Being based in a developing country brings some advantages to owners of capital.
With less capital (savings) available than in advanced nations the returns to that capital are higher. Cheaper labour costs also make for a lower cost of living as well as lower costs in running a business. Put this together and it becomes quite possible for owners of capital to afford lifestyles comparable with those available in developed nations.
However, developing country residents who keep all of their wealth within their national borders are subjecting their future financial wellbeing (purchasing power in hard currency) to dangers which are not immediately apparent. At least, not from within that country’s borders, particularly when times are good.
These dangers include:
This is not to sound alarmist – the odds of these dangers materialising in any 3 to 5 year period is modest. But when considered in the context of an individual’s 30+ year timeframe of capital accumulation, these risks are very real and should be taken by most developing country residents as an inescapable fact of life.
Chart 1 shows how higher inflation has, over 25 years, eroded the value of the rand and rupiah (by factors of 5 and 10 respectively) in terms of what each can purchase relative to the US dollar. Some depreciation is to be expected, since developing countries typically do not see capital inflows consistent or large enough to balance their need for foreign goods and services. Secondly, engineered inflation (through money printing) is seen as an acceptable means by many governments to reduce the real burden of their local currency borrowings.
Ultimately, residents of developing countries are at greater risk of seeing the instigation of capital controls and/or a sudden collapse in the value of their currency by which late stage their wealth, as measured in hard currency or global purchasing power, can be significantly and permanently impaired — and trapped in local currency.
A slow and steady decline in one’s currency is tolerable for many. But the shock of a sudden, steep drop is intolerable for anyone who plans to continue using dollar based goods and services like petrol and overseas trips. To mitigate the likelihood of such severe declines in the dollar value of one’s capital, it is essential that individuals place a portion of their investable wealth safely outside of their home country’s borders.
The next step is seeing one’s offshore wealth invested in productive assets, earning decent risk-adjusted returns in hard currency. The global investable universe is staggeringly large in size, and fraught with ways to lose money. This is where a skilled adviser can assist with securities selection and portfolio construction.
At UMAPAN, our approach is to own a select group of businesses, chosen on valuation and quality grounds, such that each is able to contribute meaningfully to clients’ returns. We spend much of our time seeking out good businesses around the world and assessing them for characteristics which enable long-term success in competitive markets.
We look for:
Once identified, we are prepared to be patient, to wait for the right price, ready for an opportunity to buy assets we intend to hold for the long term.
Precisely because these criteria collectively make for a very high hurdle, our approach is ideally suited to investing globally. There is enormous choice in global markets, but our process rapidly whittles down the available universe, leaving us with high conviction as to where clients’ capital is best invested.
We filter out many of the thousands of listed companies purely on the basis that it simply would not make sense for us to own them. We frame this test by imagining these companies to be private enterprises, with ourselves as minority investors unable to liquidate our positions.
We expect our approach to deliver better results than more popular strategies over long periods of time covering varying market environments. But we also have good reason to believe it is the superior approach now.
In financial markets today, asset prices are generally elevated when compared to underlying business values. This implies that future returns will be disappointing for investors holding the market or “diversified” portfolios. We are finding value (a company priced below its worth as a private enterprise) in situations where the near term outlook is poor or uncertain, but where the underlying business fundamentals are strong and futures are bright.
This can be seen in Yara International and Mosaic, where depressed grains prices (a cyclical negative) are overshadowing the fundamental strengths of each business in their premium, high margin fertilizer products. Mosaic’s “Microessentials”, which has come from a standing start in a matter of years, if taken alone would be the world’s 7th largest phosphates company today.
Aflac remains under-appreciated due to a hesitancy to recognise the strength of the Aflac brand in Japan, where it is the dominant seller of supplemental cancer insurance — a product which benefits from rising medical costs and declining government support. Likewise, Western Union is neglected due to the perception it is susceptible to disruption from new entrants and perennial discounting, whereas its real strength lies in its premium brand, its vast cash pay-out network, and its compliance infrastructure.
H&R Block provides tax return preparation services and has an unrivalled physical footprint in reaching the large US consumer base. This is an essential service due to the complexity of the US tax code, but more importantly because in the US the tax system is the main tool in implementing the government’s social spending programme (the world’s largest). Eligibility for means-tested subsidies can only be determined through the tax return process. One year’s poor volumes are not enough to discredit a business model that has proved so resilient for many decades.
Manitowoc Foodservice, a commercial kitchen equipment manufacturer, is a great business undergoing a long overdue transformation. The benefits of this are already evident, as margins have increased along with a downsizing of its manufacturing footprint, a reduction in inventory items, and the elimination of discounts to smaller customers. The restaurant industry is notoriously cut-throat and in the US it is currently facing a mild recession as sales growth has slowed and failures rise.
This is an industry structure we like: countless restaurants competing with each other / only a handful of kitchen equipment suppliers. Competition promotes menu changes, which necessitate equipment upgrades. Life will not get any easier for restaurant operators, but we expect years of improving financials from Manitowoc.
Aggreko is unpopular due to a decline in its fortunes from the boom years that were characterised by high capital spending in oil & gas and mining, and stronger pricing for temporary power from emerging market customers. Aggreko’s value lies not in its current earnings — it is in its high quality, long lived asset base. No other player builds generators to last, nor puts as much focus into efficiency, which translates into the lowest $/MWh for customers. To this end, Cummins, the world’s largest engine manufacturer, conducts exclusive R&D for Aggreko. With time high quality assets convert to earnings, but a myopic market will only believe this when it sees it.
We have written extensively about Textainer in our prior Quarterly Memo. This is a good example of where weak cyclical conditions and bottom-of-cycle events have masked both improving fundamentals and a solid foundation for the future.
Antofagasta is a focused, family-controlled copper mining company. Its value lies in its assets and the sheer scarcity of those assets — hard-to-replace, long-lived copper deposits in a politically stable country. Copper is an essential industrial metal and is as much a precious metal as is gold, due to their similar electrical conductivity. In the short term, the market is perhaps correct to anticipate an over-supplied market as mines built during the resources boom come on stream. But declining grades and the need to spend billions to move from open pit to underground mining in the US and Chile will result in the costs of extraction rising, and so too the price of copper.
It is possible that future supply constraints will coincide with increasing electric vehicle adoption (EV’s use lots of copper), leading to a hugely beneficial environment for disciplined operators such as Antofagasta. In anticipation of higher copper prices, management is investing today to ensure they will have suitable options for capacity expansion in place.
In the meantime, one can be sure that Antofagasta’s share price will swing in time with the copper price and prevailing sentiment.
Euler Hermes and American Express are both high quality financial services businesses where the market does not appear to be fully pricing in their competitive strengths in trade credit insurance and charge cards respectively.
Burckhardt Compression is experiencing a decline in new orders for its sophisticated gas compression products — particularly customers in the LNG transportation industry — and is right-sizing its manufacturing base in response. While Burkhardt’s customer base is diverse enough to withstand this, the longer term outlook for LNG demand and its transport by sea remains strong. In the short term the negative earnings effects from this and the integration of a major acquisition in China are masking the continued growth in its highly profitable, globally based services division.
Burckhardt’s equipment lasts longer and is more reliable than its competitors’. Lower future maintenance costs induce customers to pay a premium for quality, giving Burckhardt preference and pricing power on new builds, which in turn leads to a greater installed base and future servicing work. This is the same virtuous circle we saw in Joy Global when it too was over-shadowed by pessimism.
There will always be attractive opportunities available to those prepared to invest offshore. By working with a trusted adviser, individuals can remain confidently invested in the right assets and reap the rewards in time.
Our aim is to grow clients’ wealth substantially over many years, something easily achievable through the right investment approach and the right temperament.
Successful client-adviser relationships are long-term partnerships. This is because the value we create today is necessarily based on years of prior work, while the work we do today will continue to pay off into the future.
As we build your wealth over time, consider that today’s opportunity set of potential investment ideas is not the only relevant one. There will be new opportunities that materialise tomorrow and our clients will be best placed to take advantage of these by working with an adviser whose investment approach they trust and understand.
We look forward to working together in the years to come.