We recently attended the Columbia Acorn fund shareholder meeting and sat down with Columbia Acorn Emerging Markets Fund manager Stephen Kusmierczak to learn about recent valuation and performance trends in the emerging markets, and where he's seeing areas of opportunity.
Jason Stipp: So, Stephen, emerging-markets funds as a category have lost about 15% year-to-date in 2011, yet we still have seen investors putting money into emerging-markets funds; there is still interest in emerging markets as an asset class. In your opinion in running an emerging-markets fund, what has been behind the sell-off and why do you think investors, despite that performance, still are showing interest in the emerging markets?
Stephen Kusmierczak: So at Wanger we tend not to be macroeconomists or global strategists. We really try to focus on companies and business models, but I think that emerging markets are affected by a lot of the other distress signals you're getting, which are affecting really all sorts of asset classes.
You've got a disconnect really between in the developed markets, lots of liquidity being pushed into the markets to reflate their deflation fears. In emerging markets, they have very much a different problem: They're dealing with excess liquidity caused by our efforts to reflate the markets. It's causing inflation problems there. So, there are concerns about that.
You've got periphery of Europe facing a debt crisis. Long-term structural issues about competitiveness. And in the U.S. we've seen very anemic growth in GDP and employment. So, the same issues are facing emerging markets.
Stipp: A follow-up question, then, as you mentioned that you spend most of your time looking at bottom-up individual companies. As you're looking out at your investable space, at the valuations that you're seeing, would you characterize the valuations given that sell-off as more attractive? Do you think that you're seeing more opportunities on a company-by-company basis now than maybe you would seen before we had some of the correction that we've had 2011?
Kusmierczak: I'd say very much so. Valuations look quite attractive, especially if you look relatively. So I have the advantage of also covering developed Europe, and if we would look at valuations on a lot of the developed European companies versus what we're seeing in the emerging markets--similar valuations, but growth rates are meaningfully higher, at least expected growth rates are meaningfully higher in the emerging-markets companies. So over time, you would expect they would outperform.
Stipp: Are there any themes or any particular areas where, through your individual company research, themes that maybe have bubbled up as areas where you're seeing particular valuation dislocations?
Kusmierczak: So, we've built the portfolio bottom-up. So, it's very fundamentally driven ideas from the analysts, best ideas from the analysts. And what is striking, I think, is that the ideas that we've put into the portfolio are very similar to some of the global themes affecting emerging markets we've identified as being long-term tailwinds.
So, for example, in consumer discretionary, we have an overweight of that in the fund, and consumer discretionary we would expect to ... just as you see urbanization trends in emerging markets as people leave the farm, move into the city, they take on jobs with better incomes. You see better education opportunities, more women entering the workforce. All those things should benefit consumer spending in the long run.
And if you look at the portfolio we've constructed, we have many companies, which we think should benefit, everything from a South African property and casualty insurer to retailers and cosmetic companies in China, and homebuilders in Brazil for the low-income consumer as they move up.
Stipp: So I want to talk to you a little bit about the types of companies that you're looking at. So you're more focused on the smaller and the mid-sized companies in the emerging markets. I have a two-pronged question for you: The first one is what opportunities do you think the smaller-cap companies in emerging markets present that you might not get from some of the more broad, larger-cap indexes, for example?
But then secondly, what are some of the specific risks that are on you radar given that you're looking at those smaller-cap companies in the emerging-markets specifically?
Kusmierczak: Well, if you compare the kind of companies we're looking at versus the MSCI Emerging Markets Index, for example--you look at the top holdings or constituents of the MSCI, you look at things like Gazprom or Petrobras, Vale, Samsung, and you really don't get a diversification benefit there, we don't think. If you own Vale, you might as well own Rio Tinto, you probably have it elsewhere in one of your large-cap portfolios. Samsung is really not driven by the Korean consumer or even the Asian consumer. It is driven by trends in consumer electronics in the developed world. Petrobras, Gazprom, those are really plays on global oil.
So we try to identify companies that, again, are focused much more on local trends. Again owning the Brazilian homebuilder, owning the leading Czech commercial bank, where you see credit deepening, they have not experienced the sort of credit boom you've seen in the developed world. They are at the beginning of a credit deepening and broadening cycle. So that's what we're trying to focus on.Read Full Transcript
As far as risks, you have corporate governance issues, you have accounting issues, stock custodial issues, and so when we are looking at companies, we have analysts who are visiting these companies, visiting management teams, touring facilities, speaking with competitors in those markets, so we're not sitting in Chicago trying to make a guess on these companies without really knowing management. So many we've known--these companies that we're putting into the emerging-markets portfolio--are companies that we've owned for a long time in the flagship international fund. So, we have long-term histories with these companies. We know their track records; we know their managements, and that's a way to mitigate that risk.
We have a limited exposure to the frontier markets, so I think it's about 5% of the fund right now. Those areas, you have to even amplify the concerns I talked about with the emerging markets, and in those areas what we've done is to try to mitigate those risks, we've bought companies that are domiciled elsewhere and listed in developed markets essentially.
Stipp: Would you say that your exposure to the frontier markets will probably stay at a smaller percentage such as 5% or will that really be based on where you're seeing the most opportunity? Could it grow to be a bigger percentage if you see some valuations there that you like or some growth stories?
Kusmierczak: It may grow to be a slightly larger percentage of the portfolio, but I don't think we envision that there will ever be a meaningful [stake] just because of the risks that you've outlined, and there are just ample opportunities right now in small and mid-cap emerging markets; really that is our focus.
Stipp: Last question for you, when we think about diversifying a portfolio, perhaps for a U.S. investor, I saw a statistic recently that the sales in the S&P 500 companies are close to half--48% maybe to 50% of those sales--are coming from overseas, so you could argue that if you just held an S&P 500 index, you are actually getting pretty good exposure to the global markets as well, given that revenues are coming from those areas on these U.S.-based companies.
What would you say is the argument for then going out and seeking dedicated, in this case emerging-markets exposure? Wouldn't you be in a sense doubling down on that exposure if you buy some of this dedicated exposure there?
Kusmierczak: Well, if you're buying U.S. large cap, for example, that's exactly true, you're getting a lot of international exposure. But what are those market sets? Europe, developed Europe, Japan, primarily developed market exposure. What we're trying to offer here is really exposure to local trends in the emerging markets, which we think are durable long-term trends, again related to credit deepening, to urbanization, more consumers coming into the marketplace and moving up as well.
Stipp: So you would expect to probably see lower correlations with a fund like this than you might see even with a broader index fund, that it might perform differently that maybe some of the other, even developed international holdings that you might have?
Kusmierczak: We hope that will happen over the long term. You're getting some currency diversification as well.
Stipp: All right, Stephen, thanks so much for your insights and telling us a little bit about the new fund, and for joining me today.
Kusmierczak: Thank you very much.