M&G's Robert Secker On What He Likes In Asia -- Barron's Asia

By Thomas Streater

Emerging Markets are supposed to offer high growth and high returns. Yet since the global financial crisis, it is developed markets, with the help of global central banks, which have managed to outperform. Even so, Robert Secker, an emerging markets investment specialist at M&G Investments, believes that has created many opportunities in emerging markets, especially in Asia.

Secker, a CFA charter holder, had worked for T. Rowe Price for 10 years before joining M&G in 2010. He travels regularly to kick the tires in emerging markets, and concentrates on the microeconomic details of businesses he examines, leaving the more macro ruminations to his fixed income colleagues sitting across from him in the London office. On a recent trip, he stopped by Barron's Asia's Hong Kong office to talk broadly about those opportunities he sees.

Barron's Asia: What's your big-picture market outlook at the moment?

Secker: Emerging markets have underperformed developed markets substantially for three or four years. That lets you buy Asia on attractive valuations today. Emerging markets trade at book values of 1.5 times, that's pretty much historic lows, and it has only typically been that cheap during periods of crisis. The discount to developed markets has only been wider during the dot-com boom, when developed markets were very inflated. Asia is cheap but there's a huge variation within the asset class.

A lot of this divergence between emerging and developed markets is driven by sentiment. Also, if you look at the U.S. market, there have been share buybacks every year since 2007, so there's less equity year after year.

Q: Where do you see low and high valuations within Asia?

A: Indonesia and the Philippines are the most expensive, trading at just over 3 times book value, and given the corporate governance and the types of businesses that you can buy in those markets, it's not warranted. But people love to chase a story, and Indonesia grabs attention because the country is doing well, thanks to its resources.

On the flip side, China is about as cheap as it has even been. Korea is a market that has historically traded at a discount, but ultimately as every other market around Korea is re-rated, Korea looks even cheaper than it has historically.

The Indian market in our eyes has probably run a little bit too fast and too high. We started buying there last summer when all the talk was of the "fragile five" [countries of Brazil, South Africa, India, Indonesia and Turkey], and when India was very weak. Modi's election in March is potentially a bit of a game changer for the economy, but we are equity investors, not a macro fund, and some of the companies we owned have gone up far too strongly this year, so we have been selling into that strength.

Q: Do you think the reforms in Korea could eliminate the Korea discount?

A: Taxing the companies' retained earnings and incentivizing them to pay dividends shouldn't be too much of a stretch. But the sprawling nature of some of the businesses will still remain in place, so they probably would still trade at a discount. The discount potentially can narrow once they adopt dividend policies. Korea has the lowest payout ratio of any market. Companies are beginning to talk about adopting dividend policies, which is a step in the right direction.

Our investing is driven by bottoms-up analysis, and finding companies with decent valuations. Among the companies we like are some banks, a couple of car companies, Samsung, and retailers.

Q: What's your strategy for investing in China?

A: With China you've got many businesses that are run the wrong way and run to achieve social aims. But then, on the margin you do have a handful of companies that are focused on moving up the value chain. So they're investing more in R&D and branding. There are more patents filed annually in China than in any other market in the world, which suggests there's a bit of an attitude change taking place.

Companies are beginning to realize that if you want to be a sustainable business you can't just compete on cost. Companies that make low-margin products don't have the ability to pass on rising costs. But if you move into high-margin products you become a price maker rather than a price taker, and you're able to feed rising costs through to the consumer.

So the types of companies in China we look for are primarily those ones that are moving up the value chain and that are going to be around in 10 years from now. These businesses aren't going to be wiped out if the exchange rate goes against them.

Q: Do you avoid buying state-owned enterprises?

A: Well, there are different types of SOEs. The banks, for example, we would struggle to own because they are not designed to be run for profits but are run for achieving economic goals.

Typically we prefer privately-run businesses where management teams are incentivized to run those businesses for the same interests that we have as shareholders. We've got quite a big overweight actually in the Asia Fund in China.

Q: That leads us nicely to the Shanghai-Hong Kong Stock Connect. What do you make of it?

A: We're waiting to see how it starts. In theory, it gives us to access to 568 new names [in Shanghai]. It gives us access to what I believe is the second most liquid market in the world. The majority of current investors are retail so I expect you're going to get inefficiencies in the market. It's going to be an active stock pickers' market, which is good for us.

But you have to be very selective. None of those businesses really have had exposure to international investors before, so disclosure is going to be bad in many instances. Companies' attitudes towards international investors initially are probably not going to be ideal.

We never buy a company without speaking to the management team. That's crucial when you're investing but particularly in emerging markets because it comes down to trust. You need to be confident the managers are going to run the business in the way that you think they should.

Q: What do you think about Taiwanese stocks?

A: You've got broadly three parts to that market: The financials are a big element but they're some of the least profitable banks in our universe. Then you've got some fairly low value-add tech names, and then some chemical businesses, which are in commoditized industries. What the Taiwanese dollar does will impact the success of many of these businesses and you don't necessarily want to buy shares in a company where the success of that company is going to be based on an exchange rate.

Ultimately though, you can find a decent company if you look hard enough. We have been buying a little bit more recently because we've uncovered some better companies and it comes down to relative valuations again.

Q: You implied that Indonesia was "a story", can you elaborate?

A: We don't buy stories. We buy shares in companies and Indonesia is trading at three times book value.

A lot of the companies there are essentially operating in oligopolies based on the industry structure, and will those industry structures remain in place? You're going to have reforms now to make industries more competitive. A business that's reliant on its industry structure is going to come down to politics, which we're not going to try and second guess. Corporate governance is not great in Indonesia, certainly not in relation to some of the valuations.

If you think of the emerging market consumer story, it's a hell of a story. It's billions of people getting wealthy and consuming more, but investors are overlooking valuations.

Q: Can you explain how you look at value creation?

A: In essence: Can a business earn a return on capital above its cost of capital? If it does that, it creates value.

We look to construct a portfolio of businesses that are perhaps low return on capital today, but because there is a change in strategy, they will become value creating in the future. And those types of business we normally have about 50% of the fund in. They are typically your risk-on trade.

You can make a lot of money by buying a business that doesn't make money if it is restructuring the asset base and selling assets that aren't worth its keep. If it gets that right, it starts to grow profits and return on capital.

If a business is breaking even, what does it need to do? It needs to continue to focus on how it uses its assets. It needs to start thinking about margins and profitability. Once it gets that right, then it becomes value creating.

Finally, what drives the future success of a value-creating business? It's sustaining those returns and then it's growing them so you get the compound effect. So if you think of a business that earns a 20% return on capital, every dollar that gets put back in to the business becomes $1.20 and that gets reinvested and becomes $1.44 etc. etc. The company continues to grow its book value. Philosophically, that's what we're looking for.

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