In emerging markets, tides come and go regularly – and skinny-dipping is not our thing. For these reasons, we require a margin of safety and a solid balance sheet when we look for investment ideas.
Emerging markets have benefited substantially from a 30-year decline in interest rates, so in theory it makes sense for companies to increase their leverage when the cost is so low, to be able to make their next big (debt-loaded) acquisition, or perhaps to invest in a new factory. Major central banks and various other large institutions’ policies have been targeting this. The potential issue arises because most participants gear up together – not because it makes sense, but because they fear losing out.
Generally, peak market valuations are the time for the highest buyback programmes – but it should be the other way around. Across the emerging markets, higher debt levels can be seen from a top-down perspective.
Investor memories tend to be short, especially those of us who haven’t been in this industry long enough to have felt severe pain. We believe the ability to recall the hard times is important, and we recognise this trait in some of the companies we hold in our funds. In Asia, we regularly meet companies that still talk about the Asian Financial Crisis 20 years later, either how they survived or changed their attitude, or what they did to prepare for it. It’s music to our ears because they have clearly learnt their lessons. The companies in our portfolios typically want to keep their cash for a rainy day and look for the moment when they can buy out their key competitors at reduced valuations, or invest when no-one else is to strengthen their market position.
Like a house with no mortgage being worth more than a house burdened with one, we are happy to pay up for quality companies with sensible balance sheets and strong franchises, backed by capable and honest stewards.
…And so does motivation
As investors, we spend a lot of time trying to understand the debt conundrum and whether this relates to an attitude of a long-term owner instead of an empire builder. The motivation of the family behind the business or the manager running the company tells us a lot about risk appetite and whether they are someone who is willing to put stakeholders at risk. Equally, the debt structure may simply indicate a weak business model that requires borrowing in order to compete and remain relevant.
We actively search for sound businesses with co-owners who understand the importance of the journey rather than the destination in order to build strong fundamentals upon which the businesses can prosper. Most importantly, we look for business owners who are responsible not only for their shareholders but also their employees, as a way to enhance and improve the communities they touch by being long-term partners, and not just shooting stars that hire and fire. We believe having capital for rainy days is one of the best indicators of such vision in practice.