The concept of value investing means different things to different people. Value investing is an investment paradigm that involves buying securities that appear underpriced by some form of fundamental or quantitative analysis. The various forms of value investing derive from the investment philosophy first taught by Benjamin Graham and David Dodd at Columbia Business School in 1928, and subsequently developed in their 1934 text Security Analysis. The early value opportunities identified by Graham and Dodd included stock in public companies trading at discounts to book value or tangible book value, those with high dividend yields, and those having low price-to-earning multiples, or low price-to-book ratios. Warren Buffet expanded the value concept with a focus on “finding an outstanding company at a sensible price” rather than generic companies at a bargain price. Two key features ring true whichever way one looks to cut it. Firstly, all value investors are looking for a clear margin of safety in their investments as a result of the inherent undervaluation. Secondly, for choice, many value investors are also looking for companies that exhibit some form of future growth profile. It is the price they pay for this growth that matters most. Ironically, growth managers will never say they are willing to overpay for growth, they, for choice, would also prefer a margin of safety and an attractive valuation.
Mondrian has applied a clear value philosophy since the company’s inception in 1990. We have always used a Dividend Discount Model (DDM) methodology to define and calculate value on a global basis. Expressing value through a dividend discount model is another slightly different interpretation of value to those referenced above, and is not simply an approach isolating companies with high dividend yields today. A DDM takes the dividend today (or lack of it) and forecasts the expected growth of those dividends into the future. Mondrian uses the DDM to analyze in detail the sustainability of a business’s cash flows today and where they may trend over the long term. Therefore, a DDM does not ignore growth either; it looks to price that growth (or lack of it). Furthermore, we have an approach that explicitly analyses the margin of safety in an investment by evaluating various scenarios by looking at the range around the most likely case. A narrow range or a stock trading close to its worst case suggests an attractive margin of safety to us, or as we more typically say, skew.
Ascertaining various portfolio factors, including exactly how value focused any investment manager’s portfolio may be, has become an increasingly common practice. Technology has created a plethora of new tools to enable asset owners of all types, as well as their consultants and advisers to analyze a manager’s portfolio and determine how strong the simplistic value credentials are. For example, Style Analytics and Barra have created significant businesses by providing this data. State Street, BlackRock and WisdomTree have taken this a step further by creating value products that try to replicate through factors the many hours, days and weeks’ fundamental stock pickers spend looking at investment opportunities. MSCI also responded years ago by creating Value and Growth indices to better help measure how asset managers are performing versus their supposed style.
As explained, value has somewhat different meanings depending on one’s specific interpretation. We thought it would be interesting to further expand, and give our explanation of Mondrian’s emerging market portfolio value credentials by looking through a few different lenses.
MSCI Value and Growth Indices
Firstly, we look at what MSCI defines as value and growth stocks as they are the benchmark providers of choice for most of our clients. It is important to mention that some companies can appear in both indices which further highlight the challenges with a simple, uninformed analysis.
MSCI use different parameters to define value looking at a combination of 3 factors; price to book, forward price to earnings and dividend yield. Immediately, one can see how MSCI’s definition and Mondrian’s may vary, given our focus purely on dividends and dividend growth. Furthermore, the constituents can change on a quarterly basis. Nevertheless, we flipped this around and took a look at the growth index at March end to see if we had many companies on our portfolio MSCI considers to be growth. We analyzed the top 200 companies by weighting in the MSCI Growth Index (86% of the total). We owned 13 of these, but 7 of them also appear in the MSCI Value index too, so these can be discounted. Therefore of the top 200 growth companies as classified by MSCI, we only owned 6. These 6 account for just 15% (approximately) of our portfolio. Each can be justified on our DDM, each have a unique investment case, and each offered a margin of safety when we initiated. We will discuss Alibaba separately below, the others are as follows:
- TSMC – one of the leading technology companies globally. We have owned this stock since 2005. It has created huge value and remains attractively valued.
- LG Chem and Samsung SDI – We own these primarily for their electric vehicle battery profile in which the companies have a clear competitive advantage. The growth here is unique and justifiable given the low base.
- CSPC – a leading drug producer in China. We owned this historically and sold it during the first half of 2018 when we felt it became too expensive. We have been buying it back in Q2 after an approximate 45% fall from its peak price last year.
- Suzano – we believe the multiples are artificially inflated right now which gives an unfair reflection of the inherent value in the stock. We have owned this since 2016 and it has been a significant outperformer.
Therefore, if one compares Mondrian’s EM portfolio and the MSCI EM Growth Index, there is little commonality. A growth manager we certainly are not. That being so, how do the portfolio multiples look when compared to the broad benchmark?
Comparing our Portfolio to the MSCI EM and EM Value Index
At the end of June, the portfolio’s crude historic key metrics compared favorably to the benchmark with a discount on every measure and showing healthy stand- alone traditional value metrics, consistent with the past.
Despite this Mondrian’s portfolio is at a premium to the value index, but we believe based on our time tested methodology, there are good reasons why. Once again, understanding the data being assessed is so critical here. While MSCI keep country weights broadly the same in the value and growth indices as the standard index, this is not the case for sectors. This creates imbalances and distortions which all investors should carefully consider. The main difference is the weighting of financials at 37% of the value index. Of this, approximately 41% are Chinese financials alone. Consequently, 15% of the Value index is made up of one country’s financial sector alone and with this comes significant concentration, correlation, and possibly regulatory risk. Hence there are significant risks with investing clients’ assets to even achieve a benchmark weight here. Energy and materials total another 23%, so 59% sits in these 3 sectors.