March 9th, 2011
22. A Three Step Plan for Becoming a Global Value Investor – Step 1
The world’s tallest building is in Dubai, its largest phone company is in China, and its richest person is in Mexico. The twenty-first century—the first global century—has arrived much faster than anticipated and in a fairly stunning fashion. And it has caught many smart value investors flat-footed.
Confident, experienced investors are finding themselves on rapidly changing and increasingly unfamiliar terrain. Did Macau really surpass Las Vegas in revenues in just five years? Is Volkswagen really selling more cars in the BRIC countries than in the United States? Have a million Chinese really moved to Africa to develop natural resources?
Within this new global chaos are real challenges for the traditional value methodology. Sitting in New York, can you really go long in China? Isn’t getting accurate information a problem? Can you buy illiquid assets in Russia? Isn’t the absence of rule-of-law in many places a problem? What about the fact that there is often no real separation between commercial and government activities?
Most smart value investors with global ambitions look at China, India, Brazil, Russia, the GCC, and other places and are rightly cautious. They decide to avoid the perceived risks by avoiding the markets altogether. Or they limit themselves to short-term and liquid strategies. Or they try to invest in an indirect way, such buying European retailers with significant exposure to the emerging markets.
I suggest to the reader that successfully going global as an investor requires successfully going direct.
And it requires holding to Buffett’s most important lesson: that you accumulate wealth by targeting the most mispriced assets and going long. Market inefficiencies are your best targets and time is your best ally.
So for value investors seeking to go global, step one is to focus on going direct. And that means dealing with the five common “going global problems”:
Problem 1: Limited access to investments.
Most of the really mis-priced assets in developing economies are private. And these tend to be fairly tightly held – often by conglomerates, state-owned-enterprises and owner-managers. Even Warren Buffett was denied in his request to buy 25% of Shenzhen-based BYD (he ultimately got 10%). Getting access and limiting competition at the deal level is a primary problem when going global.
Problem 2: Increased uncertainty in the current intrinsic value
Most developing economies are characterized by increased uncertainties and instabilities. The markets and companies are evolving quickly (i.e., developing). Government actors are changing the rules. Information is limited and inaccurate. This all plays out in a greater uncertainty in the calculated intrinsic value.
Problem 3: Increased long-term uncertainty, including worries about instability
The previous problem becomes even larger over the long-term. Five years in India is a very long time in terms of new regulations. It is hard to value invest long-term if the future intrinsic value of your investment can change significantly. Long-term uncertainties (including long-tail risk) are a big problem and focusing on companies with a sustainable competitive advantage (i.e., Buffett’s approach) is usually not enough.
Problem 4: The availability of only weak or impractical claims against the target enterprise
Board seats and contracts can mean little in many of today’s rising markets. Minority shareholder rights even less. Keeping a strong claim to your asset over the long-term is a critical challenge. Note my previous blog on how to fleece a foreign investor out of their asset.
Problem 5: Foreigner disadvantages
This is the catch-all for the various challenges you face when entering a market as a foreigner. You often have less information. The rules can be written against you. There are language and cultural gaps. You are often far away. And so on. All these, and many more, manifest themselves as disadvantages when competing for deals.
I assert to the reader that none of these problems is getting smaller. They are, in fact, inherent characteristics of many rising economic systems that are fundamentally different that the Western rule-of-law democracies we are used to. Rule of law is not coming to China any time soon. Nor is the Russian government going to exit the private sector. Becoming a global investor means learning to manage, not avoid, these problems.
Having come to the end of almost ten years of investing between the developed and developing markets, I have found myself repeatedly returning to Graham’s writings. It is impressive to see how easily his methods can be re-applied to very different politico-economic environments. At the same time, I am an avid student of global investment deals, and I was fortunate enough to have worked for one of the leading practitioners.
My conclusion is that step one in going global is to solve these problems. If you can do this, then you can theoretically invest anywhere – and stay in accordance with well-established value investing principles. How do you adapt Graham and Buffett for a global age? Answering this question has become the central focus of my career.
In Step Two (my next blog), I will lay-out a framework for addressing them. Or, if you are feeling generous, you can buy my book here.