Espinosa uses screens for seven categories of value in emerging markets to identify long-term investments. These categories are related to a company’s balance sheet and cash flows and include measures such as balance sheet liquidity (cash or highly liquid assets undervalued by the market) and a company’s breakup value (when its liquidation value exceeds its market capitalization).
“The seven categories try to define value in terms of their fundamental drivers and not just in terms of multiples, which I think is the problem with the traditional definition of value of low multiples. If you do that, you could fall into traps,” Espinosa says.
He incorporates these categories with other attributes of a company, such as the spread between its return on equity and cost of equity (or ROE-COE spread), along with a company’s resilience (which he defines as its ability to prolong the growth and income stage of its life cycle for a long period) and its global validation (the company’s proven ability to sustain and defend its source of value). Espinosa also seeks a valuation he believes is consistent with the targeted minimum long-term rate of return.
“I’m not pursuing countries or sectors; it’s really all about the companies,” Espinosa says, adding that he and his team compile a portfolio of companies that each have their own individual drivers. “In my opinion, diversifying across drivers of investment return gives you a better chance of performing through the cycle. I don’t care what factor is outperforming right now. I have my diversity of companies that will drive the investment return, and I think that adds value.”
Finding Gems
The end result is a multi-capitalization portfolio where mid-caps represented 38% of the holdings at the end of June, followed by a 32% weighting in large caps and 22% in small caps. (The remaining 9% was in cash and other assets.) Countries in East and South Asia made up 55% of the fund’s assets, while Latin America and the Middle East/Africa region were the next biggest weightings at 13% and 12%, respectively.
Beyond using his valuation screens to find potential portfolio candidates, Espinosa uncovers what he calls investing “gems” by traveling quarterly for roughly two weeks at a time to less-trafficked parts of the investment world, attending industry conferences and doing company visits. He sometimes finds well-run companies in unlikely places.
“There are good companies everywhere,” he says. “Many investors consider emerging markets or frontier markets as risky. That can be true in a general sense, but when you get into company specifics there are gems everywhere.”
But not all gems are investable. For example, he notes, there are some brewers in Africa he would’ve invested in but didn’t because their equities were too illiquid. But beer has universal appeal, and the Overseas Value Fund taps into that industry segment by investing in Anheuser-Busch InBev, a Belgium-based multinational brewing giant (the result of InBev’s acquisition of Anheuser-Busch in 2008), as well as its subsidiary, Brazilian brewer Ambev.
In a white paper from last September, Espinosa explained that his fund took a stake in Ambev after he and his team ascertained that its high ROE-COE spread provided a significant buffer to continue being profitable even if Brazil suffers a recession and the Brazilian real devalues.
In an interview, he explains that AB InBev and Ambev are different companies from a portfolio perspective because they bring different things to the table. AB InBev is levered, pays a low dividend and is a deleveraging story, while Ambev has net cash and pays a high dividend.
“They offer a diversity of the drivers of return,” Espinosa says. “I expect investment returns from both but they’ll do it differently—one from lowering debt and increasing the dividend, the other by increasing its volumes and margins due to investments in terms of changing how it operates.”
Espinosa offers that investors typically find value-oriented investments in efficient, developed markets by spotting some sort of trouble (without which a company likely wouldn’t be cheap in the first place). But in the emerging markets, he says, lots of well-run companies are undervalued simply because investors aren’t turning over enough rocks to find those gems.
“To me it’s easy pickings, and we haven’t had to pursue trouble to find value,” he says. “In our opinion, that market is mature enough where you can pursue other strategies that look at other factors, and you can get them at good prices because no one is pursuing them.”