R Squared: A Strategy for Uncertain Global Markets

09/30/2015 10:00 am EST


To select stocks, Riad Younes looks to companies with dominate positions, strong franchises, good managements, and businesses that he considers relatively immune from weakness in emerging markets and commodity prices. Here, the money manager with R Squared Capital Management, discusses his long-term investment strategy and highlights some favorite global ideas.

Steven Halpern: Our guest today is Riad Younes of R Squared Capital Management and portfolio manager of the RSQ International Equity Fund (RSQVX). How are you doing today, Riad?  

Riad Younes: Thank you, I’m very well.  How about you, Steve?

Steven Halpern: Very good. Now, you’ve been recognized as a Morningstar Fund Manager of The Year, a three-time winner of Standard & Poor's Excellence in Fund Management, and you were named the Equity Fund Manager of the Year by Money Management Letter. Could you tell our listeners a little about the investing strategy underlying this long-term record of success?

Riad Younes: Thank you, yes, we’ve been managing money for more than 20 years and I would say philosophy and the process are the two key cornerstones of our success and the reason for having consistent good performance. Basically, we try to focus on three things, one, we like to invest in geographic sectors or stocks that are facing strong structural tailwind.  

Secondly, when we look at companies, we'd like to have a horizon of two to three years as opposed to one or two quarters. That gives us a better idea about our investment strategy, and thirdly, we are a very big believer in diversification to reduce risk, volatility, and give us the staying power to stay with our thesis.

Steven Halpern: Now you’ve been very right in your recent forecasts having been bearish on commodities and emerging markets, and in your recent commentary, you suggested the bubble has burst even faster than you had forecast. Could you expand on that?

Riad Younes: Yes, thank you. Yes, if you look at the boom in commodity prices, almost any commodity known to mankind have gone up by 5 to 10 times since 2002, which is the date when China joined the WTO, the World Trading Organization.

And, as we know, commodity prices should be linked to cost, so unless the cost of commodities has gone up 5, 6 times the last ten years, there is no way to justify the current increase in commodity prices, so, therefore, we were very confident that this appreciation is totally unjustifiable and sooner or later we are going to start to see a correction.

Steven Halpern: Now, how far into that correction do you believe we are?


Riad Younes:  Okay, well, you could go as low as 2002 level. I mean, there are always arguments today to defend higher commodity prices basically linked to more difficult terrain and lower grade, which, basically means it’s higher, it’s more expensive to extract those commodities.

But at the same time, also, we have much more advanced technologies which tend to, which have tended over time in history to offset these complexities, so it’s difficult to tell, but we would not be surprised at all that many, if not many commodities are back to this pre-China bubble level.

Steven Halpern: Now, specifically, regarding China, you note that the equity bubble is deflating and the economy is having trouble rebalancing.  How will this impact China’s equity markets long-term and how will it impact the rest of the globe as well as the US market?

Riad Younes: This is a very interesting question, so, basically, it was very known to many investors and economists, and even to the Chinese policy makers themselves, that also...that growth, that economic growth over the last ten years has been very attractive and very strong.

It was relative dangerous in its mix because fixed assets investments has been almost above 50% of GDP, which is very, very alarming and it’s very unbalanced.

So they realized for them they need to switch the mix and have consumption more like 50% of GDP and bring down FAI—which is fixed asset investments—down to about 35% of GDP.

This rebalancing is tricky, it takes time, and is going to close slower growth as a baton cannot be very smoothly handed away from manufacturing and infrastructure to consumers. In that sense, what they’re doing is good for the long-term but short-term is creating a little bit of weakness and imbalance.  

As far as the Chinese equity market itself, we think it’s impact on the global economy will be limited because most of the investment is done by the Chinese speculators, the mom-and-pop variety, and therefore, and also, the equity ownership in China is very minimal, so the worst effect is not really there.

And, as far as the global economy, the only effect you’re going to see again is on emerging markets and on commodity prices, because as you move away from being fixed asset investment economy to becoming more and more heavily consumer driven economy, your need for commodities and the like will minimize and decline dramatically, and therefore, this continued bear market in commodity prices will continue.

Steven Halpern: Let’s walk through some individual stocks that will help highlight your investment strategy.  First, you like the outlook for Liberty Global (LBTYA). What’s the story here?


Riad Younes: I mean, the three strategies we’re going to talk about have a few things in common.  

One, they have dominate position, strong franchise, good management, as well as their business is relatively immune from the current weakness we’re going to see in emerging market and commodity prices, so Liberty Global is mostly focused on telecommunications assets, which is mainly fixed lines in Western Europe.

And we think in that part of the world, especially, that economy is starting to pick up and cable assets tend to be very duopolistic in nature in other geographies and tend to have very strong pricing power.  A lot of strong growth related to this data explosion we are seeing today. The growth rate is there, the pricing power is there, and we like the management.

Steven Halpern: You also recommend Lloyd’s, Inc. (LN: LLOY), a London-based company.  What’s the attraction here?

Riad Younes: The attraction there is because of the crisis, unfortunately, the banking sector gets even more constantly dated, and again, this has created a very strong structural tailwind when you have fewer competition and the economy starts to grow there.  

We expect rates to be increased short-term and that should be beneficial for the banking margin, and valuations are very cheap, we’re talking buying a bank in the high single digits and you could easily have a dividend yield of 5% to 6%, so it’s a very attractive, and again, also, you're immune from this volatility you’re going to see from emerging markets, China, or commodities.

Steven Halpern: Now, finally, you suggest Novo-Nordisk (NVO).  Could you tell our listeners a little about this outfit?

Riad Younes: It’s a Danish-based company.  It’s a global company; it’s a global leader in diabetic and insulin.  It supplies almost more than half of global insulin to the world.  

The key tailwind in that industry is obesity and demographic older population.  As people get older, and as their dieting habits get worse, as we eat more and more fast foods, and we get more obese people, we’re getting more diabetic patients.

And, therefore, the need for insulin-like products is dramatically increasing.  The company has a very strong pipeline, have new launches, have leading product, and this is a company that can grow 15% earnings before interest and taxes for a very, very long time.

Steven Halpern: Now, finally, for those of our readers who may not be familiar with buying foreign companies, are these shares that they would need to buy on foreign exchanges or are they available through perhaps ADRs on the US exchange?

Riad Younes: All three companies can be listed in one shape or another here in the US so they can be bought here in the US equity market.

Steven Halpern: Thank you, again, our guest is Riad Younes of R Squared Capital Management. Thank you so much for your time today.

Riad Younes: Thank you, it’s my pleasure.

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