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The phrase “emerging markets” doesn’t just have to mean companies based in Brazil, Russia, China, or India. Fund manager Jonathan Brodsky tells about his team’s approach to getting emerging-market exposure in a variety of ways in the small- and mid-cap arenas.

Kate Stalter: Today, I’m speaking with Jonathan Brodsky, co-manager of Advisory Research’s International Small-Cap Value Fund (ADVIX). Jonathan, can you begin today by just talking about the fund’s objective and investing philosophy?

Jonathan Brodsky: The fund’s objective is to focus on inefficiently priced securities around the world. Advisory Research was founded on the belief that mid- and small-cap securities, both in the US and abroad, have more opportunity for pricing inefficiency because lack of research coverage and lack of institutional ownership.

So our area of focus is to look for these inefficiently priced securities, to research them extensively, to visit with management to get to know them very well, and then to invest in them for our clients. Advisory Research is a value-oriented investment firm with approximately $9 billion under management. Our equity-related products are all value oriented, and as it relates to this product.

Our core criteria for making investments are generally focused on a couple of fundamentals as it relates to the company. First off, we’re looking for companies that trade cheaply, based on our valuation criteria. By cheaply, we generally mean trading at a low valuation tangible to book value.

The companies also need to have very strong balance sheets, so we tend not to invest in companies that have a lot of leverage. And they have to be profitable.

The firm was founded on the belief that protecting on the downside is very important for clients, so our No. 1 objective is to make sure that our clients are put in the position not to lose money. And then our secondary objective is to find companies with good growth prospects, such as they can generate attractive returns for our clients.

Kate Stalter: Before we began recording today, we were talking a little bit about your approach to emerging markets, and it’s pretty unique. Can you talk about that today?

Jonathan Brodsky: Yes. So, the fund that we’re referring to, the International Value Fund, as I mentioned, is focused on mid- and small-cap securities outside the United States.

One question we get a lot is about the attractive growth prospects in the emerging markets, and how we are taking advantage of those growth prospects. As we’ve done our research over the years, we find the emerging markets to be very compelling long term, from a growth perspective and also from an investment perspective.

What we found difficult, however, is to find emerging-market stocks listed on emerging-market exchanges that fit our very value-oriented criteria, and that makes sense. There’re a lot of demand for these securities and limited supply.

For example, in Brazil, which is one of the more attractive emerging-market exchanges, there are only approximately 800 publicly traded securities, and about half of them would be considered liquid enough for a retail investor. So, for us, as we’re very focused on valuation, it tends to be quite difficult for us to find attractive valuations on those exchanges. [Actually, there are only about 470 listings in the Brazilian bourse, the Bovespa—Editor.]

Other exchanges around the world—for example, the Indian exchange—put up pretty strict barriers to entry for foreign investors, making it quite difficult to invest directly on those exchanges. As it relates to the ADR program, which has been historically where a lot of people have gotten exposure to emerging markets, unfortunately, those tend to be very large cap-oriented companies.

When you’re looking at large-cap emerging-market securities, they tend to be much more globally oriented than oriented toward the local market. We feel like the really attractive area, the really attractive niche in the emerging markets, is really directed at the consumer and GDP growth within the country.

For example, if you look at some of the largest emerging-market securities—for example, Samsung, Petrobras (PBR), Gazprom (GZPFY), or Taiwan Semiconductor (TSM), which are the largest representative companies within the Barclays iShares Emerging Market Fund (EEM)—they tend to be very multinational in nature.

So our goal is to really focus on finding mid- and small-cap securities that are directly related to emerging-market growth. Where we found great opportunities is in developed-market securities around the world that have exposure to the emerging markets. What I mean by that is, for example, a Japanese company which does all of its manufacturing in China, or a South African company that is listed in London. There are lots of these types of opportunities.

There are also the types of opportunities where you have companies that are domiciled in a certain country, but do almost all their business in the emerging markets. We found a lot of attractive opportunities at very good prices that fit our criteria, that give our investors ample exposure to emerging markets without paying the premium, getting high levels of security regulation, and getting a proper accounting and auditing treatment within those companies. That, quite frankly, is a little bit more difficult to find directly in emerging markets.

Kate Stalter: Jonathan, I think that leads to the question, then, of drilling down a little bit, and talking about a couple of the holdings that you have, and how you are able to identify these.

Jonathan Brodsky: Let me give you a couple of examples of securities that we own within our accounts that quite frankly, are readily tradable for retail investors. When I mean readily tradable, either they are trading in the US or they’re trading on markets around the world which are easily accessible for a retail investor.

The two that I would bring up, which would very well point out what the opportunities are for one who is seeking emerging-market exposure with a real research bent, would be the following: One example I would give you is a New York Stock Exchange-listed company. The name of the company is Banco Latinoamericano de Comercio Exterior (BLX).

It is a specialized multinational bank established to finance foreign trade in Latin America and the Caribbean. That is a longwinded way to say it is a bank that funds commodity producers in Latin America and Central America for primarily their sales of commodity agricultural products to Asia.

So, this is a very attractive bank that is primarily in trade finance, oriented around food and growth in South America with its trade to Asia. With the expansion of the Panama Canal, we expect commodity production from South America to Asia to expand significantly, and this bank should benefit materially from that expansion.

From a valuation perspective, it’s a very attractively valued security. Currently, it has a market cap slightly below $1 billion, and it has a P/E of less than ten, price to book value around one, and a very capable management team that is putting its excess capital to work.

The benefit of that is that the stock is yielding almost 5%. So this is a company that, again, falls below a lot of people’s radar, but has all of the valuation criteria that we look for, as well as very strong growth prospects directly related to emerging-market consumption growth.


Tickers Mentioned: Tickers: GZPFY, EEM, ADVIX, PBR, TSM