Global Emerging Markets Fund

We're long term growth investors.

Our research has shown that in emerging markets, companies that grow earnings the most will reward their shareholders to the greatest extent as well over the long term.

And that means five years or more, because it's only over those kind of time periods that a company can deliver a strong operational performance such that earnings overwhelm any market noise or valuation movements.

Those kind of time periods often feel long in investment terms today.

But remember that for our underlying clients, their investment goals are measured in decades, if not generations, and the very best businesses as well are investing for their own growth over those kind of time periods. So that's what we bear in mind.

So when you're able to invest with a genuinely long term and independent perspective, a few market inefficiencies become clear and so we try to focus our process on those.

Those tend to be a result of short termism. We see that rapid growth is generally underappreciated in emerging markets, as well as the duration of growth - companies that may be volatile in the short term but demonstrate tremendous predictability over the long term.

And then finally, as well, companies that investors elsewhere often don't expect to grow at all, but we see generally some kind of structural change that means that the past is not a good guide to the future. So our process focuses on finding those, often by looking at the softer elements of a company, things that don't turn up on a Bloomberg screen, or are incorporated in a trading algorithm.

The competitive advantage or the cultural elements of a business, how management allocates capital, we spend a lot of time trying to understand those and translate those into possibilities for the future, measured over that 5-10 year horizon.

So we have a 10 person strong core emerging markets team.

We tend to hire broadly.

Our team generally originates from non finance backgrounds. We have historians, professors of English literature and engineers in the team. We take the view that we can teach people financial acumen. We're most interested in a breadth of perspective, a diversity of thought.

In addition to that core emerging markets team, we also have our Shanghai research office, which is tremendously helpful for that market in particular.

And elsewhere in Baillie Gifford, we have about 85 other investors who invest in emerging markets across our broader global and international strategies, who are tremendously helpful in providing an independent but aligned perspective, offering ideas as well as challenge for us.

In terms of resources outwith the firm, we increasingly rely on independence, third party sources of research, ranging from political risk analysts in Southeast Asia to semiconductor research institutes in Europe and academic relationships in the UK, China and elsewhere as well.

All of these, internal and external, are focused on really bringing us broader range of perspectives together that we then try and assimilate and translate to views about what may or may not happen for the long term for our companies.

There are a lot of individual aspects to our investment edge.

I think all of those come from Baillie Gifford’s partnership structure, which allows us to be genuinely long term in how we approach the task and independent in how we go about it.

When it comes to emerging markets investing, I think we have a greater ability to focus on the upside look at that skew of returns, accept uncertainty and not be tethered to benchmarks.

And when it comes to a time horizon, I think we have one longer than most.

But even more importantly than that, the way we operate is on a genuinely generational basis.

Our firm has been growing for well over 100 years with a similar philosophy, and we invest in our people, we build client relationships with that in mind.

So I think that means that we have an ability to invest over the time horizons that are appropriate for our clients in a continuous manner.

How would you describe Pzena’s active edge?

Well, I think in order to be a really strong value investor, you need to have a very disciplined philosophy and process that you stick to.

And the reason for that is that it can be hard. You know, there will be times when things are not working, when sentiment is working against you, when your companies are in pain, and so having that really strict adherence to a very firm philosophy and process has really helped us over, you know, the nearly 30 years we've been doing that.

It also, I would say is part of our edge that we have such a cohesive team. You know, we're a privately owned partnership. Every person in the firm has the ability to become a partner, and we would love for everyone to become one. And so having that sort of team based approach and partnership means we're all in it together, which I think has really helped us to adhere to that value philosophy and process.

And this research process, you know, which is 30 plus years, you know, long, you know, is time tested, as you say. Perhaps you could describe it in more detail. How does it work, you know, from idea through to investment?

Sure, sure. So starting with our investment philosophy, you know, when we think of ourselves as value investors, what that means is that we're looking to buy companies that are cheap relative to their normalised earnings power. And you can think of normal earnings power as what a company should earn in a sort of mid-cycle, relatively benign environment.

So if a business becomes cheap relative to that metric, it means something bad has happened, right? The earnings have collapsed, the stock price has collapsed, the market is now treating this business as though something is broken. And so it's really the job of the research team to come in and see, well is something broken in which case the market has it right or is this a temporary problem?

Is this a bump in the road? And the business will be rectified and the earnings will improve and so will the stock price. So that's really in a nutshell the types of businesses we're looking to buy. And then we have an investment process that helps us to identify those ideas. So we start with a quantitative screening tool. It's called Stock Analyser.

We developed it internally. And essentially what it does is it takes ten years of history for each company in our investment universe and its industry, and tries to naively predict the future, to generate a naive view of the normal earnings power of each business. And what that allows us to do is to rank our entire universe. So we can look at every company in our emerging markets universe based on the same valuation metric of stock price divided by normalised earnings per share.

And any moment that we want, we can open up the screen and see from number one the cheapest to number 1,500, the most expensive company, all on this same metric. So then in order to look for new ideas for the portfolio, we hunt for ideas just within the cheapest quintile. So the cheapest 20% of that universe. And that's the responsibility of the portfolio management team.

So we spend a lot of time mucking around in this first quintile looking for cheap companies. And when an idea looks interesting, then we assign that to whichever analyst on the team covers that industry globally.

Once an analyst starts looking at a stock, it's a two part process. The first part is really to identify what does this company do, what is the bad thing that has happened, you know, why is the stock cheap? What are sort of the 2 or 3 major issues that I need to understand? And then what would I have to believe to think things are going to get better? So as the analyst in this initial part of the research project, you're really just driving towards a thesis of, is this interesting enough or not?

Once you reach a stopping point in that exploration, you'll sit down with the portfolio management team in our research review meeting. That's a meeting we have twice a week. We block off half a day, and that's where we discuss anything that's sort of going through the process. And in that initial review meeting, what we're really trying to figure out is what are the things we need to know, what do we need to learn, what are the questions that we need answered?

And ultimately, is this interesting enough for us to do a deep dive research project on?

Because I guess the answer could be this is just a bad company. Yep. And you're looking for good companies that happen to be in the wrong place. Exactly, exactly.

And thank you for mentioning that. You know, I think sometimes when people hear deep value, they think it means you're buying a bunch of cheap junk.

That's definitely not what we're doing. This is a concentrated portfolio of good businesses that have hit a temporary problem. And that sort of focus on, is this a good business? Is there some sort of downside analysis that is protective? is really critical in value investing. Because the companies are already cheap, right? So if you get it right, you're looking at a double or a triple for any of these businesses.

And so really focusing on what are the good sustainable businesses where you have some downside protection to protect you from the ones where things won't turn around. It's really critical.

The work will culminate in visiting all of the companies. So we try to do those visits in a team of two - the analyst who's done the research here, as well as one of the portfolio managers on the strategy, will hop on a plane and go visit the company wherever they sit in the world.

And the purpose of that visit is to go once we really have a well formed view of the business and the normalisation of the business, so that we can test that view with the management team. You know, this is the path to recovery that we see, these are the steps that we believe are necessary, and does that resonate with what they're actually doing and what they believe about the business.

And I imagine sometimes you have to be patient because these changes might not happen next quarter, not even next year.

Yeah, actually, you know, one of our traders who's been with the firm almost since the beginning has this saying sort of up on his bulletin board: “Patience equals profits”. And it's very true. I mean, our average holding period for a name is somewhere in the range of 3 to 5 years.

And that's because, same as in real life, you know, these problems take time to get fixed, right? As soon as something bad happens at a company and the stock price collapses, it's popping up on our screen, and it can take a number of years before the problem gets fixed. And the market recognises that the earnings power is being restored.

So that sort of patience and that sort of analysis to sift through and find the diamonds in the rough, it's going to require special people. Now being a partnership that helps you attract and retain top talent and you have a very low turnover within the investment team, but what sort of people are you looking for, you know, at Pzena to be in the investment team?

Yeah. Great question. I think, you know, fundamentally we need people who are intellectually curious, who really want to understand how businesses work, how value gets created across industries and really have those sort of frameworks of business models and how things should work. In terms of background, we look for people from a diverse set of backgrounds.

You know, I was in management consulting before I joined the firm. We have people who are engineers in aerospace companies. We have people who came from private equity. So we really love the idea of finding people with different backgrounds and different perspectives to add that diversity of thinking to the team.

So Alison, you've worked with Vanguard for a long time. How would you describe the Pzena Vanguard relationship?

It's one of our strongest relationships. You know, what's been really great for us as a firm in our partnership with Vanguard is the way that it's grown over, you know, quite a number of years now, we're well into our second decade in terms of this relationship, across a number of strategies and across a number of people in the firm.