If you’re a portfolio manager being interviewed by the media, there are a couple of pretty easy rules to follow: talk up your asset class and talk up your investment approach.
Apparently no one told this to Andrew Foster.
The manager of the $1.8 billion Seafarer Overseas Growth and Income fund has plenty he could talk up, but seems candid to a fault.
Foster set up Seafarer Capital Partners in 2011 and launched the fund in February 2012. Over three years to the end of November 2016 the fund has returned 1.8% compared with the average Equity – Emerging Market manager who is down 8.9%, and his benchmark, the MSCI EM (Emerging Markets) TR USD, which is down around 3.7%.
All the while he has enjoyed an AA or AAA ratings for his risk-adjusted returns since becoming eligible for one in 2015.
Despite this impressive track record over a period when emerging markets have been broadly out of favor and the asset class’s return to vogue in 2016, Foster is not about to start bragging nor talk up returns in 2017.
In fact his outlook for the next year in decidedly cautious, especially when compared with many who have tipped emerging markets heavily in 2017.
‘Although the emerging markets were beginning to see a nascent recovery in earnings growth I’m concerned that the conditions I saw were dependent on the US not doing anything too pronounced,’ he says. ‘As long as the Fed was increasing rates slowly and gradually, that was a great backdrop against which emerging market earnings might experience some modest recovery in growth.
‘But that recovery was very nascent and very fragile, and I am concerned that that may be quashed given where the policy environment is likely to go next. I don’t think things are disastrous in the emerging markets but this hope for a recovery in earnings may be on hold further.’
An environment of increased and faster rate rises is a by-product of policies likely to be pursued by Donald Trump and is not the only way the president-elect could affect emerging markets.
Foster is keen to stress he is not a macro forecaster but a bottom-up stock picker, and is loath to predict how the new presidency will play out. However, he concedes Trump’s victory and campaign rhetoric has increased his focus on companies’ geographic diversity.
‘One thing I have always paid attention to is the extent to which companies have their production base or service delivery base geographically diversified,’ he says. ‘I think it’s a sign of strength, as a company matures, to place different production units in different countries to mitigate cost pressures and especially political risk.
‘This election has made me even more aware of that issue. Whether a company has localized production in the US may be more important in the future. We are paying more attention to these issues than we have in the past.’
Unsurprisingly for an emerging markets manager Foster is also concerned about China, but less predictably, this has nothing to do with Trump and his stance on the country but much more to do with liquidity.
‘I’m more concerned about liquidity than the country’s outright solvency,’ he says. ‘Debt is a problem, but especially if there is not enough liquidity in the system to service the debt, that’s where you can beget a solvency crisis.
‘Very suddenly and not very publicly it is increasing capital account controls again and that is a sign that the liquidity conditions in China are poor and deteriorating. And that has me quite worried about the landscape in China.’
These worries are manifest in the fund, which is underweight China with a 13% allocation, half the 27.6% it occupies in the index.
Instead, the fund is overweight Latin America, 20% versus 13.25% for the benchmark, with 13% in Brazil and 7% in Mexico.
Foster could highlight Brazil’s impressive recovery in 2016 as a cause for optimism, but again candor kicks in.
‘Brazil’s picture is going to be very ugly for quite some time,’ he says. ‘But that said, there are some companies there that offer decent valuations and will survive the current events, and if you are a longer-term investor it might be a decent time for an entry.’
Seafarer has done excellently during a tricky period for emerging markets
Honesty is the best policy
On the topic of country allocations Foster is open about both how much it affects returns and how little he can control. Again, he clearly didn’t get the memo about talking up your investment style.
‘I’m a pragmatist who does not pretend he can control country and sector risk to any great extent,’ he says.
‘In most international investing and especially emerging market investing, if you were to analyse the sources of variants in return you would find that country and sector macro allocative issues comprise the vast majority of the variants in return. I see studies that say between 65-70% of the return is dictated by which countries and sectors you were in.
‘So it would make perfect sense to be a top-down strategist in the emerging markets, given that’s what seems to drive returns. The problem I have, and it’s very simple, is that I don’t know of anyone who can consistently predict country-level factors.’
Foster, who was a consultant in Southeast Asia before moving to Matthews Asia in 1998, where he went on to become manager of the firm’s Growth and Income and also China funds, says he has always been a bottom-up manager, but adopts a more macro approach to mitigate currency risk.
Again, he is brutally honest about the impact of currencies on his fund.
‘Philosophically, I do not think currency risk in the emerging markets comes out in the wash even in a diversified portfolio,’ he says. ‘Even over long periods of time. I think it is a negative drag on one’s portfolio, almost permanently.
‘We run a risk model internally so as to budget for which aggregate exposure we might book in a particular currency. It does not endorse some as better…but says “these currencies might be so risky, so let’s avoid overindulgence in them.”
‘That is one of the worst sins of a bottom-up micro manager: errors of over commitment. You fall in love with a bunch of trees in a given forest but fail to realize that the entire ecosystem is drought ridden.’
This approach led him to limiting exposure to Turkish companies. The fund holds Arçelik, a household appliances manufacturer, and defense technology firm Aselsan, despite identifying more investments back in 2012.
‘Had I been a pure bottom-up investor we would have overindulged in the lira, I would have bought five or six different companies,’ he says.
The fund's three-year risk-adjusted returns are highly ranked despite a slightly trickier one-year run
Against the grain
Despite Foster’s more downbeat outlook for emerging markets and candor over the drivers of returns, the fund’s performance makes it a standout, particularly in a period of weak earnings growth, which may now be set to last longer. So what is behind this success?
‘We have benefitted from owning companies in sectors where earnings growth has been relatively non-cyclical. Therefore, when the cycle produced very anaemic growth our companies tended to hold up better,’ Foster says.
He has avoided more deeply cyclical sectors such as energy, materials and to an extent commodities, although the fund was stung by owning Brazilian miner Vale, and has gained from security selection in unfashionable places such as Brazil, Turkey and Indonesia back in 2013 when they were being labelled three of the ‘fragile five’ by Morgan Stanley.
Winners here include Indonesian conglomerate Astra International, Brazil’s Banco Bradesco and the aforementioned Aselsan.
‘We have been relatively confident to invest in markets where some folk, at least judging by headlines, have been afraid to invest due to macro risk, particularly concern over currency risk,’ Foster says.
‘We’ve invested in those markets, very carefully, very cautiously, very security specific, but in those markets I think we’ve made money against the grain.’
Frank Talbot, head of US research, Citywire
Foster’s performance on the Seafarer Overseas Growth and Income fund has been impressive since launch in 2012. Not least because this has been a tricky period for emerging markets. Although some may worry about the fund lagging the rising market, the portfolio’s approach to risk management means it limits the downside significantly. In emerging markets those funds at the top over the long term almost always prioritise their returns on the downside due to the inherent volatility that comes with investment in the region. It sounds simple, but you’d be surprised how few investors manage to stay true to this – the temptation to be greedy and drawn to emerging trends is always there.