Contrarian Approach to Growth Pays Off
Morningstar 2012 International-Stock Fund Manager of the Year Rajiv Jain expects continued earnings growth for the less popular growth stories of tobacco and Indian consumer stocks.
Gregg Wolper: Hello. I am Gregg Wolper of Morningstar, and I am here with Rajiv Jain of Vontobel Asset Management. He has just been named Morningstar's Manager of the Year for International-Equity Funds. He is here to talk about those funds and his strategy, but first I'll tell you the funds that he runs. He runs several Virtus funds here in the United States the most noteworthy being Virtus Foreign Opportunities and Virtus Emerging Markets Opportunities. He also runs some funds that are offered in Europe under the Vontobel name. First, I would say congratulations, Rajiv, for your victory in this award.
Rajiv Jain: Thank you. Thanks a lot.
Wolper: You're welcome, and thanks for joining us today.
Jain: My pleasure.
Wolper: I think one thing that people might be interested in is the fact that, as we've spoken, you have said you're a growth manager. You're interested in growth, even though that's not on the label of the fund. These are growth funds and their portfolios do show up consistently in the growth area of the Morningstar Style Box. Yet, if you look at the top of the portfolio, you see tobacco companies, banks, some companies that people don't necessarily associate with rapid growth or an aggressive growth strategy. How do you think of it this way? How does the strategy play out and still be a growth strategy?
Jain: That's a good question and an important question because I've always felt that growth for the sake of growth can actually be not a sustainable strategy. And that's why if you look at growth managers, typically in down markets they get taken out. And we feel that valuation is a critical part of growth.
The second thing is capital discipline in terms of how much capital can we get back. So, for tobacco names, it is a growth industry from an earnings-per-share perspective because of the share buyback and the pricing power that they have. And the banks we feel that at this point--and as you know, we did not own banks for five odd years. We had no European bank except HSBC for almost five years. But now, at this point, last summer especially we've felt that there is a lot of capital which can be released from these. There is a lot of cost-cutting and so forth, so even if the economy is not doing well, we should be able to get a lot of capital back. So, that's kind of how the process works.
Wolper: You mentioned banks. One of the things that helped the fund survive very well better than most other funds during the financial crisis, 2008 in particular, was your lack of European banks. You didn't trust their numbers or you just weren't that confident in them. It's been a long time now. I know you haven't had many of them traditionally, and maybe we could speak differently. You mentioned HSBC; there's banks based in Great Britain and the ones that focus on emerging markets, and then there are the eurozone banks. I am curious, have you found attractive banks in the eurozone or in, let's say, continental Europe, or is it still too early for those?
Jain: Yes, we feel that they are still a little bit on the earlier side. So, our exposure is pretty much to UBS and then a couple of banks in U.K.
Wolper: What do you like about UBS in particular?
Jain: UBS, what we like is, again, their decision to cut back on investment banking, which we feel was a long time coming. If you look at the other businesses, they generate a lot of free capital. I mean, if you look at asset management, for example, they hardly deploy $2 billion worth of capital for $2 trillion of assets that they manage. So, these are very capital-light businesses. They are already one of the best capitalized banks in the world now, and we feel comfortable that the regulatory agencies that oversee them should keep them well-behaved.
Now, looking at the LIBOR scandal lately, we'll have to see what comes out of it, but that we feel is kind of history. It doesn't reflect on what possibly UBS has to offer.
Wolper: When people look at your funds, one of the most noteworthy aspects is a high exposure to India compared with other funds. For your emerging-markets fund [the allocation is] particularly high; I think it's over 25% of the fund.
Wolper: That's a lot even compared with other emerging-markets funds, versus the indexes. In the Foreign Opportunities fund, it's not that high, but compared with other broad foreign funds, it's quite high. I'm curious why you have that exposure to India and by contrast you have less China [exposure] than most funds. So, what explains that?
Jain: Well, if you look at the China-India story, we feel that it's a function of what companies are being offered. So, you can get ITC, which is a tobacco monopoly in India, and Hindustan Unilever, which has done well--it's been around for over 120 odd years in India--you cannot find any companies of that nature in China, right? You get state-owned enterprises, and banks where the government intervention is rampant. That is a big deciding factor.
Now, in case of India, we feel there is a big consumption story which will be with us for a long time; that is not well-appreciated. And even in a year like 2011, when India was one of the worst-performing markets, the reason why we lost 2% versus the average emerging markets losing 20% was actually [the fact that] India and Brazil helped us quite a bit, and they were the worst-performing markets. So, we only have a handful of names in India. They are all consumption indirectly or directly, and we feel that's a long-term story. It's not a short-term story. That is very, very powerful.
Wolper: But there is a lot of concern over India's infrastructure, government corruption, and just the difficulty of doing business in India. I know that for some multinationals, they love to go in there, and they have difficulty going in there. Does that bother you at all, those other aspects with the domestic India companies?
Jain: Well, it does bother me. However, if you look at the companies that we own, the barriers to entry are actually higher because of that. Competition can't come in there easily. So, ITC has been operating for over 100 years. Procter & Gamble has a much tougher time going to fast-moving consumer goods, whereas ITC has been able to break in within six to seven years because they already had big distribution. And for setting up consumer goods, you don't need infrastructure.
So, actually one of issues why people have had problems in India is they always look at gross domestic product and what the government can do in infrastructure. What infrastructure do you really need to run a bank? You don't care about roads and stuff, and we feel that's where the real opportunity is. And we have actually had no property exposure or exposure to infrastructure, which is why we have actually done very well in India long term.
Wolper: You mentioned ITC, the Indian tobacco company. You also have, I think, British American Tobacco and other tobacco companies in the Foreign Opportunities fund.
Wolper: That's another area where people might question and say, "Isn't the long-term prognosis for tobacco not a growth area? Fewer people are smoking, even in Europe where smoking used to be so widely accepted; there are restrictions." How do you see tobacco as a growth area?
Jain: I think, first of all, if you look at the last 20 years, one of the fastest-growing sectors in Europe has been tobacco on an EPS level. The reason is because they are very good capital allocators. They buy back a lot of stock. The second thing is smoking is not growing as such. People are not smoking more, they are smoking less. However, there's a significant pricing power.
If you look at Philip Morris, for example, they've given back to their shareholders almost 25% of the company, dividend plus share buyback, over the last four years. Now that's four years, one of the worst recessions since the Great Depression, right?
So, these guys throw off a lot of free cash. You don't need volume growth. They're pricing at 7% to 8%, and all of that goes back to shareholders. The second thing is pricing power, which allows them to manage their destiny better, which even if you look at British American Tobacco, they've grown earnings per share in the midteens over the last 15 years. There are not many companies of that size which can say they have grown earnings per share at that rate.
Wolper: That's mostly based on raising prices rather than expanding volume.
Wolper: I see.
Jain: And the question is, "Will these companies be around in 50 years?" Probably not, but at the rate they are buying back stock, they probably won't be around in 20 years anyway.
Wolper: I see. I have one last question about the emerging-markets fund. We talked about India and how in contrast you don't find Chinese companies as attractive. And I think you had said to me in the past that the same applies to Russia, you don't find that many attractive companies there. So, for our viewers, where else in the emerging markets are you finding attractive companies besides India?
Jain: Well, we have found a lot of opportunities in Mexico lately, and we are active managers. So, if you look at Brazil, a year-and-a-half ago, we had 25% in Brazil because we like a lot of utilities there. They have very predictable growth, but because of whole bunch of things, valuations specifically, and regulatory problems, our exposure has gone down. So we're now 8% in Brazil from 25% a year-and-a-half ago. However, in Mexico, we are now 15% to 16%.
Then in China, we have exposure in Macau. We like the casinos quite a bit. Then Tsingtao, which is a beer company in China, we like quite a bit; so we do have China exposure. [We have exposure to] Indonesia; we're increasing exposure to Malaysia and Thailand. We feel those are not as appreciated. They have done well, but we feel there's a quite bit of opportunities. So, yes, there are plenty of opportunities outside India. India is 25% [of the fund's portfolio], but 75% is outside India.
Wolper: That's very interesting. I hope everyone enjoyed it, and thank you again for stopping by and speaking with us. And again, congratulations on winning the Manager of the Year award.
Jain: Thank you. Thanks for having me.
Gregg Wolper does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.