Investing in the Latin American Growing Middle Class
TWST: Please start with a brief history and overview of Aberdeen.
Mr. Robinson: Aberdeen Asset Management is a Scottish investment firm. The history goes back many years, but the more recent history of Aberdeen really stretches back to the 1980s, when the current CEO, Martin Gilbert, essentially started the company via the purchase of an investment trust company. Since then the business has grown by a mixture of acquisition and organic growth, and is now one of the largest listed asset managers in the United Kingdom. The company has close to U.S.$300 billion of assets under management and manages assets essentially in four broad categories: equities, fixed income, property and alternative investments.
I'm based on our emerging markets equities team, which manages about U.S.$30 billion of equity assets. I'm based in Brazil, in Sao Paulo, which is one of the newer offices that Aberdeen Asset Management has opened. We opened the office here in Sao Paulo about two years ago, and since then it has grown to five people. Primarily we use this office to research investment opportunities and existing investments that are held in Aberdeen funds.
TWST: How would you describe the firm's overall philosophy or investment strategy?
Mr. Robinson: The investment strategy that we use at Aberdeen is very simple. We try to take complexity out of every stage of the investment process. The investment process we use at Aberdeen on the equity team is the same across the firm, so you'll find the fund managers who are in the Sydney office use exactly the same process to select investments as the fund managers in the Philadelphia office, the fund managers in Singapore or indeed the fund managers here in Brazil. It's a very robust investment process that also requires a lot of discipline with a series of steps and rules that really define the investment process. Firstly, we will never invest in a company unless we have met with management. Typically it may take sometimes a period of a few years for us to get comfortable enough with a company to invest in it, and that really leads to quite high conviction portfolios, and the portfolios tend to be quite concentrated. We have holding periods that are about five years on average. We do an awful lot of work on each company, both before we invest in that company and while we own that company, so we continue to follow up with the company, and every company that we own in portfolios we will visit that company at least twice a year.
Primary due diligence is part of the reason Aberdeen established this office here in Sao Paulo - one of the key principles of the investment process is to be located in those countries in which you invest. So that makes life easier in terms of visiting companies regularly, but also helps you understand the local culture, which hopefully allows you to make better investment decisions.
The actual process we use for finding a company to invest in is essentially a three-step process. The first step of that process we call the quality step. And it's important to say that if a company does not pass our quality step, we will not invest in that company. When we are talking about quality, we are talking about fairly straightforward criteria; we are talking about companies that have strong balance sheets, companies that are in good industries which demonstrate growth, and companies that have management teams that have demonstrated a commitment to the interests of minority shareholders in the past. So really we are looking for very straightforward, well-run companies.
If a company is deemed as high-enough quality, then we go into the second step, which is what we call the price step. And in this stage of the investment process we try to work out what is an appropriate price to pay for that company. When we're looking at companies, again, we try to keep things very simple. We examine price to earnings ratios, price to net asset value ratios, price to cash flow. We don't use items like dividend-discount models, as we think that they are overcomplicated and really not particularly useful. The second step of the investment process really is also about patience for us. We don't mind being very patient, to wait for good opportunities to buy an investment. Typically, if we think an investment has passed the quality step, then we may sit several years at the price step waiting for an opportunity to buy that company at a good valuation.
And then the final step of the investment process, the third step, is really just portfolio construction. How does this company that we want to put in the portfolio fit with all the other companies that are already in the portfolio?
TWST: We are going to focus specifically on emerging markets and investments in Latin America. Would you give our readers a snapshot of the Latin America Equity Fund in terms of its strategy and current portfolio?
Mr. Robinson: The Aberdeen Latin America Equity Fund is a fund that we've been managing since 2009, when the fund came to Aberdeen as part of an acquisition that Aberdeen made of some business from Credit Suisse. So this particular Latin America Equity Fund, which is listed on the U.S. stock exchange under the ticker symbol LAQ, has been a relatively recent addition to the stable of Aberdeen funds. We have, however, been running segregated Latin American mandates since 2004, so it's a product that we are very familiar with. The portfolio itself contains close to 50 equity holdings. Of the companies that we own, essentially two-thirds of the portfolio is in Brazil, which is where we believe the largest opportunity set is for Latin American equity investments. Also, 20% or so of the portfolio is invested in companies in Mexico, about 7% or so in Chile, and the remainder in Colombia and Argentina. So we have exposure to a fairly broad range of equity investments in the region.
When we look at companies within the region and what type of companies we're invested in, the portfolio has one fairly significant tilt in it, and that's really an exposure to companies that benefit from the growth of domestic economies within the region. The companies we have more exposure to would be companies that really benefit from growth of the middle-class consumer in the region, and that's something that has been a very powerful force over the last several years and a powerful driver that we expect to continue for many years to come. That's one thing we are really seeing here - a huge number of people every year enter the middle class. In Brazil alone, it's estimated that over the last seven years about 35 million people have become middle-class consumers. And when that happens, it means that people are getting formal jobs, formal employment, which means they are able to open bank accounts, which enables them to take out loans, which enables them to buy middle-class consumer products like fridges and TVs and the like. This is something we think is a powerful driver, and it's really the main theme that the portfolio is positioned to benefit from.
TWST: What industry sectors or types of companies does that translate to? Consumer products seems like a likelychoice for investors.
Mr. Robinson: Yes, exactly. It translates to having larger positions in the consumer cyclical sector, the consumer staple sector, so that would be things like retailers, consumer products like beauty and health care products. One important sector in the fund which is a very overweight position is the financials sector, which we see as a very good way of playing growing domestic demand as financial companies benefit as consumers become more financially active and take out loans and the like. So we see them as a good way of playing this theme. And also particularly in Latin America - and I think it's fair to say of emerging markets as a whole - the banks in less developed markets are very different from banks in developed markets, in that they tend to be much more simple, conservative institutions which essentially take deposits and then lend those deposits and earn a spread on the lending. Most banks, certainly banks that we own, have very small trading operations and aren't reliant on wholesale funding markets, so they are much less risky than their developed world counterparts.
Examples of companies we own operate shopping malls within Brazil, and also within Chile, Colombia and Peru. Those companies are very well positioned to benefit from the growth in retail spending in those various countries. Where we have underweight positions would be some of the companies that are more reliant on the health of the developed economies for their earnings. For example, we tend to have very little weight in companies that are exporters, and we have very little exposure, relative to the benchmark, in some of the commodity companies, the oil and gas companies in Latin America.
TWST: What are some of your top investment picks?
Mr. Robinson: A company that we are quite keen on, and we've held this company for years, is a company called Lojas Renner (LREN3.SA), which is a Brazilian department store company. Lojas Renner is one of the top 10 holdings in the Aberdeen Latin America Equity Fund. The company was formerly owned by J.C. Penney (JCP) a number of years ago, but J.C. Penney exited Brazil and shortly afterwards Lojas Renner had their IPO on the Brazilian stock exchange. We like this company for a few reasons. Firstly, standards of corporate governance are very high at the company. It's one of the few Brazilian companies that doesn't have a controlling shareholder, so it's much more similar in some respects to developed world companies, where you have a diffuse shareholder base. In terms of the Brazilian context, it's probably one of the best governed companies out there. It has a high free float of shares, it has many independent directors on the board, and it uses very conservative methods of accounting. So from a governance perspective, it's good.
From a fundamental perspective, in terms of the outlook for the company, it's very positive in that it's very well positioned to benefit from the growth of the middle-class consumer in Brazil. It's very much a middle-market retailer, which really will capture a lot of these new middle-class consumers that are now shopping in stores rather than shopping in markets, for instance. So we've seen very, very good earnings growth out of the company, and they have several initiatives that they are using to drive earnings growth in the future, things like moving into the homeware market.
Lojas Renner also has several brands of clothes that they're going to open individual stores around. One example, they have a brand called Blue Steel, which is a brand that's involved in jeans and quite fashionable for the late teenagers. And so they are starting to open individually branded Blue Steel stores within Brazil. This is the sort of thing that should continue to drive earnings growth for a number of years in the future, and it's a company we are quite confident in.
Another good example of a company which we are big fans of would be a bank based in Colombia, which is one of the newer additions to the portfolio but not one of the top 10 positions. We actually bought it towards the end of last year, when there was a big sell-off in financial assets caused by the continued unfolding of the European crisis. We've been looking at this bank closely for about five years, and it's one of these stocks that passed our quality test, we got quite comfortable with it, but it took a few years for the price to get in a range where we felt comfortable purchasing the bank. It is currently the largest individual bank in Colombia. It's a very conservative institution which is mainly involved in taking deposits and lending those deposits, and it's really benefiting from the broad-based growth in the Colombian economy.
The Colombian economy is doing quite well at the moment; certainly it's an economy that's quite insulated from the rest of the global economy. Exports in Colombia are a little over 15% of GDP, which is quite low. And secondly, the economy is really benefiting at the moment from the increased investment that's going into the economy. They had a very tough phase in the 1990s due to the crime issues in Colombia, and a couple of successive center-right governments have been quite tough on crime and the guerrillas. Colombia is now a much safer place, which is notably seeing a bigger increase in foreign investment, and lots of foreign companies are now returning to Colombia, and of course as they do that they will need banking services, and this bank is extremely well-positioned to benefit from that.
TWST: You had mentioned some areas where you are underweight. Are there any investments you've recently exited?
Mr. Robinson: One company that we exited in the last six months was a steel manufacturer based in Brazil, Usiminas (USIM3.SA). It was an investment where we had a relatively small weight. It wasn't a core holding for us. We owned it only for a few years, but we were getting increasingly concerned with the outlook for steel manufacturers in Brazil. They've been struggling with high input costs, because the price of iron ore, which is the key raw material for steel making, has been increasing so much recently. So they suffered input-cost increases, and at the same time they have been suffering from general weak steel prices and recent reduction in global demand for steel. So they were suffering quite a large margin squeeze, which was beginning to become quite concerning. But thankfully we were given quite a good opportunity to exit the position recently, because there was some speculation over a potential change in the control structure of Usiminas, which made the shares rally up on speculation that they would be bought at a premium by a third party. We used that opportunity, when the share price rallied, to sell that position and exit, which was a good opportunity, as we felt the fundamentals of that company had really diverged from the stock price.
TWST: How would you describe your overall approach to risk management for the funds?
Mr. Robinson: Our main focus really is knowing the companies that we are investing in and knowing what we are investing in. That's really the first step, the critical step, to managing risk - not investing in a bad-quality company. The way we are thinking about risk, from a portfolio manager's perspective, we are really trying to avoid doing two distinct things. The first thing we are trying to avoid doing is buying a good quality company and overpaying for that company. That's one sure-fire way of destroying returns. And the second thing we are trying to avoid doing is just buying a poor-quality company. So those are the two critical points portfolio managers and analysts should be worried about when managing these funds.
And then of course, Aberdeen itself has a risk-management department which monitors the funds, the tracking errors, the deviations from the benchmark and the like. But as fund managers, this isn't something we spend too much time worrying about. Our critical concern is really just buying good-quality companies and not overpaying for those companies.
TWST: What does this particular fund use as a benchmark? Would you talk a bit about recent performance?
Mr. Robinson: The Aberdeen Latin America Equity Fund uses the MSCI Latin America Net as a benchmark. In terms of recent performance, it outperformed the benchmark by about 4% last year, and it posted fairly decent performance in the years prior to that. And in terms of what has been driving that performance, we've done quite well in Brazil in the last few years, and in particular some of the more domestically oriented stocks in Brazil. So mall-operating companies, some of the retailers in Brazil have performed quite well, and they have really performed on the back of a strong domestic economy and its growing middle class.
TWST: Broadly speaking, what advice would you offer investors in terms of how to approach investing in Latin American equities and why it's a good place to invest today?
Mr. Robinson: I think in terms of why it's a good place to invest today, the countries in Latin America are really benefiting now from stability. There has been a series of pretty good governments in places like Brazil, Chile, Colombia and Mexico, which has meant that companies now have a stable environment in which they can invest. The countries tend to be much less reliant on external debt these days. Inflation has been brought much more under control. In general, countries are running a good fiscal balance sheet. Interest rates are not so low that they can't be cut, unlike the developed world. Relatively, the economic situation in Latin America versus the developed world is quite good.
Secondly, companies have made big efforts over the last 10 years to improve corporate governance. They've been paying down debt, so debt ratios of companies have declined. Returns of companies are still quite good, and certainly better than developed world companies at the moment. So I would say, while the economy is getting better, companies have gotten better, and because a lot more companies have listed on the stock exchange over the last 10 years, there are also more companies to choose from. As investment managers, we have a larger pool of companies from which to choose when we make investments. So that's why I think Latin America is a pretty attractive place to invest right now.
In terms of how to approach the market to invest, well, there are a lot of good companies, and equally there are a lot of bad companies. My personal view is that there is no real sense in buying an index tracker, because you just end up buying a lot of poor companies. My view is, the best way of approaching investing in the market is really by investing in companies where you know the company, you know the management teams, you know the assets that they are operating on the ground, and also approaching investing in this market with a long time horizon. You should at least be thinking about investing throughout the course of a cycle rather than one or two years or even one or two quarters. A long-term investment strategy is, I think, the right way of going about investing in this market.
TWST: Thank you. (MN)
Nick Robinson, CFA
Head of Brazilian Equities
Aberdeen Asset Management
1735 Market St.
Philadelphia, PA 19103
(866) 354 4005 - FAX