Emerging markets now offer investors an exciting case of déjà vu
The conditions that value investing great Seth Klarman identified as so attractive in emerging markets in the 1990s – ahead of their great run in the first decade of the 2000s – are back in abundance today
Seth Klarman, the billionaire founder of the Boston-based Baupost Group, is one of the professional investors we take most seriously here on The Value Perspective. Needless to say, the company’s investors have always held a similarly high opinion of Klarman but, back in the 1990s, a number of them did struggle to understand why he would bother allocating money toward the world’s emerging markets.
“Some prominent US investors have argued rather vociferously against international investing,” Klarman duly noted in his annual letter to Baupost shareholders in 1997. “The risks and uncertainties are greater, they insist, the work far more demanding, and the track record perhaps spottier.” He then went on to reflect on the basic underlying principles of value investing and evaluate possible reasons why they might not work overseas.
From the key point that “you should invest in undervalued securities because they alone offer a margin of safety” to the idea that “if an undervalued stock drops after you buy it and you are confident in your analysis, you simply buy more”, Klarman argued all the principles apply equally well, regardless of the market on which a stock trades or where a company does business.
“Value investing in the US is driven by fundamental analysis – a rigorous assessment of underlying value based on an understanding of a particular business or asset,” he continued. “The same principles that apply here, such as not paying up for growth, or buying businesses you can understand that are not subject to rapid technological change or obsolescence, apply internationally as well.”
One “vocal objection” Klarman said he had heard against applying value investing principles overseas is that foreign companies were not particularly shareholder-value oriented – but, to his way of thinking, the counterargument was obvious. “Of course, Ben Graham invented value investing when the US was effectively a foreign country to value investing principles,” he pointed out.
“Certainly, in the 1920s and 1930s, the idea of management running a company for the purpose of maximising shareholder value was a totally ‘foreign’ concept – one which did not really come into the mainstream until the past decade and, even now, is certainly not an operative principle at all US firms. Even a few decades ago, US managements were hardly shareholder value-oriented.”
Pros, not cons
Another argument Klarman addressed in his letter is that the rules are different overseas – for example, “the accounting murky, the annual reports unreadable, the currencies sometimes unhedgeable”. “All of these points are fair,” he continues, “but, rather than being arguments to avoid foreign markets, they are instead arguments to embrace them.
“After all, as an investor you never have perfect information, and the biggest profits are always available – just as they have been in the US – when competition and information are scarce. The payoff to fundamental analysis rises proportionately with the difficulty of performing it.” To put it another way, those prepared to do the hard work will not only reap the rewards, they will be doing so in a much less crowded field.
Klarman ended: “You might conclude future returns will be lowest in expensive markets and greatest in cheap ones; lowest where information is plentiful and straightforward, and greatest where it is scarce and hard to interpret; and lowest when markets are priced to reflect shareholder-oriented management and greatest where managements are currently indifferent. All of this, I believe, is the case, and the next decade should prove it.”
As it turned out, this analysis proved spot-on, with global emerging markets assets enjoying a great run over the first decade of the new millennium. All very impressive, you might say, but why are you dwelling on the past? Because, after a generally poor second decade, those very conditions Klarman identified in the 1990s – inefficiencies created by a lack of access to information, poor accounting practices, management not working for shareholders and so forth – are all strikingly present in emerging markets today. And whenever you spot those characteristics together, history suggests you have found a very promising place to invest indeed.
Juan Torres Rodriguez
Fund Manager, Equity Value
I joined Schroders in January 2017 as a member of the Global Value Investment team and manage Emerging Market Value. Prior to joining Schroders I worked for the Global Emerging Markets value and income funds at Pictet Asset Management with responsibility over different sectors, among those Consumer, Telecoms and Utilities. Before joining Pictet, I was a member of the Customs Solution Group at HOLT Credit Suisse.
Fund Manager, Equity Value
I joined Schroders in 2019 after previously was with Baillie Gifford in Edinburgh for 6 years and I manage Emerging Market Value. I hold a BA In European Social and Political Studies from UCL.
The views and opinions displayed are those of Nick Kirrage, Andrew Lyddon, Kevin Murphy, Andrew Williams, Andrew Evans, Simon Adler, Juan Torres Rodriguez, Liam Nunn, Vera German, Tom Biddle and Roberta Barr, members of the Schroder Global Value Equity Team (the Value Perspective Team), and other independent commentators where stated.
They do not necessarily represent views expressed or reflected in other Schroders' communications, strategies or funds. The Team has expressed its own views and opinions on this website and these may change.
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