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How the GEM team invests – some of what we actually do

  • Jan 2024
  • | Tom Prew
  • | Global Emerging Markets team

A critical part of the GEM team’s investment process is to be able to say “no” very quickly and very often, and to do so on an almost entirely qualitative basis. Being confident about what we don’t want to buy for clients affords us the time to look at hundreds of ideas because we discard so many so quickly.

We assess companies by asking three questions:

  1. “Who?” – can we trust owners and managers to look after minority shareholders?
  2. “What?” – is the business strong enough to deliver returns for long-term owners?
  3. “How?” – does the conduct of owners and managers make the company more likely to succeed in the long-term?

Let us look at a list of blue-chip companies in India. As at [the time of writing], we have nearly 30% of the fund invested in companies listed here, so it is in that sense our “favourite” country in which to invest.

Nonetheless, of the thirty companies within its “Sensex” index, we would discard more than half quite quickly. This is a significantly higher survival rate than we might find in other countries, although the casualties are all large established firms, many of them extremely popular with investors.

  • Three state-owned companies fail the “who” test. Over both short and longer term horizons, the interests of the state will and should differ from ours. A fourth company is notionally private sector but much of what it builds is paid for by the government, including defence. Minority shareholders ought to be subservient to the public good.
  • Three family-controlled companies fail the “who” test – we have concerns about corruption which would be apparent to anyone familiar with India.
  • Four financial firms fail or struggle with the “what”. There are half a dozen private sector financial firms within the Sensex and it is quite apparent to us which have long track records of conservatism and which less so. All may succeed but we prefer slow and steady in the lending business.
  • Two more firms fail the “what” test as their franchises seem premised on gaining and retaining licences.
  • One more company fails on “what” as tobacco is the principal part of its business.
  • The “how” test also has casualties:
    • One firm fails because of a history of complex finances and – in our view – paying too little tax. Not paying your dues is often a predictor of other behaviours.
    • A manufacturing firm has a well-documented history of poor labour relations.

Saying “no” to a company based on grey-area issues of human and corporate behaviour may mean there are no empirically correct answers, but by setting our standards high, we believe that we give ourselves the best long-term chance of avoiding capital loss and thereby making acceptable returns in developing countries. By keeping our criteria consistent over time, we should also reduce the risk of mistaking quality for mere popularity.

Once we have ruled out the great majority of emerging markets businesses, the more creative work of assessing a new idea can begin. Our only “process” in this regard has been to give curious people space – “If you put fences around people you get sheep”[1]. We think experience is useful but are wary of experts. What we are trying to do is assemble as many fragments of relevant information as possible whilst admitting that a final investment decision would still be made under uncertainty. We hope to arrive at a good answer, whereas an expert might believe there is always a right answer, and that on their patch, only they have an ability to find it.

Our aim in assessing new ideas is that one of us digs about for a few days (occasionally weeks), after which we discuss which nuggets of information in an internal company report might be most important. As per the Sensex exercise above, “Who”, “What”, and “How” are the headings of our reports. We don’t believe a “stock pitch” presentation format is useful for anything more than judging speaking skills or as a necessary consequence of a team that has become too large for a real conversation. Instead of sitting through stock pitches, we read each other’s work, ask questions, and offer suggestions. A company report is not the last word on a company, it is a diligently researched starting point. As time goes by, we carry out work on each other’s ideas – this isn’t stealing ideas, this is what happens if you enjoy looking at and learning about good companies. Of the roughly thirty companies in the fund today, it is impossible to say who first spotted at least twenty of them.

One of our first decisions on joining our new home at Chikara Investments LLP has been the decision to treat each other as “equal partners” which includes the idea of the equal splitting of any revenue from fund management that we might make. The simple ownership structure of our new home has helped allow this. Although the GEM team has worked together for many years, codifying that we would work as equal partners is a logical further evolution. If the first steps of giving a decent analyst freedom are doing away with prescribed stock lists or end-of-year targets, then the final step is to confirm that they can crawl down any old rabbit hole looking for an interesting idea and that you consider them a trusted equal regardless of what is found.

[1] Attributed to William McKnight, the chairman of 3M in the 1950s and 1960s

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