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EM equities: star managers' money-making strategies uncovered

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Emerging markets are often touted as drivers of global growth, and the performance of a number of emerging market equity funds over the last three and five years goes a long way to support this view. There are also a number of managers with very good Citywire Manager Ratios over those two periods.

Thomas de Saint-Seine, founding partner of Reyl Asset Management and co-manager of the Reyl Emerging Markets Equities fund, is, along with his colleagues Maxime Botti and Emmanuel Hauptmann, the top-ranked manager in the Global Emerging Market Equities sector over three years with a Citywire Manager Ratio of 1.31.

Three-pronged process

‘We have a different approach to most of our competitors,’ says de Saint-Seine. ‘The idea is that the more fragmented the market, the more inefficiencies you are going to find. Our approach is to try to capture these inefficiencies by applying three different strategies which are complementary and generate alpha at different periods of time.’

Each of the strategies has portable alpha, says de Saint-Seine, and can generate excess returns. ‘We look at 25 countries over four different continents with at least 30,000 stocks listed. We apply a filter – in terms of market cap, if a stock is below $150 million, or if it is not liquid, then we cannot invest. This leaves us with around 3,500 names, which represents two-and-a-half times the number of stocks in the MSCI Emerging Markets index.’

De Saint-Seine says it is important to have a large universe of stocks, as generally the inefficiencies are not where everyone else is looking. ‘The first strategy identifies companies with strong free cashflow. This tends to be a little contrarian and works well when the market is discriminating against stocks leaving them under-rated.’

The team never meets with company management, focusing on a very systematic process. The second strategy it employs is very defensive, based on dividend growth. ‘We generally also have volatility below the average market volatility,’ says de Saint-Seine. ‘Defensive names have strong intrinsic value, almost like bonds, and are very interesting when there are corrections in the market. Generally their beta is very low. In emerging markets this strategy doesn’t necessarily underperform a bull market, and over time stocks that return cash have proved they have the appropriate corporate governance. There’s no fraud.

‘Emerging markets are really flow-driven markets,’ he adds. ‘Stocks with lower volatility are appreciated by investors with high aversion to risk.’

The third strand applied is a GARP/momentum strategy which combines some value criteria with growth and momentum criteria as well as price trends and earnings. ‘We’re trying to identify a niche situation, a local trend,’ he says. ‘This could be pharmaceutical companies in Asia, or it could be domestic consumption in some countries.’

De Saint-Seine notes that the emerging market universe is very dynamic. ‘Trends are not necessarily the same year after year. They change over time and you must adapt your investment style. This strategy is good to model investors’ aversion to risk. When there is higher volatility in the market this approach will tend to reduce the allocation to volatile stocks. When there’s volatility, the beta of the fund will tend to decrease.’

Top 10 managers in EM equities over 3 years

Manager name Total return Manager ratio Contributing funds
Maxime Botti, Thomas de Saint-Seine, Emmanuel Hauptmann 50.17 1.31 Reyl (Lux) GF-Emerging Markets Equities B USD
Devan Kaloo 50.61 1.27 Aberdeen Emerging Markets A Acc, Aberdeen Global - Emerging Mkts Equity A2 USD, Aberdeen Global - Emerging Mkts Smaller Co A2 USD, Aberdeen Global Emerging Markets SGD, Danske Invest Nye Markeder, Danske Invest Nye Markeder - Akkumulerende, Danske Invest Nye Markeder Small Cap
Eric Lin 31.39 1.05 Eastspring Investments Africa Fund
Hugh Young 37.41 0.99 ML Global Emerging Markets
Glen Finegan 46.88 0.93 First State Global Em Mkts Leaders A GBP Acc
Petri Deryng 111.69 0.92 PYN Elite
Jonathan Asante 44.10 0.90 First State GEM Leaders SGD, First State Global Emerging Markets A GBP Acc, First State Global Emerging Markets Select III
Balthasar Meier 51.73 0.84 WMP EMA Established Leaders Fund D
David Gait 49.76 0.75 First State Gbl Emer Mkts Sustainability A GBP Acc
Wytze Riemersma -30.24 0.73 Intereffekt Frontier Vietnam

Citywire manager ratio: the manager ratio reflects how much 'added value' in terms of outperformance against the benchmark the fund manager delivers for each unit of risk assumed, where risk is defined as not mirroring the index's return. It ties together the fund manager's personal career history with in Information Ratio of the underlying funds.

Regular rebalancing

The fund’s allocation across these three strategies is fixed over time in order to cross market cycles. ‘It gives us good control of the underlying risk,’ says de Saint-Seine. ‘We target 4 to 5% less volatility than the index, and every six weeks we rebalance, adjusting the portfolio with new data received from companies, and also based on price and volumes.

'It’s a diversified portfolio; the idea is to reduce the liquidity impact on the market and we want to avoid specific risk on stocks. We also impose our own constraints. We have no more than 10% in a sector above the weighting of the index.’ The result, he says, is a portfolio which is very diversified with a lot of small and mid caps. ‘We capture special situations and it’s very complementary to our competitors, many of whom follow the index a lot.’

The fund aims for 8 to 10% alpha per year over a market cycle. Over three to five years de Saint-Seine believes this is achievable. ‘In terms of beta, it moves between 0.6 and 0.9 when we’re aggressive. The average since launch is 0.74, so we’ve been fairly defensive overall. More than 70% of our performance since launch has come from selection; the remainder from positive allocation. The effect of stock picking is to take on tracking error by selecting stocks other managers don’t necessarily have and transform that into alpha. The process is purely bottom up. We remain focused on company fundamentals and are very disciplined.’

De Saint-Seine highlights three stocks which exemplify the team’s process: China Construction Bank Corporation, which combines different criteria such as attractive valuation, attractive dividend and growth; Singapore Post, which provides investors with solid growth and a solid stream of dividends; and footwear manufacturer Pou Chen, which has strong free cashflow generation and an attractive valuation.

Team power

Aberdeen Asset Management’s Devan Kaloo, who runs a number of emerging market equity vehicles, is ranked second by Citywire Manager Ratio over both three and five years. Kaloo says the performance of the funds is primarily due to Aberdeen’s team approach. ‘There over 40 investment professionals in global emerging markets who conduct over 1,800 meetings with company management each year. Our competitive advantage derives mainly from the consistency of our approach, and the disciplines that we adhere to, irrespective of market conditions. We are active stock pickers and therefore good stock selection is the main driver of alpha, along with tactical top-slicing and adding on weakness within a basic buy-and-hold strategy.’
 
‘We try to differentiate ourselves by exploiting the advantages we have at the margin, ie better research, more cross-coverage, a culture that prefers teams to individuals – we don’t believe in star managers,’ says Kaloo. He also highlights the importance of taking a long-term view. ‘In terms of investment process our approach begins with a few basic rules: never invest in stocks we haven’t visited, never feel obliged to buy a stock because it appears we should for reasons of size or perceived value as a market proxy, for example.
 
‘What we strive to achieve, is intellectual consistency,’ says Kaloo. ‘So we avoid businesses we don't understand or ones with discriminatory shareholder structures. Working from these precepts, stocks become almost self-selecting provided we have done the essential investigative work. The more difficult decision is how much to pay. Here we place little value in ephemeral events or market noise and more on factors that will ensure we can add value in a demonstrable and consistent way over time. In short, we focus on what we can know, and have built our investment process around that.’

At present Kaloo’s portfolios are overweight domestic sectors such as financials and consumer staples, and underweight more global growth dependent sectors like materials and industrials. He is also underweight utilities and telecoms despite these being more domestic-oriented businesses, as he has concerns about the quality of these industries given the structural challenges they face and significant government interference.

Top 10 managers in EM equities over 5 years

Manager name Total return Manager ratio Contributing funds
Pekka Niemelä 36.18 1.01 UB Emerging Markets Infra Kasvu
Devan Kaloo 54.73 0.98 Aberdeen Emerging Markets A Acc, Aberdeen Global - Emerging Mkts Equity A2 USD, Aberdeen Global - Emerging Mkts Smaller Co A2 USD, Aberdeen Global Emerging Markets SGD, Danske Invest Nye Markeder, Danske Invest Nye Markeder - Akkumulerende, Danske Invest Nye Markeder Small Cap
Hugh Young 37.86 0.88 ML Global Emerging Markets
Glen Finegan 49.35 0.72 First State Global Em Mkts Leaders A GBP Acc, First State Global Emerging Markets Leaders III
Petri Deryng 104.97 0.69 PYN Elite
Knut Harald Nilsson, Kristoffer Stensrud 12.32 0.68 Skagen Kon-Tiki
Jonathan Asante 42.60 0.64 First State GEM Leaders SGD
Catherine Vlasto 14.88 0.51 Essor Emergent
Francis Seymour 31.14 0.48 McInroy & Wood Emerging Markets
Teera Chanpongsang 29.07 0.46 OP-Kehittyva Aasia A

Citywire manager ratio: the manager ratio reflects how much 'added value' in terms of outperformance against the benchmark the fund manager delivers for each unit of risk assumed, where risk is defined as not mirroring the index's return. It ties together the fund manager's personal career history with in Information Ratio of the underlying funds.

Underweight Asia, overweight LatAm

‘By region again there has been little change – we remain underweight Asia, specifically the North Asian markets of China, Taiwan and Korea where we struggle to find companies that meet our quality criteria. We are overweight Latin America where we find a number of stock opportunities in Brazil and Mexico. In EMEA our large under and overweights are Russia and Turkey respectively. Again this reflects where we find suitable companies.

‘Our picks in emerging markets remain in fundamentally good shape, valuations overall are not expensive and there is the prospect that investor sentiment could turn positive if global concerns dissipate and emerging markets’ economic and corporate profits recover in the first half of 2013,’ says Kaloo. However, he cautions that this may be difficult to sustain in the second half of the year given the still anaemic outlook for global growth and significant headwinds.

Stock picking for cautious markets

Jonathan Asante, manager of the First State Global Emerging Market Leaders fund among others, has a Citywire Manager Ratio of 0.90 over three years and 0.64 over five years. He notes that he invests clients’ money with a three-to-five-year view and hence does not really consider the next 12 months’ returns when making decisions.

‘In the last 12 months companies we regard as good quality - in consumer staples, financial, IT and healthcare sectors, for example - continued to perform better than companies we’d regard as poorer quality, in the resources sector, for example, he says. ‘We feel many consumer companies are fully or overvalued in BRIC and increasingly in Africa too. Fortunately there are still reasonably valued companies across many sectors that meet our criteria. This is because markets are not yet risk loving to the extent they were in 2006/2007.’ 

Increasingly global multinationals, wherever listed, are delivering over half of their business from developing economies, says Asante and he believes some of these are very reasonably valued. ‘We do not believe buying poor quality companies delivers investment returns for clients in the medium term.
 
‘An executive of one of the world’s global banks recently suggested to us they had always kept more “loss-taking capital” than peers because they never perceived themselves to have had a lender of last resort,’ says Asante.

‘This raises the intriguing idea that the very existence of central banks themselves creates the booms and busts that they are supposed to be preventing.  We strongly suspect central bankers won’t see it this way and are likely to create more perverse outcomes with interventionist policies. For example encouraging a banking system which has lent too much with too little capital to lend again to the riskiest borrowers may seem insane but is currently the objective of policy on both sides of the Atlantic.’

During December Asante took a position in Unicharm within the First State Global Emerging Markets Leaders fund, which he describes as a well-run personal care maker which could see a significant rise in profitability in coming years as long-term investments in global expansion start to bear fruit.

He sold Turkish financial stock Akbank on concerns over rapid loan growth in the Turkish economy. ‘The closest we have to a consistent, prudent government seems to be in Chile where we have found various companies in which to invest clients’ money over the years. Several Chilean businesses, such as retailer Cencosud and Coke bottler Andina, are regionalising their operations, which presents both opportunities and risks – those with successful track records are greatly preferred.’

This article first appeared in the emerging markets supplement of the February 2013 edition of Citywire Global magazine.

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