Emerging Markets Process
The process begins with filtering the starting universe based on market capitalization, liquidity, and foreign ownership constraints. Next, a proprietary screen eliminates companies with burdensome state ownership, onerous regulation, and commodity exposure. Quantitative tools then further eliminate companies with financial attributes associated with low quality.
These remaining securities, along with any identified through other means (e.g. travel, contact with companies, ad hoc screens), are then reviewed by analysts for potential inclusion on a watch list. To meet the quality threshold for inclusion, companies should possess durable business models, high margins, high returns on capital, positive cash flows, sustainable growth, capable management teams, and an aligned shareholder base. Companies are excluded if they exhibit unfavorable characteristics such as ineffective or capital-destroying management, questionable governance, or a weak competitive position.
During fundamental analysis, the analyst evaluates the business model, competitive landscape, and management’s track record and orientation. This assessment is captured on a custom scorecard, which is also used to calculate a proprietary quality factor score for the company. The quality factor score is designed to measure the scarcity value of the franchise and it is ultimately used to increase/decrease our Fair Value estimate. The Fair Value estimate is based on our valuation analysis – a process comprised of historical valuation analysis, peer group valuation analysis, the construction of a discounted cash flow model, and, when available, a strategic value/M&A history assessment. If the stock price trades at a meaningful discount to the Fair Value estimate, the analyst will present the idea to the investment team. The investment team will then rigorously debate the idea and decide whether to include the company in the portfolio.
The entire process also incorporates an evaluation of the company’s operating environment; companies in countries with supportive or neutral macroeconomic policies may be prioritized for fundamental analysis, score more favorably on a qualitative basis, and require a lower margin of safety. While the investment process is driven by specific companies’ merits, it is fair to say that in an unattractive macro environment it becomes more difficult for an investment to be considered at a sufficient margin of safety to Fair Value, and thus harder for the team to include in the portfolio.
The team may sell or reduce exposure to businesses if a holding trades near or above our estimate of Fair Value, if there is an opportunity to high-grade, or if the team uncovers deteriorating fundamentals.