability and just reinvest in growth. That a pretty
Speaker 4: attractive incremental return. If you look to those more like
Speaker 4: twenty years ago, they were much higher risk businesses. You know,
Speaker 4: they were much less established, they had much more threat
Speaker 4: to their business. AI might raise those threats back again
Speaker 4: for them. You know, there's a bit of an existential
Speaker 4: threat to some of those things, but if you can
Speaker 4: pick them up early, you'll make a lot of money.
Speaker 4: So what we want room from the portfolio is a
Speaker 4: kind of a core of run you know, reasonably predictable,
Speaker 4: very well entrenched businesses, high cash generation, quite predictable levels
Speaker 4: of growth, strong balance sheets, good governance, those kind of things.
Speaker 3: And then we.
Speaker 4: Want to have space to have the ones which we
Speaker 4: think are going to get there or a hart part
Speaker 4: way there and therefore generator a better return, but perhaps
Speaker 4: at a slightly high level of risk. And then there
Speaker 4: might be some which might be, for example, more like
Speaker 4: a billion dollar market cap business, a younger business with
Speaker 4: a huge runway for growth where it's establishing itself.
Speaker 3: It's got all the right attributes.
Speaker 4: In place, but it's not the polished finished article yet.
Speaker 4: And those are the stots you could make five, ten,
Speaker 4: you know, even more times your money over the next
Speaker 4: ten plus years. But there's a wide range of outcomes,
Speaker 4: so you've got to try and judge what the level
Speaker 4: of capital employed within the portfolio you're going to do
Speaker 4: with those. So we're trying to have it like when
Speaker 4: you plant a garden, you don't want all your flowers
Speaker 4: to come through at the same time, and you want
Speaker 4: the kind of the nice ones, the evergreens, but then
Speaker 4: you want the nice flowers which come through at a
Speaker 4: later point in time if you look after them. And
Speaker 4: so that's really what we're trying to do. We're trying
Speaker 4: to create the portfolio for the future. And as a boutique.
Speaker 4: You know, we're going to be smaller than you know,
Speaker 4: some of the very large investment managers out there, so
Speaker 4: we can have larger sizes and some of the small
Speaker 4: companies we think are going to be fabulous risk reward
Speaker 4: but where they would really struggle to build a meaningful position.
Speaker 4: Instead we can actually generate a more meaningful position size
Speaker 4: you're investing.
Speaker 2: It's a longer kind of term horizon. But some of
Speaker 2: the things that have popped up over the past years,
Speaker 2: such as you know, terriffs, how are you factoring that
Speaker 2: as a risk? You know, are we passed the peak
Speaker 2: tariff tensions or or or do you think of this
Speaker 2: as a one off impact to emerging markets or does
Speaker 2: this kind of change the kind of global outlook going forward.
Speaker 4: I like the angle there because I think the tariffs
Speaker 4: are the biggest issue potentially for the US. I think
Speaker 4: it's a tax on the US consumer ultimately. But there's
Speaker 4: a lot of as we go through this, and you know,
Speaker 4: the Europe is arguably, you know, perhaps more impacted than
Speaker 4: a lot of emerging markets. There's a lot of noise
Speaker 4: around this because of the way the Trump administration determined
Speaker 4: those travelers being such an arbitrary type of measure. They
Speaker 4: basically tax the most successful exporters the most. That was
Speaker 4: how they made the calculation. So inherently, if you're invest
Speaker 4: in more successful emerging markets, you actually had a greater
Speaker 4: tariff effect, and if you earn the less successful ones,
Speaker 4: you've got less tariffs.
Speaker 3: Go figure.
Speaker 4: So Brazil got impacted less because itself was a tariff
Speaker 4: protected economy which therefore didn't really feature in the international
Speaker 4: traded market, whereas I don't know, Vietnam or things was
Speaker 4: very very good. Therefore it got impacted more. So the
Speaker 4: impacts for US is, you know, you had to be
Speaker 4: a bit more careful on certain companies. So for example,
Speaker 4: Vietnamese banks are potentially if they're lending against companies which
Speaker 4: are a bit more impacted than it's a potential risk. Similarly,
Speaker 4: you're almost kind of inversely, you know, if you look
Speaker 4: at an economy like India. So it's in the news
Speaker 4: about tariffs at the moment, but the tariff exposure of
Speaker 4: the Indian economy is very low relative to the internal
Speaker 4: growth engine. So India's a very well managed economy. It's
Speaker 4: got very strong government, been doing the right things, investing
Speaker 4: a lot in infrastructure, a very youthful population with relatively
Speaker 4: low credit penetration, high productivity growth. So if I was Trump,
Speaker 4: I wouldn't be trying to ostracize India. I'd want to
Speaker 4: be friends and want to be you know, trading together
Speaker 4: and developing alongside each other, and you know, and not
Speaker 4: pushing them towards the Chinese, to be quite frank. But
Speaker 4: that's not what he's done. But we do know that
Speaker 4: Trump changes on a whim. You know, all these things
Speaker 4: are very personal. They're not well thought out economic strategies.
Speaker 4: You know, he's just a bit and a bit of
Speaker 4: a huff with India because they didn't support him for
Speaker 4: a Nobel Peace Prize against Pakistan, which would have probably
Speaker 4: been ludicrous, to be honest. But so you know, we've
Speaker 4: got a fifty percent tariff today. It doesn't mean to
Speaker 4: say you can have fifty percent in a month's time,
Speaker 4: So I wouldn't worry about it too much. Of your
Speaker 4: companies are not too impacted. We think India's one of
Speaker 4: the best, were probably the best of the major stock
Speaker 4: markets to be invested in over the next ten years.
Speaker 4: A lot of very high quality franchises, very well governed,
Speaker 4: with huge growth runways. So if you think about Coca
Speaker 4: Cola and Pepsi, the consumption of calbinated beverages in India's
Speaker 4: about four liters peranum compared with about one hundred and
Speaker 4: fifty liters peranum in Mexico and the US, So you've
Speaker 4: got this long run growth runway. So if you have
Speaker 4: a really good company patching into that, they can generate
Speaker 4: some fantastic returns over the long term. And some of
Speaker 4: the stots we've held, you know, we've held them since
Speaker 4: twenty eleven, twenty fourteen and still hold them today and
Speaker 4: they've generated amazing returns. But we see the prospects of
Speaker 4: doing that for a long period to come. So tariffs
Speaker 4: do impact, but we have to be a bit careful
Speaker 4: about over discounting them or over extrapolating them. We have
Speaker 4: to think just about trying to find the best companies
Speaker 4: in the context of what's happening in the world. It
Speaker 4: is a more fragmented world. We don't see that changing rapidly.
Speaker 4: But we've also got to be careful about worrying too
Speaker 4: much about TARIS, which can be really fickle.
Speaker 1: So we are running out of time, But I just
Speaker 1: wanted to ask one more question before we go. Where
Speaker 1: do you think the next big opportunities are in the
Speaker 1: emerging market? It's region So if.
Speaker 4: You think about what's driven the US market over the
Speaker 4: last ten years, actually, you know a lot of the
Speaker 4: emerging markets, it's been the shift to online platforms. The
Speaker 4: technology is everywhere, and AI is just another part of that.
Speaker 4: You know, it is changing things quite rapidly, and it's
Speaker 4: disenfranchising a lot of businesses. We're seeing that said with
Speaker 4: you know, shampoo companies and food companies and things. They
Speaker 4: have less brand power because people use social media, so
Speaker 4: it's easier for a young brand to challenge. E Commerce
Speaker 4: also disrupts the distribution advantages of a lot of FMCG
Speaker 4: companies and so on, So there are there are changes
Speaker 4: in you know, the relative competitiveness and where you can
Speaker 4: find the the best compounds in the future, it's okay,
Speaker 4: where are the barriers to entry? And often it's these
Speaker 4: kind of network effects from online businesses. What we find
Speaker 4: is there's a lot of companies in emerging markets which
Speaker 4: must have you know, we're often either vastly expensive or
Speaker 4: unprofitable or excessively priced IPOs back in twenty twenty one,
Speaker 4: which are now really attractive businesses. So they consolidated those markets.
Speaker 4: They've become profitable, but they're still early in their growth path,
Speaker 4: and it's a bit like you know, you're picking up
Speaker 4: the mag seven, ten, fifteen years ago in faster underlying
Speaker 4: growth markets. So we quite like those kind of online
Speaker 4: platforms that you know, monopoly doopoly businesses in frost growing
Speaker 4: areas which are underpenetrated. It could be e commerce in
Speaker 4: Southeast Asia or the Uber of Southeast Asia that we own,
Speaker 4: and there's all sorts of these kind of businesses kicking
Speaker 4: around there if you look for them, and we find
Speaker 4: that far more attractive than just going owning the biggest
Speaker 4: bank or the Samsung in career or something, just because
Speaker 4: they happen to be big in the benchmark, so we
Speaker 4: think we can do a lot better than the benchmark
Speaker 4: over time.
Speaker 1: We have to end here, but this is great. Thank
Speaker 1: you again Rob for joining us.
Speaker 4: Yeah, thank you so much. Really nice to talk to you.
Speaker 1: And Marvin. Thank you for being my co host today.
Speaker 2: Thank you, Bosh, and.
Speaker 1: I want to thank you for listening. If you liked
Speaker 1: the episode, please subscribe and leave a review. Also, if
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Speaker 1: Bloomberg Terminal until our next episode. This is David Cole
Speaker 1: with inside out of