Q: What is the history and mission of the fund? How does it differ from peers?
The Seafarer Overseas Growth and Income Fund was launched in February 2012, coinciding with what would become an extremely difficult period for emerging markets. Despite many challenges, the fund has not only survived, but performed well. Current assets under management are approximately $2.9 billion and we have grown into a 15-person company.
The reasons we’ve been able to navigate this volatility are rooted in the fund’s philosophy and strategy. Although most people associate emerging markets purely with growth investing, our approach uses dividends as current income to mitigate the volatility inherent in the asset class.
Looking at developing markets in Asia, Latin America, Europe and Africa, we identify companies that are not only growing their revenue, but also increasing free cash flow and generating current income in the form of a dividend. As of September 2017, the fund’s dividend yield was 3.4% – about 1% higher than that of the index.
Two additional factors have helped the fund’s performance. First, we take a long-term approach because that’s the way to harvest inefficiencies in emerging markets. Many inefficiencies stem from a lack of liquidity and information asymmetry compared to developed markets. Sometimes these require structural changes in economies, which are difficult to capture with a six-month, one-year, or even two-year view.
Second, as an active manager, we add value through bottom-up research and construct the portfolio in a way that reflects the current and future status of emerging markets. This benchmark agnostic approach is particularly important because most emerging markets benchmarks, fail to represent the full universe of developing market opportunities.
Q: How would you describe your investment process?
Because our approach is long-term, we view ourselves as a co-owner of the companies the fund invests in. Using bottom-up research, we find companies that have a good business model, strong balance sheet, the ability to generate free cash flow for a long time, and leadership that is trying to grow the business beyond the current generation.
What really differentiates our investment process, though, is our focus on the control party – which could be a company’s management or owner, but may include others that influence strategy and decision-making but are unseen to investors.
In emerging markets, where many companies are family-owned or controlled by government, this is crucial; we consider control-party analysis the most important part of our investment process. So, we don’t just look at the companies themselves, but at the larger picture to discover whether and how control party influences capital allocation and other important decisions.
We take collaborative approach in our investment process. During research process, the investment team holds a meeting where questions are welcomed and analysts/portfolio managers are challenged on their ideas. This collaborative approach is important because this can always bring a new perspective or factor that may have been missed on paper.
Q: How do you generate and analyze ideas as part of your research process?
We truly believe in bottom-up stock research and use it to find ideas and build on them for the long-term. Screening is used to assess the strength of a company’s balance sheet and cash-flow generation, as well as its dividend. Our focus is never on just a one-time dividend that might be captured in a year, but rather a company’s longer track record.
In emerging markets, what is seen on the ground often differs dramatically from what has been revealed during a screen, so research trips are important to our research. Each of us travels regularly to meet with companies and their competitors and to see their consumers.
When not traveling, we work from the same office in a collaborative environment that fosters discussion rather than focusing on the news or market noise. This makes us better researchers, stock pickers, and long-term investors.
Andrew Foster serves as the fund’s lead manager; in addition to three co-managers and analyst support. All of us are generalists, but it’s a synergistic type of generalism. By this, I mean that when I look at a consumer company in China, the fact I’ve viewed consumer companies in other countries helps me determine things like whether a strategy will work or if the capital allocation decisions are sound.
Once an idea is generated, it’s typically brought to the lead manager for an initial assessment, which includes how it would fit into the portfolio and what merits the company might offer. From there, our process moves to deep-dive research, which can take anywhere from several weeks to many months – there aren’t time constraints. This allows us to solidify an idea based on the development of both a company and the economy surrounding it.
Final investment decisions are made by the lead manager. However, because of the importance we place on collaboration, the evaluations of analysts and their incentives aren’t based on the stocks picked, but rather by the fund’s performance. By design, this means we all share a single goal: to serve our clients by preserving and growing their capital.
Q: Could you illustrate your research process with an example?
In emerging markets, there are a lot of interesting developments in healthcare. Our allocation to the sector is 12% – much higher than the benchmark’s 3% – reflective of increasing demand for drugs and at times, the resulting growth of international pharma companies out of emerging market.
When looking at companies in this sector, one of the key factors is finding those with the ability to grow beyond the current generation of drugs. Gedeon Richter Plc., a pharmaceutical company in Hungary, is one such company. Originally an emerging markets story, it slowly became a regional player and now starts to be recognized among global leaders – and it’s one of the fund’s top 10 holdings.
Founded over 100 years ago, the company now has global reach and exports to other European countries, China, and Latin America. Started as a generic producer, because competition was increasing in the generic pharmaceuticals space, in 2010 the company decided to focus on specialty pharma.
Since then, it increased R&D spending, and based off the strength of its hormone technologies, expanded into women’s health and other niche areas, and also began licensing out. Recently, it struck a meaningful deal with a leading pharma company in the U.S.
What impressed me about the company’s financials was that its margins remained steady despite a long and costly transformation. That’s a difficult accomplishment that gave us comfort and confidence. Also, because the company’s free cash flow and dividend history had also been consistent, its overall financial matrix gives a supporting view of the future.
We also find companies attractive when they provide an interesting exposure to emerging markets, like Singapore Telecommunications Ltd, another of the fund’s largest positions. The company owns telecom companies in emerging markets like Thailand, Indonesia, Philippines and India, and brings to them the management skills needed to grow more efficiently.
The investment allows us to capture the growth of emerging markets, but because it’s listed in the more stable market of Singapore, we have a more stable dividend stream at attractive valuation.
Q: How do you construct the portfolio?
The emerging markets space is exceptionally broad and deals with a wide variety of politics, policies, and stages of economic development. Our approach to addressing geography isn’t much swayed by these near-term factors, but focuses instead on finding good companies within a country.
For us, the goal of construction is to improve the portfolio every day. We continuously research new and better replacement ideas, yet still have fairly low turnover as a long-term investor. Though the stated turnover range is 10% to 50%, the fund tends to be toward the lower end of that.
We also emphasize portfolio diversification when we pick stocks. Diversification is critical to us, and is implemented across the portfolio by country, sector, liquidity, company size, and currency. In our search for new and better replacements, we consider each of these five aspects of diversification. A new idea might replace one from a different country or sector, and it doesn’t have to be in the same currency or have similar liquidity or market capitalization.
Even though we run a relatively concentrated portfolio, our diversification remains quite good. Typically, the fund has 40 to 60 holdings with an average allocation of about 2% to 2.5%, though should our conviction grow over time, allocation may increase to 3% to 5%.
Q: What do you look for in terms of dividends?
What we value are the companies that pay current dividends and have a history of growing them by growing net income or cash flow. By paying now, they assure us that their free cash flow is real. By having steady and growing dividend, it is good evidence that management or the control parties consider minority shareholders’ interest.
Ultimately, dividends are a capital allocation decision that can be linked to corporate governance. In discussions with management, we try to figure out how they view their dividend policy based on their cash flow generation, and look for companies that are improving in this sense.
Q: What does risk mean to you? How do you manage risk at the company level and at the portfolio level?
Risk management is embedded in everything we do from idea generation to portfolio construction. Ultimately, what we want to do is to provide some kind of a shelter from the volatility in emerging markets and deliver longevity to our shareholders – longevity in the stocks we pick as well as longevity of the portfolio across the business cycle.
When picking stocks, we look for those that have had a good track record through at least one entire business cycle, which shows us they have the experience to make it through more challenging periods. Although not a guarantee, a track record is tangible evidence that a company is more likely to continue succeeding. After investing in a company, we closely monitor its financial health through a number of metrics.
At the portfolio level, our risk management focuses on two key elements: liquidity and currencies. The need to manage liquidity risk was manifested in the recent financial crisis; having liquidity is extremely important during periods of significant market stress and is a key part of portfolio construction.
As investors in emerging markets, managing currency risk is also crucial. Even though we don’t hedge, it’s important that we understand the macro factors affecting the markets where the fund is invested.
