Invest Like the Best with Patrick O'Shaughnessy - Harvey Sawikin - Emerging Market Opportunities - [Invest Like the Best, EP.75]

Starting point is 00:00:00 This podcast is sponsored by CFA Institute, the Global Association of Investment Professionals whose mission is to lead the investment profession by promoting the highest standards of ethics, education, and professional excellence for the ultimate benefit of society. CFA Institute serves a global community of investment professionals working to build an investment industry where investors' interests come first, financial markets function at their best, and economies grow. The chartered financial analyst credential is the most respected and recognized investment management designation in the world.

Starting point is 00:00:30 The views expressed in this podcast do not necessarily represent the views of CFA Institute. Hello and welcome, everyone. I'm Patrick O'Shaughnessy and this is Invest Like the Best. This show is an open-ended exploration of markets, ideas, methods, stories, and of strategies that will help you better invest both your time and your money. You can learn more and stay up to date at investorfieldguide.com. Patrick O'Shaughnessy is the CEO of O'Shaunicee Asset Management. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of O'Shaunsi asset management.

Starting point is 00:01:10 This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of O'Shaughnessy Asset Management may maintain positions and the securities discussed in this podcast. My guest this week is Harvey Solicin, a co-founder and lead portfolio manager at Firebird Management, which manages funds dedicated to investing in emerging market equities. Emerging markets are often a blind spot for investors of all types. Most of us have never traveled to the Far East or Eastern Europe where many of the thousands of emerging market public equities operate. I've been very lucky to travel quite a bit in Asia and the Middle East, but never to Eastern Europe, which is where Firebird focuses its investments.

Starting point is 00:01:49 Harvey and I discuss his 24 years of experience evaluating emerging and frontier market countries, industries, and individual stocks. We discuss his experience buying privatization vouchers in Russia, banks in the Baltics, and how today's emerging market opportunity set compares to the past. Like so many of these conversations with investors who have earned significant excess returns, it's clear investing opportunities in emerging markets are often disguised. Finding them requires risk, hard work, discipline, and a dose of luck in timing. Please enjoy my conversation with Harvey on emerging market opportunities.

Starting point is 00:02:23 What is your single most memorable travel experience since the beginning of Firebird? Wow, that's really, that's a really, uh, tough question. You know, I'd have to say my first trip to Russia in January of 1994, because it was like stepping into a John Le Corre novel. It was just grim, gray, dirty, smelly. And I went right in the dark of winter, and I stayed at the Moscow Hotel, which is now the four seasons at the time. It was just disgusting. And I went out, they had a cafe. I couldn't eat. I couldn't find anything to eat. The cafe, the food was inedible. There was some sort of thing, like some sort of jellied thing that looked.

Starting point is 00:03:11 It was all inedible. I said, okay, there's got to be some restaurants around here. And I started walking. And I couldn't find, in a freezing cold, I couldn't find any store with any food. The stores that were open had no food. And there was nothing else open. And I said, I'm going to starve now. And I turned a corner, and there was a McDonald's.

Starting point is 00:03:30 It was only the second McDonald's in Russia. and I've never, I think the only time I was so happy to go to a McDonald's was when I was probably seven years old and they opened the first McDonald's in New York up on the Upper West Side and went with my mom. And so God bless McDonald's. And for the first few times I went to Russia and then I discovered there were some other restaurants. I just didn't know where they were.

Starting point is 00:03:55 And on that same trip, we went to the voucher auction to buy privatization vouchers, which was held in an old Lenin post office, which had been turned into an exchange where they were trading like medals in the morning. And then in the afternoon they were trading privatization vouchers. It was unheated. Guys were running around with fur hats exchanging these packs of vouchers. I recall it like it was yesterday, and it had the smell of opportunity. Like people say to me sometimes, oh, when you started out in Russia, you took, was so risky, you took such a big risk. Why did you do that?

Starting point is 00:04:32 And I would say, no, you don't understand. I was absolutely sure I was going to get rich. I had no doubt. I was so confident, you know, I couldn't wait to buy Russian stocks. I was so sure of it. How did the settlement process work? So like, what was the actual logistics of buying these things? Well, the vouchers were kind of complicated because basically they were only supposed to

Starting point is 00:04:54 be owned by Russians. So you had a Russian, you would sort of pay a Russian. broker to do it on your behalf. They would tender the vouchers and then they would receive the shares with a pre-agrement to transfer the shares to you when they received them. So you were taking, yes, you were taking some risk. This is why, you know, the Templetons of the world couldn't have done it. But since you were out of, essentially out of pocket the money and we're trusting a broker. We found a broker very early on that we trusted. Pretty soon Credit Suisse got in there or CSFB, and they became like the sort of main trader in the vouchers and developed a, and they made

Starting point is 00:05:39 a lot of money for themselves doing that and for the clients. Maybe you could begin by describing how you got interested in the mid-90s in emerging markets investing and in Eastern Europe and Russia specifically. How did you approach the markets? Obviously, we're staring at a huge map of a lot of the emerging markets behind you. There's a massive world, a lot of countries out there, a lot of different governance structures and political structures. How did you begin to approach that problem? My original co-founder, Dan Cloud, he had a very brilliant insight, which I think is something that it remains true today about emerging markets investing. His insight was that he saw lots of people making fortunes on emerging markets, but the emerging market funds never seemed to do very well.

Starting point is 00:06:24 Fidelity and Templeton, even Mark Mubius, his funds, his returns were never that impressive. And Dan said, you know, the reason is the guys who make a lot of money, they're doing it in their PA. These are guys who are sitting on trading desks buying Thailand when it's at pennies. And they set up accounts at local brokerages and they get in when the insiders are buying. And the Templetons and Fidelity's of the world only get in once there's already custody. and even GDRs and whatever. And by then it's up 10 times already.

Starting point is 00:06:58 And the insiders are already looking to lighten up. And he said, we should do a fund where we do what the traders do on the desk, where we make it, our fund is the PA. We won't have a PA. This is the PA. So that was the insight. And I think even today, I still think in those terms. I mean, obviously we now have, so we started with looking for markets

Starting point is 00:07:20 that were really baby markets without. custody where we had to go in and figure things out, set up custody with local brokers and so on. And after a couple of false starts at the end of 93, the Russian voucher privatizations began. And Dan knew something about Eastern Europe. He had traded Poland very successfully when it started. And he said, you know, we've got to get over to Russia to check this out. This looks like it could be something big. And Ian Haig, who is another co-founder, who's still my partner now, was a Russian expert, and they spent many, many hours talking about the Russian history and culture and language and approached it from every angle. And I was looking at it from a legal point of view,

Starting point is 00:08:06 from a tax point of view. So we looked at it from every angle and we said, you know, this is doable. This is not nearly as bad as people think. So that was kind of the approach was we're going to do something here that's complicated that is not set up for you easily, and we'll be the first foreigners in there doing this, and we're going to buy things. Oh, and then sort of buried the lead. The most important thing was that when we looked at the valuations and the voucher privatizations, we realized that companies were being auctioned off at 1% of the value of Western comparables. So the first auction we participated in was for an oil company, which had as much oil as mobile. Mobile at the time had a $40 billion market cap, and this company had a $40 million.

Starting point is 00:09:00 We understood that it would in the voucher auction have a $40 million market cap. So we said, look, this company does not have to become as good as mobile. It only has to become only 95% worse than mobile, and we'll make five times our money. And sure enough, and we participate, participated in that voucher auction. Sure enough, at the peak, I think that company traded at maybe a 60% discount to mobile or to Exxon. So essentially it went up, I don't know, 40 times to the peak. So that was the, it was extreme valuations, not accessible to most investors, investing alongside of Russians who were scooping up shares. The smart Russians were scooping up shares, while your average

Starting point is 00:09:46 Russian didn't understand the value of what they had been given in the voucher privatization. So they sold it. They sold their voucher for a bottle of vodka. They never had any belief that it could be worth anything. But there were a lot of Russians who understood what it could be worth, and many of them are now billionaires. Fast forwarding to today, this theme comes up over and over again in these conversations that the best returns come with a lot of the characteristics you described. Very hard, no custody, something that's happening for the first time, differentiated expertise, whether it's legal tax, regional, whatever. Fast forwarding to today, how would you segment out the emerging markets in terms of the regions or the types of opportunities

Starting point is 00:10:23 and maybe comparing the opportunity set today? Because you see a lot just statistically that emerging markets look very cheap relative to developed international markets. What does it look like in comparison to the early days when, you know, 1-100th is a good discount? It's not like that today. So how do you think about the landscape now? The truth is there are, things today that are, if not one-hundredth, they're 90% discounted. They obviously, they tend to be the countries with the biggest hair on them, such as Ukraine right now in my region. And actually, in my region, we have in our fund mandate, probably 35 countries.

Starting point is 00:11:01 We're only active in nine. Some of those other ones are countries that are just even after 25 years of freedom from the Soviet Union, they're still not ready. They developed down the wrong path or whatever. But, you know, catching one when it changes is very important. And over the years, we've caught a bunch of them because Russia was our first, but then we caught the Baltics. We got in early in Estonia on Hansa Bank in December 94, made 75X until we were taken out by Swedbank in 2006, I believe, 2004. Then we did Romania and Bulgaria.

Starting point is 00:11:37 Then we did Kazakhstan. Then we did Georgia in 2004. And even today, we're always looking to see. I've been to Ukraine. Actually, the whole team has been to Ukraine over the last year just to see. And, you know, unfortunately, we keep trying and we keep seeing it's not ready. So I think that anywhere in the world you go right now, you're going to find sort of a next big thing. Usually it's one that people are not looking at. There's always a next big thing that people agree on. And I always get the feeling that it's never going to like Cuba. Cuba's been the next big thing literally since 1994, and I, for the various reasons why I always

Starting point is 00:12:18 thought no one's ever going to make any money in Cuba. Vietnam was the next big thing for 20 years. It actually started to do well in recent years, but he had a long, long wait before it did anything. What do you think of the countries that are the consensus next big thing? What are the common variables that make people arrive at that consensus? And maybe why do you think they tend not to pan out? Or is it just a valuation story? Yeah, I think it's more like they're, they're focusing on maybe not exactly the right things, like they're looking at a country that's big.

Starting point is 00:12:48 Like Iran. Iran has been talked about in the last couple of years as a next big thing. And I know several people who've been trying to invest in Iran. But the fact, because it's a big economy, it has a lot of potential. But it's not a country that is set up for outsiders to make money. You know, I don't know a lot about it. But what I do know is that the Revolutionary Guard has a lot of control over, all the levers of power, including the financial markets and listed companies. And so you have to ask

Starting point is 00:13:17 yourself, is this a game where I can play? Now, there are some markets that never worked as emerging markets as stock markets, but people did quite well in private equity. I would say Latvia as an example. We had a couple of things in Latvia. We never really made any money there. People did quite well in private equity, especially in real estate. So one of the questions you have to ask is, is this going to be a stock market? And is there a place for a foreigner in this stock market, or is it all sewn up by insiders? And is there anything to buy that's any good? And so those are some of the factors. And I think people, and also the political, I think, you know, we started, another one of Firebird's original insights was that emerging markets investors probably focused 80% on

Starting point is 00:14:08 valuation and economics and maybe 20% on politics, when it really should be more like 50-50. And so, for example, a big part of our decision to go into Russia was an analysis of the political situation. And subsequently, you know, in all the markets we've gone into, politics are a big deal. And any time you think in emerging markets that politics has ceased to be a big deal, you can get blown out of the water, which is what happened to people in Egypt. and nobody saw that coming. All the gem funds were in Egypt and they all got blown out of the water when Mubarak was taken down. Recently, more recently in Poland, where they went to a very populist government that shook things up in a negative way in Hungary. So Central Europe politically became much, much tougher over the last few years and the performance of their stock markets has been affected by that.

Starting point is 00:15:04 How do you think about the, maybe you have a specific checklist, but sort of the, first, there's kind of three, I think about it in three ways, the economic landscape, the political landscape, and the market, capital markets infrastructure. So are there minimum conditions that you look to meet before you even consider doing deeper work on a country, maybe starting with the economic situation? I don't think we have any hard and fast rules, you know, like that a country has to have X inflation and X GDP growth or whatever. Each country presents its own factors. We kind of balance them all and, you know, we'll be a little bit more generous in terms of going into a country where, let's say, the politics is a little diceier if the valuations more than

Starting point is 00:15:49 compensate you for it. So, for example, even in Ukraine, which we still don't believe in from a macro point of view and political point of view, there's a couple of stocks that we own just because they're compelling. And you can look at them and say, okay, in all the likely bad things that are going to happen in this country, how will this company fare? For example, if they devalue the currency, is this a problem for this company or not? And, you know, it can be a fairly subtle analysis. But then when you have a country where the politics and everything is ticking over perfectly, and that happens too, like I would say, for example, the Baltic states recently, you know, they have it all going just as it should be. And, you know,

Starting point is 00:16:39 there will pay a little bit more for the equities. You're not going to find these dirt cheap bargains, but you'll find things that are still, you know, 40% to 50% discounted to Western Europe. So that for me is a good value and to blend it together. Oh, so to go back to one of your earlier questions, what do we do now? So, yeah, we started as essentially, frontier investors because that's where we got attention. But as we've matured as a company over 20 years, we have a lot more of more developed emerging markets, and we apply a different investment approach to the more developed emerging markets than to frontier markets, which require different approach. And you just, when we come to a frontier situation, we have to put

Starting point is 00:17:25 on our different hats and different glasses and say, okay, what are we looking for here? What's the play? How would you distinguish between frontier and emerging? So obviously there's MSCI type classifications. But as you think about it, what is the dividing line between those two ideas? Well, like, for example, countries that already have sort of normal custody where anybody can go in and the institutions can go in. Certainly, if their currencies are either pegged to the dollar or the euro or they're in the euro, some of our – those are the indicia. And, you know, there are countries we call post-political, which means that they can have elections, different parties come to power, but it doesn't really change anything. So, like, for example, in Estonia or Lithuania, they've had all these different governments in the last few years.

Starting point is 00:18:15 But the path is already set in stone. They are moving more and more to EU convergence. That's it. But then you have countries where elections are still absolutely critical. So that's really more of a frontier market where you're facing the prospect of a big loss if the wrong party gets elected or if they shake things up in a bad way for the market. How do you think about the access points that we'll say just generic Western investors have into emerging markets, things like ETFs, indexes.

Starting point is 00:18:44 I'm always interested where there's places that the index methodology might be very flawed. One thing to talk about here would be, for example, state-owned enterprises, how you think about SOEs and their role in the benchmarks, again, which you're evaluated? I think indexes are funds are even less. I buy them in the U.S. sort of somewhat hesitantly, but they're even less appropriate for emerging markets because of what you said. The largest cap companies are often the ones that don't build any shareholder value. So if you look at the Russian index, you know, one of the reasons it was only up 5% last year and we were up over 20% was because it was being dragged down by a few big SOEs that, you know,

Starting point is 00:19:30 we're not building value. Now, I would put a caveat in there. There are times when you need to be a stock picker, and there are times when the index is going to outperform everybody else. We've had some periods where you could have just thrown a dart in our region or in Russia, and did just as well as we did. I think we haven't had one of those periods for about 10 years. It could happen.

Starting point is 00:19:58 And I am prepared to underperform. And my investors by now, they've been with us for so long, and we have such a long track record that they're willing to give us the benefit of the doubt when we're underperforming. And I say, look, it's becoming a bubble. All the crap is going up. I'm not going to buy bad stocks just to keep up with the market

Starting point is 00:20:19 because they've become the liquidity. play. And, you know, we can get away with that. I think it's harder for a younger fund to do that because people will say, oh, they lost it. They don't know what they're doing. And, you know, they haven't had time to prove themselves through three different cycles. When that happens, how much of that is just kind of like a macroeconomic play, whether it's oil pushing up, state-owned enterprises? What are the drivers of those periods where you expect to underperform? Yeah, it's a moment, a bull market. I've been through bull and bear markets. I can say, humbly, I've been through one of the worst bear markets and one of the greatest bull markets

Starting point is 00:20:56 of the last 50 years. Because I was in the Russian bull market and I was in the bear markets of 2008 and 9. And, you know, I would say that one of the key tasks, probably the first piece of advice that we were ever given as emerging markets managers by a very smart guy who's still an investor of ours named George Robinson, who runs a very famous EMF. fund out of London was your job as an emerging markets manager is to know whether you're in a bull market or a bear market and act accordingly. It requires thinking about a lot. It means that if you're in a bull market, you need to go with the flow. You need to understand that things can, valuations can go to levels that you're not comfortable with, but certain stocks will emerge as the leaders of the

Starting point is 00:21:49 bull market. You got to ride them. And don't get too fancy and too complicated. I believe we're in a bull market right now. It's amazing that no one has used this word in emerging markets, even though they've been going almost straight up for two years. And my market, like my Russia fund, has been up like 23 out of the last 25 months or something. And yet, we're not being inundated with new money. people don't seem to realize that we're two years into this fantastic bull market. That's what it feels like to me. And because I think I'm in that type of a market, I'm taking a slightly different approach. You know, I'm letting the winners run.

Starting point is 00:22:32 The leaders that are emerging as the stocks that everybody wants, like Sparebank, let's take an example in Russia. This is a stock that has gone from 350, the GDR a couple of years ago to $19 today. and somebody who's written it from, let's say, you got in a 350 and you've ridden it to 19, it's very tempting to say, okay, I don't want to be a pig, I want to cash in. But is it over? No, I think it's halfway. And by the way, spare bank's valuation is still attractive.

Starting point is 00:23:06 It trades at something like 1.2 times book with a bank that is generating 20% return on equity in a market that feels like a bull market driven by rise. oil prices. So I think that, you know, you have to put on different hat, and a bear market is a different hat. This is very tough to do, and one of my weaknesses as a manager, in a bare market, you have to, what they say, go out back and kill all your darlings. You just got to shoot them all. Even stocks you love and you think in the long term are great companies, you got to sell them. And that is, I think, the single hardest thing for a fund manager to do is to sell a long-term by because it's going to do badly in the next couple of years.

Starting point is 00:23:47 When it comes to portfolio construction, how do you think about risk exposure? So we talked about politics and economic conditions, things like that. Do you care at all what the broad kind of universe or benchmark looks like in terms of its way to different countries? How do you think about that side of things? I think that anybody who has a benchmark and then says that their benchmark unaware as just being stupid because, you know, investors are not benchmark on. aware. Even the word benchmark agnostic is a little strong. I would say that I'm benchmark afraid. I'm

Starting point is 00:24:22 afraid of the benchmark beating me and beating me badly and for a long time. I mean, I can underperform the benchmark for a little while, but I do have an eye on the benchmark. So like some of the things that we have in our fund right now are some of the things that are big weightings in the index. And you don't want to be, for example, I don't shun S-OEs. Just because they're S-O-E's, it doesn't mean they're bad. In fact, I would say three of the best Russian companies are state-owned enterprises, and we own three of them. Actually, four, now that I think about it, and they all happen to be index components. So if you can enjoy a stock that's in the index and weight it at the index level or close to it and feel good about it, that's not a terrible thing because you might be wrong. It could be that the stock emerges

Starting point is 00:25:14 as like one of the great leaders of the market and you don't want to be forced to be in a position where you, and I see some of my peers in Russia and, you know, and this is probably true in other markets too. They just have a philosophical hatred of a particular company because it screwed them in the past or whatever, bought out a subsidiary at an unfair price or whatever. and they swear it off forever, even if the company completely transforms. And I try not to hold those kind of grudges for a long time because people change, companies change, and it's dangerous to be rigid in this business because you could get left behind.

Starting point is 00:25:56 Can we talk about the actual, the bottom up part of the process? So I think originally there's a top-down component, right? You mentioned 35 countries. You're only in nine of them. There are certain conditions or a story that needs to emerge. And ideally, it's something that other people is not Cuba, right? and everyone's not looking at it. When it comes to the actual companies and industries that you're interested in,

Starting point is 00:26:15 maybe walk us through that process, what you're looking for, whether or not there are industries that you focus on, that's something specific to emerging markets, and how you think about that? Well, in a frontier market, the first question you have to ask, you look at all the stocks in the stock market,

Starting point is 00:26:30 if it's a new stock market, and depends on how they did privatization, if there could be a lot or only a few. And you need to identify what the country, comparative advantages? What does this country have to offer? When we went to Russia, we saw, okay, this country is going to be one of the oil giants of the world. So oil stocks, you want to own oil stocks, you want to own for sure. And weirdly, when I think back to 1994, those were not considered to be the blue chips. The Russians themselves, they were very interested in buying

Starting point is 00:27:09 shares in Goom Department Store and in Red October Chocolate Factory, because these were things they knew. Like they'd chopped at Goom, now you could buy it. They'd eaten Red October chocolates. They could, they could buy that share now, but they didn't see the oil companies. That wasn't a tangible thing that they'd interacted with, so they didn't think that those were the things to buy. incidentally, when Lloyd Benson, who was Secretary of the Treasury at the time, he visited Russia and Yeltsin gave him a share of Gumm Department Store and a Red October Chocolate Factory. And I think Benson should be very angry because if he had given him Luke oil, it went up 100 times. And those stocks were dogs forever.

Starting point is 00:27:55 So I think you have to ask, what is the key sector? Is it a retail? Is it going to be a consumer-oriented economy where you want to own? things in banking, retail. Is it going to be, or like you take Kazakhstan as another frontier market we've invested in. It's only under 20 million people, so there are limitations on what a retailer can do, but they're a huge oil exporter, they have metals. So you'd kind of look at that. In a more developed market, you know, by then you already see what sectors have emerged. And you also want to see, there are certain sectors that are just non-investable for foreigners. Anything related to defense usually is very

Starting point is 00:28:34 difficult, but things that are sectors that have emerged and companies that look like public companies, once you're talking about a more developed emerging market, those are the ones. The metrics we use, again, it depends on whether it's a frontier market or whether it's a developed market. A frontier market where companies don't really have, let's say, great earnings yet, you're looking for market share. You use comparables a lot. Like if this was a Western telecom, what would it be worth?

Starting point is 00:29:08 What's their market share? Those kind of questions. In a more developed emerging market, you can go on to, you know, price to book and PE and all the normal things. But I would say that there's been a big transition in emerging markets in the last 10 years, and particularly in the last five years, away from headline numbers and two fundamental value-create. which is now what really separates the winners from the losers in the stock market. So if you look at there are companies in my market in Russia that look very cheap on a headline basis because let's say they have a 3 PE.

Starting point is 00:29:50 But the free cash flow is non-existent because the CAPEX is inefficient and a lot of stealing and nothing ever winds up going. And the only way they can pay dividends is by borrowing and paying dividends. But then you have companies that generate tremendous amount of free cash flow and share it with investors through dividends and buybacks. Those are the companies that are outperforming that have helped us a lot in the last few years to outperform. And I think that this is a result of lots of emerging market company managers having – it's a new generation of people who were trained in Western business schools or, at least they're familiar with Western practices, and globalization has had this effect on these countries of kind of the mantra of value creation is much more widely accepted.

Starting point is 00:30:48 At least in my region, I can't speak so much to the rest of the world, but I believe that in most of Asia ex-China, that's the mantra. China, I think, is a different animal, and I think people have very much. there need to be experts. How do you think about dividends? Do you care about that cash flow stream? You mentioned borrowing to pay dividends. Maybe that's a bad thing. How do you think about return of cash directly to shareholders? We're dividend hungry. We love it. At the same time, you know, if a company has worthy investment projects, more than happy for them to, well, it's the same thing that Warren Buffett always says. Like, you know, I don't want the dividends. I don't want the cash back.

Starting point is 00:31:32 I want you to invest it. And that's easy for him to say in the United States, where the investments are smart, well, let's put that this way. Where his companies tend to make smart investments. In our part of the world, a lot of that money was stolen. And so shareholders like to see the cash on the barrelhead means this is real profits. I can touch it. But my last meetings, I was in Russia 10 days ago and I had some meetings.

Starting point is 00:31:59 And they were speaking my language. They were saying, look, the board has come up with a new policy. I met with a Russian steel company. This is amazing. They were the first company to institute a quarterly dividend. They have a new dividend policy. They're going to dividend out their entire free cash flow up to 0.3 times debt to EBITDA. And if debt is below 0.3 times EBITDA, they'll pay above 100% of free cash flow to get it to that level.

Starting point is 00:32:27 Then they complained to me that other Russian steel companies that, are public, we're copying them their dividend policy and doing the same thing. When I left, I sort of said, oh, my God, can it be? Russian steel companies are competing to see who has the best corporate governance, considering where it was 20 years ago, where they would shoot you for even asking, you know, where did the money go? So I think they're speaking my language, but I do love dividends. And, you know, our fund, well, the market has the Eastern, MSCI Eastern Europe right now has a 4% dividend yield, which tells me that we're not topy. That's a sign. It's never, the PE, the market PE is 10. I've seen it at 10 before, but not with a 4% dividend yield.

Starting point is 00:33:15 I think it was probably at 10, let's say go back to 2005, 2006, it was probably 10, but the dividend yield was probably 2%, if that. So it's a whole different ballgame in my part of the world. And I would imagine it is the same everywhere in emerging markets, again, ex-China, as China is a different story. On the way in I was reading, I can't remember the name of the book, but there was an Orwell quote in the book, something to the effect of whatever has the momentum now seems invincible. And the S&P 500 has sort of been invincible here in the U.S. It's kind of on a trailing 10-year basis crushed just about every other major investable index. You also, I think, I think Firebird manages some equities, U.S. value equities. How do you think about the comparison, the opportunity comparison

Starting point is 00:33:59 between U.S. equities, maybe U.S. value equities, and emerging markets today? I think they have one thing in common, which makes me positive on both, which is that equities still offer a much more attractive return than the relevant fixed income instrument. So, for example, in the United States, it's true. Let's say that the S&P is trading at 23, whatever it is. So your earnings yield is over 4%. The 10 year is 2.7. So even after that move, it's 2.7. And people are getting excited, you know, Texan, look at the divin a yield. People forget that this is only a recent phenomenon, that the earnings yield could be higher. Yeah. It was higher than the bond yield. When I start in investing in 1992, I read The Intelligent Investor, and Graham says in there that you know that

Starting point is 00:34:56 the U.S. market is a good buy when the earnings yield is at least two times the bond yield. And if it isn't, you should just put in like 25% into equities. So I said, okay, I put 25% of my money into equities, and I said, okay, I'll wait until Graham's conditions are in place, and then I'll get fully invested. It didn't happen until 2009. That's when it finally was, and in fact, at that time, it was three times the earnings yield. I think by 2010, the earnings yield was three times the bond yield. And I said, boy, I should be buying U.S. equities. And I did. I only wish I'd gone, you know, fully invested like, you know, I should have. But anyway, so, okay, it's not as attractive now. but it's still attractive.

Starting point is 00:35:46 And so, of course, I'm having these arguments with people all the time when I say that the U.S. market is still good. And they say, well, that's only because the treasuries are too cheap. And I say, you know, if you're going to argue on that you know the fair value of the 10-year and no one else does, you know, that's a loser's argument. There's a lot of reasons why the 10-year trades were it does. By the way, so then I asked a friend of mine who's an expert on fixed income, you know, what do you think? Is it being pushed up by the Fed? He said, of course it is. If the Fed was not involved in the bond market, yields would be much higher. But they are. And they will be for a long, long, long time. There's like a 10-year process of getting the Fed out. So where's the problem?

Starting point is 00:36:34 So obviously, if the 10-year does keep going up, the yield keeps going up, at some point, it does start to look like U.S. equities are now facing very steep competition, it's going to be a factor. And I'll adjust my portfolio accordingly. So you mentioned that you try to run this place like it's your PA, which I think is what everyone would want out of their asset manager. Back to that question. So U.S. equities relative to fixed income, I understand the argument. What about U.S. equities relative to emerging market equities kind of versus that same differential across your 20 plus year history? I would say that we're now in a period where EM equities should outperform developed market equities after 10 years of the opposite. To use a cliche, what's becoming a cliche, we have coordinated global growth for the first time

Starting point is 00:37:24 since 2007. Can you say more about what you mean by that by coordinated global growth? Well, I mean, the U.S. is growing. Europe is growing, even more than the U.S., GDP-wise. China's growing. And not only is China growing, but after carrying much of the global economy on their backs for a few years. Now they're growing more on the basis of exports again, because Europe is their biggest export market, and it's growing again, and people are buying stuff. When I saw the car sales in Europe last year were the highest they'd been in 10 years, that's not fake. I mean, that's not fake news. That's a real factor that affects everything. And emerging markets are growing. So, I mean, outside of China, the others, outside of China,

Starting point is 00:38:05 everybody's growing. So that reminds me of the period from 2003 until 2007 when 4% global growth was happening and it was a great time to be in cyclicals and resource stocks and an emerging market equities. Then we went into a period of very serious retrenchment with a couple of fall starts and then it sank down again. So you had 10 years and during a period like that, obviously developed markets are going to perform better and tech and fang and all that. People are not leveraged to global growth quite as much. But I think the leadership is switched again. And I think that money has barely even started to flow into emerging markets yet. I was talking to a fund-to-fund manager who's setting up an emerging market fund of funds, and I asked him, when do you think

Starting point is 00:38:56 we'll start to see some inflows? And he said, one year after the U.S. market, that the EMS start outperforming the U.S., people start looking at them. Then it'll take another year for them to figure out what they want to do. So two years after, that's when money will start to flow in. So they started out performing probably about a year ago. So we're only a year into it. We need another year. And then I would say first quarter of 2019 will start to see more significant inflows to the asset class. So we haven't really seen much in the way of inflows to my funds, despite two years of extremely good performance. Can you talk a bit about the investor types that allocate to emerging markets? So you mentioned a lot of your investors have been with you a long time.

Starting point is 00:39:45 I always think about it from kind of the basic individual that makes their own decisions all the way up to the very slow to move massive sovereign wealth funds or something like this. When you think about potential LP investors in your strategies, how do you kind of segment them and do you believe that everyone's just kind of performance-based investing? or are there others that look to emerging markets to fill some other specific need in their portfolio? It's a combination. I mean, we have, our largest investor is a sovereign, quasi-sovereign wealth fund. It's a very large asset manager, and we fill a need.

Starting point is 00:40:15 They have a huge portfolio, and they were looking for a particular type of emerging market equity investor. We fit the bill, and we have them, and we have some other institutional types. But I would say that, you know, the more typical investor for us is a high net worth individual. somebody with a million dollars or $2 million who feels uncomfortable as they should, sticking that into an ETF or looks at Templeton Fidelity and doesn't like what they see in terms of performance and track record and says there's got to be something better and I'm willing, I'm willing to pay higher fees and for expertise. So that's a kind of investor we have.

Starting point is 00:40:55 And you know, it's interesting because come full circle, when we started out in the 90s, our investor base was exactly like that. It was high net worth individuals and then some very sophisticated institutional investors who we filled a need. Then for five years we went through this amazing boom in fund of funds which transformed the whole hedge fund industry and created unbelievable bubbles all over the place. Everything, a lot of that was pushed up by these fund of funds and most of them are gone. So we're back to the same type of marketing we did in the 90s again. And for me, like my dream investor is like a kind of an older, slightly stubborn person who's made money either investing or with a business and looks at is very skeptical, doesn't get fooled by

Starting point is 00:41:53 slick sales pitches. And that's the kind of person, and invests for the long term, and that's the kind of person who, when you're down, they will add more. If they're convinced that your strategy is right and you know what you're doing, they'll add more and not run for the hills the minute there's a twinge. So those are my kind of favorite investors. And I've had some of them, people like that for 20 years. Unfortunately, some of them are, the funds are now outlive some of our favorite investors, which, and that's another interesting thing, is to see whether the next generation has been adequately prepared what to do and how to invest. And sadly, I find that the answer is usually no. Can you talk about the value of travel in the process itself? So you mentioned that you were

Starting point is 00:42:40 just in Russia. It sounds like the team, someone from the team is basically traveling at all times. Maybe tell a story or two about why you do that and why that's valuable versus just, you know, at financial statements and information? First of all, I enjoy it. For me, going on the road is still extremely fun. Here in New York, I'm an obscure nobody. When I go to Russia or Georgia, I'm a hero, and everybody wants to wine and dine me and so on. But it's not an ego boost. I just enjoy it, and it's interesting. And when you go to a, I was in Georgia a couple months ago visiting with Bank of Georgia, which is one of our big investments. And they have a subsidiary. that's building the first hospital and clinic chain in Georgia.

Starting point is 00:43:24 And it was amazing. I visited, they showed us this one hospital. They said, this is the first neonatal clinic in Georgia. This is the first sophisticated CT machine in T. And I really felt like we were part of something, you know. And then we went to a hydropower plant that they're building. And, you know, you see, you touch what it is you're participating in. It makes you feel good.

Starting point is 00:43:49 And of course, I feel like because I've been doing this so long, I have a fairly good gut for the management. So if I see really good management. Last summer, I met with Luke Oil, which is an oil company in Russia. And it was a new IR guy. They had hired. And he was really impressive. Luke Oil always had some difficulties with investor relations, never had the right person. And I said, okay, this guy is awesome. I loved what he was telling me. He told me some things that, while not inside information, were very insightful as to some things that were going to happen with luke oil that have happened, like the decision to institute a buyback. So I felt like it increased dramatically my confidence in that position that we held, and we added to it.

Starting point is 00:44:38 So you get these insights meeting with people, and the opposite, too. Like you visit a company. I was just in Russia. I visited a few retailers. And I visited a retailer called Magnet. And I first visited their stores two years ago. This was the market darling two years ago. And on paper, it looked really good. But if you actually visited the stores, you saw that they were letting them go to pot. They were dirty. There were inventories sitting all over the selling space. And then I went to their competitor, X5, which was us introducing a sparkling new store format and only a little bit more expensive. And I said, you know, X5 is going to eat Magnet for lunch. And we sold our Magnet, which had a huge gain on.

Starting point is 00:45:27 And at that time was, I think it was the third largest holding in the, in the ETF, and switched into X5. And sure enough, X5 has outperformed by a couple hundred percent. So then I went just recently, but they said, no, no, magnet, it's still good. They've just reformatted their stores, they're going to be just as good as X-5s. This is the story that the brokers are to, the analysts are telling, while presumably they're still trying to offload magnet chairs onto people. And I went to the magnet store last a week, and it was still, even the refurbished store was still no good. It was dirty. There were empty shelves because they have this just in time kind of logistical strategy, which is not working. There's empty shelves. And there was still inventory sitting all over

Starting point is 00:46:15 the floor and carts. And then I went to this, a couple of other stores that were sparkling and new and filled with goods and they just can't compete. So these are the things you see when you go. So even in the more developed emerging markets that have plenty of research coverage, you have to see with your own eyes sometimes frontier markets without a question you have to go. You can't develop an opinion about a frontier market unless you spend some time there, know the people, the business culture, get a feeling for what's going on there. And even then, you don't always get it right. You know, we've had some huge mistakes over the years, thinking that a country was going to be great and then it went in a different direction.

Starting point is 00:46:59 And sometimes you can, you have to adapt to that. What do you think the biggest mistakes are that emerging markets investors make? And you can interpret that two ways. One would be, you know, your direct competition, other active managers in emerging markets, but also just allocators to the asset class. The managers that I've seen over the years fail usually fail for a couple of reasons. I mean, one is that they get arrogant and they forget that they're outsiders and they try to do things that are too funky, get involved in sort of, I saw one asset manager put like his, of a portfolio equity fund, put almost his whole fund into a private company. And then he got screwed and and wound up losing the fund.

Starting point is 00:47:47 I've seen a lot of people just get suckered into very large illiquid things. So matching, and I learned a lesson myself in 2008 about matching liquidity to the terms of your fund. And sort of style drift, I would say, is a big risk in emerging markets because people think that they can do anything. They think that they're, just because they had some good early returns in an emerging market, they think that they can, they now master that market. They can do private equity there. They can do derivatives.

Starting point is 00:48:19 They can do shorting and become very overconfident. So I think that's one of the biggest mistakes and liquidity mismatching. And just lack of patience. I mean, literally, I was in a almost 10-year bare market in emerging markets. And then it turned bullish about two years ago. But I had to go from, you know, 2008 to 2000. and 16 underwater, no performance fees, you know, investors not particularly thrilled. And we survived in that environment by very, very disciplined bottom-up stock picking, dividend, investing for

Starting point is 00:48:59 dividends. And we were able to, you know, kind of do okay relative to the markets. But we knew that in that environment, we just had to wait until things got good again. Emerging markets is very streaky. You have to be around when the good times happen. In terms of investors, they make the same mistake in emerging markets they make everywhere else, which is buy at the top, sell at the bottom. I am begging. I have a few investors who are either, they put like a toehold in my fund and they said they'll give you more later or they're looking at it and looking at it and looking at it. I'm saying, please, don't wait until we're 20% from the top of the next bull market and then give me all the money. Don't be like that. Don't be like that.

Starting point is 00:49:40 please. And most people, that's what they're going to do. For me, if that's the way it plays out, for me, for us, the goal is going to be how to handle what do you do with inflows when you're not confident about the valuations and you feel you're near the top and sell at the bottom. You know, I had a couple of big investors. I would say several of my biggest investors pulled a rip cord at the exactly worst time at the end of 2015. just as oil was getting ready to bottom out, just as the global economy was turning, just as Europe was starting to grow again. They just gave up and sold at the bottom of that particular cycle.

Starting point is 00:50:23 So patience, long-term, and I would say look for managers. And another thing is, and here, you know, this is sort of self-serving, but I believe that emerging markets investing is a very specialized skill, much like distressed debt investing. I've been doing it for 23, 24 years. I think I learned something over that time. And so much like the top, when I invest with other fund managers, if I invest with distressed debt, I wouldn't buy a distressed debt mutual fund or ETF. I find the best manager and give them money, and I'm more than happy to pay them 2 and 20. If they'll have me, because a lot of times they're closed, you know, and I have to ask, please. But with emerging markets, everybody's attitude is like, oh, I can just by the ETF? Well, good luck, because look at the historical performance of not only the ETFs, but the mutual funds against the top-ranked EM managers, hedge fund managers, who net of the performance fees and what they've delivered. So I think we're more like distressed debt than we are like,

Starting point is 00:51:30 say, U.S. equities, but that's self-serving, of course. You mentioned the smell of opportunity in Russia in the mid-90s. What comes closest in today's market to giving you that same sense? There's nothing that jumps out at me right at the moment that I feel like is a screaming by that I would be so excited to just be able to buy some. I think like the whole thing looks pretty good. It reminds me of where we were in about 2005 when we were only a couple of years into that bull market. I hope this one progresses in a more measured way and doesn't turn into a crazy.

Starting point is 00:52:05 I think it will because people were burned last time. So I don't really see anything that in the public equities that I think is an absolute screaming screaming by. I mean, you know, I do some things outside of my funds with my personal money that I think are interesting. I invested in a ride sharing service called Via here in New York. I think it's quite interesting. I think that's a model that could be very big around the world. What makes that distinct from, you know, the Ubers and Lillies?

Starting point is 00:52:39 of the world. So VIA is a private company that runs these like vans in big cities. They're in New York and a couple of few other cities. And it's really an alternative to public transportation. They're like an alternative to buses. And they have this incredibly sophisticated algorithm that matches people up on routes. And they even use some sort of AI to make sure that the root that it takes is also psychologically attractive to you. So for example, they pick up people in a line all over the Upper West Side and then they take them to their offices, but they don't take you out of the way, even if it would be shorter, because they know that you're going to believe that they took you out of the way and it made it longer, even if it made it shorter. So it's an unbelievably brilliant

Starting point is 00:53:26 algorithm developed by these two former Israeli military guys. And so I was lucky enough to be able to put some money into that. And a round along with Mercedes, which took half the round. So little things like that. I bought some gold coins recently. Interesting. What was the thinking there? I think that gold, I don't want to get involved in a discussion on cryptocurrencies,

Starting point is 00:53:49 but let's put it this way. I don't think. You're talking to the wrong guy. I don't think they're going to replace gold. I think that there's a, I saw Cameron Winklevoss on TV claiming that cryptocurrencies were the new gold. And I could see, you know, I told you I've spent a lot of time analyzing people to see their level of truthfulness. And I saw in his eyes that I don't think he really believed what he was saying himself.

Starting point is 00:54:14 They're not going to replace gold. Gold has been around, you know, an ounce of gold buys you the same amount of wheat now as it did in Moses' time. I don't know if you will be able to say the same thing about Bitcoin. But whatever, the point is that gold has been, my point is not that cryptocurrencies went up is that gold went down partially because of them. So while I'm not a gold bug, I felt that having some gold coins, plus I used to be a coin collector when I was a kid. So the idea of buying some incredibly cool coins, which also had investment value. And, you know, that was just a little personal diversification. What was your all-time favorite coin in your collection? I don't know. Probably some, I remember buying a mint set of, you know, with Kennedy half dollar.

Starting point is 00:55:00 in the 60s when I was a little kid and, you know, Kennedy was, so I still, I still, I remember exactly what it looked like. It had these real shiny Kennedy half dollar and then the rest of the U.S. coins. But that started me as a fund manager. I mean, I think that if you scratch a lot of the top fund managers, you'll find a coin collector, a stamp collector, a collector, because, I mean, it's the same, it's the same impulse, isn't it? I mean, it's, we all love to consume. But there are some of us that our favorite kind of consumption is consumption that is also feels like investment. So when you buy coins as a kid, you're buying something with your money, but it's something you know is going to have value over, or you believe is going to have value over time.

Starting point is 00:55:48 And I was one of those kids. There are other kids who spent all their money on, you know, cotton candy and this and that, and I was always the other kind of kid. And I would say that this is also why so many fund managers are. art collectors like I am because I don't get any particular pleasure in, you know, spending a lot of money on, you know, particular kinds of travel or this or that. But when I buy art, I have this feeling of both consuming and investing at the same time. And so I think most of most fund managers who are good, they have that gene for long-term accumulation of wealth.

Starting point is 00:56:29 by acquiring stuff. Sounds like a good interview question for people. Did you have a stamp collection as a kid? You'd be surprised. I bet you, why are so many fund managers, art collectors? I think these are probably the kids

Starting point is 00:56:43 who, when they were, had baseball card collections and coins and stamps and everything else. So I have two closing questions for you quickly. The first is if you were to choose

Starting point is 00:56:53 one country, you could only travel to one of the various countries you spent time in purely for enjoyment. And that could be investment. enjoyment, it could be pure travel. What country would that be? I would say that right now,

Starting point is 00:57:05 of the places I invest in, the place I would recommend going to the most is Moscow. Because the city has really transformed in the last five years so that it's, you know, the hotels are great. There's a lot of great Russian food like Russian cuisine, but with contemporary spin on it. Not jellies? No, just amazing farm to table Russian food. all over the city. The city looks good. There's an Uber and Yandex taxi. You can get around.

Starting point is 00:57:38 Everything works. And it's fascinating. There's a lot of museums to see. So it's just a fascinating place to visit. Tack on St. Petersburg. And I think that's a fantastic vacation. My closing question for everybody is to ask what the kindest thing that anyone's ever done for you is. Other than a family member, I don't know.

Starting point is 00:57:59 I think that I would give a shout out to my old law firm, Wachtel Liptin. They worked me very hard, but they always treated me like, they treated their associates like real important people, and they compensated us fairly. And then when I left, they were extremely nice to me. I then went on to write a novel, which was published in 1995, which was about a law firm that some said was like Wachtel Lippton, and it wasn't a particularly favorable portrayal of the legal profession, I have to say. And, you know, Marty Lipton wrote me a note saying how much he liked the novel. And I thought that was just a class move. He's really somebody who stands out to me

Starting point is 00:58:46 as a class act. Fantastic. Well, this has been a really, really interesting conversation. Thank you so much for your time. Thank you. Hey, everyone. Patrick here again. To find more episodes, of Invest like the Best, go to investorfieldguide.com forward slash podcast. If you're a book lover, you can also sign up for my book club at investorfield guide.com forward slash book club. After you sign up, you'll receive a full investor curriculum right away and then three to four suggestions of new books every month. You can also follow me on Twitter at Patrick underscore Oshag, OSHAG. If you enjoy the show, please leave a quick review for us on iTunes, which will help more people discover invest like

Starting point is 00:59:28 best. Thanks so much for listening.

Invest Like the Best with Patrick O'Shaughnessy - Harvey Sawikin - Emerging Market Opportunities - [Invest Like the Best, EP.75]

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