Ladies and gentlemen, welcome to the Business Brew.
I'm your host, Bill Brewster. As always, wanted to give you
all a big shout out. I got the Spotify or I guess
creators wrapped recently and wanted to thank you all for
listening. It was meaningful to me to see
that collectively we have accounted for 763,000 minutes of
listening time this year. That's crazy to me #1 show for
1600 fans, thank you so much. Top 10 for 9300 fans, thank you
so much. You know, this has been fun and
I, I try to do this in order to give back and it's nice to know
that it's appreciated and, you know, just meaningful to me to
have the community that that has joined along with this journey.
So with that in mind, this episode features Jim Hayes of
Lucerna Global Capital Management.
Jim and I discuss primarily emerging markets opportunities.
I realize that's on the back of another emerging slash foreign
episode, not by design, just kind of how it happened, but
actually sat down, met with Jim two nights ago and found him to
be a really cool guy to sit down and chat with.
So should you enjoy what you hear in this episode, please
give him a call. I know he is looking forward to
hearing from from people that like like the episode.
So very real career, very real guy.
The views expressed by Jim are not necessarily those of Lucerna
Global Capital. They are his own and do not
constitute financial, investment or tax advice.
The content is intended for educational and entertainment
purposes only and Lucerna may hold positions in the securities
mentioned. Nothing in this podcast should
be construed as an offer to sell or the solicitation of an offer
to purchase any investment product or security.
Listeners are strongly advised to perform their own due
diligence and consult with a qualified financial professional
before making investment decisions.
Love the disclaimers. I know you do too.
Do your own work. It's educational and
informational purposes only. You know the drill, so I hope
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Appreciate y'all hope you had a great Thanksgiving.
Enjoy the episode. All right, ladies and gentlemen,
thrilled to be joined by Jim Hayes today.
Jim, how you doing? I'm well, thanks for having me
on. Yeah.
Thanks for coming on. Your firm is Lucerna Capital,
right? Did I say that correctly?
Lucerna Global Capital. Right, all right, there you have
it. You want to give people a little
bit of your background and then we'll get into what you do.
But I feel like giving people a sense of who they're listening
to is a decent idea. Yeah, sure.
So I've been involved with the emerging markets asset class for
about 30 years and started out of college as as a banker with
Morgan Stanley in New York on their Latin American team.
I was one of two professionals to move down to Mexico City in
1994 to open their office down there after Morgan Stanley spent
time with Bain and a handful of their international offices,
including Istanbul and Johannesburg.
Then was at a hedge fund in Brazil before going back to
Business School after that in both the long short worlds and
for 14 years of Fidelity investing in emerging markets.
And then started my own firm list on the global capital about
four years back. What was it like moving around
that much when you were young? It was great.
It was a great time to do it. It would be more difficult now
with, you know, family and other conflicts.
But it was a, it was a great period of life.
Yeah, no doubt. That'd be cool.
What was your favorite place to live?
Oh, I suppose different places for different reasons, but Rio
de Janeiro always had a soft spot in my soft.
Yeah, that makes sense. All right.
Now I'm starting to understand some of the lat Am.
Like, you know, you seem to like lat Am.
I'm sure it's bottoms up but I I understand the comfort level
right? Sometimes.
It's good to contextualize why, why people are seeing things so.
All right. So you worked at Fidelity for a
long time, Yes. Correct.
OK. And what was the product that
you worked on there? So I was on a a handful of
different products, but the largest was the Fidelity Series
emerging markets Fund, which peaked at about $35 billion in
assets. So it was one of the one of the
bigger funds in the industry and it was a Co managed fund by
sectors. So I managed to a handful of
different sectors there. And which sectors were those?
So I did financial services, real estate, utilities, com
services. It expanded a bit over time, but
a handful of different sectors, as I say.
OK, no, that makes sense. I'm just trying to so, so after
Fidelity and I apologize, I know that we had a catch up call
before this, but I'm just trying to figure out exactly your your
trajectory to where you're at. So what did you do after
Fidelity? So after Fidelity, I formed
Lucerna Global, brought on board Brent Badamini, who was also a
14 year veteran at Fidelity and he used to run the Latin Fund
there and and we've been up and running for about four years.
All right, good deal. Now, now I dig.
And what was, I mean, so what's what was the catalyst to sort of
going out on your own? What was the opportunity that
you saw or the reason for starting your own thing?
Yeah. Look, Fidelity was a great
platform. I think I felt like we got a
great experience based there in terms of dealing with different
styles of investment in terms of in terms of building a great
network amongst the global emerging market community in the
in the C-Suite, getting to know that they know the street, other
investors, etcetera. But I think there were two
reasons that finally spurred me to spin off and do this.
One was I thought it was a frankly this was a bit
premature, but I thought it was entering a really interesting
secular window for the asset class and emerging markets have
under underperformed for most of 15 years.
And you know, usually these things work in cycles.
So I thought that was we were, we were approaching an
interesting moment from that regard.
And then secondly, as I say, you know, the fun product that I was
on had gotten quite large at 35 billion.
And I felt like there were there was probably a a better
mousetrap to to look at the industry through than than my
old seed. Yeah, yeah, 35 billion if if
size is the enemy of returns, you start to hit it, I would
think at at that point or at least flexibility, right, if
you're in a a big place and a big fund.
So, you know, it's funny, I sort of started paying a lot of
attention to the markets when the bricks were like a very real
thing and that was the trade everybody had to put on.
And then we went through the GFC and it felt like quality was the
only thing that people should touch US, quality specifically.
So I'm sure that some of what I just said is completely wrong,
but I'm curious to hear your take on what the cycles have
been and sort of the drivers behind what, what made the
cycles what they were and what leads us to where we are today,
let's call it over the last 20 years or so.
Yeah. Look, I would say the last real
bull phase in emerging markets was post the the last downturn
in in US or global tech. So coming out sort of O2 to O
seven O 8 was the last real upswing and period of our
performance for emerging markets.
And at the time it was driven by the fact that there was the
perception of superior growth from a demographic and GDP
perspective, GDP growth economic perspective, as well as from a,
from an earnings perspective, a low penetration in many
countries and many products and therefore a nice tailwind in
terms of in terms of bottom up companies being able to grow
over time. So that was the the perspective
back then. This time, at least thus far,
big part of the rally has been driven by by AI semiconductors
in places like Korea and Taiwan. But, you know, we think that
it's a, it's a broader, more secular theme that's likely to
broaden out beyond that as well. I mean, I guess what drove sort
of the underperformance of the last decade or so, because the
reason that I'm asking that question is it seems to me like
when you're looking at emerging versus developed markets, you're
almost always going to have lower product penetration and
consumer sort of type names and probably better demographics.
Or is that sort of an assumption that's wrong?
No, I think that's, I think that's right.
You know, in an AI world, the perception of whether or not
demographics and large young populations as a positive or not
is shifting. So that's a, you know, that's an
open question. But no, I think your, I think
your, your broader point is largely right.
Look, if you, you know, if you look back over 60 or 70 years,
the emerging markets versus developed markets periods of
outperformance have tended to work in cycles.
They've tended to be around 7 to 10 year cycles.
This one's been a little, little bit longer at 1314 years.
And typically what happens is, you know, at the start of that
period at the dollar is weak, US growth accelerates because of
that export driven and otherwise companies grow faster, you get
multiple expansion and the inverse happens any.
And then you know, eventually the dollar gets expensive and
currencies get cheap and companies are better positioned
from a competitive perspective and start to grow off a low base
leading to faster growth, leading to multiple expansion of
a, a, a virtual cycle coming out of a vicious cycle.
And that's basically what we we think we're seeing now after.
Under. 15 years, a very, very limited U.S. dollar earnings
growth for emerging markets with, with FX having been a big
part of the tail headwind. Rather we're we're now moving
into a window where FX becomes a tailwind and and earnings growth
is going to be quite a bit better.
So how much are you monitoring trade deadlines and whether or
not we're decoupling from China? And when you know what, what
does that mean? I mean, how is that a lot of the
job right now? Or am I sort of overstating its
importance? It's a great question and
obviously that it's a noisy period from a lot of
perspectives. I think bigger picture and week,
I'm sure we'll talk more about China.
I think bigger picture, most would agree that and the US and
China are, are separating and drifting apart from an economic
orbit perspective. And I don't think that's done.
And you know, the various headlines and twists and turns
don't, don't really threaten to change that narrative in my in
my view, but that creates opportunities for, for other
parts of the spectrum. And that's, that's a big part of
what we're trying to find. We're very bottoms up, but we're
we're sector we look, we focus on a domestic consumption
related sectors across the footprint and we're trying to
find specific opportunities, good companies where they're
trading at a displaced valuation and where things have either
already begun to improve or they're poised to improve.
So we think that that's a powerful combination which we
can find good companies right at right at the beginning of a
period of our performance or or improvement, improvement and
perception. We think that that's a formula.
Yeah. I mean, that makes sense.
Yeah. Yeah.
Well, so one of the reasons that I was, I was going through your
old writing and well, not old about a month or two ago, but
one of the things that I think that you said is like Brazil has
the potential to, I don't want to say solve that might be
overstating it, but mitigate some of the rare earth earth
risk that the US sort of has encountered from China.
I, I believe that's what you said.
If I, if I didn't pray, if you didn't, please correct me.
But it just, it gets me thinking about how much geopolitics
creates the top down that the bottom up sort of benefits from,
if that makes any sense. Yeah, no, that's absolutely
right. So, so we like the Brazilian
market and the, and the Latin American region from a, from a
number of perspectives. It's, you know, that for for the
much of the last 15 years, the, the regions had a fairly non
business friendly political backdrop and regulatory backdrop
from a, you know, tax policy perspective, etcetera.
And that's, that seems to be shifting.
It started with Argentina a couple years back.
Chile has an election this fall, which it looks like will will
involve a shift to the center right, followed by Columbia in
the spring. And then the big one is, is
Brazil next fall. And you know, we think it's a we
think it's a real trend. It echoes trends we're seeing
across other parts of the world in terms of, in terms of anti
incumbent and the rest of it. But we think it's going to be a
really a very powerful driver in Latin America given the starting
point and valuations. And then given the starting
point in terms of investment cycles.
You know, Brazil right now, the entire market trades at 8 times
forward earnings. And and the last time it was as
cheap was in 2002, the first time that Lula was in power,
came to power and the market proceeded to go up 700% in
dollar terms in five years. Now there are differences this
time. At the time it was being pulled
along by China and commodities and their, and their, their
property bubble or the early stages of their property bubble.
So that's different this time around.
And we don't think the market's going to go up 700% in five
years, but we do think that the market's going to do very well
over the next several years if we're right on the electoral
outcome. And then a different angle,
which is the one you were asking about is the geopolitical angle.
And, and Brazil is the largest unaligned producer of rarest.
And so we, you know, we think that there's a reason that the
current administration in the US is focused on Argentina and
Latin America and Brazil in terms of improving the
relationships and improving the sourcing of, of, of those
materials. Yeah, I mean it makes it makes
some sense from a NS perspective, right.
I mean it's forming your own sort of hemisphere or not
hemisphere, but side, you know, whatever NS trade bloc.
What so like when you, I guess when you are identifying ideas,
what is your process look like a little bit?
Are you focusing on a country and then saying, OK, I think
this country is going to get better and therefore I'm going
to start digging around for bottom UPS ideas there?
Or are you, you know, do you use a lot of screens?
Like how does that work? Yeah.
So I refer to pieces of this, but I'll but I'll back up.
And we're very much bottoms up stock pickers having spent 14
years each at Fidelity and before that I was in the the
Tiger cub world on the hedge fund side.
And so we're very much company specific finding individual
opportunities from that perspective.
We do have a a sector filter that we use.
I talked about domestic consumption.
So that tends to be financials, real estate, consumer, Internet
π T And that's because we think that that's where the best
compounders are found. Those are the sectors where over
time the best compounders have emerged.
And also because those are the sectors that are dependent upon
domestic demand and drivers and where we think we've built our
our sustainable edge and knowledge base over time.
Now that all of that said, you know emerging markets are
dispersed and emerging markets, you can't divorce the process
from the macro. You need to understand the macro
in order to both gauge upside potential or help gauge upside
potential as well as to be able to help gauge downside risk,
right. So what we do part of our
investment process is before any idea gets into the portfolios,
we have a very detailed spreadsheet that we work through
starting with various risk dynamics.
So starting with the macro, the politics, the fiscal, the
reserve ratio, etcetera, leading to if it's a regulated industry,
leading to the regulatory backdrop, competitive backdrop.
And then company specific, whether it's the balance sheet
and whether it's earnings outlook, whether it's
governance, which is I think a very important topic in in all
markets, but a particularly important topic in emerging
markets where there's a little bit less visibility than what
you have in in the US and in developed markets.
Oh, interesting. Do you mind like double clicking
on how you think about those a little bit like how, you know,
building out the spreadsheet? I mean, I assume the politics
goes from like where the country is to where it's going.
How do you do you think through the implications of like if a
country is drifting more, I guess more socialist would
obviously not be positive, more sort of center right would be
more positive. But just kind of curious how you
think about each of those metrics and then and then if you
stack rank things, you know, just kind of talking about your
process a little bit. Yeah, sure.
So, so to be clear that the spreadsheet and and the
investment checklist process is company specific as opposed to
country specific. So we're, you know, we're
digging in, but an important part of that first part of the
risk analysis is understanding where the company is based and
what that means from a effects perspective, right, from a macro
perspective, which can feed into FX weakness or strength.
From a political perspective, which can feed into investment
or can feed into regulatory backdrops.
So it's, you know, these are things that that we try to kick
through and there is some interplay between the country
dynamics and the and the company dynamics or the sector dynamics.
You know, it's funny when when I was a young and I would have
told you, you know, Oh well, Republicans are better for oil,
right? This just kind of a, you know,
the US centric, but then you look at the returns and it's
actually that usually when left-leaning administrations are
in, they sort of enact a little bit more supply discipline and
the returns of the stocks are actually better under what you
might think would be a hostile administration, which is kind of
an interesting way the world works.
Yeah. I don't know if you can
generalize in the same way in emerging markets, but it is an
interesting it, isn't it? Yeah.
So what are, I mean, what are some of the themes that you're
most most excited about or, or what makes you, you know,
excited about the portfolio today versus, you know, other
times in history or or just generally today?
Well, as I say, we, you know, we, we start with a bottom up
company specific focus. And I, I think the most exciting
thing for us about the current backdrop is just the
opportunities that we see from up from a bottom up company
specific perspective, right after 15 years of
underperformance, there's some really good companies that
traded really cheap valuations where we think there is the, you
know, ability to sustainably compound for many years to come.
And I think that that's a harder argument to make in some of the
developed markets. So, so the example I I sometimes
give is across big chunks of Brazil or Indonesia or other
markets, you can find 15% growers that are expanding their
margins, have good balance sheets and and large Tams over
time that traded 891011 times earnings.
Whereas in the US you often find 4% growers at peak margins that
trade at 35 times earnings. And eventually we think the math
gets pretty powerful in favor of.
Emerging markets now, OK. So when you're talking about
that, are are you referring to, I just want to make sure that
the comp is apples to apples because I, I noticed like a lot
of a lot of your portfolio seems skewed financials.
But within financials there's a ton of different, you know,
companies that could exist. But when when we're talking
about like a mid teens grower or or even a high single digit
grower, is that a bank or is this a consumer, you know,
staple type company that that you're talking about?
Yeah. So it's a it's a very good
question and good point in the context that different sectors,
you know, trade differently and and have have different
valuation multiples and ranges and should.
And so yeah, we're not comparing when I say that I'm not
comparing an emerging market bank to A to AUS based staples
company. But if you know you can find
emerging market based consumer slash staple companies that have
that profile that I described where they're growing in the
teens and traded that kind of multiple and we think that
that's really compelling. Yeah.
What is, I mean, what's is it just a general apathy that's
creating that opportunity or is it, is it capital is flown to
the US and it's 1 so often like what do you attribute the
difference in opportunity sets to?
Yeah, I think it's, it's a number of things.
You know one to be fair when you look backwards as emerging
markets as I had referred to earlier have not grown dollar
based earnings over most of the last decade and 1/2 right.
And so the US driven by technology, but other things,
you know, share buybacks, financial engineering, etcetera,
have grown earnings and so therefore have attracted capital
and seen multiple expansion. And, and the, you know, it
hasn't and there have been numbers, there have been a
number of false starts for emerging markets over the last
15 years, right, where people have gotten briefly sucked in
and then and then had their hearts broken again and again
and again, right, as always works with these cycles.
And so there are people that have stopped believing and I get
that, that makes sense. But eventually, you know, the US
companies that have grown for this period of time have played
through some of the drivers of that growth and they find it
more difficult to grow going forward.
I think that that's going to be true in this current window,
right? We're having such large
investment. I mean, it's unclear how we're
going to monetize those. I think that the forward profile
for earnings growth in the in the US and and in big parts of
developed markets is a little bit more murky than what it
usually is. Whereas whereas big chunks of
emerging markets are growing off of a lower base, they have
falling interest rates, they don't have the same fiscal
mismatches that are developed across across developed markets.
And so we think that as the cycle turns and as earnings
growth in emerging markets accelerates, catching up with
developed market earnings growth, which is less likely to
accelerate and may in fact decelerate, we think that's
going to that's going to help drive the RE rating that we
anticipate. Yeah.
It seems to me that from your writing the some of the thesis
is a little bit of the development.
The developing markets have been better managed fiscally and have
a little bit more dry powder to stimulate relative to what we
may experience here. Is that fair or is that not
correct? Well, I think that is correct.
If you look at the US fiscal situation and policies, we're
blessed to have the global reserve currency.
But if we didn't and if the world looked at the US like an
emerging market, it would be a vulnerable emerging market.
In that context, we haven't, we haven't been managing our house
from a fiscal perspective in a very responsible manner.
So how far do you think that we can push and use our position to
continue to extract good results or are we at the end or close to
the ends of sort of a, a large cycle for for US assets?
I know this is an impossible question to answer, but I do
think it matters. Yeah.
Look, it's an important question, maybe the most
important question. And, and, and views will vary.
So I have a biased view in that, in that I'm focused on emerging
markets and there I'm sure there will be people amongst your
audience that will disagree with me.
But I would say the following. I think it's difficult to time
these things exactly, but excesses have developed in both
directions, right. the US is have grown nicely and is trading
or developed markets have grown nicely and are trading towards
the top end of their historical valuation range. the US and US
growth sectors in particular and emerging markets remain,
although they've had a better year this year, near the bottom
end of their historic valuation ranges.
And so without saying it's now or within three months or
whatever, because again these things are very difficult to
time, I think that the risk reward over the medium term has
shifted very firmly in favor of emerging markets from my
perspective. Yeah, it's always, it's a tough
conversation to have when like sometimes I, I talk to friends
about what's the market doing and I say, you know, if you're
talking about the headline stocks, they're doing great.
But under the surface the breath is, is not great right now.
And really like anything, well, I shouldn't speak in such
generalities, but interest rate, consumer interest rate sensitive
consumer names, things that are tangential to building, you
know, I mean boat manufacturers, just consumer discretionary
restaurants, those are not trading at rosy valuation.
So it's, it's an interesting bifurcation that we have here.
And sometimes I I don't have a good sense of how good the comp
is when I read emerging markets trade at X versus the US trades
at Yi just don't have a good sense of the composition and
whether or not it's apples to apples.
Yeah. And again, there are there are
some distortions based on the fact that you know, the US has a
higher percentage of its mix towards growth and technology.
And therefore structurally there is an argument for a higher
multiple for the market than there would be for a market
that's mostly financials are mostly mining, right.
So that that's all true. But again, even within sectors,
I think that there's there's a pretty wide gap in terms of the
valuation ranges that are being applied to U.S. companies versus
those and most of the rest of the world.
Yeah, Yeah. Well, the other thing that's
always interesting to think about is what is the market
capitalization to current earnings and then how much
reinvestment is, is possible, right?
Because a high market cap implies you got to be able to
reinvest profitably for a long time in order to create some
sort of reasonable return on your investment, right?
And it seems like in certain spots we may have gotten a
little bit outside of the realm of what can be reasonable.
Yeah, I think that's right. That's that's a version of the
of a famous old Buffett indicator, which recently has
has triggered more more cautionary levels.
Yeah. Do you are, is there anything
like do you look at that relative to sort of do you apply
the same lens to different emerging market countries like
on a country to country basis or is that not really something
that you worry about, it's more just bottoms up?
It's more bottoms up and in most of the markets it really isn't a
consideration, but there are some where it can be a driver,
you know, where the, where the deepening or the development of
the capital markets can be a driver.
So India is an example where you know, really they've, they've
developed a domestic investment culture over the last decade or
so, which is, which has led to sustainable inflows and savings
rates being boosted over time. And, and, and it's a, it's a
very healthy dynamic that hopefully will spread across
other parts of the emerging markets footprint.
I hope you're enjoying the conversation.
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Check it out. There are other examples, but
that's a. That's a more recent example of
of development. Your strategy is X China, am I
correct? So we have a few different
strategies. Are we launched with a sort of a
mid net pan emerging market or flex net pan emerging markets
long short fund, which does include China.
We have an SMA only low net X China long short products.
So those are both hedge funds and then at the end of the year
we we intend to launch a long only ex China concentrated
product as well. OK, so the OK, so let's go the
first one. If I was a 5 year old and didn't
understand what you were saying, explain that product to me once
more. Yeah, sure.
The terms do get a little a little confusing.
So Pentium means everywhere including China and that's a
difference with the other two products.
And then mid net or flex net means that it's a little bit
more of a opportunistic type risk profile where, you know,
for example, in 22 when, when, when the world was complicated
and most companies were, were were missing numbers, etcetera.
We could have a, you know, risk profile or we could have a, an
exposure profile which is quite low and that exposure profile
which is quite low and, and a better time.
So we can have a net exposure which is higher.
Low net in our context means ±20% net exposure.
And so that's the, the ex China hedge fund product that I, that
I described. It's an SMA forum.
SMA is a separately managed account.
We can go into that, but I'll, I'll, I'll leave that hanging
for now and then and then long only the final product that I
described is Ex China concentrated.
Concentrated means 15 to 25 names.
And the idea there is, is finding compounders and letting
them compound at a tax efficient basis over time.
With the with the low net product, what would your gross
exposure be? So the range is ±20%.
We've averaged over time in the in the mid teens positive.
And that is so big, but if it's you get into low net, what are
you, you're like 120 long and 70 short or 80 short?
Oh, I'm sorry, did I mishear your question?
What was the gross exposure you asked?
OK. So, yeah, so yeah, so the gross
typically there has has been more like 150 a 160% and that
typically would be, you know, maybe 80 by 80 by 70 or 90 by 90
by 70 as examples. Yeah, interesting.
So what are some of your, what are, what are the markets that
that you're jazzed about like as a listener if they say, OK,
well, you know what, what should, why should I call Jim?
What's what's some things that have you excited that you're
looking at? Look, I, I'd say I'll break that
into a, a, a couple pieces. I talked about from a, from a
specific to regions perspective. I talked about Latin America,
which is a region that we like structurally, not necessarily
always, but we think this is a particular window where you know
it's the cheapest emerging market region and you do have
this catalyst for change which we think is going to play out.
Southeast Asia has been a laggard and you know the storm
talking about Indonesia and the Philippines in particular are
two markets that we like a lot. They're trading towards the low
end of their historic ranges. They are in rate cutting cycles
and should benefit from that. Typically they would have
performed better. I think they've been left behind
partly because of the AI thematic, but they're both very
large markets in terms of in terms of populations.
They're both very small markets in terms of, in terms of capital
market penetration, market cap. And we think that, you know,
they're, I was going to say sort of earlier stage India type
stories that haven't yet been discovered.
I think that that's oversimplified because they're
they're big differences, but I think that they are markets that
have been that have been ignored and that as they get discovered,
you're going to see a nice combination of deepening
financial penetration, more activity, more interest and,
and, and expanding valuations. So those are two markets that we
like a lot as well. And then across some, yeah, it's
harder from a top down perspective to to pick examples
of backdrops which we where we're putting the table, but we
do find a lot of bottom up company specific opportunities.
So me as you know, Central, Central and Eastern Europe,
Africa, Middle East, etcetera. Yeah.
So I mean, what kind of businesses are you looking for
when you're thinking about compounders?
I mean, in, in some of these countries that are, you know, I
mean, are we looking at companies that are making
washing machines locally? You know, the, the economy is
starting to, to turn over and people are starting to get
things like basic electricity and what not.
Like what it what is the portfolio?
And I know it's hard to generalize, but but just kind of
like what's I know banking Bank of Columbia or I guess the
parent company now was, was something that that you've held,
but like what kind of businesses are you looking at?
Yeah. So one big picture point I'd
make that I think surprises many folks is that emerging markets
is obviously a dispersed asset class and there are nearly twice
as many stocks listed in emerging markets and there are
in the US Now the US has been shrinking due to private equity
taking private etcetera, M&A. And so it's a, it's an asset
class that's got a, you know, well, big.
It's a big playground is the starting point.
One of the, as you say, it's difficult to generalize, but one
theme that's worked out nicely for us is digital banking.
And we've had a digital bank in Brazil that I won't, I won't go
into specific names, but we do think that that's a market where
you've got reasonably high financial penetration, but
digital penetration is lower. There's a name that's known and
followed called New Bank. And this was the one that we
have focused on is a much smaller and much cheaper version
of that. But it's got similar growth
rates. It's growing the top line at 25
to 30%. At the time we bought it, it was
trading on 1.4 times forward book versus new bank on 6 times
forward book with a lot faster Roe expansion off of a lower
base given operating leverage. So that's been a great name for
us. Another name that that I think
is differentiated that you won't find in a lot of emerging market
portfolios is a is the largest Pan African tower company.
It reminds me a lot of American Tower, which I first started
following in the Tiger Cup world back in in 2000 to 2 1/2 billion
market cap at the time delevering quickly and it went
on to become a hundred bagger. American Tower did and there's
some very similar dynamics here. It's a reasonably recent IPO
that came out of the point when interest rates were starting the
spike that hit the results, it hit their perception.
They got quite cheap, but they are now delevering very quickly.
And at the same time they're expanding they're they're
they're accelerating their top line growth and it's trading at
a very compelling forward valuation still.
So it's you know it's trading at six times forward EVD EBITDA
growing the top line in the teen in the mid teens and we think
it's got lots of room to to grow.
Interesting. So, yeah, I mean, I listened to
somebody talk about the American Tower pitch back when it was a
$2 billion company. If only I could go back in time,
but I wouldn't have been smart enough to see it.
So it doesn't matter if I could go back in time.
But boy, what a win that was. So if you can recreate it,
that's a good thing to just hold on to.
Well, and that can be the beauty in emerging markets is that, you
know, there aren't, there aren't too many wireless tower
companies and some of the domestic investor bases, you
know, haven't, aren't as familiar with the story of what
happened with American tower. And so, so at least initially,
that gives you the opportunity to sometimes buy these things at
a displaced valuation. And then as the, it's, it is a
very powerful business model. And so as the results start to
come through and they and they should and they're it's a
predictable business model, you get both the growth in that
multiple expansion that I described.
So something that's going on here is any time an active
manager is pitched, people say, well, why not just have an ETF?
Because you can't beat the index anyway.
What is that? Is that similar in emerging
markets? Are there ETFs that can sort of,
I don't want to say do what you do because I don't think anybody
can be displaced necessarily by an ETF.
But on average, do you it? Does active management stand a
chance against the ETFs in the OR are they going to eat
everybody's lunch over there too?
Yeah, great question. You know, a couple of things.
One, emerging market ETFs are still quite a bit more expensive
than developed market ETF. So the largest is EEM as the
largest ETF in the emerging market industry or asset class
and its cost ratio is 72 basis points, right.
So it, it gives you a bigger gap than what you typically see on
the US side. And and at least for us, we're
trying tend to set starting AUM levels or starting AUM rates
which aren't too far off from that.
So that's the starting point. But then the second thing I
would say echoes what I was saying before, it's it's an
asset class that's very dispersed or many more names and
there are across even developed markets as a whole.
And it's less well covered by a margin as well because it's an
asset class that's been in the wilderness or in a bear market
for 15 years. So there are a lot fewer
analysts covering on the sell side or on the buy side covering
even the largest names, but in particular the the midcap names.
And so, you know, we think that's a real opportunity over
time and justifies active management over time.
How big's your team now? There are four of us and the
idea is over time to to continue to expand and to add sector
specific analysts as we continue to grow.
And are you on the road a lot or is it primarily done reading and
via Zoom? You know, it's a question I get
a lot about access and travel and and I would say that's one
of the, you know, angles. It's been surprising and nice in
terms of, in terms of launching in a, in a post COVID era.
I think that emerging market management teams would have
gotten over the hump eventually in terms of terms of Zoom and
and and virtual interaction, but it happened a lot more quickly.
But that's been a nice, that's been a nice spur for us in terms
of, in terms of our ability to get in front of our stay in
front of management teams. And we're on the call, we're on
calls several nights a week with Asia.
It's frankly more efficient way than the old days when we used
to go to Jakarta and C4 companies and spend the rest of
the day in traffic, an hour and a half between each company.
But we also do still travel quite a bit as well and and have
boots on the ground. Yeah, I would think one of the
tough things is just making sure that you you get a sleep
schedule that can work. But I mean it would you'd be jet
lag if you were flying over there.
So not, not really that different.
But the time time changes must be an interesting thing to
navigate at times. It can be.
Yeah. Huh.
What? What?
What else should I ask you? I don't know what else to ask.
Yeah. Well, you know what one topic we
get a lot is China. And you know, as you've heard me
say, we we do have a product that that that looks at China,
but we also have a couple of products that that don't.
And so I I get the question for for why and, and what our views
are in China. And I would say to be honest, we
remain that that is one part of the footprint where we remain
more cautious, right. So there's a, there's a stat
that I like to share with people, but you know, over the
last 10 years, the MSCI China index has has returned 3.4%
with, with 24 plus percent annual volatility.
Whereas the emerging market X China index has at a higher
return of 4.8% with lower volatility of 17 1/2% during
that same period. And we think parts of that are
structural. So China had an epic historic
property bubble, I think the biggest in the history of the
recorded financial world and that's Lakeland persist for
longer. In terms of the deflationary
impact of that is 1 concern that we have demographic headwinds.
The population is now shrinking, but also we also putting a
higher burden on the working portion of the population that
has to support the elderly portion of the population.
And then geopolitical pressures, which we think are more
structural than temporary. So, you know, there are often
the pushback we get is there, there's lots of innovation there
and there's a more compelling AI story out of China than there is
across most of the rest of emerging markets.
And I get that. But my question is, you know, in
a economic structure which emphasizes utility and social
good over a monopoly profits or excess profits, I don't know how
much of that the shareholder base is going to see over time.
And so that's a market where we tend to be structurally more
cautious in favor of some of the rest of the emerging market
footprint that I described before.
Well, I don't know that you can answer how much the I think a
couple things can be true. I think it can be true that
there can be a return on AI spend.
I think it can also be true that it's hard to handicap who's
going to win and that you have to have your eyes wide open to
the game that you're playing. And it is an interesting world
that we're living in with such high spends of capital for what
it what is definitively a very widely quickly, widely used,
quickly adapted product. But it seems to me that that
anyone that's highly confident in the end state economics is
kind of kidding themselves. And not to say that that the
tools cannot drive a lot of efficiency through other
organizations that could benefit without necessarily owning the
software or the model itself, though maybe that's a dumb
thought. I don't know.
So you know, you'll, you'll speak to people in this in this
forum and and elsewhere that spend more time on AI
specifically than I do. But, but, but I would just
highlight the differences between the model and, and what
the US is trying to do and, and what China is trying to do.
So the US is, you know, try often and this the, you see this
replicated in other industries and industry structures, but you
know, the big, the big wins and the big gets bigger.
And so that's why everyone's racing to make sure that they
have the best chips and the best and the best product in order to
be able to amortize those profits as they gain dominant
market share over time. Whereas in China, what they're
really trying to create is they're, they're trying to make
AIA commodity and they're throwing lots of state resources
at it in order to, in order to spread out the development.
But they're trying to do a low investment version of it, which
can then be replicated and sent out across the rest of the world
at a cheaper at a in order to help perpetrate their footprint
or their technological road map over ours.
And which again, I think it's going to have implications in
terms of what the ultimate profitability of their AI
economic ecosystem is going to have.
What's I mean, what's the end state of all that?
Who knows, But you kind of wonder if if they get if they
get the AI. Yeah, I don't know.
Be interesting to see. Hopefully we wins for no other
reason than I I'm on our side as a matter of birth, but it's it's
this is kind of a scary time. I feel like to have the the US
and China hit a road sort of a block.
I mean, I, I sort of, I can't help but think at times as an,
as AUS citizen, do I have risk if I own Chinese, you know,
companies in the same way that we had Russia risk And I, I
think that's real, but maybe it's not.
I echo a lot of what you've just said.
I, I too, certainly hope that we, we prevail in terms of our
pace of innovation and technological road map.
And then we, we win in the AI contest.
I do think, look, I, I hope we don't get to a point where, you
know, Chinese stocks are frozen and, and mark to zero in the way
that Russian stocks were. But I do think it's a risk more
so than it is with, with any other idiosyncratic emerging
market. And, and, and even without that
playing out in a, you know, in the worst scenarios, I do think
that we've already seen and, and we're likely to see more
regulatory pressure, which encourages first state pension
funds and the like, but but eventually more broadly, which
discourages US based capital from from being invested in
China. Yeah, yeah.
The other thing that I, that is interesting when I, I read your
comments on the China returns versus the standard deviation of
returns, which it's not a great ratio.
But the other thing that I find interesting is people that have
been to China, I have not tell me how competitive and how
quickly changing it is. And that can lead to like not
great returns, right? I mean, capitalism is brutal.
And if it's, if it's brutal there, maybe it's not the best
place for your money. Maybe, maybe ex China is a good
place just simply because it's less competitive.
I don't know. I would, I would encourage
people to go because it's a fascinating place in a lot of
ways. But but I agree with you.
I think that their economic structure is, is such that
you've got a distorted cost of capital and therefore inherently
very competitive business structures or, or, or industry
structures, and that makes it difficult to generate
predictable growing earnings and returns.
You know, that's a, that's a backward looking comment.
But we think that despite some noises towards anti evolution
and, and, and getting rid of excess capacity, they have
other, other pressures, including high unemployment
rates and high youth unemployment that's going to,
that's going to restrict them from being too stringent in that
direction. And so I think that a lot of the
backward looking pressures we've seen on earnings growth in China
remain forward-looking pressures as well.
When you said, I believe you said a distorted cost of
capital, right? I did.
So I think people would argue that we have a distorted cost of
capital in America just based on the reserve currency and what we
can do with interest rates. How how is it different there
versus here? I guess to the extent that
emerging markets, other emerging markets don't have that
distortion, does it make their fundamental economy a little bit
more unstable footing? So the way you know, the way it
typically works in in China is you have, you know, let's take
EVs, electric vehicles, right? It's a private sector for the
most part, but you have heavy state investment at both the
state and the federal level and subsidies which which enabled it
to get off the ground. And that's fine on one level.
And that it did in fact enable it to get off the ground and it
made great strides there and are likely to have, you know, a
better market share across the world in the in the electric
vehicle the world than they have in the, in the pre electric
vehicle world. But it also means you get a lot
of capacity because everyone in every state wants to have their
own wants to be in the race, wants to have their their their
foot in the game. And So what that leads to is
state backed sources of capital that lead to over investment,
that lead to wasted capital, wasted investment.
And the need to export things to other countries that below other
countries cost of capital, right?
Exactly right. Yeah.
And then and then, OK, so here we have the reserve currency and
the blunt tool of interest rates.
So like an economy, I'm part of my ignorance on this, but does
Brazil have anything that they can do or are they at more at
the mercy of what, what the world around it is doing?
And are they on more solid footing in a weird way, because
they're they might have to react more and, and that may make
their system a little bit more robust.
Does that make any sense? Yeah, I know.
I understand what you're asking. You know, I would say not just
Brazil, but, but many emerging markets, you know, they are
constrained by financial markets and, and, and, and that does
constrain the politics in terms of how much they can spend.
And otherwise, if they, if they let their fiscal balance blow
out, the markets will punish them and their currencies will
weaken. And you know, it will have knock
on effects because, because it becomes a vicious cycle.
As the currency weakens, it drives up inflation, which
drives up interest rates. And so, you know, governments
for the most part try to try to avoid that type of that type of
vicious cycle. You know, Brazil is an
interesting case because right now it's got the highest real
rates in the world in terms of in terms of larger economies,
they've got 15% interest rates and inflation is low single
digits. And so normally that's unusual.
Normally those rates would have would have already been falling.
But you've got a political backdrop and a lack of fiscal
trust, which has prevented that from happening thus far.
And so it's going to be an interesting situation because,
you know, I described an election that's happening next
October. And it's going to be a bit
binary where if the current party, the PT under Lula wins,
it's going to have one set of outcomes where rates stay higher
for longer. And if, if the opposition wins,
which we think is more likely, it's going to have a different
outcome. It's going to mean that rates
can fall faster, leading to the type of virtuous cycle that I've
described in a couple different ways in the call.
Interesting. Why does Lula want or why does
the party want higher rates? Everybody seems want lower
rates. No, they don't know.
It's just, it's just imposed on them.
I'll be a little careful about how I describe it because, you
know, it's politics and people, some of you are differently.
His party is believes in handouts and, and trying to
subsidize at the lower levels of society.
And in order to do that, they tend to, they didn't have a ton
of fiscal room to begin with because Brazil's spent beyond
its means for a while. And so they push the envelope a
bit. And because they push the
envelope a bit, there's distrust amongst the financial community.
And then it's been a tug of war back and forth.
Interesting. Yeah.
Where the museum, the opposition, the theory is, and I
think it's, it's, it's largely accurate that if the opposition
were to come to power, there's there's a lot of pent up
investment that's been waiting for falling rates and waiting
for a more business friendly regulatory and investment
backdrop. And they would put that money to
work at the same time as rates would fall.
And it could create that sort of sort of virtuous cycle I keep
referring to. Yeah, well, maybe foreign bonds
aren't a terrible idea. Who knows what are what are some
other sort of questions that you get that I've I've omitted or,
you know, failed to ask. I don't mean to put you on the
spot. I just want to make sure that I.
Think that's fine. I think we've I think we've
covered a lot of it. Maybe one other thing I would
say is that there are a lot of emerging market products out
there that you know own very similar 25 to 30 names, but they
tend to be the the mega cap growth darlings, whether that's
the TSM, CS of the world, the Samsung's, the $0.10 etcetera.
And, and there are many, there are fewer what we consider pure
stock picking bottom up products out there.
And so we think that's a real opportunity because, because
it's such a dispersed wide asset class with with such a wide,
wide sandbox and so much it's not well picked over.
So you know, as people, I would encourage people to take a look
at the asset class if they hadn't for a while.
And as people take a look, you know, try to scrap that, scratch
that second, second layer below the surface and, and, and see
where the opportunity lies. Because while, while there are
some great companies that I, that I referred to upfront,
they're pretty well understood. They're pretty well covered.
They're pretty well priced. And we think there's a really
interesting layer beneath that. So that might be 11 nudge that I
give to folks. Well, it would make sense that
after 15 years or whatever of the, I mean, even though the
breath in the S&P stinks, the S&P keeps going up, right?
And I mean, I know, I know that as that happens, it becomes more
and more of a concentrated bet on a few names.
But it is hard to tell the average person, here's a
financial product that goes up with drawdowns that are kind of
pretty small. You should be looking around for
other things that haven't worked as much.
Financial markets tend not to have one product that wins
forever. But maybe, maybe they have
invented one. Who knows.
But it seems to me like there's probably a a spot where the more
enterprising investor has a decent forward outcome.
But that could be a bias that I have.
My listeners probably have that bias too, to be fair.
Look, I, you know, again, I won't try to, I won't try to
time an asset class shift specifically.
It's possible that the US market just treads water for a long
period of time as opposed to going down dramatically, right?
And at the, and at the same time international markets or
emerging markets start to outperform.
So it could happen in a lot of different ways, but I, I would
just reiterate my my thought from earlier that regardless of
timing, but from both the top down perspective, at least given
our view on on the dollar and where we are on that cycle.
And from a bottom up perspective, given the
opportunity set that we see it really compelling valuations on
the emerging market side of the spectrum versus versus a lack
thereof that we see on the developed market side of the
spectrum. I just think it's a really good
a good time to be kicking the tires and taking a closer look.
All right. Well, I, I, I guess maybe the
way that I would say it is, I suspect there's a lot of
portfolios that are overweight US and it might make sense to
look at total portfolio allocations.
So if somebody does that and likes what you had to say, how,
how should they contact you? So I'm easy to find on on
bloombergorlinkedinortheybestemailformeisjayhayes@lucernaglobal.com. YES and yeah, please do, Please
do reach out. Happy to happy.
All right. Well, thank you very much.
I appreciate you stopping by and I hope you have a great day.
Thank you, enjoyed it.