Navigating Emerging Markets: A Conversation with Glen Finegan of Skerryvore

Glen Finegan, Lead Portfolio Manager of Skerryvore, discusses the company's bottom-up approach to investing in emerging markets, emphasising governance, pricing power, and diversification as key drivers of long-term success.

Chris Gosselin: Welcome. My name's Chris Gosselin from Australian Fund Monitors. Today I'm talking to Glen Finegan from Skerryvore, who's all the way from Scotland. Actually, he's all the way from Ireland via Scotland. Skerryvore operates out of Edinburgh in Scotland, and they have an Emerging Markets All Cap, pretty much unconstrained equity fund.

Glen, welcome.

Glen Finegan: Thank you. Nice to be here.

Chris Gosselin: So, all the way from Scotland, you're doing a bit of a global trip. You're now aligned with Bennelong, but prior to that, the strategy has been operated by you and others for a long time. I think it goes back 2009 or 2010. And then for various changes of ownership, Bennelong came along in 2020, is that correct?

Glen Finegan: Yes. This strategy, this philosophy has been operating since the early 1990s under different forms of ownership. I was lucky enough to get a job working on the team, implementing it back in 2001, and that was under the ownership of First State Investments based here in Sydney. And I left that team in 2015, or end of 2014, and I continued to invest in line with the strategy for a firm called Henderson, which became Janus Henderson.

And then in 2019, me and my team took the view that second half of our careers, we'd rather be business owners and have an independent operating structure, an investment boutique that couldn't be impacted by changes of ownership and corporate management, and all that sort of thing. And we were very fortunate to meet Bennelong, who've been a fantastic sort of minority partner in our journey to date. And yeah, you're quite right there, the RE for our fund here in Australia and have been really helpful in terms of growing the assets in that fund, which are now just over 600 million Aussie dollars.

Chris Gosselin: Fantastic. And they give you distribution in Australia, which you probably wouldn't have had otherwise.

Glen Finegan: Yeah, that's right, and really to distribute the strategy globally. Yeah, we've had to think as a small team based in Edinburgh, we've had to think about different models for different markets. But yeah, Bennelong have been a great partner here.

Chris Gosselin: So tell me about the strategy. I mean it sort of explains it. If you look at the name Global Emerging Markets All Cap equity fund, that tells you what it does. But there must be a lot more to it than that. It's unconstrained. Tell us about the strategy.

Glen Finegan: Yeah, we're bottom up investors in the developing world. We think there's an interesting opportunity for investors to tap into when thinking about X developed world markets. Most of the people in the world live in the developing world. So there's billions of potential consumers, growing middle classes, and lots of underpenetrated products and services that we think should be able to grow over time. So it seems like a sensible thing to include in a sort of global asset portfolio, some exposure to companies that are exposed to, whether it's consumption or innovation in the developing world.

You're right, we're unconstrained, so we're not restricted by the benchmark in any way. And that means our funds have looked very different to the benchmark and that's been helpful at times. And other times our relative volatility of our strategy can be quite high. But what we've been pretty good at is delivering low-volatility, absolute returns from the asset class. And this is an asset class that, frankly, for more than 10 years now, it hasn't been a great investment for investors. It's struggled to deliver, really, returns, anything like you might've enjoyed from developed world markets where things like technology stocks have done very well.

So our approach has delivered better returns by focusing on very well-governed businesses, which are likely to protect you from some of the rule of law challenges that come with investing in the developing world, and also companies with real pricing power. A headwind of being an emerging market investor is that currencies tend to devalue, which means inflation. And you need to be careful, I think, to make sure that you're invested in companies that can grow earnings in real terms because we're not here to deliver emerging market currency returns. It's real, absolute returns we're looking to deliver. So what that means is we spend all our time studying the history of listed companies all over the developing world, studying the people behind them, their track record of how they built their business, how they treated all different stakeholders in their business, as a way of trying to assess how risky they might be from a governance perspective.

And major differences between our strategy and the benchmark, or the peer group, have included things like we've never invested in a Russian equity because we couldn't find individual companies with models of corporate governance that we felt would protect us or our clients. We've never invested in a state-controlled bank in emerging markets, or anywhere, actually. Because ultimately we view that the vast majority of state-controlled companies, of which there are many around emerging markets, will allocate capital based on what politicians want them to do and not in the interest and not to generate returns for minority shareholders such as ourselves.

So our subset of investible companies is privately run businesses, usually with quite long track records that you can assess how they've treated all the stakeholders and where you can point to governance structures that have protected minority shareholders for long periods of time. And then also the types of franchise we tend to, or we're looking for, are those with forms of real pricing power. So they can be strong brand owners, like Coca-Cola bottling operations around emerging markets, where you have both the branding power of Coke but also hopefully growing consumption per capita over time. And you're aligned with investors like normally a local family partnered with The Coca-Cola Company. So a strong form of governance structure combined with a real growth and pricing franchise.

Chris Gosselin: You mentioned privately-owned companies, but you're talking listed companies that have non-government ownership.

Glen Finegan: Yeah, when I use the word private, I'm referring to non-state controlled enterprise. But state-controlled enterprise make up a pretty significant percentage of the market, total market cap of what's available to investors in emerging markets. So, the entire Chinese banking system is state-controlled, Petrobras in Brazil is state-controlled, and so it goes on. And then you also have very successful groups that are notionally private, but have built their franchise based on very strong political connections. It could be the cousin of the president, or it might be that you have strong suspicion or belief that it's been co-opting political decisions or regulators that's enabled the business to flourish. And we would try to stay away from all of that state ownership, overly politically connected groups, and look for genuine private businesses or private sector businesses that have good exposure to an opportunity that should grow.

So there's lots of those in the consumer space. Might be convenience retail operators in markets such as Mexico or Brazil. It could be Coca-Cola bottlers in Africa. We own a Coca-Cola bottle in operation in Nigeria, for example. Consumption per capita's really low, volume growth is strong, population is forecast to grow substantially. So hopefully a good place to sell soft drinks.

And other forms of pricing power we quite like include businesses that you can point to a constant reinvestment in intellectual property. So innovation, there are names such as TSMC, which is a clear leader in its field in semiconductor manufacturing. And it's got there by consistently reinvesting a substantial portion of its earnings in proving its intellectual property. And that allows us to believe it has sustainable pricing power. And there are lots of other examples earlier in the journey, perhaps, than TSMC. But we own a global-leading electric motor manufacturing company out of Brazil, an interesting machine vision company out of South Korea, an industrial automation company out of Taiwan. So these are private businesses with long history of governance and a strong element of intellectual property. So the bulk of our fund is leaning into really well-governed consumer-facing businesses where you think you've got real pricing power because of brands or distribution. And then also businesses that have a degree of pricing power from reinvestment in capability or intellectual property.

There's a whole bunch of stuff we avoid. Obviously you have state control, where we just think capital is being allocated according to politicians' whims as opposed to in order to generate returns for you, the minority. We much prefer to invest in price makers and not price takers, and that means we don't invest in the many commodity-producing companies that are listed in emerging markets. Now, many of those fall under state ownership or politically-connected sort of governance models that we wouldn't invest in anyway. But we prefer companies that are in control of their pricing. So that keeps us, also, it keeps us away from sort of regulated utilities. I don't want to invest in a company where ultimately it's up to a politician for a price we can sell electricity for, water for, or whatever it might be. So we try to stay away from heavily regulated sectors. And all of those things have meant our strategies, being able to compound returns in a much more sustainable way than perhaps the benchmark returns might suggest was possible.

Chris Gosselin: You mentioned the benchmark. I noticed that you way underweight China, which has probably been a good thing to be just recently. But is that underweight for the same reason that you're concerned about political risk or interference? Or just the whole China issue, and communist party control, government control?

Glen Finegan: Yeah, so we're very valuation driven. I mean, there's no point in owning these good-quality companies that we try to identify if they're too expensive. So there's two ways to lose money, buy a bad quality company, and the other one is pay far too much for a good one. So when it comes to building our portfolio, we're very valuation driven, and that's really been why our position in China has been so extreme.

We felt back in 2020, particularly early '21, the China market was performing very strongly, and valuations of the small subset of private businesses that we've identified that we might like to own for the long term were trading almost entirely at valuations that simply made no sense. We're regularly looking at PEs of 120 times. This was not uncommon on the market at that stage, and I'm talking about not the state-controlled part of the economy, but this subset of entrepreneur-led private businesses where you feel you're not having to make any kind of governance compromise to consider owning. But they were all way too expensive.

Fortunately we were right, and there's been a huge kind of bursting of that bubble and valuations have gradually improved in China over the last sort of three years. Arguably the economy has deteriorated. People can now see that the amount of misallocated capital into real estate and the sort of the debt hangover that that's left. But equally, we're not looking to invest in property companies in China. We're looking for more interesting, longer-term, compounding type businesses. And some of those have become cheap enough over the last sort of eight to 12 months and the China weight and the portfolio has been going up. We probably, at our minimum, maybe only had one. I think we only had one holding left in China, probably under 2% of the fund. We're now closer to 10% of the fund. And that's because names on our watch list that we've deemed for a long time to be good enough own have become reasonably valued enough to own for us to believe that our kind of absolute return hurdles could possibly be met by the growth that they might be able to deliver.

So our largest holding in China today is a privately-run, founder-led pharmacy operator that run chains of chemists. And pharmacy in China's pretty fragmented sector. And this is one of a group of companies that are sort of consolidating this fragmented sector. And when we first looked at this company back in 2020, the franchise made sense, the ownership model made sense, the opportunity it was going after made sense, but the valuation made no sense whatsoever.

And what we've seen is a very substantial fall in its share price, particularly through last year. And that enabled us to add that to the strategy at the end of last year. And it ran November time last year. And when I say our absolute return hurdle, we're looking to earn 10 to 12% per annum from our holdings in emerging markets. And the share price of this business had fallen to a level where 10 to 12% per annum over our five-year anticipated holding period looked achievable. So we're very happy adding that to the strategy and it's just outside of our top 10 holdings within the strategy. And then we've subsequently added one or two more names as valuations have continued to improve.

So we certainly, we don't have any form of anti-China bias. We fully recognize the state control, state interference risk that exists there and we're actively looking in sectors where you're more of a domestic-facing franchise so you're potentially insulated from trade war problems, if there was to be one again. And also operating in sectors where we just don't believe the government's particularly interested. I don't think the government cares where you buy your aspirin. They probably care a lot about your political views of certain issues. But another business that we've recently out of the portfolio is quite a high-end branded kitchen equipment business. And again, I think your choice of dishwasher, it comes down to free will in China still. So businesses that operate along normal sort of private sector, competitive lines are interesting to us in China. And valuations have come to a level where some of those names have been going into the portfolio.

There is a large number of Chinese companies that we're not going to invest in because they're either actively controlled by the state, or we believe they're at very high risk of becoming controlled by the state or directed by the state. And that's kept us out of the big technology companies in China. We haven't owned any of the businesses like Alibabas and Tencents because we had always feared government interference in this sector. And then over the last three years we've seen very active government interference in this sector. And it only served to underline the politically exposed nature of companies that collect lots of data on the population and things like that. So that's not an area where we are likely.

So there's quite large parts of the China market where we don't see companies that meet our requirements. But then you have this whole subset of businesses, operating sectors, and activities that could have long-term growth opportunities. I think pharmacy in China is very interesting. It's a huge population, rapidly aging. Sounds like a great place to sell medicine. So I think where we can find businesses that meet our needs, our weight in China can certainly go up if valuations allow that.

Chris Gosselin: How do you handle the research? So you're based in Edinburgh, you've got a team of how many?

Glen Finegan: Yeah. Well Skerryvore is 17 people, but there's seven active full-time investors, yeah.

Chris Gosselin: And so you've got this huge mandate, in a way. You can immediately cut out a lot of countries because of political interference or…

Glen Finegan: Yeah, companies for sure. Yeah, we can narrow down the company.

Chris Gosselin: Sure. Actually managing that and having feet on the ground, company visits and those sorts of things, that must rack up a few air miles?

Glen Finegan: Yeah. Over the years it has done. I mean, I've personally been involved in running this strategy since 2001. So I've spent plenty of time over the years out meeting companies. Our whole team travels regularly out to meet companies around emerging markets. We have two team members in China this week, for example. So that is an aspect of our job.

But I think an important part of doing this with a small team as opposed … because there are other, larger firms that they might have a Brazilian office and a China office, and that's quite a different approach. I think it's more of a kind of siloed approach. We've deliberately chosen to have our whole team based in one location, in one office, where really everyone feels a high degree of ownership of the portfolio and the decision-making around the portfolio. And I think a key aspect to doing this with a small team is to be a low-turnover investor. So if we have 43 or 40 holdings of thereabouts in our all cap strategy with under 20% turnover, we don't need to generate that many new ideas per year in order to meet the needs of the strategy. And so it's a combination of new idea generation. I certainly hope our team in China will come back with one or two interesting new ideas.

And also constantly monitoring our watch list of businesses. We have over 300 companies on a watch list that we've put together over many, many years traveling around EM where we're confident in governance, we're confident in the strength of the franchise. And a big part of our job is monitoring the various valuations across the portfolio and the watch list, and ensuring there's proper competition for capital taking place. As an active example, just over the last few months that we are recognizing that valuations in some domestic-facing Indian companies are beginning to get a bit stretched, and moving those out of the portfolio back onto the watch list. And hopefully picking some interestingly valued Chinese names that have had to be on the watch list for evaluation.

Chris Gosselin: Yeah. You mentioned before this sort of five-year ownership sort of concept, that sort of vision to say we're not trading companies, we're owning companies. We're owners of companies along with the founders.

Glen Finegan: Yes, very much so. That's how we think, yeah.

Chris Gosselin: And that's important. How do you overcome at the current time, or just have to put up with it, obviously there are a handful of stocks in the US that are taking an awful lot of oxygen as it were, out of the … markets are at all-time highs or close to them, new all-time highs continually being grabbed from just this handful of stocks. It's difficult to do that when you're not in the limelight. So I guess what I'm getting to is what's the strategy, or the advice to investors? Is it to say you need to have some diversification? Or you just need exposure to the rest of the world? The world doesn't, in fact, revolve entirely around the US or a half a dozen or a dozen tech stocks.

Glen Finegan: Yeah, I mean that's it. We're somewhat fortunate that those stocks are not within our investible universe. So we don't have to sit here and explain why we think they may be very overvalued, but-

Chris Gosselin: But you've got to fight for the investors.

Glen Finegan: Yeah, for sure. So from that perspective, it's more just about making the case that there are different forms of growth available when you incorporate the developing world into your investment universe. So whether or not AI is a massive bubble and you're potentially at risk in owning an expensive name in the US, you can lower that risk by saying, well, I'll have some soft drink exposure in West Africa, or I'll have a business that's rolling out convenience stores in Latin America, or what about selling medicines to aging people in China? So these are different forms of growth that should, or could, be somewhat resilient even if some of the things that have driven developed world tech companies up turn out to be maybe-

Chris Gosselin: That bubble gets pricked.

Glen Finegan: … a little bit hyped, let's say. I mean, markets have a tendency to get a bit hyped up, and there's certainly elements of hype to those names. And diversifying into more potentially resilient long-term consumption trends and things like that, that feel relatively predictable, probably makes some sense. It's not to say you shouldn't own US stock markets, I mean they've been-

Chris Gosselin: Well, extremely good at delivering returns. There's a reason it's the richest country in the world, right?

Glen Finegan: But it's just about rounding out a portfolio and having different forms of growth as a way. We're all trying to achieve better inflation-beating compounding of essentially what are largely speaking retirement pots or endowments for future needs. And having all your eggs in one or two baskets seems a bit risky when there's lots of other sectors, and countries, and structural trends that you can diversify across.

Chris Gosselin: So diversification is really one of the major-

Glen Finegan: Yeah, I would say that.

Chris Gosselin: Well, it's the major way to avoid risk in my book.

Glen Finegan: And even with our fund, if you look at the sector exposure in our fund, you'd say, "You've got quite a significant exposure to consumer." But we even view that as very diversified. Because our China pharmacy chain is classified as consumer, but it's really, it's healthcare, isn't it? And our Nigerian Coca-Cola bottler is classified as consumer, but how different that is to, out from a just stage of development, to a somewhat more mature Eastern European retailer, for example? So although they fall under one sector, there's a lot of diversity of cash flow, let's say, and what has proved over long periods of time to be pretty resilient cash flow as well.

Chris Gosselin: The fund's available as a PDS through Bennelong in Australia?

Glen Finegan: Yeah, it's called the Skerryvore Global Emerging Markets Fund. But yes, Bennelong are the RE for the strategy. Yeah. I'm not in charge of distribution, but it's on-

Chris Gosselin: It's on multiple platforms.

Glen Finegan: … it's multiple platforms, and has a nicely diversifying following in terms of smaller institutions all the way through to sort of retail investors.

Chris Gosselin: And I think we cover it from a research point of view, a number of other research houses cover it as well.

Glen Finegan: Yeah, it's well-covered from, yeah. It has ratings from multiple. Yeah.

Chris Gosselin: Terrific. Glen, fascinating to talk to you. Enjoy your trip to Australia.

Glen Finegan: Thank you very much.

Chris Gosselin: You've chosen the coldest time of the year, but you come from Scotland, from Edinburgh, so that's not going to make any difference to you at all.

Glen Finegan: It's not too bad!

Chris Gosselin: Thank you for your time. Really appreciate it.

Glen Finegan: Very nice to meet you. Thanks very much.

Chris Gosselin: Thank you.

Glen Finegan: Thank you.