Paul Espinosa of Seafarer Capital Partners says there’s an open field for value strategies in developing economies
Water is released from the Three Gorges Dam, a gigantic hydropower project on the Yangtze River in central China. The dam is operated by China Yangtze Power Co.
Most investors playing emerging markets are looking for rapid growth, but Paul Espinosa, a fund manager with Seafarer Capital Partners in Larkspur, Calif., believes emerging markets are also “a more fertile ground for finding value than developed markets.”
When you think of emerging-market investing and the mutual funds and ETFs that specialize in emerging markets, you’re probably focused on the explosive growth of the mobile web and what that means to providers of internet retail and related services, such as Alibaba Group Holding Ltd. BABA, +0.52% No surprise there, but Espinosa, who is the lead portfolio manager of the Seafarer Overseas Value FundSFVLX, +0.25% said plenty of value can be found in “old-fashioned” business in developing economies, for several reasons:
• Stock markets in emerging economies are more volatile than in developed ones, making it easier to find stocks that are cheap relative to cash flow.
• Interest rates are not only more volatile in emerging markets but also higher, making the cost of capital higher for new or expanding businesses “so asset prices tend to be cheaper.”
• “There are few strategies pursuing EM, so it leaves the field more open for a value strategy.”
The Seafarer Overseas Value Fund is quite small, with $11 million in assets. It was established in May 2016. It has returned 20.3% over the past year, compared with 17.8% for the MSCI All Countries World Ex U.S. Index, and 21.4% for the entire Emerging Markets fund category, according to Morningstar.
Espinosa also co-manages the $2.5 billion Seafarer Growth and Income InvestorSFGIX, +0.16% which was launched in 2012 and has a five-year average return of 8%, compared with 4.5% for its fund category, through June 22, according to Morningstar. The fund has a five-star rating from Morningstar, but is closed to new retail investors.
Espinosa, who spoke with MarketWatch on June 23, gave two examples of value plays, based in part on his team’s analysis of companies’ cash flow and the use of cash, rather than just analyzing revenue and earnings:
Credito Real S.A.B. de C.V. CREAL, +1.85% is a new holding for the Seafarer Overseas Value Fund; shares were purchased during the first quarter. The Mexican company is a nonbank lender that specializes in making loans to government employees, and loans are repaid by withholding funds from the employees’ wages.
Here’s the price action, following Donald Trump’s election win on Nov. 8, that helped make the stock attractive to Espinosa:
Credito Real S.A.B. de C.V.Dec 16Jan 17Feb 17Mar 17Apr 17May 17Jun 17Source: Dow Jones Market Data
Espinosa said the shares were cheap not only because of Trump’s victory (following his announced plans to build a wall on the southern U.S. border as part of an effort to clamp down on illegal immigration), but because investors expected the company to pay more for its funding as interest rates rose.
“But as lending growth slows down in Mexico, this company is growing its loans and cash is going up on the balance sheet,” he said. Although Credito Real’s pace of loan growth has slowed, the cash accumulation means a lower cost of funding for future loans, which should bode well for further growth and even better cash flow down the line.
China Yangtze Power Co.
China Yangtze Power Co. 600900, +0.47% is a state-owned company that operates the Three Gorges Dam in China’s Hubei province. Espinosa said he had traveled to China to meet with the company’s management, and was impressed with their “coherent, logical and competent” answers to his questions.
He said it can be a challenge to find state-owned enterprises with strong management, but he is very confident in China Yangtze Power Co.’s team, not only because of the importance of the assets it manages, but because of the major anticorruption efforts of China’s government.
The shares have a dividend yield of about 5%, which is, of course, attractive to investors. Espinosa also said the company treats its shareholders well; dividend payments are about 70% of cash flow, with the rest being reinvested in the business.
As more dam projects are completed on the Yangtze River, they will be purchased and operated by China Yangtze Power Co., so there’s plenty growth expected over the years ahead, he said.
The fund’s holdings
Here’s the fund’s geographic breakdown as of March 31:
And here are the fund’s 10 largest equity holdings as of March 31: