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Thinking About Opportunities and Challenges in Developing Markets

January 12, 2023 in Africa, Best Ideas Conference, Equities, Global, Letters

This article is authored by MOI Global instructor Fred Steiner, managing director at BCCM Advisors.

Fred is an instructor at Best Ideas 2023.

Since 1960, only about a dozen countries out of 150 or so have managed to materially better themselves relative to their peers. About half of the dozen grew from building a manufacturing base and the remaining half comprised of small nations that either attracted beachgoer tourists or got lucky with an abundance of oil and gas or diamonds. What do they all have in common? Exports: Each of these countries experienced more than 10% annual USD export growth since 1960. So, the question is, what are the prerequisites to building an export led growth model? The answer lies primarily in literacy rates and electricity and an interrelated relationship between demographics and geography that can leave some economies hopeless in the pursuit of industrialization.[1]

Why Exports?

To date, the only proven way to create sustainable economic growth in developing economies is via exporting manufactured goods. This is because the development of a light manufacturing base employs a significant proportion of the population and foreign exchange revenues derived from the exports can be used to import requisite technology, materials and capital goods inputs to further expand export capacity. In that manner, you get a virtuous cycle wherein exports drive savings, savings enable investment in export capacity, which, if allocated well, translates into further exports (as illustrated in the above chart) and jobs, jobs, jobs. This circular process not only serves demand on a global scale, but also stimulates domestic demand for which capital is attracted to produce products and services that would otherwise not exist. This in turn further stimulates local job creation while diversifying the local economy. This is how an agrarian economy transitions into a successful developing economy and, over a long enough period, a developed economy.

The labour intensive, low-end manufacturing export model is a process of then graduating up the value chain toward higher value capital intensive high-end electronics and light industrial goods to eventually heavy industrial goods. As a nation graduates one stage, other economies compete to take its place. This process, by our count, is on its third major iteration since the 1960s when the Asian Tigers[2] began their industrialization journey. Beginning in the 1980s, China steadily took market share from the Asian Tigers while the latter gradually moved upward in the value-add chain. Today, many of the Tiger Cub economies[3] and Bangladesh are well into the first stage of this industrialization process while China has migrated upwards. In short order, the Tiger Cubs too will be transitioning upward in the value chain, making way for a wave of new entrants.

The gains to be had as one of the new entrants are vast: Much like you often see winner takes most in many industries, the same goes for exporters. Paul Bairoch found that the Asian Tigers, “which represent less than 3% of the Third World market economies’ population, in 1990, provided almost two thirds of the total exports (excluding re-exports) of manufactured goods of the entire Third World.”[4] While this graduation process may be an impossibly long investment horizon in a world obsessed with daily, weekly, and monthly performance, the outputs are surely mesmerizing and tangible: In 1960, Ghana had a greater GDP/capita than Korea, and in 2000 Kenya and Vietnam were equals on the same measure.

Literacy Rates

The first prerequisite of developing a manufacturing base is for a nation to achieve a 70% literacy rate. Simply put, no economy has grown sustainably below this threshold and any attempt at industrializing prior to achieving 70% literacy rates has been futile. Egypt tried and failed in the 1950s, Ghana in the 1960s and Nigeria in the 70s and 80s.

As noted above, in 1990, the Asian Tigers effectively exported 2/3rds of emerging economies’ total exports. At the time, China’s literacy rates had just surpassed the 70% threshold. Fast forward thirty years and Korea has graduated up the value-added chain with Samsung shipping nearly 300 million mobile phones globally. Meanwhile, China has 25% of the world’s manufacturing exports and has already transitioned away from the sweat shops that might come to mind when thinking about Chinese manufacturing.

Electricity Capacity

The second prerequisite for industrialization is having sufficient power generation and distribution capacity. This is rather obvious: If you do not have a consistent supply of cheap electricity, it is impossible to compete in highly competitive low-margin light manufacturing.

Ironically, what China should have done over the past decade is build power plants and distribution networks in heavily dense cities throughout its One Belt, One Road recipient nations. China grew in large

part by attracting rural population to the cities where they manufactured goods with cheap electricity. Instead, China has built railways, roads and ports to many regions that do not have the export capacity to compete on a globally competitive stage. Ethiopia, for instance, has been a large recipient of Chinese investment, but its manufacturing sector is, contrary to beliefs, exceptionally small. So small that it is less than 5% of GDP. Why? Because despite having a fraction of the labour cost as, say Bangladesh, Ethiopian companies cannot manufacture textiles competitively due to the comparatively high cost of electricity.

Geographic & Demographic Handcuffs

Geography has played an overarching, decisive role in which nations can outperform or are handcuffed. Post-World War II, all the sustained high-growth success stories originated by having land or seafaring access to developed Europe or America, or by being geographically located between Japan and Singapore, which happens to be where almost all the world’s population growth occurred (see diagram in the appendix).

There is little doubt that the next leg in global population and urbanization will occur in Africa. This is a blessing and a curse. For one, as Charlie Robertson argues, countries that bear more than three children per woman will simply be too poor to develop because parents will not have any savings after providing care for their children. But what if your nation has fewer than three children? The answer is there is nothing to get too excited about. Countries with the highest labour growth rates do not necessarily translate into high GDP/capita growth rates. The same goes for nations with low labour growth rates. This is because, on average, labour’s contribution to real GDP growth is about two percentage points, give or take half a point.

Put differently, dispersion across countries’ GDP/capita results are simply too great relative to the minor dispersion in labour growth rates for any given country. Turns out this is how it works with urbanization rates, as well, and it is easier to portray with the twenty most urbanizing countries and region over the past thirty years, according to the World Bank.

We’d wager few would have guessed Haiti coming in the top 10 most urbanizing countries since 1991 (we would have never guessed either!). The message, however, is clear. Take for example, Vietnam. Vietnam’s increase in urbanization ratio was 13 percentage points lower than Cost Rica’s, but its cumulative change in GDP per capita was roughly 5x. Thus, not all urbanization rates or labour growth rates are created equal, and by no means do either imply a positive impact on GDP/capita growth. This makes sense, Nigeria’s population is, on a relative scale, exploding and Lagos has attracted millions of migrants to its city, but many end up living in squalor. It comes down to what a non-geographically handcuffed nation does with those rates of growth and does the nation have the prerequisite literacy rates and electricity capacity to leverage an urbanizing and growing labour force.

This data explains the country level performance, but the regional performance relationship is difficult to refute. As pointed out before, the vast majority of the world’s population growth occurred in Asia, especially along the shipping lanes from Singapore to Japan. We argue, without being able to quantify an amount, this bodes well for Africa as a continent and several of its regions.

Africa’s Lions and Bedouins

The African countries that largely fit the above bill are Morocco, which is well on its way to industrialization, then Ghana and Egypt, followed by East Africa’s Kenya, Rwanda, Tanzania, and Uganda. South Africa has already industrialized, but it is in some respects slipping backwards as our readers will be aware of.

Morocco passes each of Charlie’s three tests. It also has direct access to Europe, where the majority of
its exports are shipped. Today, the country boasts burgeoning aerospace, automotive, electronics and offshoring industries. In the not-so-distant future, Morocco may double its entire existing installed energy generation capacity to send cheap, renewable energy to Europe.

Ghana may well chart the same path as Mauritius did beginning in the 1980s. At the time, Mauritius had recently experienced two major currency devaluations, was dependent on the IMF, and had a debt load that was effectively drowning the country. But it also had begun its transition toward industrialization supported by literacy rates and electricity. Today, Mauritius not only has a well-established textile industry, but also a developed financial services industry. There’s considerable evidence Ghana is well on its way, with USD exports growing ten-fold since 2000. The West African nation is also located in the same neighbourhood as Nigeria, which boasts a population of 200 million. One can easily envision Ghanaian made textiles replacing Chinese and Bangladeshi made garments hawked by street traders.

Egypt also passes the three tests and has the considerable geographic advantage of being able to serve the demand of the Far East as well as developed Europe via the Suez Canal. Further, the population density in the Cairo-Nile delta region is similar to that of the Guangdong-Hong Kong-Macao greater bay area. The North African Nation also has ample cheap electricity. It, currently, however, imports far in excess what it exports. As your manager has written in recent letters, however, the pandemic followed by the Ukraine war are forcing the country’s leadership to address structural changes that should help to grow exports significantly. The country has all the ingredients to be a major success, and quite literally can pave its own destiny.

Lastly, East Africa’s Kenya, Rwanda, Uganda and Tanzania look most alike Korea in the 1960s with literacy rates having surpassed 70% in the past decade. Like Korea at the time, they are all currently mostly agrarian economies, take in significant foreign aid, export very little, and are short of cheap electricity. However, industrialization is a common goal across region and while there have been missteps in building their power generation, each of the countries recognizes the importance of cheap electricity.

And what about the rest of the countries and the role of the internet in breaking down barriers? Without calling out individual names, the good news is nations can go from largely illiterate to literate in a matter of fifteen years as has been shown by Korea and building out an electrical grid takes years, not decades, and that’s to say nothing of solar in rural areas. Then there is the role of the internet economy, which many very bright investors argue could equal the physical economy. We think this is a bit of a stretch and is not as scalable as light manufacturing with regards to absorbing large amounts of labour, but the internet will undoubtably play a major role in absorbing, educating and enriching the lives of whole swathes of Africans.

THEY SAY A PICTURE IS WORTH A THOUSAND WORDS

Since 1960, all of the world’s developing markets that sustainably and dramatically improved GDP/capita did so via manufacturing exports and were located in Asia

[1]The role of education, electricity and fertility in economic development is a topic we have discussed in prior letters and are thankful for Charlie Robertson’s contribution in helping our understanding. His recently published book “The Time Traveling Economist” is a goldmine of supporting data and arguments. Thank you, Charlie.
[2]Taiwan, Hong Kong, Singapore, and Korea
[3]Thailand, Indonesia, Malaysia, Vietnam, Philippines
[4]Charlie Robertson, The Time Traveling Economist

Seizing the Opportunity in Energy and Industrial Businesses

January 11, 2023 in Best Ideas Conference, Equities, Global, Letters

This article is authored by MOI Global instructor Bob Robotti, president and chief investment officer at Robotti & Company, based in New York.

Bob is an instructor at Best Ideas 2023.

In the 1940s Alan Jay Lerner penned the musical, Brigadoon, in which two American friends get lost in Scotland on a hunting trip and end up in the magical village of Brigadoon, a euphoric village that only rises from the Scottish mist every one hundred years. The last twelve years have been a financial Brigadoon, especially in America. No recession, very low inflation and low, even negative interest rates — it was Shangri-la for capital.

Throw in the attendant benefits of the strong US dollar, and you have a period where the average investor experienced a repeating trifecta: 16% returns for the S&P 500, 2% inflation, and a dollar which continues to buy more and more of the world’s goods and services. A 14+% real return for over a decade. A sustained 14% real return sounds too good to be true. So, how did it come to be?

We think two things led to this euphoric period:

1. Free money and low interest rates
2. China’s cost and scale advantages leading to low inflation

Free Money and Unrestrained Unicorns

After the 2008 World Financial Crisis (WFC), governments reacted in a distinctly different way than they did after the Great Depression. In 1929, governments learned that when they stood back and let the system cleanse itself, Wall Street failing led to Main Street failing. This time around governments were extremely active in staving off the collapse of the world’s banking and financial systems.

Monetary policy after the WFC is unique in that it was endorsed by both liberal and conservative administrations, even if it was often misdirected and ineffective. In its own way it was a new version of the Reagan years of ‘trickle down’ economics policies. The monetary policy of governments post-WFC made money free to do the same, trickle down and jump start the economy.

However, free money didn’t make a robust economy, but instead created one on life-support. While goods and services saw little inflation, financial assets inflated dramatically! These free money policies also suppressed interest rates to 5,000 year lows. I think that bears repeating. A 5,000 year low. With infinitesimal rates, financial assets began to be mispriced, and we saw plenty of capital ‘swimming naked!’

One major manifestation of this free money period was the rise of the Unicorn – another mythical animal that would feel at home in Brigadoon. Companies that could grow and receive huge amounts of new capital at little to no cost, and without needing to produce cash, just the promise of a “someday” that could conceivably create oodles of cash. The length of time this continued made it so anyone daring to point out holes in this business model were branded stuck in the past with an outdated understanding of economic progression. This belief was made harder to fight against as those doing the laughing were laughing their way to the bank.

It seems that today, the horns might be falling off these unicorns. A troubling development as they were trained as unicorns, and now that they can’t fly without the free money, they are having trouble walking or working the fields. With no use as horses, and no magic as unicorns, maybe they only have value to the glue factory?

China

In the meantime, on the other end of the globe, China continued to be a juggernaut, little affected by the WFC. Since 2008, China’s GDP has nearly tripled as the world continued to flatten. The interconnection of far-off lands through inexpensive transport, relative global peace and mostly open borders helped usher in today’s China. The economic integration of 1.2B Chinese people, successfully lifted hundreds of millions of people out of poverty and created an engine of consumable goods. This massive generator of low cost, high scale goods successfully devoured any potential for inflation to rise over the last 12 years, as it has for decades

To be clear, “China makes and the world takes” still holds true. Today China makes 50% of the worlds steel, chemicals, aluminum and even cannabis. Ross Perot was wrong in part, but right in sentiment. That giant sucking sound was NOT Mexico but China, hoovering up industries, jobs and, with it inflation for decades.

In recent years, rising costs, alternative sourcing and changing policies are evolving the 40-year reinvention of China into a more mature economy. Today there is plenty of talk about the possibility of ‘deglobalization’. We are already seeing real policies and investments being made to reshore production across the globe, and especially in America. The combination of China’s rising costs, depleting domestic resources, increasing dependence of inputs from abroad, and continued growth means rising costs for the world’s low-cost producer.

Years ago, Marty Tuckman saw the future and shared it with me. Marty ran Interpool, a container leasing business here in America. The manufacturing of containers had followed the migration of lowest cost. Initially these containers were made in the Midwest, close to American steel production, and then they migrated to the South, then to Mexico, then to Taiwan, and finally to mainland China, the lowest cost producer of everything on a scale that probably couldn’t be replicated. This was all in the hunt for reduced costs, mostly in the form of labor.

Today, three worldwide manufacturers control almost the entire market for new containers. They are all based in China (a slight caveat being some start up competition in Vietnam, but the scale is tiny, and they still import key components from China). Moving away from China will not have the scale efficiencies and therefore additionally sources of supply will cost more.

So how did we get the Brigadoon combo of high returns and low inflation? Free money boosted returns, and China ate inflation.

What Now?

“In Economics, things take longer to happen then you think they will and then they happen faster than you thought they could”
-Rudiger Dournbush, MIT Professor

As Brigadoon once again gets shrouded in the mist, what happens next? The above quote is one I have been using a lot recently, as I am constantly reminded of the difficulty markets have accepting true systemic changes.

That artificial, manipulated world has evaporated, and its return is as likely as that of Brigadoon…not in our lifetimes. In the new world, the winners and losers will be very different. The past patterns of this period will not provide useful tools for identifying future success. The investment world is largely in denial, the first stage of market rollover.

This is further sheds light on the need for active managers, specifically those with the skill set and ability to invest differently. In the value investing world this group has been winnowed down through fund migration, style drift and even general despair. The ability to pick the quality companies within sectors is again emerging as crucial today, especially as indexation is still the behemoth in the room, misdirecting capital flows

Our caution to investors was summed up in a quote often attributed to John Maynard Keynes a century ago. “When the facts change, I change my conclusions. What do you do Sir?”

Energy is the Driving Force of the Universe

What happens when free money leads to big returns? Capital flows in that direction, but the flipside of that is that it must be pulled from somewhere. One major area where capital was pulled from was conventional energy. This has always been the case for this cyclical industry, but there are also critical structural changes that have occurred concurrently which provide important differences: climate concerns and the maturation of the world’s oil supplies at current prices.

The world has entered a period of energy shortages largely due to that underinvestment… I’m not talking about an oil shortage, or even a natural gas shortage like currently exists in Europe. I’m talking about a comprehensive shortage of energy in all forms. We need not only more conventional energy for longer than is ideal but also more renewables for both energy needs and to mitigate carbon production.

In recent years every part of the world has focused on building out renewable energy production in all its forms: solar, wind, and hydroelectric. Now even further off alternatives are attracting attention and capital. Hydrogen and nuclear fission are garnering attention and investment dollars… We even see the reemergence of nuclear.

Simultaneously, the world has focused on becoming more efficient by reducing usage and increasing the ability to store energy to better distribute/use it at periods of peak demand. Success with high double-digit growth has facilitated reductions in the existing energy generation sources particularly sources causing environmental concerns like fossil fuels and nuclear.

The problem with these plans is renewables are a small percentage of total energy production. Even after a period of sustained investment it is less than 10% of worldwide supply and we seem unable to grow these alternatives fast enough to power the rest of the world’s needs. This problem is exacerbated not just by worldwide growth, but also the increasing demand from electrification and the shuttering of some of the world’s historic energy sources.

This metamorphosis is time consuming, capital consuming, resource consuming and as a result inflationary. We can and will continue to drive ahead, but at a cost. Our observation is that the drive from climate concerns has caused some unintended consequences and lead us into the middle of the “First Truly Global Energy Crisis.” That’s not my characterization., or even that of a major oil company, but the acknowledgement of Fatih Birol, head of the International Energy Agency (IEA), a Paris-based think tank focused on advancing sustainable energy security. This effort will take steel, cement, copper, silicone, rare earth minerals, other basic materials and lots of energy. Two steps back to make a giant, necessary leap forward as oil production is tapped out at anywhere near today’s oil prices.

Not all countries are created equal though. Over the last decade, America has become energy independent. Critically true when it comes to natural gas. Further, we are producing excess supplies which we can, and do, export to the rest of the world. In addition to powering the economy, many industrial companies in America use natural gas as a key raw material including chemicals and all the downstream products like, fertilizers, methanol, ammonia production, and many others. Further, available, plentiful, and affordable natural gas provides cost advantaged electricity which further powers North American industries and moderates costs to consumers.

China, You’ve Changed Man

While China has been the bastion of low-cost goods for decades now, that has shifted. China is more in line with the rest of the world, and because of that, their ability to devour inflation is limited.

Westlake Corporation (NYSE: WLK) is a critical producer of epoxy, a fundamental element for many light-weight manufactured goods. A good example is blades for wind turbines. Westlake is one of only three western producers of epoxies. In rough numbers, about half of epoxy is made in China, and half by Westlake and its peers. China’s quarantine in response to the COVID-19 pandemic has significantly slowed down activity and demand in the epoxy industry.

This has led to China dumping epoxy into the world market and dragging down the price. This dumped epoxy is mostly made from coal, and is therefore a high cost, high carbon producing way of making lower quality epoxy. Westlake has identified this and is convinced that the constrained Chinese activity is transitory and that Westlake’s cost advantage will grow as it comes back.

As countries begin to reshore production and build out new, clean energy infrastructures, meeting the demand for energy is going to be a huge undertaking, especially as we are starting out with limited availability worldwide.

Conclusion

All these macroeconomic observations are driven by aggregating the grassroots microeconomic observations which come from our bottom-up stock research focused for decades on industrial businesses in both America and around the world. Those industrial businesses are closely interrelated with commodities which are in a period of increasing demand once again after an extended period of being poor return businesses and therefore ignored by most capital market participants. They have also gone through a prolonged period of underinvestment logically due to those poor returns. Over this time most economic participants have formed strong views of this historic disappointment.

We identify this investor limitation as the “myopia of linear thinking”. They refuse to even think to revisit this area. Investors ignore strong results as transitory or value traps. Past experiences have fixed these views in investors’ minds. Investors see no need (and have limited experience and knowledge) to identify and appreciate structural changes that have transformed these businesses and their return generating abilities. Not only changes in return generating abilities but the sustainability of those earnings. Barriers now exist to new entrants and combined with limited interest from the remaining participants to add capacity that profitability should be more sustainable. This is why we believe we are invested in what Buffett characterized as “better businesses” available at Ben Graham cigarbutt prices.

Intelligent Investing in a Markedly Different Investment Environment

January 11, 2023 in Best Ideas Conference, Equities, Global, Letters

This article is authored by MOI Global instructor James Davolos, vice president and portfolio manager at Horizon Kinetics, based in New York.

James is an instructor at Best Ideas 2023.

Financial markets thrive on predictability, as greater certainty about the future permits greater risk tolerance, which promotes economic growth, ergo growth in wealth. The past decade, if not decades, of modern central economic planning have sought to reduce economic uncertainty, largely by intervening in free markets by providing liquidity support through monetary (interest rate) and fiscal (spending) measures.

The requisite magnitude of financial support to stimulate the economy has grown in excess of nominal economic growth and financial leverage within the system, creating reliance on a rapidly increasing amount of stimulus. This cycle of ever greater financial stimulus may have recently culminated (temporarily), after U.S. money supply[1] grew approximately 45% between January of 2020 and April 2022. This translates into approximately 31% of the total U.S. Dollars in existence having been “created” within the past 26 months.

It should come as no surprise that an unintended consequence of decades of policy aimed at supporting asset and economic growth is inflation. “Inflation” first came in the form of financial asset inflation (i.e. stocks, bonds and private assets), followed by consumer and producer goods (e.g. CPI, PPI), and now, seemingly, everything.

The U.S. Federal Reserve is no longer denying that inflation is extremely unlikely to abate on its own, and it has begun raising interest rates aggressively in order to combat rising price levels. Tighter money can only combat inflation by reducing demand, as interest costs consume more of businesses’, individuals’ and governments’ cash flows[2].

Contractions in demand are often associated with economic contraction, i.e. recession. Fear of economic/demand contraction is driving irrational price action in financial markets, as investors underestimate structural trends and rely on heuristic analysis of past cycles. It may shock many people to learn that commodity prices and broader consumer prices can, in fact, rise during a recession.

To quote Zolten Pozsar of Credit Suisse, “You can print money, but not oil to heat or wheat to eat.” This quote summarizes the dilemma that central banks face, as decades of underinvestment in indispensable raw materials are coinciding with growing demand, specifically from emerging (non-OECD[3]) markets.

Further, there is a growing risk that aggressive central bank policy aimed at reducing inflation via curbing demand will achieve its goal in reducing growth, but without impacting structural inflation, thus resulting in stagflation.

This leaves the global economy in a very uncertain position, where restrictive bank policies are in direct conflict with slowing global growth. We do not have any unique insight into what will catalyze this dynamic to shift, or how or when it might occur, but we do believe we have an informed opinion about what the ultimate economic and investment implications are. In short, the current paradigm of investing, which has reigned for decades is shifting – and at warp speed due to the policy mismatch.

This change will be uncomfortable, and many individuals and institutions will surely reduce exposure due to the uncertainty, which will pressure asset prices. However, this short-term orientation fails to recognize the difference between cyclical and structural inflation, hence missing investment opportunities in secular inflation beneficiaries.

The past 40 years can be characterized as an era of abundance, driven primarily by globalization, technological innovation, and declining interest rates. These supporting trends simply cannot be sustained, and most are either stalling or outright reversing. This will result in a markedly different investment environment for the next decade as compared to the past – yet most investment “models” rely on historical performance and correlations based on 10, 20 or 30 years of data, which is no longer a valid analog.

Specifically, we believe that the changes in these trends, in conjunction with underinvestment in raw materials, will result in a new era not of abundance, but of scarcity. In short, the new era will place a primacy on existing high quality, hard assets – which stands in stark contrast to the prevailing primacy on intangibles and cheap investment capital.

[1] M2 Money Supply
[2] Cash Flow: Cash Flow is the increase or decrease in the amount of money a business, institution, or individual has.
[3] OECD: Organization for Economic Co-operation and Development

A Stock for a Grandchild: Applying a Long-Term Mindset to Investing

January 10, 2023 in Best Ideas Conference, Equities, Global, Letters

This article is authored by MOI Global instructor Bogumil Baranowski, founding partner at Sicart Associates, based in New York.

Bogumil is an instructor at Best Ideas 2023.

Now, that’s an idea!

I was sipping my coffee one morning, and I got a phone call from my partner, François Sicart. He likes to surprise me with interesting questions, and that day was no different. He said: “if you were to pick one stock to recommend to a client as a gift to a grandchild, what would it be?” I gave him an answer immediately, and we had a long conversation about it, which planted a seed for this article.

The client’s request was not the only source of inspiration, though! Once a year, I get asked by a dear friend, John Mihaljevic, to share one stock with the MOI Global community of investors. It’s an invitation-only global group of thoughtful lifelong investors of which I’m privileged to be a member.

It’s a challenge I take on every winter, and I pick one out of all the stocks we bought in the recent year. I take it very seriously, I usually immediately write down a handful of tickers, and then I boil it down to one idea over the next few weeks. I always remind my MOI listeners that it’s just one stock out of 30-50 that we might be holding at any given time. We will hold it for a while, maybe forever, but it can play its own unique role in the portfolio. One might pay a healthy dividend and offer a limited downside; another can still grow fast and potentially have a much bigger upside.

The third source of inspiration was my conversation with another dear friend Christopher Tsai, a fellow MOI Global member. He was a recent guest on my podcast Talking Billions, where I have intimate conversations about money, investing, and more with friends and friends of friends. He brought up the idea of aiming for a big, huge upside in investments. We concluded how chasing a 10-20% gain is not worthwhile, but making our money 20-50-100 times over in a particular stock (likely over many years!) is something we aspire to!

Picking one stock for a larger audience reminds me of yet another good friend Antony Deden. Whenever he is asked to recommend one stock, he feels like a doctor asked to recommend a good medication without knowing the patient or ailment. Hence, I always recommend my MOI Global listeners to research the idea and see if it may belong in their portfolios.

Here, picking one single investment, I was influenced by my partner Francois Sicart’s question: I had the stock for a grandchild in mind. One of our clients became a grandparent and wanted to gift a single stock. I like that idea a lot – as I do any idea that can turn someone into a lifelong stock investor.

Since I already had a great chat with Christopher Tsai, and I had John’s request on my mind, I had an idea ready to share!

I immediately knew it had to be an investment that would not only be around for the next two decades but has a chance to become a much bigger company. I thought of a relatively new company, yet established enough so it won’t go away and vanish before the grandkid goes to school!

Obviously, the company had to be already public, with a few years of financials and, ideally, a profit. I needed to have some reasons to believe it was already mature enough to defend itself against any competition.

Ideally, this company would operate in a fairly new industry or, if it’s in an old one, at least have a new way of doing things, a disruptor.

Equally important to me was the market potential. I preferred a company that could become global or, even better, already was global. I tend to find more of them in the US market than elsewhere, but it’s just my personal bias since it’s the market I’m the closest to and the most familiar with.

With a two-decade or longer investment horizon, the entry point, the price we pay, could be seemingly less important, but being a disciplined value contrarian investor at heart, I love a good deal. I’ll pay up for quality, but I still want to know that I got more than I paid. Hence, preferably, I’d like my investment candidate to be down, cheap, and out of favor with the market at the time of purchase.

I know it’s still a relatively young company in a promising industry with a big wide long runway ahead, but if I can buy it half off or even cheaper, my odds of turning it into a successful investment immediately rise.

When my partner called, he was a little surprised by how quickly I gave him the answer. What he didn’t know was that, unknowingly to both of us, I had been preparing for this question for a few weeks now. Between John’s request and Christopher’s wise words, I knew exactly what kind of stock a grandparent could gift to a newborn grandchild.

This made me think, why wouldn’t we buy more stocks with that mindset? We’d trade even less, keep the long-term horizon in mind, and possibly even do just fine with very respectable returns in the process!
Next time you think of buying a stock, pause for a minute, and ask yourself, would it be a good stock for a grandchild?

I can think of at least one (if not more) that could!

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Get Your Capital a Passport: Traveling Beyond the United States to Invest

January 8, 2023 in Best Ideas Conference, Equities, Global, Letters

This article is authored by MOI Global instructor Amit Wadhwaney, portfolio manager and co-founding partner of Moerus Capital Management, based in New York.

Amit is an instructor at Best Ideas 2023.

We are often asked by prospective investors whether they should invest capital outside of the United States or if it is good enough to just gain global exposure through US companies. The US has a plethora of industry-leading companies, some of the strongest regulation and transparency globally, and by far the world’s largest and deepest capital markets. Additionally, many of the companies based in the US and listed on US exchanges are multinational corporations that derive large portions of their revenues and earnings from developed and emerging markets around the world. So, isn’t it a better and simpler method to access international markets through a US-listed multinational corporation subject to more stringent domestic laws and regulations? In short, looking at the world as it is today, we believe the answer is emphatically no.

While certainly simpler, we believe that this approach disadvantages investors in several ways. First, limiting one’s opportunity set to just one country – even the country with the largest capital markets globally – may result on the whole in less attractive valuations (as of the end of November the S&P 500 traded at a P/E of 19.7x[i] while the MSCI All-Country World Index ex-US traded at 13.7x[ii]) and investment opportunities. Simplistically, if one is looking for bargains in the most wellcovered and capital-rich country in the world, we believe that they will be harder to find. Secondly, it also doesn’t allow investors to take advantage of the significant diversification benefits of not having all of their investment eggs in one country basket. Finally, while this may be a controversial statement, there are many cases where the “best” company within an industry does not have a headquarters in the US. In fact, there are whole industries and business models that are just not available listed on the US market. Be it natural resources, a business or way of doing business unique to a specific region, a labor pool with specific skills, or just a long-tenured globally recognized brand – there are many reasons why the “best” may be outside of US borders.

Potential for Better Prices

The main reason at present for sourcing international exposure by investing in companies outside of the United States is simple: more attractive valuations. The US is the world’s largest and most popular financial market, capturing the majority of investor attention. According to the World Bank, the US accounts for just 24%[iii] of Global GDP, yet Morningstar recently estimated that it represented about 75%[iv] of the assets in US Equity Funds. As a result of this, it is also one of, if not the most, competitive markets for investors looking to invest capital and generate above-average rates of return. We believe that this combination of deep sell-side analyst coverage, plentiful investor capital, and home country bias all result in making it significantly harder to find attractively valued opportunities.

We believe that there is merit in looking where others won’t or can’t. Having a wider area across which to cast our proverbial net, where there are fewer competing investors, allows us the possibility of finding opportunities overlooked by others – at valuations that may not reflect the persistent optimism that has been a feature of the US equity markets in recent years. A simple example of this is Arcos Dorados Holdings, Inc. (“Arcos”)– the master franchisee for McDonalds in Latin America and the Caribbean. While it has many of the same strong brand assets of the American listed analogue and more attractive long-term growth characteristics, it still trades at a significant discount relative to the US-listed company (Arcos trades at a P/E multiple of less than half that of McDonalds Corp.[v]). Additionally, while US-listed McDonalds Corp. has a global footprint, the faster-growing segments of that footprint are outweighed by its significantly larger exposure to slower-growing developed markets – such as the US – which substantially dilutes the exposure to other regions. In our opinion Arcos is a more attractive prospect for investors even though it is not US domiciled, providing – in our opinion – a similar core business but with a more concentrated exposure to a high-growth region.

Additionally, aside from the prices being potentially more attractive outside of the US, while the US is home to many of what are perceived to be the world’s best companies, it certainly does not have a monopoly on them. Many of the world’s best businesses are in fact headquartered outside of the US, with business models and brands that have stood the test of time and have existed for many decades in some cases. However, over the past decade the “best” businesses have been more narrowly defined to be those perceived to have good “quality” (e.g. growth potential, brand names, technological disruption). In our opinion, investors have cared less about the price that they have paid for these businesses, as long as the “quality” was perceived to be there. This has been in context of a long period of low/zero interest rates. Should the environment change to one with some more inflation and higher interest rates, the price paid for things might once again matter, not just the “quality.”

Potential for Better Portfolios

While international markets, and especially emerging markets, are perceived to be individually more risky and volatile than the US market, there are significant benefits that investors may get from allocating part of their portfolios outside of the US. While multinational companies domiciled in the US may have exposure to revenues in varied markets around the world, the US stock market tends to trade in a highly correlated manner – especially in times of exuberance or fear. Investing in stocks listed across multiple different geographies around the world has historically provided diversification benefits to a portfolio. Additionally, a portfolio allocated to a variety of securities around the world, with differing business models, regulatory regimes, and currencies may provide additional diversification benefits.

Looking forward, a significant amount of growth is expected to come from emerging markets, where approximately 85% of the world’s population lives and which has some of the strongest demographic characteristics. There are massive transformations occurring in these countries that are creating immense new opportunities as people shift from subsistence to entering the middle class and transition from survival to spending to directly improve their quality of life. While it is likely that many US-listed multinational companies will sell products to these billions of people, it is likely that locally established companies will be the ones that will capture the majority of the opportunity as it develops, despite their relatively discounted valuations. Restricting one’s investments to US companies may result in not having companies in the portfolio that will best capture this opportunity.

The events of 2022 have cast a strong light upon the need to secure the world’s sources of energy, showing in stark contrast the scarcity value of hard assets. While much attention has been paid to oil and gas in this regard, it is just as true – if not more so – for other natural resources. Many of the natural resources that will be needed to transition the world towards a zero-carbon future, as well as those needed to fuel it in the interim, are in countries outside of the US. While US multinationals may have some hand in many of these projects, a US-only portfolio will likely be missing exposure to many of the natural resources located in countries outside of the US.

Akin to the situation of natural resources that may be plentiful or only available in certain geographies, there are also many types of attractive industries and business models that exist exclusively outside of the US (unique businesses such as Saskatchewan Wheat Pool in Canada or ABB Grain in Australia). Artificially limiting one’s potential investment universe to just one country could result in missing these businesses wholesale.

Aside from the individual companies that will be missing from a US-only portfolio, it is also worth touching on the recent strength of the US Dollar, which has performed very strongly in recent years, providing a strong headwind for those investing in foreign-denominated securities. While the US Dollar has largely moved in one direction – hitting a two-decade high[vi] in September 2022 – there are likely diversification benefits to a portfolio that has exposure to a wider array of currencies than just one, blunting any potential dollar underperformance.

Not Without Challenges

While the benefits of investing internationally are many, in our opinion, it can also be fraught with challenges. This is why it may be better for most investors to outsource this portion of the portfolio to an active manager. Regulation and norms vary significantly across markets – what may be acceptable in one market may be frowned upon in another. Knowledge of the regulatory, political, and accounting aspects of every single country one invests in is important. Additionally, investing outside of the US tends to cost more. There are costs to opening and maintaining the accounts across the various countries in which one may seek to invest.

Lastly, in our opinion it is important to look beyond broad indexes and ETFs. What at first glance may be largely believed to be broadly-diversified indices may turn out to be considerably less so the more an investor learns what is contained within an index. One example is the MSCI All-Country World Index, which is a very widely-used global index including both emerging and developed markets and covering 85% of the global investable opportunity set. While perceived as a well diversified global index, it likely has more US-listed large cap tech companies than most people realize. To wit, of the top ten securities in the index, investors might be surprised to learn that as of November 30, 2022, none of the top ten are Non-US companies and seven of the top ten are what the market would generally consider to be technology companies. The index, which is capitalization-weighted, reflects what has worked well in recent years, namely US-listed large cap technology companies. In fact, the dominance of these companies in the index has grown significantly, with the Information Technology sector now representing 20.8% of the index – and this excludes companies that are widely-viewed as tech companies, but are not categorized as such (Amazon, Alphabet, Meta, Tencent, and Tesla, among others). This concentration has been one of the largest drivers of the index’s decline thus far in 2022.

In short, gaining exposure to international markets through US-listed companies is a lot like visiting Las Vegas. Yes, you can say that you have been to the Venetian – but you have not wandered along the Grand Canal; you have been to the Luxor – but you have not seen the wonder that is the pyramids; and you may have visited New York, New York – but the view looks quite different from the top of the real Empire State Building. Which is just to say, it is a proxy, but not the real thing. And, in our view, a cheap imitation in many respects except its relatively expensive current valuation.

Moerus Capital Management LLC, founded in 2015, is an investment management firm offering investment products to institutions, financial intermediaries, and individuals. Through our fundamental, value-oriented investment process we aim to buy securities of predominantly well financed companies that trade at substantial discounts to our conservative estimates of intrinsic value. Our portfolios are unconstrained by geographic, industry, or index considerations, resulting in portfolios that are built from the bottom up and based on the best absolute value opportunities currently available. We believe that this investing discipline provides investors with a unique portfolio, long-term price appreciation potential, and mitigated downside risks.

Any investments discussed in this letter are for illustrative purposes only and there is no assurance that Moerus Capital will make any investments with the same or similar characteristics as any investments presented. The investments are presented for discussion purposes only and are not a reliable indicator of the performance or investment profile of any client account. Further, you should not assume that any investments identified were or will be profitable or that any investment recommendations or that investment decisions we make in the future will be profitable. There is no guarantee that any investment will achieve its objectives, generate positive returns, or avoid losses.

THE INFORMATION IN THIS LETTER IS NOT AN OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY AN INTEREST IN ANY INVESTMENT FUND OR FOR THE PROVISION OF ANY INVESTMENT MANAGEMENT OR ADVISORY SERVICES. ANY SUCH OFFER OR SOLICITATION WILL BE MADE ONLY BY MEANS OF A CONFIDENTIAL PRIVATE OFFERING MEMORANDUM RELATING TO A PARTICULAR FUND OR INVESTMENT MANAGEMENT CONTRACT AND ONLY IN THOSE JURISDICTIONS WHERE PERMITTED BY LAW.

[i]Source: spglobal.com – as of 11/30/2022
[ii]i Source: msci.com – as of 11/30/2022
[iii]Source: World Bank
https://data.worldbank.org/indicator/NY.GDP.MKTP.CD?most_recent_value_desc=true
[iv]Source: Morningstar
https://www.morningstar.com/articles/1065413/you-probably-own-too-much-domestic-equity
[v]v Source: Bloomberg – as of 12/27/2022
[vi]Source: Reuters
https://www.reuters.com/markets/europe/dollar-ascendant-investors-gear-up-fed-2022-09-21/

MOI Global