In an interview with Universal-Investment, he reveals how he successfully selects undervalued emerging market securities and why emerging markets are mistakenly portrayed as more risk-prone at the moment. Krohne is a renowned expert on emerging markets and has already used this strategy in a US investment vehicle since May 2004 to achieve an annual return of about 12 percent after costs.
Universal-Investment: Mr. Krohne, value is a decisive factor for you in the selection of securities. How does value influence your investment approach?
Krohne: When selecting the individual securities for the portfolio, the focus is on the quality and substance of companies, very much in line with the value approach. We always invest when relevant companies can be purchased at an especially attractive price. We look for companies with low debt, a profitable business model and good growth prospects. They should also have a P/E ratio of 5 or lower. On average, the P/E ratio of securities in our portfolio is currently 7.8, even though the securities already performed very well last year. The average dividend yield is 4.6 percent at the moment.
Universal-Investment: How do you choose suitable companies for the portfolio?
Krohne: In the portfolio, you will only find companies that generate their entire revenue in emerging markets. We only purchase companies that are traded on the local exchanges in emerging markets, not in New York or London. In the past 15 years, I have visited about 1,000 companies in 80 emerging markets in order to visualise exactly how the firms operate on the ground. For example, I have visited cement factories in Bangladesh and breweries in Ecuador, and I’ve spoken with real estate agents in Vietnam and bankers in Zimbabwe. It is essential, particularly in emerging markets, to gain detailed insights into a company on-site, but often you have to talk with more insiders locally in order to get more important information that finally leads to an investment decision.
Universal-Investment: Emerging markets are always considered very prone to volatility and riskier than the established markets. For this reason, many investors remain reluctant to invest broadly and directly in emerging markets through funds. What advice do you give to these investors?
Krohne: Investments in emerging markets fluctuate just as much as any other listed investment. One should be aware of this. There is a widespread misconception that emerging markets are very speculative investments. If you take a closer look at the risk-reward profile, there is a lot to be said in favour of investing in emerging markets – especially as an addition to the investor’s overall portfolio. Furthermore, the equities that are included in the AvH Emerging Markets Fonds UI portfolio only correlate with global stock markets to a limited extent. For example, Russian second-tier stocks or Kenyan equities are barely affected by global financial flows. One should also bear in mind that emerging market securities have performed best in the last 20 years – not just in terms of absolute return, but also risk-adjusted return.
I’m not bothered by short-term volatility if the fundamental data fit.Axel Krohne ,
I’m also not bothered by short-term volatility if the fundamental data are sound. For example, the rock-solid shares of a duty-free shop operator in Egypt generating a dividend yield of 13 percent can be bought at the moment. In Russia, there is a port operator’s stock whose P/E ratio is less than 4 and has a dividend yield of 8 percent. As a value investor, you accept a difficult market environment there at times. From my experience, I can also cite another example from the past: In 2010, I invested in the Vietnamese leisure park operator Dam Sen Water Park, whose fundamentals outweighed the unpredictable performance of the Vietnamese market. This stock has since generated a return – including dividends – of almost 800 percent.
Universal-Investment: In recent years, emerging markets have performed worse than those in Europe and the US. How significant is this from your perspective?
Krohne: You’re right about that, and individual emerging markets have also been disappointing in terms of economic growth. But this is exactly where the value investor’s big opportunity lies because it is easier to find undervalued securities in a tough market environment. In particular, small emerging markets, such as Vietnam, Cambodia and Kenya are currently among the fastest-growing countries in the world. The economic dynamic in most emerging markets will also turn out to be much stronger than in Western countries. Two-thirds of the world’s population lives in emerging markets, which still have a lot of pent-up demand in many areas. This will have a positive effect on economic developments.
Author: Axel Krohne, EM Value, and Timo Lüllau
Date of issue: 2/21/2017
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