Never let a good crisis go to waste

This video first appeared in Livewire 20 March 2020

There is an old saying that you should “never let a good crisis go to waste”, the idea being that every crisis also brings the opportunity for a creative response.

Alex Duffy Portfolio Manager of the Fidelity Global Emerging Markets Fund echoes this sentiment. He believes the best companies are:

“...those that keep investing in the downturns and further their competitive advantages, because when the upturn comes, they take disproportionate amounts of market share, they'll have a better product offering, and they generally just create more consistent value cycle to cycle”

Watch or read to hear two examples of companies that Alex thinks demonstrate this quality, and what he sees as the single biggest myth about investing in Emerging Markets.

Transcript

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I think emerging markets are always seen as a bit of like 'The Wild West' of investing. So, they're always sort of seen as something kind of exotic and when it goes up people are interested and then as soon as there's a problem people exit and say they'll never go back again. And I think kind of... That is a preconception which has been justified really by the nature of the investment universe, right? And this is what we really tried to do, I think the index is a very poor proxy for emerging markets as an investment universe.

And so, the portfolio is firmly focused on providing exposure to the positive reinvestment opportunities that exist within emerging markets whilst mitigating exposure to the negative risk factors of governance of balance sheets and foreign exchange risk. So, FX risk and government risk. And so, we seek to dampen the volatility significantly through doing that.

Actually, that would be the biggest myth that I would like to bust: That EM is just a volatile asset class and you can never actually make sustainable long-term returns. I think the way in which we address the asset class actually proves that you can invest with a reasonable margin of safety and a reasonable level of conviction.

So, I think emerging markets in most portfolios, they are now forming a form of a sort of structural allocation. I think that the allocation will grow over time. And I think that happens for a variety of reasons.

First of all, the exposure of global emerging markets in the standard global equity benchmark is around 10/11%. That grossly understates the contribution of these markets to global output, job creation, future economic growth.

And so, I think the over time that just increases as these markets open up, as they get more developed, as you see more active managers like us growing our presence there, helping to somewhat legitimise and formalise these markets that will encourage, greater oversight and greater participation. And so, I think that sort of 10 to 11% level naturally grows over time. There'll be hiccups along the way but to us the sort of structure story is reasonably robust.

Two biggest lessons

One, just alignment. We don't run any of the companies that we invest in. We don't run them. We are shareholders, we entrust our capital to the management teams and we need to ensure that they treat it with respect and they do the right thing. And we lose the most money when that stakeholder alignment is either not appropriate or doesn't exist. And so, ensuring that you've got trust in the companies that you invest in and that they're incentivized to do the right thing with the capital, is absolutely critical to mitigating losses and then providing the fire power to generate returns over the longer term.

And the second thing I would say is that ensuring that you own businesses that have the ability to take market share in downturns is critical.

The best companies in emerging markets, the ones that you genuinely create the most value in, I feel are those that keep investing in the downturns, further their competitive advantages, because when the upturn comes, they take disproportionate amounts of market share, they'll have a better product offering, the consumer will know that they've been there through good times and bad, and they generally just create more consistent value cycle to cycle.

And so, they will be the two things that as a long-term owner of companies I would, I would strongly, strongly advise people to pay attention to.

Examples

Bank Central Asia (BBCA.JK) is a key one in the Asian bank that provides that opportunity. Great management team, been throughout the age of crisis, seen Indonesia in all different economic environments and have consistently managed their capital well.

I've talked about Lojas Renner (LREN3.SA) in Brazil. I think they do a similar thing. One of the best things that happened to Renner in recent times is that the Brazilian economy went into free fall and all of the global peers exited and they kept investing in getting better. And now as they exit that recession, they're really starting to capitalise on that.

So they will be two stocks that I would reference as being in that sort of environment. And they're both heavily represented within the portfolio.

24 March 2020

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Alex Duffy

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