Transcript of The Value Perspective Podcast episode – Meet the Manager, with Vera German

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Hi everyone and welcome to the TVP Pod. This year is our 10th birthday – not as a podcast but as a value franchise, here at Schroders. We wanted to celebrate this by throwing a ‘party’ with some of our longest-standing clients and past podcast guests – inviting them onto the pod and turning the tables. Usually, we interview people from all walks of life about their fields of expertise but, in this ‘Meet the Manager’ miniseries, some clients and guests will introduce us instead and get to ask any burning questions they have been harbouring over the last 10 years. We will continue to publish our regular podcasts as normal but hope you also enjoy this miniseries where we place the value franchise in the interviewee seat as a birthday treat.

In this third episode in our Meet the Manager series, Scott Spencer, a partner in the Columbia Threadneedle multi-manager team, interviews fund manager Vera German. Scott has more than 20 years’ experience in researching funds and, before joining Columbia Threadneedle, did stints at Aberdeen and Credit Suisse. Scott manages the daily activity of the stable of funds in addition to his broader fund selection role, in which he leads the sector research teams for the US, Asia and emerging markets, and is also a member of the specialist investments team. Here, he interviews Vera, who joined Schroders in 2018 from Baillie Gifford. That, in fact, is where the conversation starts as Baillie Gifford is one of the best-known growth managers in the UK and Vera joining the value team illustrates the sentiment sometimes attributed to Warren Buffett that ‘Value investors are born, not made’. Scott and Vera discuss her journey into becoming a value investor; how both literature and legendary value investors have shaped her investment style; international value investing and a focus on emerging markets; and how she thinks of macroeconomics in the context of value investing. Enjoy!

Chapter headings for Vera German on The Value Perspective Podcast

Please click on the link below to jump straight to a chapter

* From growth to value via Peter Cundill ...

* Who else sparked the value ‘lightbulb moment’?

* Countering algorithms; avoiding value traps

* A value approach to emerging markets investing

* Value misconceptions, including ESG compatibility

SS: Nice to see you again, Vera. I hope you are well. I am interested in your path to value investing as you came to it from a different type of approach. Please could you talk a bit on your background and how you found value investing suited you as a style?

VG: Sure. It’s a great question and really goes to the heart of the fact that investing can be a very personal thing. So, when you find an approach that you like the most – that fits your personality and fits with your view of the world – it can be quite a powerful thing because it makes you enjoy your job so much more. I started my investing career at Baillie Gifford, which as listeners may know from – not least from our podcast episode with the firm’s fund manager Tom Slater – is not exactly a value shop. In fact, it is the exact opposite!

For the first few years there, I was just learning the ropes – doing my CFA exams and trying to get to the bottom of what investing actually is. And, as time went by, I realised there is a pattern to the kind of cases that I am attracted to. Those were typically more contrarian investments – struggling businesses and companies that others weren’t interested in looking at – and there was something about this possibility of going against the opinion of the market that I found very interesting.

I was very lucky in that the organisation – despite not really embracing value as a style for their own investors – had a very strong desire to mentor people and to help them develop in whichever way was best for them. I had some incredible individual mentors and one of them in particular recommended a book to me called There’s Always Something to Do by Canadian value investor Peter Cundill. He was an interesting personality in general but one of the habits I found particularly interesting is that, every January, he would go to a market that had performed the worst the previous year.

This is the 1980s we are talking about here and, at the time, for emerging market investing in India, say, you would have to go and physically visit a government building there, register as an agent with the Securities Commission and work through tons of paperwork and bureaucracy. So it required a lot of time and effort and the fact he felt that was worthwhile – that the returns on those kinds of assets would justify that investment of time – I found very interesting. So, starting from Peter Cundill, I just started reading around and listening more and talking to people and that is how I realised that perhaps value investing was the thing for me.

Who else sparked the value ‘lightbulb moment’?

SS: A lot of people do point to Peter Cundill as an influence on their journey to value investing. When you were reading around the subject, did anybody else help spark that ‘lightbulb moment’?

VG: It might make more sense to think there was some big value investor whose big book I read and then nothing was ever the same again – but the truth is, when you are discovering something new, it’s the first couple of investors and books you come across that are really the most significant in the journey of discovery. That is because everything is new – all those things they say to you – and you just go Oh, wow! Suddenly, this makes so much sense.

So, for instance, there is a Spanish investor called Francisco Garcia Parames. He has had different phases in his career, I believe, but he is more of a Warren Buffett type of value investor – competitive moats and sensible management teams and not overpaying – so he doesn’t necessarily go all the way into the deep value side of things. I can’t remember how I found out about him but I realised he had just written a book – yet it was only available at the time in his native Spanish, meaning I would have to wait maybe nine months for the English translation.

Now, I speak English as a second language – obviously – and I speak some French. So I thought, Well, how hard can Spanish be? So I used to stay at work after hours with Google Translate open on my computer – and obviously a lot of words in investing, like ‘investment’ and ‘management’, are all easily translatable. And, basically, this was the first – and so far the only – book in Spanish I have ever read. Again, he was just talking about some of the capital cycles that he used as a foundation for his investing – but, to me, it felt like a massive revelation and like, Suddenly this is an explanation that makes so much sense to me.

SS: That is interesting. Now, you were saying before about Peter Cundill having to go to India to register as an investor and so forth – that is one example of how value investment has changed over the last years as you don’t necessarily have to do that now. Are there any other changes you have noticed in terms of how you approach value over, say, the last eight or 10 years?

VG: I have only been an investor for just over 10 years, so I can’t vouch for how things were before, but it seemed to me, even when I just joined the industry, it was still a quest for more information – this idea that ‘more information equals better decisions’ so let’s sign up to 20 expert networks and let’s speak to everyone we could possibly speak to. And while that approach has some benefit to it, from everything I can see around me now, the focus has become a lot more on filtering out information and making some very clear decisions.

How much time do you spend on something? How much reading do you want to do? This concept now of, after you have found out 80% of what you need to know on an investment, you can probably already make a decision. Yes, you could spend another two weeks on the remaining 20%, but the marginal value of that information is not that high – you’re only doing it for your own comfort so you feel psychologically more comfortable with making that decision. I would say that is probably the biggest shift in the last 10 years.

Countering algorithms; avoiding value traps

SS: OK. Now, value investing is about buying good businesses at cheap prices and, as you say, an awful lot of information or computer power or filters can easily do that work for you. You don’t have to go through your own individual spreadsheets – you can just press a button and find out which stocks are the cheapest in whatever benchmark. So how important is that extra work you do from a fundamental perspective in checking these conclusions, given you are obviously now competing against computers that can do that quicker and easier than most people can?

VG: My basic view on that, which is perhaps a little self-serving, is that any programme, any computer, any algorithm will stand or fall on the same point – the output is only as good as the input. All those programmes are made by humans, humans have biases, humans make errors and you will never write an investment programme that does everything perfectly. There will still be bits of the market it misses. And ultimately, unless we are talking about a fully computerised trading programme, of which I believe there are loads, most people in investment use these things as a short cut or a starting point. At the end of the day, after the computer has, let’s say, filtered or screened everything for you, the decision is still yours.

And that starts from the kind of things you are looking for with the filter or screen, which is why we are quite proud that our screen is very simple – we just want the cheapest 20% of any market. Once you start adding more metrics to the programme, you are just pre-screening already with your existing biases, which means whatever your screen ends up giving you, you’re probably going to like – because you’ve pre selected them. So I think, as long as human judgement is in there somewhere in the decision-making process, it will always be flawed, the markets will always be inefficient to some degree, and therefore an investor who is willing to work with their own biases and try to be as objective as possible will always have a place to exist.

SS: And on focusing solely on that cheapest 20% of any market, the cardinal sin of value investing is buying ‘value traps’. What kind of work do you have to do to check the underlying quality of any potential investment to make sure you avoid these traps? And how important is it to do so?

VG: Ultimately, the checklist we use as a team, for instance, is pretty simple – and there have been lots of studies statistically that help too. The US stockmarket, for example, offers 150 years of data on things that typically trip up value investments, such as structural change being too strong. The classic example there is nobody wanting to buy the last manufacturer of horse-carts when everybody is about to start driving cars. Or there is the financial strength of a business – so, if the business is under pressure but the management team are predominantly worried about being able to meet their interest costs, that is the kind of thing that means companies just go bust and never recover. So there are all those classical factors you can reference.

Personally, because I am involved mainly in emerging markets investments, the overall macroeconomic and political environments in which companies operate can make a big difference. You can be the greatest company ever but, if you happen to be in the wrong geography, then macro and political factors can completely destroy you. And it doesn’t have to mean the company itself goes bust or doesn’t recover – it can simply mean that, while your return in local currency may look amazing and make you look like a genius, as a US dollar investor, your return is completely suppressed by the currency returns. So, for me, it is that awareness of the macro environment in which companies operate.

Secondly, ideally, you need some sort of a catalyst. I have lots of conversations with my co-manager about this because, if the catalyst is obvious, then the market should be able to see it and it is probably already in the price. Equally, though, do you really feel comfortable with investing in something where you literally cannot imagine a scenario in which the underlying performance of the business improves? That seems to me an interesting call to make. It is not necessarily, therefore, the existence of a catalyst in plain view but whether I can imagine a scenario in which, say, the commodity price that influences a particular business goes up.

A value approach to emerging markets investing

SS: You mentioned there how the macro is probably a slightly more important part of value investing in the context of emerging markets. Are there any other tweaks to a traditional value approach to, say, US or UK equities you feel you have to apply when looking at emerging markets with a value hat on?

VG: I’m not sure I have a very good answer to that question – in the sense that I have never really been an investor in UK or US equity! So I can’t speak from personal experience. Ultimately, though, emerging markets are a risky asset class and you need to take that into account. Certainly, I think an interesting theme that has emerged in the last couple of years – and sometimes manifests itself in ways that are terrible for humankind – is the way politics always plays a role.

Sometimes, when I speak to developed-market investors, I feel they have had a Goldilocks period for 20 or 30 years. Yes, of course, there was the global financial crisis. Yes, of course, there were other occasional crises. But, by and large, world trade was expanding, geopolitics was helpful, it was relatively stable so you could ignore politics and macroeconomics, most of the time, and just say, I choose companies, I am a bottom-up investor – that is the only thing I care about.

And therefore the difference was more pronounced in the emerging markets, where you could never truly ignore that – even for a growth fund. Let’s talk about, for instance, Coca Cola FEMSA in Mexico. For a very long time, Mexico had the highest consumption of fizzy drinks per capita in the world. This was a growing, stable business, commanding high multiples, with good returns and great brand power – and then the Mexican government got so concerned about the effects of fizzy drinks on people’s health that they slapped a sugar tax on it. I believe this was the first in the world at the time so, even as a growth investor, you could have picked an amazing company yet political interference still meant the shape of the business changed almost overnight.

So that was the way the world used to be seen – but, now, I would like to think even my colleagues in the developed world are starting to ask themselves questions about under which sort of circumstances politics can make or break an investment. How political is this particular industry? And what are the bigger-picture trends? I am not saying all of us should become top-down investors but I do think investors no longer have the luxury of just closing their eyes and saying, This stuff doesn’t matter in my market.

SS: Does that mean then, as a value investor in emerging markets, you feel you have a better opportunity set because all that political noise creates more opportunities?

VG: I think the simple premise is emerging markets is less efficient as an asset class – there is more volatility; the information is less readily available; the accounting standards have not been harmonised as most countries have their own. Furthermore, most people have a home bias to some degree – all those faraway places seem strange and scary.

I’ll give you an example – five or so years ago, just after I joined the value team, we were having a conversation about some of the Russian oil stocks. We were looking at some risk scores and my colleagues were saying they had added a couple more points on to account for expropriation risk. So I was like, OK, where does this actually come from? And we tried to calibrate the number of risk points they were adding to these companies by virtue of their being Russian versus the statistical probability of assets being expropriated. And while expropriation is a big news event and, when it happens, everyone talks about it, in reality, there are only a handful of times where it has actually happened.

So for a team that prides itself on basing decisions on statistics and base rates and probabilities, it seemed a funny thing to me and a classic example of, Ooh, this looks like a place without rule of law – therefore, there must be expropriation risk. Yet expropriation risk of 10% and expropriation risk of 0.1% are very different things. So it is my job to look past these kinds of biases. Also, because of its inefficiency and other issues, emerging markets is a more volatile asset class so I think we just have more opportunities – and perhaps more frequently, because things move more quickly – than developed market investors.

Value misconceptions, including ESG compatibility

SS: OK. What would you say is the main misconception about value investing?

VG: I think they are plenty! But I’ll pick one relating to emerging markets. Certainly, when you talk about the fact you run a deep-value emerging markets fund, most people assume you just own commodity companies. And, again, this is an interesting issue because that is really the phenomenon of the last 10 years. In 2008, 2009, 2010, commodity companies were all the rage – the biggest components in emerging markets indices were Gazprom in Russia and Petrobras and Vale in Brazil and all the rest of it.

And then, after the commodity ‘supercycle’ ended and Chinese growth started declining – that is when they became the sort of low-quality, ‘bad’ companies value investors own. And while there is usually some availability in that market segment – if you want to buy some of these businesses – all sorts of companies can become cheap over time, for good and bad reasons. And I feel very lucky in that emerging markets is such a massive universe, with so many businesses and sectors and countries, that I don’t just have to own indebted commodity companies. I can own pretty much whatever I like – so long as I think the valuation is compelling.

SS: One thing we hear a lot in terms of misconceptions of value – and it would be interesting to hear your take on it – is that value investing is not compatible with ESG. Again, maybe it is because of that perceived link with commodities but I know that, as a team, you have done a fair bit of work to demonstrate you can actually be an ESG investor and a value investor at the same time.

VG: The main problem with most big-picture arguments about ESG is nobody seems to be able to agree on what the term actually means. I believe the UK and the European regulators are both working on achieving a clear definition but, before you know what that is, it will mean different things to different people. This is unlikely to come as a surprise to anyone but, if you want to invest in emerging markets, the ‘G’ or governance side of things has always been incredibly important. You have to think about things like management teams that are linked to the government and so on.

So, for us, some of these factors have always been part of the game – and, in that regard, there is nothing new. Let’s pick the ‘S’ or social part of ESG. Again, you’re dealing with mining companies and, most of the time, mining companies do not mine next to big cities but where there are, for example, indigenous communities – and the resulting disputes have been part of the picture for emerging markets investors for forever. So I think there is nothing that makes ESG and value inherently incompatible – but that argument is always difficult to have without settling on a definition first.

SS: Looking forward, as we sit here today, how bright do you think the future is for value investing?

VG: I would like to think it is very bright, of course! Investment styles move in and out of fashion – and that is absolutely fine – and it also depends on the macroeconomic trends. I don’t necessarily think the value investment philosophy is the king of it all and should work in every environment on every day of the week. I think value is a conservative way to invest because, more or less – to simplify it massively – you are buying an existing asset base, not the promises of an asset base in five years’ time.

And so I think value will always have a place. It has rigorous analysis behind it. It has years of data that suggests that, over the longer term and on average, it allows you to outperform the market. And so it makes sense. And, given where valuations are today, it seems likely the returns from here should be pretty impressive. At the same time, the world is an unexpected place so I guess we’ll see.

SS: OK. So, so far, no regrets about leaving a growth house and joining a value team.

VG: Absolutely not. I enjoyed growth investing – but as an observer, while value investing is something I love doing every day. So, yes – I’m happy!

SS: That’s great, Vera. Thank you very much for answering my questions.

VG: Thank you.