Keeping a cool head

Natasha de Teran talks to Jacob Rees-Mogg about the role of the emerging market fund manager during the recent troubled times for global markets

This year emerging market funds have seen unprecedented inflows of new capital. Better still, they have – by and large – lived up to expectations, offering above-average returns. In the nine months to the end of September the global emerging equity funds monitored by research firm Emerging Portfolio had returned 33 per cent.

One of the higher-profile fund managers to charter these waters is Jacob Rees-Mogg, who heads Lloyd George Management’s Global Emerging Market operations. Rees-Mogg had originally trained as an investment manager at J Rothschild before moving to Hong Kong to join Lloyd George Management in 1993, where he focused on Asia. He returned to London in 1996, where he manages a number of emerging markets account including LG Emerging Markets Funds.

The fund launched in November 2002, and until September 2003 returned 28.8 per cent, outperforming the MSCI EM Free index by 4.5 per cent. This year the fund has fared less well, although returns have been positive: the fund is up 14.9 per cent YTD, compared to the MSCI index, which is up 18.3 per cent.

Accounting for the less than stellar performance this year, Rees Mogg is phlegmatic. He says: “We tend not to do brilliantly when markets are leaping up – as we aim for steady growth rather than spurts.”
Investment strategy

The investment strategy adopted by Rees-Mogg is to run core portfolios, focusing on solidly performing stocks. While his fund tends to outperform in weaker or steady markets, it loses out on the short-term bounces that weaker stocks enjoy in times of upturn. He adds: “We don’t want to put the bulk of our assets into high-risk stocks, and are happy to miss out on these. EM stocks are high-risk, and I believe you can run a better fund if you put the emphasis on being cautious. It is more important not to lose money than to follow every opportunity.”

The cautious attitude revealed above is consistent with the entire way the fund is run. Rees-Mogg admits he doesn’t advocate an active trading approach, and prefers to focus on a small portfolio of 40–45 stocks at any one time. The top ten stocks account for 35 per cent of the fund; they change rarely, and mostly when share price movements bump the allocations around.

Teamwork

Rees-Mogg works with Edward Robertson, the fund’s co-manager, who specialises in Russia and emerging Europe, as well as with a team of country and stock experts spanning Europe, Asia and the Americas. The investment process is both top-down and bottom-up, and detailed first-hand research is integral to his portfolio strategy. The network of LG analysts, with whom he communicates daily, is responsible for producing company-specific research and carries out more than 400 on-site company visits a year, seeing almost every company in which he invests. Individual stocks are screened for their attractiveness based on market capitalisation (minimum $250m), the liquidity and availability of free float, and knowledge of the company and its management, as well as on more quantitative measures such as the P/E ratio, price-to-book value and return on equity.

One of the key attributes necessary in an EM fund manager is a cool head: allocating funds to economies that have repeatedly thrown up unwelcome problems is not for the faint-hearted. One recent hiccup among EM countries has been in Russia, where Putin’s strong-arm tactics against Mikhail Khodorkovsky, the former Yukos chief executive, have unsettled the markets. Despite the sell-off that hit the market since Khodorkovsky’s arrest, Rees-Mogg professes to be “more than happy” with his 11 per cent allocation to Russia. The arrest caused a 15 per cent fall in the entire Russian market in a week – with a 22 per cent drop in Yukos shares. He adds: “We believe that this is really a political issue, that it will soon be sorted out, and that markets will recover well.”

The Far East

China is one of Rees-Mogg’s favoured investments. More sceptical investors have made much of the possibility that a good percentage of the country’s strong performance owes itself to the yuan’s artificially low currency pegging against the dollar. Both economists and the US authorities have been arguing for a revaluation, which could serve to erode some of China’s growth, but so far the Chinese have held out – even against a backdrop of rampant speculation in the currency markets. Rees-Mogg is confident that either way the investments will work out well.

“We are already positive on China, but even if the yuan were to be revalued we believe it would present a very good buying opportunity. China has a huge surplus with the US, and a deficit with the rest of Asia. If there was appreciation of currency, you would get a 20 per cent cut in import and labour costs from the rest of Asia and the only rises would be in domestic costs. Because pressures on the domestic labour market are low, wages would not suffer from upward pressure. The markets would probably react badly initially, but fundamentals are good, and companies would perform well thereafter.”

Another country currently much in vogue with EM investors is Korea, where Rees-Mogg is underweight compared to the benchmark indices. His rationale for this is again clear. He says: “We are in Korea very much on a stock-selection basis. When I was in Asia I specialised in Korea and know the country well. There is only one stock usually held in EM indices and portfolios, which we don’t have, and that is Samsung Electronics. We prefer not to hold it because we are concerned that it has never issued an ADR. This is not a problem in itself, but because the firm has lots of subsidiaries it is very difficult to know whether you are getting full accounts. Their not having issued an ADR does not inspire confidence in the published versions.” Samsung Electronics accounts for 7 per cent of the MSCI index, leaving Rees-Mogg in a minority of one in his opinion, but highlighting the actively managed approach adopted by his fund: his index-tracking brethren would never be so bold.

India and emerging Europe

Elsewhere he is equally independent, favouring India, which has an 11 per cent weighting in the fund – double the MSCI’s allocation to the country. In India he admits to relying “very heavily” on his research colleagues, who have done a “very good job” in identifying buying opportunities. Here he has favoured motor manufacturers, which have performed well on the back of the recent improvements to the country’s notoriously haphazard road infrastructure.

In emerging Europe he and his colleague Robertson have looked to the tiny and much ignored Estonia, which despite its imminent EU accession still has a very low GDP per capita ratio, meaning that it will be held in EM portfolios for some time yet. In Estonia he applauds the high levels of corporate governance and the stable economy, both of which help to stem the unwelcome surprises prevalent in less monitored economies.

Argentina, one of the potential come-back vehicles favoured by more foolhardy investors, is still off Rees-Mogg’s radar. LG’s longer-standing EM funds had sold out of Argentina well ahead of the country’s melt-down in early 2001, and he sees no reason for returning yet. Despite the bullishness of some of his contemporaries, his approach to the economy is characteristically cautious – a sensible if unsexy approach to a country whose stock market is rallying even while the status of its outstanding debt remains unclear.