Reprinted from Money Show.com interview with Paul Goodwin August 25, 2008:
Emerging markets have been beaten up in the last few months and this Russia/Georgia conflict, unfortunately, points out one of the problems with investing internationally—the uncertainty of government and political actions. Would you please share your thoughts on the precautions that investors in emerging market issues should take to protect themselves from adverse consequences to their portfolios from such actions?
Of course every investor should follow the usual advice that all investors know by heart. Diversify your portfolio among different asset classes, including bonds, value stocks, income stocks and growth stocks. Avoid overexposure to any one sector or industry, no matter how hot.
But the Cabot approach to growth investing has two additional rules that are especially appropriate for aggressive growth investors. The first is to use a strict loss limit of 15% (in difficult markets) or 20% (in supportive markets). If you routinely sell any stock that falls 15% from your purchase price, you will avoid the huge losses that can sap portfolio performance for months. The second rule is to always be prepared to exit the equity markets and go to cash when the general trend of the market is against you. When the major indexes fall below their 50-day moving averages, for instance, the savvy investor knows the value of getting out of stocks and into cash.
What is your opinion on investing in frontier markets? Are there any, in particular, that you like, and which ones would you not invest in at this time?
For most investors, frontier markets are too chaotic to allow intelligent investing. Risk and reward always go hand in hand, and when you can’t get a meaningful handle on controlling risk, you’re not investing, you’re gambling. Frontier markets can turn in tempting results, but Cabot prefers the risk-controlling effects of investing only in stocks that trade on U.S. exchanges as ADRs. Knowing that the company you’re investing in has to meet the reporting standards of a major U.S. exchange offers a meaningful benefit.
We don’t rule out the possibility of investing in a particular frontier-market stock, but collective investing in frontier mutual funds, derivatives or index funds is the equivalent of rolling the dice.
Should investors look at global investing from a top-down approach, country, sector and then stock? Or should they be more concerned with the company’s fundamentals, and pay less attention to the macro factors?
Cabot China & Emerging Markets Report uses a SNaC approach to stocks. We want to find equities that have excellent stories (S), supportive fundamental numbers (N) and technically strong charts (C). A stock that has all three will always be a better bet than a pure story stock, fundamental stock or stock with a technically attractive chart. Demanding strength in all three mandates a bottom-up, stock-by-stock approach, regardless of country.
What percentage of their portfolios would you recommend that investors allocate to global issues?
Portfolio construction is something investors should discuss with their financial advisors. There are no blanket allocation rules that work for everyone. With that said, however, we think it’s appropriate for a properly diversified portfolio to allocate up to 10% of its equity component to emerging market stocks.
A commentator recently said that after the Olympics, Beijing and Shanghai were going to be passé as far as investors are concerned. Instead, they would be looking further afield in China. What are your thoughts about the investment potential in other regions, in China? Do you have any favorite sectors?
If you confine yourself to investing in ADRs, which we regard as a prudent risk-control step, then city, province, even country becomes less of an issue. When I’m selecting a new stock to recommend, I screen the entire universe of emerging market ADRs. Not just China, not just BRIC stocks, but everything from Turkey to Peru to South Korea. My favored sector is the one that has the strongest stocks. That means I don’t have to try to guess what the market will be favoring in six months. I know what it’s doing now.
What are a couple of your favorite emerging markets investments?
In China, I think Sohu.com (SOHU) is a very strong company with great earnings (up 410% year-over-year in Q2) and a dominant position in the Chinese Internet world. As the favorite web portal for Chinese Internet users, Sohu offers a sticky confection of news, games, a dozens of specialized group sites that keep users online (and clicking on ads). Once China emerges from its recent swoon, SOHU will be an attractive proposition.
In Brazil, I think Gafisa (GFA), a national homebuilder, will be a winner when the country emerges from its interest-rate tightening cycle. Demand for housing is high in Brazil, and Gafisa’s large inventory of land suitable for development is among the nation’s largest. It may take some time for the Brazilian market to get back onto a growth wave, but when it does, Gafisa will be a big winner.
Would you comment on the recent dismal performance of emerging markets amid rapidly rising inflation and a slowdown in developed countries’ economies, and whether you think the story is over—for the most part—for at least the next couple of years in these markets?
One of the most important rules of the Cabot approach to growth investing is to resist the temptation to try to predict the future. The best results come from sticking to what you know, and all we can really know is what has actually happened. Our market timing indicators trail the market, they don’t lead it.
But with all that said, one major truism that individual investors always forget is that markets bottom when the news is worst. By definition, the moment the last discouraged investor finally gives up and sells his last stock is the moment the market begins to turn up. I don’t know when that will happen, or if it has already happened, but I can read the numbers that show how steeply both emerging and developed markets have already corrected. This is exactly the kind of discouraging, hope-squashing environment that provides the seed bed for the bright future.
Link to interview on moneyshow.com
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