A brave new world of opportunity

After a couple of years licking the wounds it sustained in the split-capital trusts debacle, Aberdeen is back, and would like the world to know about its emerging markets fund.

Aberdeen Asset Management could more rightly be called Dunkirk Asset Management. It has stepped back from disaster (split-capital trusts), rearmed and just a few years later swept on to D-Day (buying Deutsche).

But victory can only be regarded as complete when things return to normal. And that is precisely how it’s looking at 1 Bow Churchyard.

It is a long time since the press paid much attention to Aberdeen except to ask it about compensation, payouts, resignations and so on. But now we can return to normality. And there’s nothing more normal than a safe, straightforward investment presentation from a self-assured manager.

Actually it could have been a bit safer – the choice of presentation was global emerging markets rather than UK equity income.

As we all know, emerging markets have had something of a good run. Surely now is not the time to plunge in deeper?

Devan Kaloo, head of emerging markets at Aberdeen, is prepared for the question. Yes, markets look expensive and may be heading for a correction. But in all the time he has been managing emerging markets money, he has never been more confident about the quality of the stocks he can find.

“It is right to strike a note of caution,” he says. “Emerging markets have enjoyed a great run as a result of the decline in interest rates and better fiscal management by governments, so it’s no surprise they have been re-rated.

“There are concerns going forward; if global growth slows, it will hurt the exporters. The other issue is the oil price; most emerging markets are net importers, so it’s a tax on spending and it’s inflationary. But it’s a threat faced equally by the developed world.”

But this is no reason for gloom: “At the company level, the outlook is better than ever. Companies are in better shape than at any time in the past.”

There are two major caveats – China and Russia. In neither country can Kaloo find companies that meet his stock criteria. He likes transparency, a firm legal footing, demonstrable rights for minority shareholders. He dislikes cross-shareholdings, domineering family control and government intervention.

That sort of thinking takes him instead to India. What impresses him about India is just how many good-quality companies he can find despite a bungling government.

India makes up just 6% of the MSCI emerging markets index but 14.5% of Aberdeen’s GEM fund.

“In the past India has been an awful place to invest because of government interference. But there are some hints of structural change, and there are some companies which are tremendously well run,” says Kaloo.

He picks out Hero Honda. It is a joint venture between India’s Hero and Honda of Japan. Most people don’t think of India as a manufacturing superpower, but Hero Honda has now become the world’s biggest maker of motorbikes.

“It is super-profitable, with a 64% return on equity. Yet it’s still cheap on 13x earnings. The management are phenomenal, with a track record of operating in India through the economic cycle.”

One Indian stock Kaloo is not in is Reliance, the country’s biggest company. “I have never invested in Reliance and I’m extremely unlikely to hold it in the future,” he says. His distaste for the stock come downs to how it has treated minority shareholders. Family-run, it has a maze of cross-holdings and Kaloo says when transfers have been made between the different holding companies, there has been significant mispricing. He makes some other, more colourful, comments about family members, which for legal reasons are probably best left unpublished.

Although the fund is overweight India and China (via Hong Kong-listed stocks), overall it is underweight Asia. That is because Korea and Taiwan make up about 35% of the index, and Kaloo holds only 13% in the two countries.

Taiwan suffers from lack of brand pricing; in the electronics price wars, Dell wins and its suppliers in Taiwan lose. Korea, meanwhile, has been “steadily sliding” since 2002 after a brief hope for restructuring after the Asian crisis. His biggest concern is for companies that rush headlong into new markets where they have no experience, citing manufacturers who launched into credit cards.

Aberdeen’s approach is not top-down or country-driven. It is quite the reverse, with a portfolio of just 60 stocks, held on a long-term basis and bought using an entirely bottom-up process. But certain themes do emerge.

Most of us regard emerging markets as exporters using cheap labour to make inroads into developed world markets. Kaloo eschews the exporters, preferring domestic-orientated companies instead. It is a simple but believable story: these countries have fast-growing young populations who for the first time have money in their pockets and want to spend it.

“We think you should always be skewed to domestic stocks rather than the exporters. For example, in Taiwan, the only stocks we own are domestic.”

He would like to buy more stocks in South Africa, whose fundamentals he thinks are better than in most other emerging markets. But unfortunately it is dominated by banks and mining stocks where the management keep wanting to buy in the West to diversify their earnings. As an emerging markets manager, that is the last thing Kaloo wants.

It is a surprise to find that apart from India, the emerging market where he can find some of the best opportunities is Brazil. Again, he cites domestic stocks, listed on the Nuovo Mercado, where as a foreign investor he feels he is finally regarded on equal terms with the family trusts that have for so long dominated Latin America. But he won’t go shopping in Argentina. Companies there are almost encouraged to mislead investors, and if there is one rule in his approach to running money, it’s that if management lie or cheat then they have to be slung out of the portfolio.

Few advisers are going to be telling investors to stock up on emerging markets at this point in the cycle. But if it’s global growth you are worried about, then this might be a sensible safe-harbour fund.