Hey Reader,
Why listed emerging market equities belong in the private equity bucket of your portfolio
Think about listed emerging market equities as a long-term investment asset class. Don't think about them as a liquid asset class where you can jump in and out, because that approach will more or less ensure that you lose money in listed emerging markets.
Put them in the same bucket as private equity instead. Concentrated portfolios, long holding horizons, and actively influencing the companies in the right direction over that holding horizon. In my experience, that's the only way to make money in emerging markets.
Most listed funds run on one-day capital
Most of the mutual funds active in the public markets are structured as fully liquid vehicles, where the investor can go in and out of the fund with a day's notice.
It means that the manager is sitting on capital with a one-day duration. And if your capital has a one-day duration, you are in practice investing on a one-day horizon.
If the investors in such a fund don't like where the manager is taking the portfolio, they vote with their feet and leave the fund. In practice, this type of investor looks very closely at two things:
- The absolute performance of the fund. If it is going down, they want to leave.
- The relative performance of the fund versus the index. If it drops below the index, they also want to leave.
Why fund managers hug the index
For the manager of that fund, this means in practice that it becomes impossible to invest with a long-term horizon while deviating much from the average market allocation.
You can barely afford to be wrong. But even more so, you can absolutely not afford to be wrong alone, meaning wrong in a different way than the rest of the market.
This is a big part of why the discount on so many well-run listed companies in Southeast Asia persists year after year. Most house funds and local asset managers in the region trade in and out of positions daily, so they cannot stay on the register long enough to implement a long-term agenda with the company.
Where an activist fits in
This is where the private equity way of owning comes in. In essence, what we do at Endurance Capital is a private equity playbook applied to public markets.
We buy in via the stock market to become one of the top 5-10 largest owners, often take a board seat, and work collaboratively with the company to close the gap between price, value and full potential.
Being an activist is a lot like being a small party in a fragmented parliament. You rarely have a majority on your own, so you build a coalition with like-minded institutional holders that, together, can exert the main influence on the direction of the country.
None of that is possible on a one-day horizon. A proper change agenda in a listed company takes years to play out.
Why the volatility comes with the returns
The right investment horizon for this kind of work is five years. That is how long it takes for a deeply undervalued company to revalue, and how long it takes for a proper change agenda to lift its shareholder value. It is similar to Warren Buffett's idea that you should only buy what you would be happy to own even if the stock exchange closed the next day and stayed closed for five years.
During those five years you will inevitably go through periods where the portfolio is down, and periods where it is down versus the index. Keep in mind that what enables the high returns is exactly the volatility of these share prices. It is what gives us the unusually attractive entry points in the first place. With that volatility as the backdrop, it would be extremely unlikely not to see periods where the investment looks like it is underperforming. What matters is whether you have the staying power to wait out the full horizon.
The psychological pain you feel when the portfolio is down in certain periods is the price you need to be ready to pay to realise the long-term returns.
What to do?
Look at how your emerging market exposure is held today. If you hold it in daily-liquid funds or ETFs that you, or your adviser, move in and out of when the headlines change, then you are treating it as a liquid asset class.
Ask yourself which bucket that money really belongs in. If the answer is private equity, hold it with the same discipline, which means concentrated portfolios, long holding horizons and actively working on the companies as an owner over that horizon.
In my experience, that is how I have seen money being made in listed emerging markets over the long run.
Christopher B. Beselin
Investing, compounding & exiting
Christopher B. Beselin is the Chief Investment Officer of Endurance Capital. The views & opinions expressed in this newsletter are for informational and educational purposes only and should not be considered investment advice.
PS. If you're a qualified professional investor and you're not sure where to begin structuring your emerging market investment exposure, feel free to schedule a 1-to-1 emerging market strategy call with Christopher B. Beselin via this link. DS.
