Different Worlds, Same Investment Style

Editor’s note: This article first appeared in the Q2 2022 issue of Morningstar magazine. Click here to subscribe.

The three portfolio managers who run Pzena Emerging Markets Value PZIEX grew up in three different countries and majored in three different subjects at three different universities. But as college students and young professionals, they shared one thing in common: They had no plans to become investment managers.

Caroline Cai, who traveled to the United States from China to attend Bryn Mawr College, did major in economics and mathematics. But she points out that at this liberal arts college, her economics courses focused more on broad macroeconomic topics than on finance, accounting, or investing. Meanwhile, at Dartmouth College, Allison Fisch majored in psychology, with a minor in drama. And while studying at the Indian Institute of Technology in Kanpur, Rakesh Bordia focused his attention on engineering and computer science.

All three, though, were curious to learn about the world—and about business in particular. That led to a second commonality: All headed to management consulting firms before landing in the investment field (with Bordia first getting a Master of Business Administration and spending time as a software engineer). For Fisch and Cai, the destination was McKinsey, though they were in different offices and didn't know one another at the time. Bordia's consulting experience came at Booz Allen.

The field of management consulting has received its share of criticism over the years. But these portfolio managers say their time at McKinsey and Booz Allen boosted their knowledge base and provided a solid foundation for their future endeavors. "Consulting allows you to learn how businesses work, how they're run, how people think," says Bordia. Fisch puts it in straightforward terms: "Consulting is a great way to learn about a lot of different things."

As they gained experience as consultants, the research began to take a back seat to people management and building relationships, which all three found much less compelling. Though there wasn't necessarily a straight line for all three, between 2001 and 2008 they all ended up at New York City-based Pzena Investment Management and have served as analysts and portfolio managers there since.

The Right Match

Bordia says that once he realized investment management was his true passion, he looked for a firm that fulfilled three criteria: It must have a value-investing focus; adhere to a long-term perspective; and be willing to hire former management consultants. Bordia included the value requirement because at some point he had realized that he'd been a value investor since his initial stock-buying forays as an MBA student.

Cai learned value investing at AllianceBernstein, where she started her investing career as an equity analyst. Fisch also leaned toward value, coming at it from an angle framed by her major in psychology. "You could argue that the entire value-investing cycle is a psychological phenomenon," she says. After all, value investors aim to capitalize on market gyrations between optimism and fear—cycles that are especially prevalent in emerging markets.

Pzena has just one investment style—deep value. Founded by Richard Pzena in 1995, the firm began offering U.S. strategies in 1996 and global strategies in 2004. Soon after, Pzena launched its emerging-markets strategy as an internal vehicle in 2008, Fisch and Cai, who had both been serving as research analysts, became its managers, along with Pzena co-CIO John Goetz. (Goetz stepped off the fund in January 2022.) Separate accounts for outside clients were created a couple of years later, and in 2014, Pzena Emerging Markets Value was launched as a public mutual fund. Bordia contributed to the strategy as a senior analyst, then joined Fisch and Cai as a comanager in April 2015.

Fisch and Cai relish the amount of diverse companies and cultures they encounter in this investment arena, adding that the travel involved provides variety. Cai notes that she feels a personal connection to emerging markets because she grew up in China and still has family there. At times, this background provides an advantage. One benefit: "I don't need a translator in China," she says with a laugh.

Bordia says it's critical to have a flexible mindset when looking at emerging markets. In the United States, he says, a company typically has a process that functions essentially the same way regardless of who's carrying it out, while in India, where he grew up, "processes are only words on paper—in the end, it's the people who matter."

That said, Cai emphasizes that even though an emerging-markets investor must have a mindset that's more "open to different things in different parts of the world," the factors these managers look for when assessing an emerging-markets company are very similar to those they want to see in a company based in a developed market.

Diving Deep for Value

In Pzena's version of value investing, the managers divide their investment universe into quintiles based on valuation and only consider buying stocks in the cheapest one. If a stock in the portfolio rises into the next quintile, the weighting can be reduced, and when it hits the midpoint, it must be sold. That's a deep-value approach, in which investors are willing to invest in a downtrodden company without necessarily seeing any improvement as long as they believe its problems have been overestimated by investors or can be solved more easily than most think.

Deep value, thus, contrasts from its cousin, relative value, a more cautious approach. Relative-value investors tend to wait until they see some actual positive change, such as the company selling an underperforming division or installing new management with encouraging strategic plans, before jumping in.

Pzena's focus on beaten-up fare leads here to a differentiated, roughly 50-stock portfolio, with price multiples well below the MSCI Emerging Markets Index. Most of the fund's assets are invested in Asian markets such as South Korea, China, and Taiwan, though it also owns developed-markets stocks like Standard Chartered and Cognizant Technology CTSH that have high emerging-markets revenue exposure.

Because this is a deep-value approach, it's helpful to compare the fund's record not only to the broad MSCI Emerging Markets Index but also to the MSCI Emerging Markets Value Index. From the fund's 2014 inception through March 25, 2022, the 3.9% annualized return of its institutional shares trailed the MSCI Emerging Markets Index's 4.1% gain. But it soundly topped the MSCI Emerging Markets Value Index’s 2.6% annualized return—and it even came out ahead of the diversified emerging-markets Morningstar Category average of 3.5% during a time when value lagged.

Given Pzena's caution on valuation, one might expect the fund to outperform when markets tumble. These stocks are already really cheap, so in theory their downside should be limited, as opposed to the highfliers, which seemingly have much further to fall. Often it does play out this way. But in the pandemic-induced bear market of early 2020, which ran for about two months, Pzena Emerging Markets Value's institutional shares lost a painful 41.8%, much worse than either index or the category average. In that downturn, investors turned toward growth stocks, thinking they could weather an economic collapse better than the more cyclical fare typically included in value-leaning portfolios.

In mid-February 2022, when Russia seemed poised to invade Ukraine but had not yet done so, the managers said they were overweight Russian stocks versus the MSCI Emerging Markets Index. They noted that this probably wouldn't surprise anyone, given their deep-value, contrarian approach. That said, the overweight was slight: The portfolio had about 4% of assets in Russian stocks compared with the index's 3%. This example shows how the managers try to strike a balance between their deep-value conviction, which leads them to areas being trimmed or shunned by most investors, and their risk-awareness, which reins in their tendencies in that direction.

That doesn't mean they always get the timing right. After not owning it for many years as its share price soared, they added Russian bank Sberbank to the portfolio on a moderate dip in the fourth quarter of 2021. Just a few months later, Sberbank's value cratered after Russia invaded and broad-based sanctions were imposed. On Feb. 24, the day of the invasion, the managers released a statement saying that they always factored political risk into their calculations, and though they recognized the serious nature of the situation, they had decided to hold on to Sberbank as well as their other Russian stock, Lukoil. A follow-up issued on March 10 confirmed that they still held both stocks, partly because they thought both companies still had strong business fundamentals but also because their severe price declines meant that they were negligible amounts of the portfolio (0.01% and 0.02%, respectively).

Team Decisions

Such decisions are made collectively, for Pzena Emerging Markets does not have a designated lead manager. Rather, the three managers work as equals, the typical arrangement at Pzena. "Decisions have to be unanimous," says Bordia. That includes the analyst who covers the company, he adds.

Although speaking with company managements forms an important component of their research, Cai emphasizes that this comes at the end of their process, after they have identified companies that look cheap on the surface, have worked with the analyst or analysts to investigate and evaluate the company's financials, and have talked with suppliers, competitors, and customers.

"By then, we've formed a hypothesis on what makes the company successful," Cai says. The purpose of the management visit thus becomes to determine whether company executives see their business the same way the portfolio managers do, and if not, how they differ.

For this reason, they concede that not being able to meet in person with company leaders for the past two years made evaluating them a challenge. They point out, as many other fund managers have done, that although company executives—barred from traveling—were actually more accessible during the pandemic than they had been before, there's nothing like being in the same room. "We're eager to get on the road," says Cai.

Pzena Emerging Markets Value has not been evaluated for an Analyst Rating by Morningstar's manager research analysts, but the fund was added to the list of strategies in Morningstar Prospects in the first quarter of 2022. That publication takes note of funds not covered by Morningstar analysts but that have traits that make them worth keeping an eye on.

Fees are a headwind here, ranking average for the fund's institutional share class and above average for the investor shares. Like all emerging-markets strategies, this one takes on risks beyond those that face developed-markets offerings—and its overall Morningstar Risk rating is Above Average within the diversified emerging-markets category.

That said, the Morningstar Prospects report detailed that the managers' approach "isn't for the faint of heart but has plenty of merit." In particular, the report pointed to Pzena's deep research team—it's now 28-strong—and "time-tested approach."

As recent events have demonstrated, emerging-markets investing can be perilous and highly unpredictable. Backed by the knowledge from their varied backgrounds and decades of investment experience, these managers stand ready for whatever comes their way.