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Playing the plan: Mawer’s emerging markets equity portfolio | EP107

April 27, 2022 Print

Russia, the potential parallels to Taiwan and China, and macro to micro portfolio considerations in an inflationary environment.


  • Our long-term thesis and current assessment of Russian investments
  • Risk scenario mapping: Taiwan, China, and deglobalization
  • Why a high inflation environment is a significant concern in emerging markets, and how we manage for it—e.g., Dino Polska, TSMC, Baltic Classifieds Group
  • Opportunities in chemical logistics and finding a roll up—[Guangdong] Great River Logistics and Milkyway Chemical Supply Chain Service Company
  • Recommended reads: Red Notice (Browder, 2015), Putin’s People (Belton, 2020), The Changing World Order (Dalio, 2021)


A transcript of this episode is available below, modified for a more enjoyable reading experience. For more posts exploring the ideas we talk about in the episode, check out our Related Reads links.

Your Host
Andrew Johnson 121 Web 2022 light

Andrew JohnsonCFA

Institutional Portfolio Manager

Andrew Johnson is an institutional portfolio manager at Mawer Investment Management Ltd., which means he works directly with some of the largest and most well-established companies, organizations, and charitable foundations that have chosen Mawer to be their partner in managing their assets. He values the opportunity to work with executives as well as board and committee members to ensure they have a full understanding of how their capital is being invested to help achieve their objectives.

Before joining the firm in 2007, he held positions in both the accounting and legal departments of a diversified private holding company based in Nova Scotia, where he was born and raised.

Mr. Johnson has a Bachelor of Arts from Mount Allison University and is a CFA charterholder with investment experience since 2007. He is a member of the CFA Institute and the CFA Society Calgary. Mr. Johnson has completed the Not-For-Profit Governance Essentials Program through the Institute of Corporate Directors. He has served as a volunteer with Make-A-Wish® Canada and is past President of the Calgary Sunrise Toastmasters Club.


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This podcast is for informational purposes only. Information relating to investment approaches or individual investments should not be construed as advice or endorsement. Any views expressed in this podcast are based upon the information available at the time and are subject to change.

Andrew Johnson:


Welcome back everybody to another addition of Playing the Plan. Today, we are talking with Peter Lampert. Peter is the lead manager of our international equity strategy alongside David Ragan and leads our Emerging Markets [Equity] strategy, which we are going to talk about today. Peter, you're a popular guest on the podcast. Thanks again for making time for us.

Peter Lampert:


Thanks for having me back.

Andrew Johnson:


All right. Enough with the pleasantries, let's get right where the listeners are going to be most curious when it comes to emerging markets and that's the topic of Russia. So, I wanted you to take us through and our listeners through the portfolio's exposure to Russian securities. But more broadly speaking, take us through the risk assessment and the thinking around portfolio construction with Russian holdings since you've been essentially building the portfolio.

Peter Lampert:


I'll start with our exposure today and then back up to how we've been thinking about it over the years. So starting off, we do invest in Russia. We have invested in Russia over the years, so the invasion of Ukraine is certainly extremely concerning. It's certainly a huge impact for those directly impacted in Ukraine, but also there's knock-on impacts around the world, impacting many people. And in our emerging markets portfolio, at the time of the invasion, we had a 3% weight in Russian stocks. So, trading has been halted in those stocks. We can't currently sell them and we've valued them down to zero, essentially reducing our exposure. Not the way we'd like to, of course. And how we got here—if we look back over the years, we're bottom-up investors; we just invest in great companies around the world. Our first investment in Russia was the Moscow Exchange in 2017, which was the first year of our emerging markets portfolio.



And they have a monopoly in securities trading. It's a great business. And over the years, we found more companies there that meet our bottom-up criteria. So, Tinkoff is a world-class digital bank headhunter, which is the dominant jobs/classifieds site in Russia and Softline, a leading software distributor.

Peter Lampert:


And these are the types of great businesses we like investing anywhere in the world and they happen to be in Russia. It always starts for us with the company fundamentals, but then of course we do have to pay a lot of attention to the macro and political risks, so that's another element of our process. And for example, thinking about political risks, another stock we had in the portfolio was Sberbank, but we had exited that position given it does have higher political risk. It is a partially government-owned bank in Russia. From a top-down perspective, Russia does have a mix of positives and negatives.



And thinking through our thinking before the war, the positives were that Russia had a very strong fiscal situation: large FX reserves—which, they now can't access most of them—but low debts, they're major producer of oil and other commodities, so the economy naturally had a very strong outlook in an inflationary environment where commodities would do well. And it's a tailwind for the whole country, for the whole economy, and the companies that we'd invested in. So those were a lot of the positives. But of course, there are negatives and they're well-known in Russia. I think a lot of people would share the same concerns that we have around the concerns around the rule of law and the treatment of shareholders. I've read some fascinating books on the topic. My favourites were Red Notice by Bill Browder, where he describes his experiences investing in Russia. And Putin's People by Catherine Belton, which describes how Putin and a number of his colleagues operate the country and how the government really works.



And so there are some concerns there. And we manage that risk by firstly limiting our overall weight—our maximum exposure to Russia at any one time. We had limited to 10%, which was the maximum we had in the portfolio. And secondly, investing in good companies with good corporate governance and companies outside of the government's crosshairs. So, we just completely avoided sectors like oil and gas and mining. Those sectors are more strategic to the country. The assets can't be moved, so it's easier for government to confiscate them if they choose to do so. And there's a history of that happening in Russia.



When we look at all of these factors, of course, the one big overriding factor was the prospect of war. And as we were watching the military buildup throughout last year and into early this year, we didn't know the odds. We didn't know if Putin was bluffing or if an invasion would go ahead, if it did go ahead, how severe would it be.

Peter Lampert


Certainly the level, the scale of the invasion, this level of horrific war was not our base case. But we had to consider this, this risk. And not knowing—in a war, all bets are off. You don't know what the outcomes and implications would be. That's why we had been reducing our positions throughout January and February as the risk was increasing.

Andrew Johnson:


That's a really good overview, thanks Peter. There's been at least some distance between now and the initial invasion. Of course, war is still raging with tragic consequences. But with that distance, and purely from an investment perspective, have you and the team been able to reflect and come away with any learnings from this experience?

Peter Lampert:


I think certainly we've talked a lot about that—and discussing, self-reflecting, and reviewing mistakes and providing feedback amongst the team are all big parts of our culture and our process of continuous improvement. And certainly we've had those discussions. Should we have been reducing our positions even more quickly, so we weren't stuck with that 3% position at the time of the invasion? But at the same time, we don't want to overreact to every risk out there. It's easy to just say, "Hey, there's lots of risks" and be tempted to sell everything. So, [we] try to strike the right balance. I think one learning is yes, we should have of acted faster. But at the same time, not trying to overlearn from this one case. And if that becomes a repeated pattern, maybe that's a bias we have to recognize and correct for in our process.

Andrew Johnson:


Another large part of the investible universe for you is China, and there are a number of different directions we could go in with China. (And you've been on the podcast several times talking specifically about the risks and opportunities there.) More recently, many are drawing parallels of what's happening with Ukraine and Russia with China and Taiwan. So, from a risk perspective, how are you incorporating that into your portfolio construction? And I think especially given the level of sanctions in restriction of trade and cutting Russia off from the global marketplace, in response to their invasion.

Peter Lampert:


Yeah, I think we're certainly paying a lot of attention and the entire world is paying a lot of attention to the war in Ukraine. Not only the military war that's going on, but also as you've mentioned, the financial and economic response from the U.S., Europe, and their allies and wondering, what does this mean going forward? Is this a playbook that could be used in future conflicts?

Peter Lampert


Most top of mind, China and Taiwan. I was surprised. I think many were surprised at the willingness of the U.S. and the West to weaponize the dollar and to enact such extensive sanctions, including freezing the Russian central bank reserves. So, from here, it's not hard to imagine if they may try to use a similar toolkit with China, or if in fact, one of the reasons these sanctions have been so harsh is to send a warning to China and hopefully try to reduce the odds of an invasion of Taiwan.



But I think the implications for investors—especially those of us based in the West—is that we have to, when thinking about China and Taiwan, we have to not only consider the military implications of a possible invasion, the human implications of a war, but also now the financial implications. And a lot of the things that we've taken for granted for the last 40 years of increasing globalization, we need to question some of those basic assumptions. Will stock markets remain open? Can investors in the West invest in companies in the East and vice versa? Or will more financial de-linkages occur?



These are some very significant questions that we need to ask. But like all risks we consider, it's not the only scenario. It's not the base-case scenario that we're expecting, and it doesn't mean we avoid investing in China and Taiwan completely. This is an emerging markets portfolio: 55% of it is invested in China and Taiwan. That's the largest part of the universe and we find many great companies there. But we need to be aware of the different scenarios that could play out. We need to manage that exposure and we're not looking to take our weight any higher there. If we find more new ideas in China and Taiwan, we'll probably replace something else we have there, and increasingly looking for ideas in other parts of the world to help improve our diversification.

Andrew Johnson:


Have there been any conversations with you, the [emerging markets] team, broader Research team around the longer term implications of this? And what I'm thinking is that—are these flashing signals of an acceleration of the deglobalization that we've been seeing signs of in the past five-plus-years or so? Has there been any conversations around what that means going forward longer term from a deglobalization standpoint?

Peter Lampert:


Definitely. We talk about that a lot amongst the Research team. We're bottom-up investors. We're focused on investing in great companies and we spend our days analyzing businesses. But just because you're a bottom-up investor doesn't mean you can ignore what's going on in the world around you.

Peter Lampert


And we certainly think about these big picture themes and these longer term trends that could have major implications. My favourite book on this topic is The Changing World Order by Ray Dalio. And he lays out a very convincing case for how empires rise and fall over time and looking at a number of factors. And the way he's looked at the data, the U.S. empire is past its peak and the Chinese empire is on the rise.



And when that happens, there's often conflict. And so how that shakes out, how we should position for that, what does it mean in a less globalized world? Those are all, I think, important things that we have to consider, while also not losing the perspective that hey, buying great companies and holding them for the long term is a great investment strategy. But just being aware of some of these other risks out there and trying to mitigate them where we can.

Andrew Johnson:


A couple great book recommendations so far! We're going to have a whole list to attach to this transcript. Those are some very big topics that you've just covered. And underneath all of that, there are other global issues you face as a portfolio manager. One in particular is the inflationary environment that we currently find ourselves in. There's no way to know how long this lasts, but my question is really around is there anything unique to an emerging markets portfolio when it comes to inflation?

Peter Lampert:


I think there's a lot of challenges going on in the world right now, and you can tie them all together with the Russian war, with potential conflict between the West and China and inflation, and they're all interlinked. And these are things we have to consider as investors. So, specifically with inflation, we're seeing very high levels of inflation generally around the world and it's a significant concern. And it's something we have to consider both at the macro and micro level. So, like you say, in emerging markets, it's even more of a concern. At the macro level, inflation can trigger social unrest. We saw that with the Arab Spring. Even Kazakhstan earlier this year, we saw increase in fuel prices lead to protests. And that's not uncommon.



And with higher levels of inflation, we should expect more of that. And that hits lower income consumers the hardest—when food prices are rising, when fuel prices are rising. And most of those low income consumers happen to be in emerging markets. So, that's something we need to be aware of—the potential for social unrest [that] could lead to political unrest.

Peter Lampert


And then also at the micro level, looking at individual companies. It's really important in this environment to invest in high-quality companies that have pricing power that can pass through cost increases to maintain their margins without facing demand destruction to maintain their cash flows. And that's something we all always look for as part of our investment philosophy, investing in high quality companies. But it's even more important now in these high levels of inflation.

Andrew Johnson:


Are there any names that come to mind? I know you mentioned food inflation and then we own a grocery store, I believe, in Poland. Dino Polska—how are they managing this so far?

Peter Lampert:


It's a bit of a puzzle because they're having a challenge. Inflation's hit over 10% in Poland. Dino is a grocery store, food retailer. It's a great, excellent management team. They run the business very well. But they're a smaller competitor, and their largest competitor has publicly stated they're willing to invest in price or not pass through all the cost increases in an effort to gain or maintain market share. And that puts pressure on all of the other competitors [and] hurts margins across the industry when the industry leader is not passing through inflation. And it may be because they don't think their customers can afford the price increases. They may actually buy less food if food gets too expensive. So, this is the puzzle. Because on the one hand, you want defensive businesses that can cope with a weaker economic environment, because the other thing in emerging markets is when there's high levels of inflation driven by the U.S. and rising interest rates, that can lead to capital outflows from emerging markets. Capital flows back into the U.S., and that can lead to less money in emerging markets and economic slowdown.



So, you have these twin problems of high inflation and potentially weaker economic growth. And so you'd want defensive businesses in that kind of environment. Something like a food retailer should do very well. But when you have these low-income consumers that can't necessarily afford the higher inflation, it's very difficult for companies to pass that through. The typical defensive businesses, like a food retailer, like consumer-packaged goods, may not be so defensive if they're seeing margins decline and an inability to pass through price increases. So Dino's one we actually trimmed recently. It’s still a great business, great long-term outlook. They're gaining market share. They're opening new stores. We still like it. It's a core holding of the portfolio. But the weight had gotten a bit high.

Peter Lampert


We trimmed it back a bit on some of these inflationary concerns. And I think it just highlights that yeah, inflation is an even bigger challenge in emerging markets. And I think some of the standard playbooks to deal with high inflation and weaker economic growth that may work better in developed markets may not be as relevant or applicable in emerging markets.

Andrew Johnson:


Yeah, I think it also highlights just the complex adaptive nature of markets, where, you're going to have participants make different decisions based on what's happening out there, lead to increased competition in this case. So, that's the micro-micro level. Let's step back and talk about the portfolio as a whole here—and I know recently you and the team sat down and had your Matrix meeting where you run through the portfolio holdings and the positioning, and you get a chance to debate and discuss all the risks and opportunities with the portfolio—are there any discussions from the most recent meeting that you think may be worth sharing?

Peter Lampert:


I'm happy to share a few of the highlights from that discussion. Like you said, every quarter we go through this: take a step back from the day-to-day in-depth work we're doing on companies, take a step back and look at the overall portfolio. And the three of us on the EM team rank all of the companies, update our rankings, see how they plot, which are the highest quality companies and which ones have the best return potential. And especially in a quarter like we had in Q1 with significant volatility, significant share price declines… We saw quite a few moves on that Matrix where a number of companies, the valuation got much better, but at the same time, something like Dino facing more of a headwind as well. So, we have to factor that in. Some of the things that we talked about—inflation, that's one of the key issues, and the companies with pricing power that can pass that on.



Some examples are TSMC, the leading semiconductor chip maker in the world. They've been increasing prices by 20% last year, because they have essentially a monopoly on leading edge chips. There's a semiconductor shortage; they're the only ones that can supply them. So, that's what we look for—companies that have a unique value proposition to their customers. No one else can do what they're doing because of their competitive advantage and they can get the pricing through for that. So TSMC's one we've maintained at a 6% weight. That's our maximum position size. Baltic Classifieds Group is one we've added to. It's aptly named. It's a leading classifieds site in the Baltics.

Peter Lampert:


And they're increasing prices at 15% because they've been under-monetizing; their rates are too low relative to the value that they provide their customers. So, even if they face higher wage inflation—which they are in the Baltics—they should be able to maintain their margins to pass that through.



So, that's some of the discussions that we're having, and which stocks to add to. As well, we're adding to some stocks that have just sold off too much. In our assessment of intrinsic value or our estimate of the fair value range, many of our stocks have sold off quite significantly, and we are adding to some of them we think are very attractively valued. At the same time, we're trimming some where the share prices have held up quite well and just mathematically, and you can imagine as the market sells off and many shares sell off, the companies with share prices that held up well, the weights drift higher in the portfolio. And for risk management, we trimmed a number of them back. I think those are some of the key themes that came out of this Matrix meeting. We also considered and added a number of new companies as well, which is a nice time in the Matrix to look at some of the new ideas and how they stack up to the rest of the portfolio.

Andrew Johnson:


Great. Yeah. Well, why don't we highlight a few stocks to talk through the philosophy and illustrate the process and maybe idea generation? Do you have any examples that would be good to do that?

Peter Lampert:


Yeah. Two of the new ones we added to the portfolio actually happened to both be in China. One was [Guangdong] Great River Logistics and the other Milkyway Chemical Supply Chain Service Company. I'm not sure the Chinese name, but that's the English translation. Anyway, they're both in China, both in the chemical logistics industry. And we first came across Great River. The idea came from Samir, who's a colleague on our Canadian and U.S. small [and mid] cap team. And it just highlights that ideas can come from anywhere. Because we all have the same philosophy, the same investment process—even though Samir's not directly on the emerging markets team, when he found a great company, he was able to identify that and pass it along. And as we researched it further, it turned out to be exactly the type of company that we like to invest in, meets our investment criteria.

Peter Lampert:


What they do is operate chemical storage tanks located in industrial zones at ports [and] along river ports in China. So when chemicals are transported between ships and trucks, they're held in these tanks. And Great River is the major operator of these tanks around China. And it's a roll up: management's just buying more of these across China. And we really like those businesses because an industry roll up gives very visible, predictable growth. We know how many tanks there are, and we can just see them deploying capital at attractive returns on a repeated basis and getting very steady growth that way. And the reason that they can buy these assets at attractive prices and not face much competition for them, is because they have a great track record of safety and operational effectiveness. All of these acquisitions need to be approved by the local governments operating the industrial zones.



And no government official wants to be the one in the newspaper for an explosion like happened at the Tianjin port. And so finding a reputable, safe, responsible operator like Great River is very important. So that's their competitive advantage. In emerging markets it's rare to find these roll ups—most companies that we found drive growth organically. It really stands out to have a great management team successfully executing a roll up. And then from there, we found Milkyway. We came across Great River first. Milkyway in our research was operating in the same industry, but it's a different business. They do distribution for chemicals companies. And we've actually seen this business before. We have Azelis and IMCD in our international equity portfolio, and this is a very similar business in China. We think that's a fantastic business model in the rest of the world, so we were really excited when we came across a similar company in China.



And it turns out that it's just a great management team with a huge market potential and they're executing well on their plan. So, they distribute chemicals on behalf of large companies like BSF and other multinationals that want to sell into China. And that's just a very underpenetrated industry. Many companies, especially the major Chinese chemical companies, are still doing their distribution in-house, which is much less efficient. So Milkyway has 1% market share or something very low and there’s huge room for growth as they continue to gain market share.

Andrew Johnson:


Excellent. Well, that's, I think, a good spot to wrap up with taking us through some of the philosophy and process in action, Peter. As always, thanks for joining us and bringing this perspective.



I certainly appreciate it, I know our listeners do as well, and I'm already looking forward to next time, so thank you.

Peter Lampert:


Okay, me too. Thanks Andrew.

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This blog and its contents are for informational purposes only. Information relating to investment approaches or individual investments should not be construed as advice or endorsement. Any views expressed in this blog were prepared based upon the information available at the time and are subject to change. All information is subject to possible correction. In no event shall Mawer Investment Management Ltd. be liable for any damages arising out of, or in any way connected with, the use or inability to use this blog appropriately.