Since bottoming at the end of October, the MSCI Emerging Market Index (MXEA) and MSCI Asia Ex-Japan ...
2 Small Picks for the Big Global Picture
05/03/2012 7:00 am EST
The phrase “emerging markets” doesn’t just have to mean companies based in Brazil, Russia, China, or India. Fund manager Jonathan Brodsky tells MoneyShow.com 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.]
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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.
Kate Stalter: Can you tell us about one more, perhaps from a different sector, Jonathan?
Jonathan Brodsky: Yes, I’d be happy to. As I mentioned, I’m trying to be accommodating as it relates to stocks that are readily tradable. I’ll give you one in Hong Kong, because Hong Kong is another market, again, that most retail brokerage firms will allow trading. It is a very easy market to trade in and out of.
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The company that I will mention in Hong Kong is another company that is highly related to emerging-market consumption growth. The name of the company is a little hard to pronounce, and I’ll spell it for you, but it’s Yue Yuen Industrial Holdings Limited (Hong Kong: 0551).
This is the largest manufacturer of athletic, casual, and outdoor footwear in the world. They are the major manufacturers of athletic footwear for Nike (NKE) and Adidas, as well as most other branded shoe companies around the world.
This is a Taiwanese company that is listed in Hong Kong, and most of its sales historically have gone to European, US, and Japanese markets. But now, because of the incredible growth and consumption in emerging markets and the demand for Western brands, you’re seeing strong growth from the underlying shoe companies—which directly benefits Yue Yuen, which has been working with and for the shoe companies for over 30 years.
In addition, Yue Yuen has its own retail outlets within China, approximately 3,000 retail outlets in China, where they are selling these branded goods.
So this is another company that has great growth opportunities, related to consumption, listed on a developed-market exchange. The market cap of the company is around $4.5 billion, so it’s a nice mid-cap company. The P/E is a little bit north of ten, with a yield of 3.5%, trading at a small premium to stated book value. So from a valuation perspective, again, very attractive.
Long term, we see consumption in footwear as being very much driven by emerging markets. In the short term, however, you have the Olympics, as well as a number of important soccer tournaments, which should propel earnings in the short term. But long term, we think the growth prospects for this company are very attractive.
Kate Stalter: Let me just wrap up today by asking you: many of our listeners are individual investors who are concerned about their retirement portfolios. How would they work a fund such as yours into their overall portfolio?
Jonathan Brodsky: Well, we believe strongly that diversification is important for all investors, and certainly those who are nearing retirement. So, the idea of investing in the overseas market is overdue for many people.
Historically, the US has really led the developed markets and the investable equity universe. What people don’t realize now is that over 70% of the world’s market capitalization is outside of the US, and only 30% in the US. So from an exposure standpoint, we feel like we offer our clients access to that 70% that they probably aren’t getting otherwise.
In addition, the dynamics of large-cap investing in the equity markets have shown limited diversification benefits over the years, and what I mean by that is, large-cap international securities and US securities on the large-cap side are a little bit north of 90% correlated, so you are not getting diversification benefits that you did historically.
When you look at mid- and small-cap securities, like the ones I mentioned today and the ones that are in our fund, you get significant diversification benefits. You also get that attractiveness of the valuation that I mentioned and exposure to some very compelling companies that are directly related to emerging markets.
The outgrowth of our valuation criteria as we invest is a very attractive yield. So the fund we mentioned today has a yield of around 3.5%…which is not one of our objectives as we’re researching our companies, but an outgrowth of the quality of companies we find, as well as the valuation in which we’re investing.
So, I think for those entering or nearing retirement, we offer tremendous opportunity from an exposure standpoint, benefits of diversification, and then growth and income from the companies in terms of yields. Around the world, yields tend to be very attractive, and certainly this portfolio reflects that.
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