How should we be thinking about politics and the impact of elections in countries like India, France, and the UK?
Elections are part of the landscape in international investing. Every country has them; they are on different frequencies, and sometimes, they can be very significant. Like all macro events, you have to devote time up front to dig in and see what the critical issues could be and whether the impact will be permanent. Tax changes, for instance, come to mind with elections. Developed democracies are very institutionalized, so the degree of freedom to make radical changes is somewhat limited. You have to be disciplined in your risk assessment of developing countries, however, because you can have an outsized interest or impact there. We are confident in our process. We’re focusing on the best companies, and we have mechanisms, such as our portfolio construction framework, that help us deal with the ebbs and flows and the ups and downs of volatility in the international sphere.
We’ve seen a policy divergence among foreign central banks. The European Central Bank, among others, has been able to cut rates, while the U.S. Fed has signaled higher for longer. How are you thinking about interest rates as you allocate in these markets?
I learned early in my career that money is a commodity whose price is set in the U.S. So, when you talk about central banks becoming out of sync with U.S. monetary policy, which itself is changing and surprising at times, the usual implication is that it will have an impact on the currency. And sure enough, for the countries cutting ahead of the Fed, there has been some weakness in those currencies. We take into account all of the macro considerations when we build our company models. There will be instances where a movement in the currency could help certain industries and companies and do the exact opposite for others. You have to take it company by company and not paint with a broad stroke, whether the impact is negative or positive.
Japanese stocks have done well over the past year and a half. Do you think the changes we’ve seen in policy and management philosophy have made a lasting impact on these stocks?
I’ve seen this story play out at least twice, so call me skeptical. But there are reasons to believe this could be one of those rare circumstances where this time is different. First, since pre-COVID, over the last three or four years, management at over 50% of the index companies has transitioned to a younger generation. So, there is some optimism in a new outlook for these companies. Second, I think of the elements of accountability. The Tokyo Stock Exchange has embedded some of its policy direction with listing requirements, so there could be consequences for companies that don’t follow that direction. Those are two concrete reasons to think we will get more traction in focusing companies on maximizing profitability and becoming more shareholder-friendly.
How does the team feel about emerging markets right now? And then, specifically, China?
What’s unique about emerging markets is that they are not a single region. It’s an eclectic collection of all the markets beyond the original list of investable markets, so you can’t describe it generically. There are many nuances, but structurally, we think of emerging markets in terms of tiers. We’re interested in globally competitive franchise companies, and in my experience, those types of companies will come from top-tier countries like Korea, Taiwan, India, Brazil, Mexico, and China. Put aside tier two and tier three, the frontier, which is much more speculative and does not tend to fit with our focus on world-caliber blue chip companies.
Within that top tier, you must be familiar with what’s happening in the different major markets. China, for instance, is in a complicated situation. Politics have had an impact. The regulatory regime has been focused more on control and power and less on maximizing stock prices. The market has seen a significant decompression of valuations over the last couple of years. That has really de-risked a lot of the macro concerns. Whether it be Japan, emerging markets, or countries like China, our focus is on the companies, finding the best, and zeroing in on them. We look for companies that can grow faster and are more profitable than their competition, have a strong balance sheet, and have the wherewithal to handle any turbulence in the macro environment, whether elections, central bank changes, or any of the peculiar aspects of various countries.
Now, are the much lower valuations warranted? Yes. We constantly build layer after layer of additional risk premia to handle the risk we perceive. If a company’s fundamentals clear those hurdles and we have strong conviction, that company and stock can win its place in the portfolio.