Visit with Somerset Capital Management
September 23, 2012
I had the opportunity to sit through the Somerset Capital weekly research meeting this morning. The meeting is an important part of their overall investment and risk management process that I thought I would share with you.
First a bit of background:
- Redwood felt there was a need in the market for lower volatility exposure to emerging markets
- While other firms launched EM debt and EM balanced funds, our research led us to believe that a conservatively managed, dividend-focused fund was more prudent at this stage in the rate/sovereign cycle, and a better long-term option.
- After a global search of managers we uncovered Somerset Capital Management, and were very happy to partner with them given;
- They were a specialist emerging market shop; not a conglomerate.
- They had deep expertise in emerging markets with the team dating back to the 1990s at Lloyd George Management.
- Their partnership structure ensured all partners were significant owners in the business, and that prudent limits on AUM and good governance would come from that.
Despite this being a Tuesday in August, particularly, shortly after Olympics here in London, the meeting was well attended with 3 PMs, 5 analysts and their macro specialist, with people dialing in from Singapore.
Runners and Riders – each of the top and bottom 5 or so performing stocks over recent days/weeks/months are discussed for any news or market chatter on what could be driving the short-term price changes.
- Portfolio Review – the portfolio manager or APM then reviews any names in the current portfolio that have had news.
- Watch List – each portfolio has a list of companies on a watch list, businesses they like, that might not currently meet valuation requirements.
- Analyst presentation of current holdings, earnings reports, companies to consider
Today’s meeting saw the following companies explored in depth:
Rosneft – Russian Oil and Gas
BM&F Bovespa – Brazilian Stock Exchange
Alpartagas – a sandal maker – yup, sandals all over the world.
So the focus of discussion to me is that risk is always the first thing discussed at a portfolio level. What is not working and why? The focus is first on the companies that are not working, and secondly on the companies that are working, should we maintain our position or take profits if the stock has appreciated. In addition to P/Es, sales growth, margins, market share etc etc etc. also centres around qualitative factors like “what is the useable life of a sandal?” and also delves into political issues such as government policy and regulatory rules in different countries.
An interesting conversation was had with respect to one of the laggards in the portfolio over the last couple of weeks. A Chilean company is raising 2/3rds of its market cap to buy Latin American assets from the parent that owns a significant interest in the company. There is opposition to the deal, as investors feel like the parent company which is based in Italy is using it’s subsidiary as a non-arm’s length way of recapitalizing the parent. An example of the cheeky things that happen in EM companies.
Also, just a reminder to us that many companies that appear to have nice yields, low P/Es and no debt (Chinese banks) can be tripped up with things like significantly dilutive rights offerings.
The firm also invite third-party advisors onto their call to provide outside perspective.
The view is that China is deteriorating. The numbers coming out of China are continuing to be bad. A deceleration is happening, and it is being seen in commodity prices as well. Rate cuts are a longer term way to increase economic production, but short-term, loan growth is necessary to re-accelerate.
India’s central bank has acknowledged that inflation is an issue, and are willing to sacrifice some growth, to keep inflation in check… overall a real positive.
When we assess our sub-advisors we look for several things:
People – are the key decision makers stable, and those present responsible for performance.
Performance – is performance as expected based on the firm’s investment philosophy
Philosophy – is the investment philosophy consistent over time, and is it ingrained in the investment process.
Process – is the investment process consistent and is applied appropriately and consistently over time.
I think the collegial but challenging atmosphere that exists at Somerset is a model to be replicated. While investment managers are responsible for the stocks that go into their respective portfolios, there is a tremendous amount of analyst support (including PMs acting as analysts) and overlapping experience on country and sector coverage that ensures a high degree of challenging discussion on new and existing portfolio names.
I would say that 60% of the meeting focuses on how portfolio companies could actually hurt the portfolio (risk management); 20% on emerging macro issues/trends (again risk management) and 20% on the examination of new ideas not currently on the firm’s watch list (return generation.)
After doing the job of a fund analyst for almost 10 years at 2 investment dealers, and working closely with Somerset for the last two years, I believe that their firm’s structure has addressed many of the key issues that arise in many investment companies. Their view on how investment firms should be run, manifests itself in an organization founded by Dominic Johnson called the New City Initiative. http://www.newcityinitiative.org/