First state looks to beer price

From Fund Selection 06 October 2003

‘We feel that the benchmark is a poor indicator of where investment opportunities are’
David Gait, First State

By PWM Editor

Roxane McMeeken explains some unorthodox pricing methods for the Global Emerging Markets product. The price of beer is among the numerous indicators that First State Investments uses to assess the value of stocks considered for its Global Emerging Markets product. The fund is a recent addition to the range of vehicles selected each month by PWM’s panel of fund selection experts.

David Gait, senior portfolio manager at the Australian funds house, belongs to a team of 10 running the vehicle from an Edinburgh office under Angus Tulloch.

First State recently combined three Asian equity teams across Hong Kong, Singapore and the UK plus all global emerging markets fund management under Mr Tulloch.

Mr Gait explains that the fund is run on a stock selection basis. “We start with a blank piece of paper and scour the universe for 70 to 80 of the best emerging markets investments.” The firm loosely defines emerging markets as countries with an average gross domestic product per capita of $10,000 (E9120).

“We don’t start with the benchmark,” says Mr Gait. “We are aware of it and of how we differ from it. But we feel that the benchmark is a poor indicator of where investment opportunities are.”

Over the long term this strategy appears to have served the fund well. The product returned 118.34 per cent over five years to date, against the MSCI Emerging Markets Free’s 76.88. Over the past year, however, the benchmark has beaten the First State team, returning 15.47 per cent compared to the fund’s 11.64.

Focus on downside

Mr Gait reveals that First State has eschewed benchmark hugging in order to adopt an “absolute mindset”.

“This isn’t an absolute return strategy. We are not allowed to short stocks. It is rather that for every situation we focus on the downside – how much money could we lose from this investment rather than how different are we from the index.”

The three key factors informing First State’s stock selection process are price, quality and growth.

A whole range of financial and non-financial metrics are used to assess pricing. “We use as many different valuations as possible”, says Mr Gait. “The price per hectolitre of beer or per tonne of cement can be much more useful than more traditional indicators in countries where there has been a currency devaluation.

“During the tech boom everyone was looking at the price-earnings to growth (peg) rate. But we looked at the price to book and saw that things were being overdone.”

Companies are judged in terms of the quality of their management at First State, where a significant amount of time is spent meeting the management teams. “We meet up to 1000 companies a year. Around 50 per cent come to see us at the Edinburgh office,” says Mr Gait.

“In over half our meetings with the management we are discussing their attitude to risk. For example, many companies are going into China. But are they diving straight in or testing the water first by just going into one region? Are they feeling the stones to cross the water, as the Chinese say?”

In analysing growth potential, First State looks for companies that can deliver sustained growth over three to five years. “We like companies that are realistic about their growth prospects,” says Mr Gait. “Very few companies can grow at 20 per cent a year.”

He stresses that First State does still keep a watchful eye on the wider political and economic environment. But he adds, “It’s very hard to get the timing of the macro right. The downside to holding good stocks in a bad environment is better than holding bad stocks.”

Fund facts