Announcer:
Before we begin this Bennelong Funds Management podcast, we would like to acknowledge the traditional custodians of the land on which we are recording and pay our respects to elders past, present, and emerging. We celebrate the stories, culture and traditions of Aboriginal and Torres Strait Islander communities who work and live on this land, and we commit to an ongoing journey of reconciliation and respect.
Jonas Daly:
Hello and welcome. My name's Jonas Daly. I'm head of distribution for Bennelong Funds Management. Today I'm joined with Glen Finegan from Skerryvore Asset Management. Welcome, Glen. Nice to have you.
Glen Finegan:
Thanks, Jonas. Yeah, nice to be back.
Jonas Daly:
Always good to have you back. So look, I thought it'd be a great opportunity to really update investors on business to start with and then kind of lead into some of the macro positioning and macro thoughts of how you are seeing what's going on in the world at the moment, but also then current positioning and outlook to the portfolio. And also understand what your current thoughts are on where emerging markets is going to land over the longer term. But obviously you've had some really big headwinds of late, so we'd love to cover those off. But before we start, I just wanted to say congratulations, obviously on the gold rating with Morningstar. Fantastic news. And I suppose it just supports some of the other high ratings that you've got there, which has been a great start here. You've also got the Undiscovered Manager award from Morningstar up there, fund manager of the year award. So that was nice to see that.
Glen Finegan:
Yeah. 22 years of career later, still undiscovered. But look, it's great that the strategy's got some recognition. So yeah, very appreciative of that.
Jonas Daly:
Excellent. So we'll dig into more on the macro side just to kick off. From a geopolitical point of view, how are you seeing the world, obviously opportunities, but also there's some pretty big threats if you open any newspaper at the moment?
Glen Finegan:
Sure. I mean, I think 2019 was an interesting time to launch an emerging markets boutique. I mean, we didn't know it, of course, but we were on the cusp of a global pandemic, which would close down economies and isolate China for years and result in some quite profound changes in terms of, I guess, supply chains globally and things like that. You wouldn't necessarily have seen that going on. And then I guess more lately we've seen short selling reports and attacks on politically connected groups in India suggesting that might be levels of impropriety there.
So yeah, it's been an interesting backdrop to run an emerging markets strategy. We've got a very defensive approach to building watch lists and building portfolios in emerging markets. And that's ironic, the point might be that if the worst of times might have been the best of times to launch a strategy like this, because we've had a three-year opportunity to demonstrate that we do what we say we do, you can generate absolute returns from owning good quality emerging market companies, particularly if you're very focused on governance and alignment. That's meant the strategies avoided a lot of the sort of banana skins that presented themselves.
Jonas Daly:
I think China obviously is a really key focus here, and especially for Australian investors. There's a lot of, obviously talk about China as obviously a big trading partner as well. So let's just focus on maybe China and India. But really let's kick off with China because isn't there an argument from what you're saying, it's just go zero China, why even have a couple of names in there at all?
Glen Finegan:
Yeah, I mean look, China's a big part of the global economy. There are plenty of businesses in China that are not state controlled and don't fall under this kind of foreign investment bar that the internet businesses. So I think we recommend excluding state controlled enterprise businesses that are state directed and obviously the VIE type names, but that aside, China's a huge economy, thousands of listed companies. I think it'd be remiss of us to not be working hard bottom up to try and identify businesses that might be creating valuable franchises. So yeah, we're searching in a few particular areas in China. I mean we're looking at businesses that are becoming multinational, so businesses that have maybe built some kind of homegrown advantage but are able to take it global. We're looking in areas where businesses are developing very strong brands domestically. We've had investments in brewers with premium brands in the country and even a tissue manufacturing business, but a sort of branded tissue, which is maybe becoming a little bit more like a Kimberley Clark more premium product, not just tissue. And there'll be a family behind that in joint venture with a Swedish pulp and paper company.
So again, you're looking at the shareholder structure and saying there appears to be strong alignment between people calling the capital allocation shots and minorities like ourselves. It's a brand creating companies. And then I guess finally in the area, which I think we've had a reasonable amount of success in, is looking for businesses that build a franchise based on trust. And in China, clearly there's been an issue around theft of intellectual property and we've identified businesses operating in the pharmaceutical sector that have a demonstrable track record of being a reliable partner for multinationals. So we do have a position in a company called Hangzhou Tigermed, which essentially it runs the administrative side of drug trials and China's got a very large and rapidly ageing population.
So there's an awful lot of multinational companies that want to launch their drugs in China. You need to conduct a domestic trial and there's a large pipeline of trials to be run. So rather than we're not taking any kind of success failure risk, but we're essentially picks and shovels, there's businesses like the picks and shovels of the drug development industry in China and it looks to us like there'd be a lot more outsourcing of this type of thing. And certainly if you compare it to the US, the level of outsourcing in China is still very low compared to where it probably ends up. I think we're looking for those businesses where you can point to a level of integrity and alignment of the people behind.
Jonas Daly:
Less government control.
Glen Finegan:
Well away from government. And I think this is largely sort of mid-cap China. It's not the commanding hypes in the economy. I think as the bigger you get in China, the more risk state direction starts to become a factor. So yeah, I think bottom up stock picking in China with the same rules applied, don't compromise on the quality of the people, the franchise, the balance sheets and hopefully it can generate decent absolute returns.
I think the one thing to say about China, even though the market's had a pretty torrid time since 2021, valuations are still quite high. So we have a relatively substantial watch list of these sort of mid-cap companies, but still only about 8% of the portfolio invested in China, which has gone up and we were probably down to about 2% at the peak of the valuation craziness there. So it's gone up a bit, but certainly not the biggest country allocation in the strategy.
Jonas Daly:
Interesting. And obviously the world's changed as far as how we access, I suppose, exposure to various emerging markets, can access emerging markets via traditional stock exchanges as well. So is there much other indirect exposure to China?
Glen Finegan:
Oh, yeah. Any global equity fund will have pretty significant exposure to China, whether it's Unilever or Heineken or South Korean cosmetics companies or whatever. They're all, been generating significant revenues in China. So I think there's a difference between generating revenue in China and having the ownership in China and thinking about the government and alignment risk. So yes, you might, I don't know, in the event of very significant sanctions on China, you could lose revenue as a shareholder in Heineken, but you won't lose your ownership at the company. So whereas I guess you look at the Russia experience and if you had equity in Russia, it’s now worth nothing and you've no prospect of recovering anything really.
Jonas Daly:
Well, a lot of Australian investors are kind of accessing that growth in China through BHP or Rio for example as well. But not having done stock directly.
Glen Finegan:
Yeah. We don't own the commodity producing companies, but certainly whether it's consumer goods, businesses that have brands in China or even actually a Japanese listed but South Korean games developer, Nexon, that China's a big part of the population who play its games, a lot of them are in China. So yeah, we have revenue, we've much more revenue exposure to China than we would have equity exposure to China, for sure.
Jonas Daly:
This is an index unaware strategy. So not being obviously the MSCI, sometimes they dictate how much weight you have in the index. So if you were to take an index fund or ETF, you'll naturally just have that market cap weight to China. And we spoke about it on our last podcast, but there will be times where I suppose it's just to let investors know if China runs very hard, it's unlikely it's going to be hard to keep up with that.
Glen Finegan:
Yeah. You'd sort of expect that. I mean the last sort of headwind for the strategy would've been sort of '18, '19, when China tech companies became very much the driver of index returns and they're these VIE structures, so we didn't own them. I do think they've changed, as I said earlier, I think they're now explicitly under the watchful eye of the government. So capital allocation there is clearly compromised. We can see shareholders of Alibaba, VIE have never had a dividend, but the government's been able to take very large donations towards its common prosperity funds and want to be out of the company.
So are they going to be the drivers of the next emerging market bull sort of state directed tech platform to China? They could be, but I'm more enthused by the idea that genuinely private businesses backed by capital allocators with strong track records and great opportunities to invest are more likely to maybe drive the next sort of wave of excitement around EM. And that would lead you to think about fast-growing Latin American companies or fast-growing Indian businesses.
India's likely known for having issues with corruption and many of the businesses there would fail our kind of governance and alignment test. But there are hundreds, if not maybe thousands, of companies to look at in India. And there is a subset of companies there with very long track records of looking after the interests of all stakeholders very carefully, and where you can point to a governance structure which might be a family owner or it could be a foundation. We've got a big holding in a Tata group company and obviously the Tata governance structure is structured as a foundation, but you can look at a hundred years of Tata history and try to take a view of how risky they might be and that history would suggest not very risky, they have higher standards of governance.
Jonas Daly:
So tell me about Tata, it’s consulting?
Glen Finegan:
So our position’s in Tata Consultancy Services. And again, I think this is another maybe sort of thing that drives our stock picking in EM: we're looking for businesses in EM. We've got no interest in making compromises to invest in EM. If anything, we think that the risks of investing in EM mean that it's the absolute last place you should make any compromises, because a compromise is very likely to cost you dearly, as investors in Russia have found out. And that's just one recent example. So we are looking for businesses in EM that are not just interested in meeting local standards, but are either out to meet or even set global standards.
And there's lots of them. We look across – within India, you have names like Tata Consulting Services and Infosys, which if you think, they started out as low cost body shops, if you want to call it that. But over time, by reinvesting in their businesses, they're now global leaders in IT services and compete head-to-head with Accenture and every other developed world peer. So those type of success stories that being able to come out of EM I think are well worth considering for a strategy.
And there's lots of them, not just in India. I mean, we have a position in Brazil in an electric motor manufacturing business called Weg. Weg competes head-to-head with ABB, Schneider, every global capital goods company you can think of, Weg is able to take market share from them and that's more been historically in motors themselves, but the next wave for Weg is to take share in the control systems, the automation systems behind the motors and how you sit, so all of that kind of additional stuff that maybe still is dominated by developed world businesses. Weg is hot on their heels. And so I think if you go around EM looking for global leaders, that's a kind of good mindset to have and it'll help you avoid some of the bigger mistakes in emerging market investing.
Jonas Daly:
Excellent, that makes sense. And obviously there is an overweight, and again we're not looking at overweights cause we're not index aware, but 24% of the portfolio currently sitting in India versus the benchmark at 13%, but just going back to China, the index has 31.1% and your portfolio has 7.5. So there's some key differences there if anyone's kind of asking the differences between Skerryvore and your typical index aware fund or index fund.
Glen Finegan:
Yeah, there's biases. I mean, there's other biases in the portfolio. We've got a big bias towards the consumer staples sector, about 40% of the strategy.
Jonas Daly:
Yeah, I saw that. That was massive. So what's driving that?
Glen Finegan:
Well, it's interesting because it slightly gets up my nose that the sector's called consumer staples. And the one thing we don't own is staples. We don't own rice companies, pasta companies, sugar, the type of things you think of as staples and we don't own them, ‘cause those types of businesses are more like commodity than value added businesses, pricing power. So I think if you look at what makes up our staples weight, it's the leading convenience store chain, essentially what looks like 7-Eleven of Latin America, it's called OXO, which is a rapidly growing company that's rolling out stores in Latin America on top of the 22,000 stores or something they have now. They're building a digital payments app so that the stores can sort of operate as an informal bank branch. You can cash in, cash out of the digital wallets and things. So this is anything but a staple. This is an extremely well-run consumer facing franchise with great pricing power and great prospects to grow.
We own Coca-Cola bottling operations in countries where you could argue demographics should be on your side, where you've got rapidly growing populations, large groups of young people, and consumption per capita is low. And you have on top of that the very strong Coca-Cola brand that gives the businesses pricing power. Another subset of our consumer weighting is we own some of the leading pharmacy chain operators around emerging markets. And again, why aren't they healthcare? But they come in under consumer.
Jonas Daly:
Are they under discretionary consumer?
Glen Finegan:
No, no, no. All of the names I've just given as examples would be under the staples. Consumer discretionary is more things like vehicle retailers. We did add a vehicle retailer in China to the portfolio during the depths of the property crash. Now, we figured with lockdowns and property prices falling, you are going to have very suppressed demand for Porsche 911s and fancy cars. That's what this company sells. And with the reopening and the business coming back to normal, you'd kind of expect maybe a bit of pent-up demand to mean that that business goes back to historical levels of profitability. So we've tried to take advantage of some distressed valuations in China under the discretionary category.
Jonas Daly:
And look, we’ve seen the same in categorisations in Australia as well in Australian equities, it's misleading in that consumer discretionary space. But I think with ...
Glen Finegan:
Where we're not exposed maybe is just energy assets, utility assets, and this is because of pricing power. We want to own businesses that are in control of their own destiny. And if you dig a commodity out of the ground and sell it, yes, you can try and control your costs, but you've got no control over what revenue you're going to earn. And in the regulated space, whether it's toll roads or energy generation or whatever it might be, we don't like owning companies where the politicians set your rate of return. So we'd much rather businesses where pricing power is in the hands of a proven management team. So in emerging markets, regulated assets are not of interest.
Jonas Daly:
Absolutely. So those are companies that have that ability to pass on that price increase. And is that coming through, obviously there's a couple of names that you mentioned already, but any that come to mind that have done recent price increases?
Glen Finegan:
Yeah, we've seen it across the board. So the efficient retail businesses, the inflation is their revenue. So the revenues are going up and then you're relying on them to extract the operating leverage. And a CEO of a South African retailer who is retired now, but we used to enjoy speaking to, he said, inflation makes a genius of me. So this makes his job easier, right, because revenue’s going up. So yes, we're seeing inflation in revenues and then therefore obviously the profits, the retail businesses that we're invested in. And then in some of these consumer goods companies, I mean yes, the Coca-Cola bottle will pass through inflation and it hasn't hit volumes. The Heineken related businesses we own. I mean Heineken itself, revenue per hectolitre was plus 11%. So I guess that's … lager beer is a staple. So if you want to know what inflation is, if you want to know what global inflation is, it's probably 11%, because that's what Heineken went up by.
Jonas Daly:
Some of these companies too … I think in our last podcast as well, you were talking about how they have some arbitrage where they do have that benefit of cheaper running costs or labour costs. Could be other countries for example, but then this will make you ...
Glen Finegan:
I think maybe what we were talking … I mean certainly in the case of something like Heineken, you have such a broad range of businesses within it. You have developed European footprints and a place like Italy or wherever it might be, and then you have very prospective markets that might take some time to really deliver big profits, like India, which are still pretty early stage for them. Nigeria, Heineken's the biggest brewer in Nigeria, but with large young growing population. So yeah, thinking about Heineken's pricing power, it's a combination of earlier stage markets and premiumisation in China and low consumption per capita in Nigeria, price in Europe, you're not really going to get volume growth in Europe. So yeah, you have to think of the constituent parts to try and work out what you think the company might be worth.
Jonas Daly:
Turkey is an interesting one with inflation, what's going on there? Huge amounts of inflation.
Glen Finegan:
Yeah. Turkey has been one of the biggest contributors to the portfolio’s absolute return over the last, certainly the last 12 months, maybe longer. Obviously they had that awful earthquake, which has had a horrible death toll there. From an economic perspective, the impact’s quite limited. The east of Turkey is not really the sort of economic powerhouse of the country and that's the part that was hit. So the industrial heartlands of Turkey are more the European side of the country and have been unaffected, which is good news. It means that the government continues to make tax receipts and can hopefully help with relief and reconstruction and what have you. So the economy wasn't taken out by the earthquake, despite the horrible human cost of it.
What interests us with Turkey is it's very noisy politically. There's an election coming up allegedly later this year. And clearly the economy hasn't been particularly well managed. The view has been of the president has been to cut interest rates when inflation was up very high. And that's caused...
Jonas Daly:
Double digits, was it like...
Glen Finegan:
I think it's been up like 80 plus, yeah. And that that's caused the currency to be very weak, which of course only makes the inflation worse because you're importing things. So you've had this kind of mismanagement of the economy.
But there are some different kind of more structural things about Turkey than the current political regime. And one is it's a member of the European single, it's a member of the European Customs Union. So you can manufacture things in Turkey and export them tariff-free into Europe, and a lot of companies do, and it's got a very highly educated workforce. It produces thousands of engineers every year and what have you. So it has a very sophisticated industrial base despite the kind of chaotic political leadership in the country.
And the best industrial business there we'd argue is controlled by a family called Koc family who’ve been in business for almost a hundred years and have formed joint ventures at multinationals like Ford. We own Ford Otosan in the strategy, it's the biggest manufacturer of Ford commercial vehicles for Europe. And of course the side effect of a weak currency is it makes Turkey more competitive as a manufacturing hub. So what we've seen is companies like Koc Holdings and Ford Otosan rally from extremely low valuations, historically low valuations, to a more normal valuation over the last sort of 12 months or so. And that having positioned ourselves in these very good quality companies at a time when Turkey was really unpopular, has really helped.
And I think that kind of speaks to our philosophy. We've been able to identify a global leading industrial company in Ford Otosan, which has great long-term prospects there, converting the vehicle manufacturing lines to electric at the moment. So from 2026, I think all the vans coming, they make transit vans, all the transit vans coming into Europe will be either hybrid or electric. So there's a big investment program going on which shows you the confidence the company has, it's investing in its operations. So we haven't had to take any corporate governance risk, any balance sheet risk. The franchise is very strong, it's got very strong partnerships with multinational companies. The business has a 90-100 year track record that we can look at. They've always been out of politics. It's not a political family, it's an industrial family. They've managed businesses through military dictatorship, through military coups, through chaotic coalitions and through president Erdogan's regime. So they know how to do business in Turkey.
Jonas Daly:
Who controls interest rates, is that the government as well?
Glen Finegan:
It's the president, but it doesn't, these guys certainly at the parent level, they've got a net cash balance sheet. In fact, most of the companies in our portfolio have net cash balance sheets. We prefer to invest in companies with no debt 'cause it's just one less thing to go wrong, isn't it?
Jonas Daly:
I'm conscious of time because look, this is really interesting, but just in terms of current positioning, just getting back to what you've topping up a few stocks, but also your outlook as well. Obviously you're focusing on those companies. You've covered a lot of them who have pricing power, but just anything in regards to just current positioning and your outlook for emerging markets.
Glen Finegan:
Yeah. I think I just sort of alluded there, I think maybe because the China technology companies had such a big run, now that's over, maybe the mindset's changing, but the confusing of China and emerging markets, China's part of emerging markets for the time being, it's considered part of the emerging markets' universe. It's certainly, it's not all of emerging markets and it's a very broad and very diverse set of countries and they're all in different parts of their cycles. We just talked about Turkey having a bit of a tough time, but India, things going along quite well in India, let's say.
There is maybe an overarching trend which is sort of China linked, which is post the pandemic and the lockdowns and what have you. As I mentioned to you, companies are retooling supply chains. We're seeing significant investments in places like Mexico and Turkey, Vietnam, India, anywhere with an industrial base that would not be considered overly aligned with China is benefiting from developed world corporates, realigning supply chains. And I'm not saying that there's a permanent rupture between the developed world and China, although clearly the relationships got more complicated. But it's clear to me from corporates we talk to all around the world is that they're not prepared to be solely reliant on China.
And that creates an interesting backdrop for investments in Mexico and Turkey and Brazil and countries that can potentially take some market share ... and corporates there and foreign investments, and EMs always benefit when foreign direct investment is coming in and many are on the right side of this realignment and supply chain. So yeah, it's a broad universe. So I think we've got significant positions in Mexico, in Turkey as we just discussed, and in Brazil as well actually. And some of these markets are pretty unpopular. Despite Turkey having done very well, the stocks are still cheap there. They’re just really cheap. I think keeping a very open mind and not letting the index tell you where to invest, I think is kind of the key.
Jonas Daly:
And that's one thing that stands out to me, what you guys are doing at Skerryvore is that you're just not taking on that unnecessary risk in emerging markets. It's a much more conservative way to play EM and look, what we're seeing already is there’s proof in the pudding here, it's coming through, especially in these turbulent times with a lot of this geopolitical risk going on.
Glen Finegan:
We've set this business up to pursue this quite differentiated investment philosophy, and ultimately we set out to be absolute return investors in emerging markets. So I think anyone looking at the investment trust needs to be aware that we can do extremely well in relative terms just as we have done recently, but we can equally lag very euphoric markets when things are getting quite excited and what have you. But if I look back over the track record that I have, which sort of formally begins about 2008, we've been able to deliver far better absolute returns than the peer group and the index. But I think most importantly we've done it with a lot less volatility. So yeah, I think if you've got a reasonably long-term time horizon and you don't like stress, we’re probably an interesting option for you.
Jonas Daly:
And that track record is there. Obviously on the risk return side, it is in that top tier of having a very strong risk return profile in emerging markets over the 20 years that Glen's been investing. Well, look, thank you very much once again. It's great to have you in Sydney here, and good luck with the rest of the trip and thanks for talking to us today. Cheers.
Glen Finegan:
Thank you very much. That's great.
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