Secker said the mindset of the average investor is focused on growth, particularly in emerging markets, and they don’t like to buy companies that are shrinking.
“That means we can pick these companies up at very distressed valuations.”
Valuations are key
Emerging markets are currently trading at huge discount to developed markets: 30-35% price-to-book, he said.
“The only time they have been cheaper than developed markets was during the Asian Financial Crisis (in the late 1990s),” Secker said.
His team looks for companies where the management team is remunerated on profitability instead of growth targets. Return-on-capital is most important. He said there’s an 80% correlation between return-on-capital and valuation in the marketplace.
“We sell good stories and buy bad stories. We look for low return-on-capital businesses that will grow from loss-making businesses to ones that create value.
“Too many companies have overgrown and gone through rapid expansion and moved into areas that are not in their core competencies and they don’t understand the competitive landscape.”
Ultimately longterm valuations drive returns, Secker said. “If you buy a business that’s priced to generate levels of profit structurally it cannot ever achieve, at some stage the market becomes rational and there’s a sell off.”
“Similarly with buying some beaten up companies in cyclical sectors people have fallen out of love with. At some stage there will be a mean reversion, which drives all investments. Those expensive companies will revert to mean and cheap companies revert upwards to mean.”
Who runs the company?
Secker said his firm’s emerging market funds are “unashamedly boring, longterm, bottom-up funds” and the investment strategy is contrarian.
The investment team follows value, and that strategy is moving them away from Thailand, the Philippines, Malaysia and Indonesia and toward China and to an extent Korea.
When taking a longterm view on emerging markets, assessing corporate governance and speaking to the management is crucial, he said.
“A lot of the easy money in emerging markets has been made and now it’s more about company specifics.”
A big issue in emerging markets is direct state influence in a company, Secker said. The company could be run for socio-economic or policy goals rather than profits.
He said a China ETF will typically have an 80% weighting to state-owned enterprises, which are often run to achieve political goals. For example, he stays away from Chinese banks, which remain a large part of the index.
“Running a company is not about top down but about bottom up and the state may be dictating how that company is run.”
China bull
The firm moved to overweight China in the past year.
“China has underperformed massively the last six years and valuations are at historic lows. It’s a very cheap market and people still view it pessimistically because of slowing GDP growth, but there is no correlation between GDP and stock market growth.
“China lends itself to active investing. The range of companies – from very good to atrocious — is enormous and you have to be selective.”
Secker said the firm is evaluating investing in A-shares through the stock connect, which he sees as a huge positive in the longterm.
“Shanghai is an incredibly liquid market, second only to the US. The volumes are enormous because it’s largely retail and shortterm in nature. Because it’s largely retail, it’s liquid and inefficient and more of a stock pickers’ market.”
