Hello and welcome to the Morningstar series, "Why Should I Invest With You?"
I'm Emma Wall and I'm joined today by Mark Asquith, Manager of the Somerset Capital Emerging
Markets Small Cap Fund.
Hi, Mark.
Hello.
So, I thought we'd start with China.
It's the biggest part of emerging market investing and it's somewhere that you're not feeling
too positive about at the moment, is it?
Yes, easy to say after it collapsed in the second half of last year and the beginning
of this year.
I think it's like the baddie at the end of the Western who gets shot and then you think
he is dead and he comes back with a hidden weapon.
China is not particularly attractive from a bottom-up perspective.
Valuations are better, but fundamentally the businesses remain unattractive.
They are in a system which is largely rigged by state-owned players which makes it very
hard to compete against them, especially in the small cap space and regulated pricing
along with vested interest.
So, it doesn't make for a particularly healthy industry landscape.
Then from the top-down view, they have been running like a rat on the wheel since 2008
when there was a huge fixed asset investment and the concomitant debt overhand given that
there weren't prices available to generate returns on that investment.
So, they tried to equitise the heavily indebted companies at the beginning of last year, hence
you saw the huge rally when then collapsed as people decided these weren't good credits.
They then doubled credit growth at the end of last year.
So, we're in quite a scary situation, but they may have one last weapon and that could
be they double credit growth again or they may devalue the currency.
But both have profound influences for the world.
You may get a strong deflationary pressure; you may get strong inflationary pressure.
And of course, as a stock picker, all of that is just background noise, validating your
decisions not to go for these companies because their investment case is not compelling?
It's nice when they both align.
So, if both top-down and bottom-up are negative then it's an easy avoid.
I say easy, but the beginning of last year we had almost nothing there and it was going
through the roof, that's less easy.
I know that you put some cash to work at the end of 2015 into areas that you saw opportunities
in, one of them being South African stocks, which I think a lot of investors know very
little about with the exception perhaps of Tiger Brands (UG5A).
What investment opportunities are there out there?
So, it's the best performing stock market since 1900 which a few people know and you
see very high returns on capitals and the companies there.
So, those are two symptoms.
What are the causes of those symptoms?
It has actually incredibly wide range of industries and wide range of listed industries, everything
from quite strong construction, stroke road building firms, right the way through to branded
goods and they have been forced to develop those because of apartheid.
So, you've got that wonderful range of sectors to invest in, very good management teams and
a lot of strong compounding growth stories, so something likes Clicks (CLS), which we
bought recently, is basically the Boots pharmacy of South Africa with tremendous growth.
It wasn't one of the cheap stocks we bought last year, 19 times earnings, but I think
its growth is being drastically underrated.
Something like Raubex (B7P), which is a road builder, was trading at five times price to
earnings, 0.5 price to book, with a good balance sheet, competitive advantage in a cyclical
industry where we're seeing supply exiting.
So, a couple of opportunities there.
And looking then across the other side of the globe, I know South America is also an
area where you have been deploying cash.
I think a lot of concern about that region has been oil price, commodity-related.
However, it seems like you are finding opportunities there?
Yes.
I mean, as ever, the starting point is, these are stock markets, not GDP markets or commodity
markets and it's the quality of the companies and the prices you get them at which dictates
the opportunity set.
You can buy the entirety of South America for less than Taiwanese weighting in the MSCI
Index, less than the Korean weighting.
I mean, Mexico, Chile and Brazil together has some 12%, 13%, they are miniscule compared
to what they are.
No one wants to be there.
They have had a little pop recently.
There may be a drawback.
But there are plenty of good Brazilian small cap companies…
And not all related to energy or are you seeing opportunities there?
Again, few related to energy.
I won't touch Petrobras (PETR4), but you can buy in Brazil M. Dias Branco (MDIA3), which
is the number one pasta and cookies manufacturer.
We're buying at 11 times price to earnings.
Staple stocks have been at 30 times for years.
You can buy Porto Seguro (PSSA3), a fantastic auto-insurer.
Everything they do only increases their barrier to entry, their stickiness with the customer.
Again, you can buy that almost single-digit P/E multiples.
In Mexico, I've just been talking to ARA (ARA), one of the homebuilders there, and the industry
has seen huge bankruptcies over the past five or six years, declining returns for a decade
and growth is coming back and they are available at very cheap valuations.
So, South America, much hated, doesn't make up much of the index, worth looking at.
China, Korea and Taiwan together make up about half the index; I think there's still trouble
there, although they may be jumping up and making a little more appreciation this year.
But long-term there are other areas to look at in GEM.
Mark, thank you very much.
Thank you.
This is Emma Wall for Morningstar.
Thank you for watching.