Portfolio Management GQG versus MFG, page-9

Energy Stocks, EmergingMarkets Appeal to This Money Manager

By Reshma Kapadia

UpdatedOctober 23, 2021 / Original October 21, 2021

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Rajiv Jain has built his career on savvy stock-picking in globalmarkets, and a willingness to look different from other growth managers—andeven past versions of himself.

The approach helped Jain grow GQG Partners, which he co-founded in 2016after a successful run at Vontobel Asset Management, into a fund firm with almost $86 billion in assets. The $9.3 billion GQG Partners Emerging Markets Equity fund (ticker: GQGPX) that Jain lead-manages averaged a return of 17% over the past three years, beating 88% of its peers, while the Goldman Sachs GQG Partners International Opportunities fund (GSIMX) averaged a 15% return over that period, beating three-quarters of its peers. This year, it is up 11.5%, ahead of 95% of its peers.

Jain sees potential trouble ahead in shares of software companies. He’salso wary about the changes afoot in China, including a government crackdown onChina’s biggest companies, debt troubles in its property sector, and an energycrisis as the economy slows. In a recent conversation with Barron’s, Jain discussed how these concerns are shaping his portfolio, why he is investing more in emerging markets, and the opportunity he sees in foreign banks. An edited version follows.

Barron’s: What concerns youabout this market?

RajivJain: What is considered defensive today. It used to be the Coca-Colasand Nestlés. Today, it is some of the SaaS [software as a service] stocks,like Atlassian [TEAM] or Snowflake [SNOW], which are trading at more than 35 times forward revenue. We like Salesforce.com [CRM], which is still trading around eight times revenue, with high-teens revenue growth.

Paying a [high] valuation for a $10 billion company is very differentthan for a $100 billion company. Investors are extrapolating Amazon-likeexperience in way too many companies. That is the biggest risk, if we get evena slight tick up in interest rates.

Whatelse isn’t as defensive as it seems?

Look at companies in Europe that are growing 6% to 8% and trading at 30to 45 times earnings—like industrials Atlas Copco [ATCO.A.Sweden] and Sika [SIKA.Sweden]. Sika is a fantastic company, but margin expansion gets difficult from here, and they need larger acquisitions to move the needle.

LVMH Moët Hennessy Louis Vuitton [LVMH.France]has grown earnings per share at an average of around 10% over the past decade—avery good decade in China and for world travel. It’s really an 8% to 9%earnings-per-share growth [stock] at best from here, and trading at around 30times forward earnings. It could easily go back to 18 to 20 times earnings,especially in a slowing-growth environment, as China begins to crack down onconspicuous consumption.

“Growth at any valuation” has done well over the past decade, and thatcould change with rising rates.

Muchof your portfolio reflects a bet on a recovering economy. What is driving youroptimism?

We are more upbeat than the consensus [about global growth]. There’s anunderlying resilience. Consumer balance sheets in the U.S., France, Spain, andeven emerging markets are in good shape. It doesn’t have to be a very strongrecovery, just gradual—but faster than the past nine to 10 years.

From a global GDP perspective, 2015 was a worse year than 2008 as Chinaslowed down, emerging markets struggled, and Europe was coming through itsbanking crisis. The rest of the world is coming out of subpar growth. We areseeing that in earnings from banks, steel companies, and construction companiesin a host of emerging markets and in Europe.

Whichcompanies will benefit?

European banks are seeing strong earnings revisions, so valuation may belower than what meets the eye. Take Crédit Agricole [CRARY]. French loan growth is up mid-single digits, offsetting interest-rate pressures. The French consumer is flush with savings, and lending is positioned to revamp as the economy rebounds. The bank is also well diversified with Amundi asset management, second in market share in Europe after BlackRock and an underappreciated asset, as well as insurance and wealth management, which is driving fee-income strength. The stock is trading well below book value, at roughly 60 cents to the dollar.

Howelse are you thinking about your portfolio?

We like Microsoft [MSFT] and Alphabet [GOOGL]. Everyone owns them, but they are not that expensive. It’s one level down where [multiples have gone up fast]—for companies thought of as the next Amazon.com [AMZN], like Sea Ltd. [SE]. The Asian e-commerce and gaming company is now expanding into Latin America and even Poland. With a market cap of almost $200 billion, and roughly 14 times forward revenue, the math gets hard.

Wheredoes the math look better?

Some of the large-cap energy stocks are remarkably cheap—assuming noenergy crisis. Free-cash-flow generation is good at $65 oil. Exxon Mobil [XOM] is the best integrated operator with prime oil acreage globally. Its Guyana [offshore oil] project is one of the most compelling long-cycle projects, with peak production totaling more than half of current Exxon production.

Exxon offers a 6% dividend yield and a 10% 2021 free-cash-flow yield.Free cash flow could compound at an annual rate of about 10% over the next fouryears, driven by an assumed recovery of oil prices to $80 a barrel and anormalization in refining and chemical margins.

Chinahas reined in big companies like Alibaba Group Holding [BABA] and Tencent Holdings [700.HongKong]. What lies ahead?

The focus [for investors] has to shift from some of these largee-commerce companies. If you believe, as we do, that we are in the early stages[of the government’s crackdown and shift in investors’ sentiment], there willbe fewer winners and more losers, which are widely owned. Some of thestate-owned enterprises will be winners—and those generally aren’t liked byforeign investors. That will be the seismic shift in the market.

Whatis an example?

China Merchants Bank [CIHKY],which trades at 10 times earnings. That’s much more expensive than the typicalChinese bank, but it is a high-quality bank with a long, successful trackrecord and industry-leading profitability metrics. It had a head start inretail banking, and used the first-mover advantage to build the country’s bestretail franchise and wealth management business. Currently, retail loansaccount for 56% of total loans, and the loan book tends to be lower-risk,thanks to the company’s underwriting capabilities and also because mortgagesaccount for nearly half the retail loans.

Howwill China Evergrande Group’s [3333.HongKong] troubles and those of the broader property market affect the bank?

China Merchants’ direct exposure to property-related developments is7.5% of its loan book, and the latest nonperforming loans in this sector areabout 1%. The bank has provisioning levels in excess of 400%, which gives uscomfort that it will be able to manage stresses in the property sector.

Whatimpact do you see on the economy from Evergrande’s implosion?

If you talk to local bond investors, they seem sanguine that this isbeing taken care of. It’s well discounted. It’s not the first time we areseeing large players go under and manage. [Evergrande’s problems] are a directresult of Beijing’s three-red-lines policy for developers from a year ago. [Itcreated new financial thresholds for developers as a way to tackle debtproblems.] From a system perspective, it’s a good thing, not a bad thing. Thebigger issue is the brewing energy crisis.

China has been rationing energy, forcing factories to shut down. How isthis going to affect other global companies?

It’s affecting commodities and supply chains as we see power cuts to alot of key industries. I don’t think markets are fully incorporating that. Thatmakes tight supply chains tighter, and the potential for “transitory inflation”to last longer.

What’sthe outlook for emerging markets?

Our exposure to emerging markets in our global fund is on the high sideversus history, but less heavy in large-cap Chinese technology stocks. We havealmost the same exposure to Brazil, Russia, India, and China—that hasn’thappened in a long time.

Chinese earnings estimates have gone down while Brazil and Russiaestimates have gone up sharply. Who is the biggest beneficiary of energyprices? Russia. Over the past 20 years, which market has done better: MSCIRussia or MSCI China? The math is very powerful in Russia because of thedividend yields with companies like Sberbank [SBRCY], which yields 8%.

LatinAmerica has been ignored for years. Is it attractive now?

We are upbeat on Brazil. Credit growth has picked up sharply since lastsummer and LatAm steel demand is higher than in 2019. This is coming after adrought of six to seven years of credit growth. We like Itau Unibanco Holding [ITUB] a lot. Loan growth is picking up, and valuations are attractive for a very high-quality franchise.

India’sSensex is up 26% this year. Is there still an opportunity there?

The initial move has been toward the usual suspects—the IT services andprivate-sector banks. But state-owned banks like State Bank of India [500112.India], which we own, and domestically focused businesses with more cyclicality, are seeing a revival after a long time. It feels like the beginning of a meaningful capex cycle, similar to what happened in 2002 and 2003.

Thanks,Rajiv.