What does ‘quality’ mean in your approach to EM equities?
I think it’s important, because ‘quality’ is a word that gets bandied around a lot, to define the terms that we use when we talk about quality companies. Quality for us means a number of things in the context of investing. Does the company have pricing power? Is it the lowest cost producer? Is it winning market share against its competitors? Can it grow without leverage because its returns on capital are sufficiently high enough that it can self-fund its growth?
[We think] companies with those attributes have an ‘anti-fragility’ about them because they’re unlevered, they’re not really affected by monetary policy if rates increase massively. It tends to negatively affect their more leveraged competitors. They can win market share, and because they have a competitive advantage they tend to just continue to win over time. A portfolio which has got a lot of quality companies at its core, tends to have a much greater level of resilience to whatever the macro [environment] throws at it. I think that’s particularly important in a world like we live in today, where there’s so much uncertainty over many different things. We spend a lot of time in our process trying to weed out companies that we see as being low quality, and we spend a lot of time trying to work out whether the companies we see as being quality are losing some of those attributes. It’s a very core part of our process, and I think it is important to define ‘quality’, because the term does get thrown around a lot!
What is the team’s view on investing in Chinese equities today?
The last few years has seen a big slowdown in the Chinese economy, which I think is driven partly by structural factors and partly by cyclical factors. It is partly externally induced, and partly self-induced. I think, more importantly, there’s also been a massive drawdown in Chinese equities. At points earlier this year, the Hong Kong market got close to levels that we’ve only really seen during financial catastrophes of the past.
I think it’s important to make the point that investing in China gives you opportunities you simply can’t get elsewhere. It’s a very dynamic, entrepreneurial, innovative economy. There are companies in China that are world leading and I think you can say, without any kind of exaggeration, that are changing the world. Particularly if you think about electric vehicles (EVs) or renewable energy, some of these companies and entrepreneurs are changing the world positively. There are things in China that you simply can’t get if you take China out of your investment equation. Many of these companies have become very cheap over the last few years and I think it’s beholden on us, really, to take the idea seriously that we need to be greedy when other people are being fearful in China.
We think there are great opportunities in investing today, and I want to make one more point, which is that the turmoil of the last few years has made some of these entrepreneurs reassess their own approach to capital markets, and we’re seeing much greater generosity in terms of capital returns than we have seen in the past.
I think precisely because these entrepreneurs have had such a shock in terms of seeing their own net worths tumble, they’re rethinking their relationship with capital markets. I think that’s a big positive. In every crisis, there are always positive outcomes. There are always things that change for the better, and I think that’s what we’ve seen in China over the last few years. So, we’re cautiously optimistic about investing in China today. We retain a smallish overweight, but the companies we own I think are fantastic companies and they are trading at very reasonable prices.
A portfolio which has got a lot of quality companies at its core, tends to have a much greater level of resilience to whatever the macro [environment] throws at it.
Do high valuations in India more than price in the country’s strong economic outlook?
India probably has the most exciting economic growth story in emerging markets, and probably the world.
I spent around a month in India last year, and you can see vast amounts of infrastructure absolutely everywhere. You can sense the entrepreneurial energy. Everyone already knows about the demographic story. I think it’s also really important to say that [Prime Minister] Modi has made reforms to the Indian economy that will underwrite higher potential growth for a decade – it’s not going to be something which just benefits the Indian economy in the next year or two.
I think the issue we have today is that India’s economic growth story is not a secret. Absolutely everyone knows about how great the economic growth story of India is, both externally and internally. And when you have such a consensus around a great outlook, and the outlook is so great that people can’t even see any potential pitfalls, you do start to see some hyped-up valuations. You start to see, I think, some behaviour in the markets which is slightly concerning in terms of people being overoptimistic and overpaying for the opportunity set. And this is what we find again and again when we look at India on a stock-by-stock basis, particularly in the small mid-cap space. We find companies whose valuations we simply can’t justify. We love the business, we love the outlook, but we can’t understand how people have managed to convince themselves that this is a great stock purchase opportunity. So, as a result, we are sitting a little bit underweight India today.
We have companies in the portfolio that we’re very happy with that aren’t trading at these very overhyped valuations and don’t over discount the opportunity set. But there is a long list of companies we would like to buy that are simply too expensive for us today. So, our pencils are sharpened, we have a stack of ideas in our inventory that we’d love to be able to buy, and we’re ready if and when there’s a pullback. This isn’t a prediction – we can’t tell what will happen over the next 12 to 18 months with Indian equities, but if and when there’s a pullback, we’ll be ready to load up in India because we’re as excited about the opportunity set there as anyone else.
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