Fund Manager Q&A

"We've had 10 years of fantastic structural growth, however, the next 10 years may be even more exciting than the last, and adoption will happen at a much faster rate. This story is only at the very early stage". In our latest Livewire Q and A, we took the opportunity to catch up with Damian Bird, Portfolio Manager at LGM Investments to get his latest insights on Emerging Markets.  In this eye-opening discussion, we discussed some of the filters he uses to screen for companies, why he thinks the domestic consumer is a nation's biggest and most important asset, and one opportunity that he thinks could bring a smile to every investors face.  

I noticed that after finishing your economics studies at Oxford, it took you three years before you started working in finance. What was holding you back? 

When I came out of Oxford, most of my classmates were all straight into what they call ‘milkrounds’, the grad programmes in the senior banks. It was either finance, law, or consulting. I wanted to challenge that, but I wasn't quite sure exactly what to do, so I went to Paris and did a French literature course for six months. 

I stayed in France and toyed with the idea of becoming a sports journalist. That was quite good fun. I worked for Eurosport.com, and they were trying to build out their English language website. So I did the minute-by-minute sport reporting for some of the football in England, which was quite good fun. But then I decided I wanted to keep sport as my passion, not my job, and didn't want to go down that as a career path.

So I moved back to London and tried to do a job that I thought would be enjoyable. I liked the idea of advertising. It sounded fun. I did that for a year, but quite quickly realised that a cerebral challenge was just as important as enjoyment or pleasure.

Within six months I decided I wanted a change and started looking around for a role in asset management. That was in 2008. I got hired in the summer, just in time. I signed my contract in, I think August, and then started work right at the end of the year. It was lucky because if it had gone on for two months, no one would've been hiring, so I got in just in time.

And what was so appealing about emerging markets? Was it a contrarian move to be different to your classmates?

No, I don't think I was deliberately being contrarian or trying to necessarily go out of the box. I was interested in a number of different avenues, and EM somewhat came to me when I went looking for it. In some ways, that's a bit of fortune in that respect.

So how would you describe your current role to a stranger at a dinner party?

When I break it down, I say our job is to invest in emerging markets. Essentially we take money from the west over to the east, and invest it in the equivalent of Tesco, Coca-Cola, Walmart, Colgate, all these types of businesses, but on the locally listed versions, with a long-term view, with the aim of coming back in a number of years and returning more money to our investors than we have in the past.

To be able to do that job properly, you need to visit all of these countries, so I spend a lot of time on the road, visiting places from China, India, Indonesia and Vietnam to South Africa. When I worked out of Cape Town for a while, I found myself visiting places I would never have imagined my career sending me five years ago like Rwanda, Ivory Coast, Senegal, Nigeria, Ghana, Zambia, Zimbabwe, Mozambique, Tanzania, Uganda, Morocco, Egypt - there's probably more I can't remember.

When you go to somewhere like China or Brazil, and then go to Ghana, you can very much see that sort of economic development part. I've been living in London for 35 years, and in that time not much has changed. Okay, so they're building a crossrail that will be quite big, but more or less, London is still the same as it was before.

You go to some of these other countries, and even over a 10-year period, they are completely different. Take somewhere like Singapore. The complete central gravity of the city has moved from where it used to be. When I lived there in 2009, there were three metro lines. Now there's six. They've built three new metro lines in 10 years. Nowhere does that. Imagine how long it would take to build three metro lines in Sydney!

Some countries are going down the infrastructure-heavy development path. China's got phenomenal infrastructure. Roads, airports - fantastic. 

Ten years ago there was not a single metre of high-speed train line in China, and today, over half of the world's high speed train links are in China. 

That's how quickly the Chinese model can get these things done. It's pretty amazing.

You run a concentrate portfolio of ~40 stocks. What are some of the filters you use to assess opportunities?

So, we have some broad brush constraints, which would be mostly market cap-led. We say that for a large fund that's going to provide liquidity on a daily basis for our investors, we think $1 billion is the low end of the appropriate market cap, in terms of liquidity. So first of all, we screen the universe for companies over $1 billion, but after that there's not a lot of practical fundamental quantitative screens that go into how we think about the universe.

The universe is about 25,000 stocks. Our philosophy is that the appropriate way to manage money in the markets is to focus on the long-term opportunities there, so five to six billion people living in EM, on an annual basis, they're all getting richer. There are very powerful tailwinds driving that story - urbanisation, young populations, economic catch-ups, the positives from technology development around the world, and the emergence of the middle class is very much a long-term story.

When we make investment cases, our view would be, let's start today, and we'll have a look forward 10 years, and we ask ourselves, "Do we think this business is in a practically, structurally growing market, and is it dominant in its space?" If you do that, your universe shrinks from 25,000 down to four or five hundred.

I'd love to tell you, "Oh, we put all of these things on Bloomberg, and we screen it through and then that's our list of 500." The reality is, it's a much more know-how based process. We're looking at dominant, high-quality businesses in emerging markets. Basically, what are the best companies in each different market, and let's focus on them,

Have the recent performance headwinds in emerging markets shifted the way you are positioning the portfolio?

So we're big investors in India. There's been a couple of short-term headwinds that India's been through over the last couple of years. You had demonetization in November 2016. That was essentially when they cancelled all bank notes in the country overnight. The idea for that was to essentially to bring everyone in the country into the formal banking system, but economic growth for a quarter or two totally dried up. You saw a 30% drop in the overall market in India for about a month or two and then it came right back.

So that for us would be a short-term dislocation, but it’s more of an opportunity than a risk. 

If you closed your eyes and came back six months later, nothing had happened. 

We're very happy to look through these short term issues and try to focus on the long-term structure of story.

Is the standoff between Trump and his EM counterparts the sole reason behind your focus on the domestic EM consumer? 

The trade war is clearly a structural negative for a lot of the east Asian economies, because, as I've mentioned before, their economic model is based around being export powerhouses predominantly to the west. So if someone comes along and interrupts that model, that's going to create challenges to these countries and companies in that space. So if you were sitting on a portfolio of companies that are heavily invested in exporters, I think you have to look structurally at your portfolio and ask, "Have we got a long-term issue here?"

That's not really a problem we have in our funds, because we have always been of the view that the more attractive part of the asset class is the domestic story. So, those five to six billion people living in EM, all getting richer on a monthly, quarterly, annual basis. That economic opportunity, and that wealth creation which creates sort of incumbent businesses is phenomenal.

Why would you focus on a business that sells its stuff to a much smaller population of over-geared and over-levered consumers in the west? 

If you're one of these exporters, your competitive advantage is your company owns a cheap currency, you have cheap land and cheap labour. As your country gets richer, all those competitive advantages get pressurised. Cost of labour goes up, cost of land goes up, currency probably goes up, too.

Those companies will do best at a time when the EM market is weak, and the western world is rich. I don't think that's the most attractive investment case, but also, I think, as an investor in the asset class, why would you want to build a portfolio of stocks that are essentially correlated to the same theme as it would be when you're investing in global equities or western equities, especially when the western economies, arguably are not as strong as they might look, right?

We've had juiced up interest rates for eleven years, governments are highly geared, the consumers are highly geared, the corporates are highly geared. Contrast that to the emerging world where you've had much more rational interest rate regimes.

Can you give us some examples?

Say, something like Samsung Electronics, it's a global champion, an amazing business, but so many of its products ultimately end up in western homes. I just don't think that's the most attractive investment case. I'd much rather invest in toothpaste in India. There's 1.2 billion people. Somewhere in the region of, let's say, 500 million people in India brush their teeth. So, that's 700 million that don't. Roll forward 10 years. Do we think more Indian people are going to brush their teeth?

I'm happy to be on the side of "yes". That's our investment thesis, right. Is it going to be another 100 million people, 200 million people? I don't know. But it will be more. Ultimately, it doesn't really matter. But there's a huge runway of growth from getting all those 700 million people into brushing their teeth, but you've also got the people that currently brush their teeth. A lot of them probably brush their teeth, say, once a week. So, you think about them going from once a week to twice a week, and from twice a week to four times a week, four times a week to seven times a week, then from daily to twice daily. And then you can roll them up the value ladder. So, just basic toothpaste, the Total, to whitening, to charcoal, to all these premium points. Then you've got exactly the same market with toothbrushes. The long-term runway is enormous.

So in India today, you can invest in a Colgate subsidiary. It's always had about 55% market share in almost every country. Toothpaste market share is very stable, because the consumer patterns are quite sticky. That for us is a far more interesting structural story than selling flat screen tellies.

In a recent report you mentioned that market reactions clearly highlight how fragile investor sentiment is at the moment and how little actual company fundamentals are currently being considered. Can you elaborate on that?

My colleague wrote that and he's talking about China. So there were certain companies, where if you were big exporters to America, your business is structurally under pressure in a way it hasn't been before. And there are constraints on your growth opportunities. However, if you're a domestic business in China, there's been no immediate interruption to how your business is running, so when people trade these types of themes, they tend to blanket buy and sell into these markets, so when people are worried about trade wars they sell China and it's to some extent independent of what type of business is there. So our domestic guys, who are putting up fantastic numbers, they get hit aggressively by this sort of thematic trading, so this is sort of technical stock price moves, rather than reaction to fundamentals.

It's perfectly rational to price in this risk to the exporters. It's not rational to price in this risk to the same extent to the domestic stories. And therefore, some of the share price reaction that we're seeing, we think is not necessarily reflecting the overall narrative.

The two biggest weightings in your portfolio are financials and consumer staples. What do you find so compelling about these sectors?

It's competitive moats. All the way looking forward, its businesses with a deep competitive advantage today, that is durable over our investment horizon. We think moats can be naturally found in businesses with strong brands, in businesses with first-mover advantage, in businesses with high switching costs, economies of scale, positive network effects working in their favour. So that's the core of what we do, in terms of looking for businesses that we like.

I would argue that the financial system has got some very, very material moats, because if you look at the dominant banks in most markets today and then rewind 50 years, they are the same names. It's actually quite a low mortality rate.

It's the same sort of moats as a classic consumer company. So that's why we like these types of businesses, because we think they'll be durable over a number of years.

And this thesis obviously holds in your biggest portfolio position in HDFC Bank in India.

HDFC are way, way ahead of their competitors' market in India. Why India's attractive as a banking market is because 75% of the assets in the Indian banking system are run by state-owned banks.

And 25% are run by private sector banks. In 1994, when India opened up, 0% were run by private banks and 100% were run by state-owned banks. And so the private sector has gained 25% share over the last 20 years, and we're highly confident that over the next however many years, that the private sector is going to make incremental gains in the space.

Roll forward 10 years, and the aggregate size of that market will be multitudes of what it is today. So, if these guys can get 50% of that market in 10 years time that opportunity is absolutely enormous.

Is that what's the most exciting part, just this ridiculous growth runway compared to developed markets?

Absolutely. It's the longevity of it that is key. Appreciating the scale of it is sometimes very hard to do sitting in Sydney or in London. 1.2 billion is so many people and the aggregate size that that can grow to in terms of opportunity for business, is just absolutely enormous. What's Australia? 25 million people?

So just think of it. In theory HDFC Bank can be 50 times larger than CBA. CBA is a $100 billion business! I'm trying to think of some rather dominant consumer businesses here, Coles or Bunnings, or something like that, right? And how big that can be if you multiply it by the opportunity within India.

Now clearly, it doesn't get there in five or 10 years, but the ability to grow ... What I love about, say, a lot of these EM markets is, I look forward in the 10-year view, and I say "Wow, I see amazing opportunity." But, let's flip to 2030 and we're sitting at our desk going, 

"We've had 10 years of fantastic structural growth, however, the next 10 years may be even more exciting than the last, and adoption will happen much faster."

So you've got such visible runways in terms of opportunity set in some of these markets, and I just think I'm so fortunate to work in an asset class where you have such powerful fundamentals behind you. I'm not sitting here talking to you about, "Look, we've got these great bond funds, aggregate yield is -0.2. It's great. Honestly, you should invest in it." But there will be some people who are right? Because that's the state of many bond markets. You're being paid to lose ... or rather, you're paying for the benefit of owning bonds.

So, there are lots of fragilities in the global system. There's lots of bubbly asset prices around the world, that if you really break it down, do they really make much sense?

So what's your outlook then, what do you think is the biggest tailwind looking down the track?

When people ask, "Should I invest in EM now or why should I invest in EM now?" And I always say that the reason to invest in emerging markets today is the same reason from five years ago, and the same reason it was 10 years ago and the same reason it will be in five years, and the same reason it will be in 10 years.

This structural, fundamental story is only at the very early stage. Let's say four billion people getting 20% richer over a five-year scenario. That is so much economic value that's being created and that, as I said before, is a story that will go on for 20 years. So yes, there will be bumps along the way, but if you want to - I don't like the word "bet," but let's say the word bet - you will come back in five years time or 10 years time, and most of these EM countries are going to be much, much wealthier than they are today with more middle class people with higher disposable income, with a higher share of the aggregate consumption around the world.

The future of the world is India and China, Brazil, Indonesia, Vietnam, and places like that. That is where the weight of the world economy is going. That's the side I'm taking. You want to go against that bet? Be my guest. 

Learn more about the opportunities in Emerging Markets

In developing economies, rising incomes and increasing levels of consumer spending fuel long-term growth potential. Embrace the emerging consumer. To find out more, click the 'contact' button below. 

BMO Global Asset Management (Asia) Limited (ARBN 618067959), Pyrford International Ltd (ARBN 165504414) and LGM Investments Limited (ABN 19 381 443 479) are exempt from the requirement to hold an Australian financial services licence under the Corporations Act in respect of the financial services each provides to "wholesale" investors (as defined in the Corporations Act) in Australia. Pyrford International Ltd and LGM Investments Limited are regulated by the Financial Conduct Authority under UK laws, and BMO Global Asset Management (Asia) Limited is regulated by the Securities and Futures Commission under Hong Kong laws, which differ from Australian laws.

BMO Global Asset Management (Asia) Ltd ARBN 618067959 is exempt from the requirement to hold an Australian financial services license under the Corporations Act in respect of the financial services it provides to wholesale investors (as defined in the Corporations Act) in Australia. BMO Global Asset Management (Asia) Ltd is incorporated in Hong Kong and authorised and regulated by the Hong Kong Securities and Futures Commission under Hong Kong laws, which differ from Australian laws.



Comments

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Robert Bittar

A very interesting read. Thank you. However, I have been wooed in the past re the Asia story. Growth from domestic markets rather than export market. In 2014/15 I bought PM Capital Asian Opportunities Fund Ltd and Platinium Asia Fund. Their performance has been unremarkable. In fact I sold them both last week. I notice that this read is not only re Asia. nd it appears quite convincing. Let's hope that this fund will be more rewarding.