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Anyone of you who is interested in the experience of the most successful value investor in Russia: Bill Browder, and how his success backfired heavily, leading to his prosecution and death of his lawyer. Take the opportunity to see his guest lecture at Columbia University with Robert Heilbrunn Professor of Finance and Asset Management, Bruce Greenwald.
I believe this scenario should be more explicit in our emerging market valuations and not be tucked away in a political risk premium in the discount rate.
Investors and valuation advisers have to consider what happens to valuations if Turkey’s government changes, what happens if Russia will re-nationalize financial institutions, what is the valuation impact of an ‘Arabic Spring’ inspired regime change in Angola, what happens when Greece exits the Euro zone and becomes the Mediterranean Argentina?
See per below a summary of the most interesting viewpoints, tips & tricks I got out of this lecture.
Getting to a proper valuation for an emerging market starts with taking a macro view, working your way down to the micro
- If the macro environment is favorable it doesn’t mean the companies on offer are great investments
- Stop thinking of getting exposure to an emerging market, that’s a sure way of losing money
- Start thinking about identifying undiscovered deep value opportunities – cheap/mispriced assets on an absolute and relative basis
- Privatization programs could offer great value opportunities, but ask yourself:
- Is there an investor friendly government?
- Why is government friendly? What is their incentive?
- Why are oligarchs friendly? What is their incentive?
- How could a change in this incentive and attitude affect your holdings?
- If not friendly? Stay out. Or realize, your market entry is a speculative bet, not an investment
- Is there an investor friendly government?
- Analyze economic fundamentals:
- Is the country a large oil producer? Timber? Diamonds?
- Are there other fundamentals supporting growth?
- Who profits from GDP growth? Don’t automatically assume GDP growth will translate in higher household consumption and revenue growth
- Be skeptical
- Look for fact based analyses to uncover lies
Note from Bruce Greenwald (the interviewer): “..keep in mind that every time you are buying and think an asset is going to perform well, somebody is selling it and one of you is always wrong. Who do you think is wrong when you‘re flying in and they are local?”
Before making any investment, conduct very thorough due diligence on the ground
- Depreciated assets often harbor hidden value, go there, determine reproduction value with you own eyes
- Being a local specialist on the ground gives you a competitive advantage in the valuation process
- Signals of conflicts of interest or worse fraud:
- Find out who owns the company
- What else do the owners do?
- How much do they own?
- How much do they own of other things?
- If you’re investing in an agricultural company and the owner also owns the fertilizer supplier, that’s not a good thing.
- A company that has switched auditors, is not a good thing
- A company where the majority shareholder is a politician
- Do a stealing analyses: Interview customers, consumers, competitors, employees etc. whether there is any stealing going on, check the facts with local registry offices (real estate, land holdings)
- Generally only companies that have stock options tend to overstate earnings, so reported earnings and assets are generally accurate. Implying they are earnings after stealing. Accounting generally counts what’s there.
Once uncovered fraud, what to do?
Fraud, can be also an opportunity: if you can stamp it out, your earnings will increase and so will the value of the companies.
- To get back leaked assets and stolen earnings: involve the press and government in your findings
- Make sure you do all this complying with local and international regulations
- As soon as you get invited for yacht-parties by your clients/investors and get awash with more cash to invest, it’s a sign you should liquidate your holdings (and those of your clients) It’s too much money chasing deals
- Think hard about what your contingency plan is, when relations with government or oligarch relations turn sour. If you see it happening: act fast!
- Think hard about what your contingency plan is, when relations with government or oligarch relations turn aggressive, towards you. If you see it happening: act fast!
Comparative attractiveness of emerging markets vs. free democracies
- Emerging market growth is all fine and nice however there’s huge economic value to fuzzy stuff like democracy and free press, so companies trading in markets without political checks and balances should be bought into against a higher discount than their comparable peers in democratic countries.
- Bill Browder: “…my single biggest lesson learned is that we undervalue what makes America and other democratic countries great, and we shouldn’t, because that plays a real role in valuation and what something’s worth..”
On country diversification:
- Country focus makes you better in knowing all that’s going on, but when political risk becomes unfavorable, that’s the only country you know
- Covering more countries costs more time and effort to figure out what’s going on locally
- However there is a 80/20 rule to this all. With 20% of the effort you can get 80% of the value reasonably estimated. As long as you buy-in cheap enough, and your downside is limited on an earnings or asset basis you can make the investment
Bill Browder on current attractiveness of emerging markets (November 2010)
Bill Browder: “…emerging markets are not attractive on a valuation basis, however they are a bubble about to be inflated due to all the completely absurd money printing that’s going on. We all know this will end in tears, but in the meanwhile there’s money to be made..” Bruce Greenwald’s warning: “…if we try to do what Bill describes it will end in tears for all of us, including Bill, the first time he invested in Russia.”
Disclaimer: this is a limited excerpt of the interview mixed with my personal notes and interpretations. This is not an exhaustive summary. Interpretation errors are mine and the quotes are not a literal transcript of the statements of the speakers. This is no investment advice.
Bill Browder has recently written down his experiences in a worthwile read:
- VaR is radioactive material because you’re not looking at the risk that matters most. Tail risk!
- CAPM is CRAP (Completely Redundant Asset Pricing)…
- Economists envy science and mathematics…
- Optimization (e.g. leverage) is mathematically beautiful, but in business downright dangerous…mother nature works with extensive redundancies…(two lungs kidneys etc.)
At GMO’s website (free registration required) you can find a paper based on the speech Montier delivered at the 65th Annual CFA Institute Conference in Chicago on May 6, 2012: