Emerging Markets: Why then, why now?

Ted Seides from Capital Allocators sits down with Daniel Graña, Emerging Market Equity Portfolio Manager, for a wide-ranging discussion on what led him to spend his career focused on emerging markets and why he believes the case for emerging markets investing is still strong.

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Ted Seides: I’m Ted Seides and this is Manager Meetings. This show is an exploration of investment opportunities through conversations with money managers conducted by one of the manager’s institutional clients. We’ll share the stories and strategies that attracted their attention and capital. You can learn more and join our mailing list at Capitalallocators.com.

Today’s episode of Manager Meetings is our first sponsored show with our friends at Janus Henderson Investors. I had the chance to speak with Daniel Graña, who’s responsible for Janus Henderson’s Emerging Markets Equity Strategy. Janus Henderson is a leading global asset manager with $400 billion under management. Our conversation covers some stories of the “Wild West” early days in emerging markets, Daniel’s strategy focusing on the intersection of good companies with good governance and good countries, portfolio construction, application of the process to China, benefits of aligning with a large organization when tackling emerging markets, and the case for emerging markets today. Please enjoy my conversation with Daniel Graña from Janus Henderson. Daniel, thanks so much for joining me.

Daniel Graña: Thank you very much for having us.

Seides: I’d love for you to take me back to where your interest and engagement in emerging markets started.

Graña: My grandfather’s chain of neighborhood hardware stores in Cuba were nationalized after the Cuban Revolution. My father’s two brothers became communists and denounced the family as counter revolutionaries, which made life very uncomfortable for the rest of the family. My mother left failing Peru and I married a Soviet refugee whose family suffered from religious persecution. So as you could appreciate, I’ve always been fascinated why some countries fail their people whereas others did not and that led me to spend my entire professional career in emerging markets.

Seides: Where did that start, your professional career?

Graña: Sure. So I worked in investment banking, which is working for the dark side, bringing a lot of these Latin American companies public, helping governments to raise sovereign debt. And what I learned from that experience is really crucial to understand the controlling shareholders’ motivations because in emerging markets, the vast majority of companies have a controlling shareholder, whether it’s the state or a family. Acceptable business practices in emerging markets are very different and I could give you an example: The Mexican glass bottle wars. 25 or 30 years ago, a Pepsi bottler, new shareholder to the company, managed to gain majority share of the carbonated soft drink market in Mexico City area over Coke. That, of course, is unheard of, unbelievable. But the way he did it was very emerging markets. He painted these Pepsi trucks with the Coke insignia, circled around all the mom-and-pop shops. At the time in Mexico, a lot of these drinks were sold in mom-and-pop shops and convenience stores and they were using glass, not plastic. And so he would go around and collect these glass bottles and smash them. Coke of course, expecting these glass bottles to come back to be able to sort of wash them and refill them and send them out again, didn’t know what was happening. And he managed to put his Pepsi bottles on the shelves and gain market share. Of course when Coke found out what they were doing, they painted their Coke trucks with Pepsi logos and collected the Pepsi bottles from the convenience stores and smashed them and that started a glass bottle war. But they ended with a truce where Pepsi ended up about 40% market share in the Mexico City area, earning himself the Pepsi bottler of the year, but I don’t think New York really fully appreciated how he did it. And so my years as investment banker highlight to me the importance of corporate governance. You really need to understand who the controlling shareholder is, you really need to understand that what is acceptable in some countries is not going to be acceptable in others and that was an important life lesson for me.

Seides: When you stay around these countries in emerging markets long enough, you also have lots of big political events. What did you see in your early investment banking years about, call it the “political governance” as it affects companies and stocks?

Graña: One that certainly comes to mind, when I had just switched over to the buy side, this of course is the political governance. I strongly believe that you can’t have a purely bottom-up discussion on emerging market stock because you miss a key part of the story, which is the nature of the system these companies operate in. So the story that I like to tell is Russia. There was a time when Airbus and Boeing were thinking of the next generation aircraft; what should be [the] materials used? And there was a debate whether they should use composite or titanium. The vast majority of the world’s known reserves of titanium are in Russia and so I went to see the oligarch who, of course, there are always oligarchs in Russia who owned VSNPO, which is the company that had the titanium reserves in Russia, to see if they could get surety of supply. Obviously, once you design an airplane using titanium, your expectation is you’re going to lock that in for 30 years. You can’t design around that once you start using titanium. And so when I had dinner with him at a restaurant not too far away from the Kremlin, he starts very loudly complaining about the corrupt Putin regime. Made me feel very uncomfortable. It’s one thing to do it in his office, another to do it in a very public forum. And even then, I was … even though it was many, many years ago, I knew of the nature of the regime. So I changed the subject. I asked him about his family, get him off of that rant. He mentioned that he had sent his wife and his only child to Switzerland with a billion dollars. And that tells me everything I needed to know, that clearly he felt uncomfortable, that clearly he was feeling pressure. And so I decided to pass on the opportunity. A few months later, he gets that proverbial knock on the door, an offer he cannot refuse. He had to sell his company at a significant discount to these friends of the Kremlin, and the deal was off: Airbus and Boeing walked away. The share price collapsed significantly. And so the moral of the story is that political governance. So it’s not just about corporate governance, which we just talked about, but it’s also about political governance in emerging markets. The nature of the systems, as I said, rule of law, the predictability, the regulatory regime, the predictability of the tax regime, these are all important questions to ask in emerging markets that we all take for granted in developed markets.

Seides: Somewhere along the way in your years on the sell side, I have to imagine you yourself must have come across an interesting situation or two in the early years. I’m wondering if you could share one of those?

Graña: I would point you to the first Mexican REIT that came out of Mexico. It was a very complex transaction. The company actually didn’t exist. We had to piece it together and explain to potential shareholders in the prospectus that this company was a recreation, a proforma, piecing together many different companies. But nevertheless, investors were beginning to look for alternatives in emerging markets, not just staples, not just growth companies. They wanted to see something different. How about a high dividend yielding REIT? And so after a significant amount of work to deliver this IPO which we moved the entire team to New York to be able to do it on time, surely after the IPO, the controlling shareholder disappeared. He went on a horseback ride on his beach resort and never came back. And low and behold, the company was also short of funds. So again, you need to ask yourself who these controlling shareholders are and you need to appreciate that things are different in emerging markets.

Seides: So what was the path that led you to go from the sell side to the buy side?

Graña: Certainly as an investment banker, we were very transaction-oriented. Certainly, we were financial advisors to companies and governments, but I wanted to eat my own cooking. I’m always suspicious of chefs who won’t eat their own cooking. And as an investor, that’s exactly what you’re doing. When you make recommendations, when you place them into portfolios and you as a shareholder of the fund, you are eating your own cooking. You have to believe. As an investment banker, we would sometimes put together a transaction that we didn’t necessarily, at least I didn’t necessarily believe in. But if the shareholders, if the market wanted to buy it and that was the market caveat emptor, that was their decision. But I want to be more than a situation where I was investing in things that I bought into, that I really fundamentally believed in. That’s what led me to move away from investment banking and toward the buy side.

Seides: So I know you’ve been on the buy side and have been for a long time before you joined Janus Henderson. I’d love to hear what you learned first making that transition initially and then in the years since.

Graña: Certainly investing in emerging markets is different. Countries and companies are at different stages of their development which means the institutional guardrails are not as well developed. This creates a lot of opportunities, but also a lot of risk. It means the standard deviation of outcomes are much greater in emerging markets. And so as I developed as an investor, I came to believe that the best hunting ground is found at the intersection of good companies with good governance in good countries. So well before ESG became important, again I’ve highlighted a few examples on the corporate and political governance, it was clear that putting governance as part of the DNA of your process had to be there. Emerging Markets are different. And then you might ask, well what about good countries? Why is that important? Top-down factors like macroeconomics, politics, geopolitics, political governance play an enormous role in emerging markets. You just look right now, compare the extreme diversity in COVID experiences across emerging markets, that’s partially driven in many cases, mostly driven by the quality of the political governance. You can look at the number of countries that have debt crises, bank crises, currency collapses, they have a lot of things in common. They require a meaningful amount of external savings to balance the books. That’s a choice. That is a choice. And so paying attention to the politics because the politics will drive economic policymaking and the economic policymaking will drive the kind of environment these companies are swimming in and the kind of risks. There’s some countries that like to skate on thin ice and that is something that as an investor, we should know. And so it’s that combination of finding good companies with good governance in good countries that I think make for a more sustainable, better outcome situation in emerging markets.

Seides: So as you walk through each of those and let’s start with that country assessment, what are the key variables that you want to look at to determine if that’s a country you’re likely to invest capital in?

Graña: What am I looking for? I have to understand the political process, I have to understand the macroeconomic management, I have to look at the comparative advantages of each of the countries, I have to look at things like industry diversification. Taiwan, two-thirds of the index is tech. Russia, 80% of the index are oil and gas and natural resources broadly. These are all factors that matter because I’m not predicting GDP growth or inflation, I’m making an assessment of the choices that these countries have made. In some cases, the people have made them via choosing politicians, in other cases, they’re in dictatorships. But the choices that are made influence the environment that these countries operate in. The implication of all these choices, the economic trajectory of these countries, macroeconomic and geopolitical risks that these countries take and then, of course, because of the industry issue that I raised is the cyclical considerations. And so this is what we do. And how do we do that? Well, we meet with the country head of the IMF and the World Bank, we meet with politicians, we meet with opposition politicians, we meet with journalists, we meet with regulators. We meet with everyone and anyone that can give us insights into that process, the political process, economic process and the resulting outcome. We also spend a fair amount of time with our own resources at Janus Henderson with the emerging market debt team who of course, have a different perspective on these countries. And so in an understanding of the macroeconomic direction which is an accumulation of all the past choices they made as well as the future direction. And sometimes those align nicely that the country has made very good choices in the past and continues making good choices for the future. But sometimes it’s more about the change in trajectory. Maybe they’ve made bad choices in the past, but now they’re making good choices and that creates an opportunity. And so by having these discussions, we make an assessment of where these countries are headed and that creates an environment of where I can push my analysts to say, “These are countries that look attractive and these are countries that are less attractive. They’re a better picking pool over here and a radioactive picking pool over there.”

Seides: And how stable are those assessments over time?

Graña: The thought is to have a view that’s relatively stable over a two- or three-year time frame acknowledging that there will be some reasons to change the view whether it’s a political election or whether it’s a particular vulnerability to US interest rates and now we’ve changed our view on US interest rates. But certainly the view is to have a semi-firm two- to three-year view so that it can help us guide where the most attractive picking pools are.

Seides: How do you intersect your assessment with what’s happening at the country level with how that impacts particular industries within that country?

Graña: So the Chinese have this concept called politically correct. What does it mean to be politically correct is to invest alongside national policy goals. And certainly while China’s an extreme example that you always do generally want to be investing in companies and industries that are being politically correct, that you generally need to appreciate that as countries develop, that certain industries will have their day in the sun. And certainly some industries will have support from the government and some industries will be faced with regulatory thunderbolts from the blue. And so what we try to do is then go from the macro to the micro and that’s where the heavy work, the heavy lifting is done by our analysts to understand given the environment, the soup, the river that I’ve identified and in terms of the operating environment these companies face, what are some of the industries that are going to be winners and what are some of the industries that are going to be losers in this? We’re very concerned about the currency, for example. Maybe exporters are better placed to be, for instance. And so these are the kinds of discussions that we have that we start marrying the top-down views with the bottom-up views. Now let’s be clear. The bottom-up is enormously important. You have to choose the right companies, strategies, the right moats, the right valuation, but in emerging markets, that top down does play a big role.

Seides: So once you get into the bottom-up, what are the types of companies that you like in your portfolio?

Graña: So what we like to do is I ask my analysts, I don’t want research reports on Mexican cement. I want you to tell me how you’re different. A research report says this is the Mexican cement industry, these are the major players. That’s not as interesting as, “We should buy this stock in the Mexican cement industry and this is the homework that I’ve done to have a differentiated view and we would like to divide that differentiated view in four key areas, either you have a differentiated view of the magnitude of the earnings or cash flows that you see, you have a difference of view in the duration, the quality or the use of the cash flows that are going to be generated.” So are they empire builders for example or are they actually going yo return cash to shareholders? This allows us to focus our stock selection in one of those four key drivers. If you believe that the market is misunderstanding the duration of growth, then let’s see the homework that you’ve done to have that view and that gives us more confidence that we’re not focusing on research projects, but actually an investment case is being made for the stock.

Seides: When it comes to constructing your portfolios, a lot of strategies like this are benchmarked against whatever it is, Morgan Stanley Emerging Market Index, which is just a construct of size and can’t possibly take into account all the factors you’re talking about, about investing with good countries and the right type of culture and sectors. How do you think about the benchmarks that you’re investing against?

Graña: In emerging markets, between 95% and 98% of the money managed in this asset class is benchmarked against MSCI Emerging Markets. It’s a reality. I know that in other asset classes you have more diversity. We don’t have it in emerging markets. So for better for worse and I think for worse, we have to live with MSCI. And what do I say by for worse? I don’t agree with the opportunity set that they’ve created. It’s a poor starting point. I’ll give you some examples. Between a quarter and a third of the benchmark are state-owned enterprises, think Gazprom, Rossneft, Petro China, ICBC, Petrobras. Most of these companies that I hope you can appreciate are governance challenged. They don’t necessarily represent the future of emerging markets. And so MSCI places a heavy emphasis on state-owned enterprises and they miss a lot of new economy stocks. And I don’t know why MSCI has that bias and partially because they want to see how an industry develops before perhaps putting them in the benchmark. What happens is the benchmark misses a lot of the future and captures a lot of the past. A lot of these old economy stocks, old cyclicals, oil and gas names, those feature very prominently in the index. The other thing that it misses is we don’t care where the stock is incorporated or where they’re listed. We care where the exposure comes. If the vast majority assets or vast majority the revenues, vast majority of the story driven by emerging markets, we consider that to be an emerging market stock. Why should it matter that it trades in Toronto or London or Singapore? Maybe they don’t have a home country listing and keep in mind though, I don’t consider Apple or Unilever or ASML to be an emerging market stock. Yes, emerging markets are 20%, 30%, 40% of the story, but it’s not 80%, 90%, 100% of the story. The other thing I’d say is that the index also decides who goes in and who goes out. Surely, surely, Korea and Taiwan should not be considered emerging markets. Surely. And yet they are. Surely, Vietnam should be upgraded to emerging markets in the foreseeable future, but it hasn’t been. They were very slow to upgrade countries and they’re very slow to migrate them out. Israel was the last country to be migrated out of emerging markets. I think it was 12, 15 years ago. And so they keep adding new countries. The starting point is very poor and so what we talk about when we start our process isn’t narrowing the universe. Many investors talk about, “Well, I want to tell you which stocks are my kind of stocks and what kinds of stocks are not my kind of stocks.” But here, I think we need to talk about expanding the universe first. Another example is that MSCI only has about 400 China A-shares. So those are the stocks that trade in Shanghai and Shenzhen. Only 400 of those China A-share stocks are in the benchmark. There are 4,000. Surely, there’s a better way of finding attractive names than narrowing 4,000 to 400. We certainly find some interesting ideas outside of what’s in the benchmark. We typically are between 35% and 45% of the portfolio in out of benchmark ideas again, emerging market ideas. But a significant amount of what we invest in are out of benchmark ideas and that leads our portfolio to act differently from others that focus more explicitly on the benchmark.

Seides: When you put this all together, what is a portfolio that you’re constructing look like in terms of I guess you’d start at the country level, sector level and stock level?

Graña: Specifically, what we then look at the stock level is we look at the valuation skew. I don’t like point estimates. I think that gives you a false sense of security that you know what’s going to happen in Russia in year eight or China in year 12. Give me standard deviations. If the stock plays out as you expect, what do you think the market will pay for it? That’s your base case outcome. If the stock plays out even better than you expect, that could be your reasonable bull case. And if the thesis is broken, what’s a reasonable bear case? You could always come up with uber bear cases in emerging markets, but give me a reasonable bull, a reasonable bear, a reasonable base case. And that is how we compare stocks across sectors and countries. Now that we’ve identified which are the good companies in the good countries with good governance, the way we compare those stocks is to look at a stock that might have 80% upside and 20% downside on that versus 20% upside and 50% downside. That gives us an ability to compare and so it then becomes those portfolio candidates. It moves from these are the best ideas within that intersection to now let’s compare how we build a portfolio from those best ideas. The next step would then be the most crucial step because I’m a very firm believer in risk-adjusted returns. The next step is how do these stocks play with each other in the sandbox? What I mean by that is the risk characteristics. If we already overweight Korea, overweight technology, overweight growth, then adding another Korea technology growth name has certain risk implications. The focus is to deliver great risk-adjusted return through market cycles. And so it’s very crucial to me to understand the risk implications of adding every stock in the portfolio has to earn its keep, but also has to play well with the rest of the portfolio.

Seides: When you put that together in a portfolio, what’s typical kind of number of names you have?

Graña: We usually have between 50 and 80 names. My sell bias is agnostic, which is a very strange term. I allow the bottom-up stock picking to drive my portfolio tilt if the bottom-up stock picking leads me to a tilt toward value, then so be it. If it tilts me toward growth, so be it. There are times to be tilted one way or the other. We are not theological about having a growth portfolio or value portfolio and I think that’s important in emerging markets. You have to consider that before 2008, value outperformed growth on average six out of seven years in emerging markets. But post 2008, growth, I think has outperformed 9 out of 11 years. And so if you always had a value bias or always had a growth bias, you would tend to outperform in one regime and tend to underperform in another. Maybe the construct of value versus growth is artificial. Why not allow bottom-up stock picking to drive what you own in your portfolio?

Seides: There’s probably nothing more topical in your world today than China and we’d love to hear maybe through that lens of the country assessment, the governance and companies, what you’re doing in China today.

Graña: It is very topical. And so we would spend more of our due diligence time with these companies asking whether they are being politically correct. Are they investing in the goals that the government would like to invest in? And as we see it today, the government would like companies to help localize. So in other ways, innovation, replace Qualcomm, replace SAP with Chinese equivalents. One of the lessons that the Chinese government took from the US/China trade war was that they were very vulnerable. They had to import a lot of semiconductors, they had to import a lot of semi-cap equipment. They wanted to localize and so one of the key themes for the Communist Party is innovation. If you’re a Chinese company, if you’re helping to replace a foreigner, then you will be supported. Another key theme for the Chinese government is decarbonization. You might argue why? Why is that a key theme for the Chinese government? There’s a yawning gap between domestic consumption of oil and domestic production of oil. And the vast majority of the imports must then come from volatile parts of the world, mostly the Middle East. And most of that comes through the Malacca Straits. You can imagine one major country placing aircraft carrier group on one side of the Malacca Straits and you could starve China of crude oil. But there are also good economic reasons. Did you know the vast majority of the solar supply chain is in China? Did you know that producing intellect in China, they’re producing electricity from solar and from onshore wind is almost at parity with producing electricity from thermal? No subsidies needed. So I’m not even talking about pollution. Of course that’s a rising concern among people in China, I’m talking about with economic and geopolitical reasons for the Chinese government to announce this pledge that they announced last year, decarbonization by 2060. That will be the biggest story after COVID. I think the market as commentators will look back on 2020 and will miss this, but will say many years later, that was the big announcement that the Chinese government making this splashy announcement that in my mind, is credible. And so if you are helping to decarbonize, if you are a battery manufacturer or of battery components or you’re building electric vehicles, you’re going to have the support of the government. Another key theme of course, is geopolitics with data security. These are the kinds of themes that so long as the companies that we invest in are supportive of these themes, the kinds of risks that we see are reduced. It’s a different approach. You have to ask these political governance questions in China that perhaps you wouldn’t have to ask in other places. And this is why it’s a key part of our process. If you choose to ignore the top-down, if you choose to ignore the political governance questions in my view, you shouldn’t be investing in China. You shouldn’t be investing in emerging markets. These companies as we could see from certain industries like the education sector, could suddenly be subject to surprises from the government. What I would say is it’s not the end, it’s not the beginning of the end of investing in China. It’s the end of the beginning. And what do I mean by that is the kind of approach to invest in China must change and evolve. We’re invested in a company that is very politically correct because they’re utilizing technology to solve local problems. The largely state-owned enterprise banking system in China was not designed to finance the largely private sector SME sector. And so a lot of these smaller companies struggle to access capital. And now we have a company that uses blockchain, artificial intelligence and a digital currency in order to digitalize the supply chain relationships so that banks have the confidence to lend to SMEs. This is exactly what the government would like to see. They’re not paying a patent to a Western company for this benefit. It’s solving a less domestic problem and it would certainly have the support of the government. So as a result, these are the kinds of ideas that we like. Obviously, we’re much more sensitive to companies that have to do national service and that’s why we’ve generally largely stayed away from state-owned enterprises everywhere but certainly in China because those that do national service don’t always have the interests of minority shareholders in mind.

Seides: When you have that type of alignment with the government’s interests in a sector that say in China as you say is politically correct, how does that influence how you think about just the valuation of the business itself?

Graña: So as I said, no one really knows what’s going to happen in the far-off future in emerging markets so we have to not be theological and we have to approach valuation in many different ways. I don’t like to see one way of approaching valuation. If you look at EV to sales, many of these early-stage companies evaluate on EV to sales, let’s confirm that. Let’s confirm the valuation coming from something very high up on the income statement with a DCF. Let’s confirm that with comparing similar stage companies and other jurisdictions. One would argue that maybe the duration of growth is higher in China relative to say to U.S., but at the same time, the risks are higher. And so we can have that debate that where was Google trading? Where was SAP trading at similar stages of their development? Give us a sense of what these stocks were trading at and compare. And so that will give us a framework of is this even in the realm of probable and possible.

Seides: When you see a company like that, that is aligned the right way with tailwinds, how important is the management team?

Graña: Enormously, enormously. Earlier in a lot of these emerging market histories, the kind of capabilities that was asked of the management teams was more on the political side, political connections, how you developed your moats was directly related to how you can influence the government to set up barriers or creative ways of using government regulatory pressures to make sure that you are the only license holder. But as the world has evolved and changed and as those barriers have come down, I wouldn’t necessarily say they’ve all come down everywhere, the ask on the management team has changed. And then suddenly, the kind of things that you ask about for a management team are more like what you would expect to ask for a management team in the West. And so building a culture, rewarding employees with stock, what are your moats? How defensible are those moats? What are your thoughts about returning cash to shareholders? Are you an empire builder? Many of these old school controlling shareholders, the old families, are empire builders. They find it hard to return cash to shareholders. You could point to a lot of Korean companies for example are that way. And so the asks of the management team are changing but at the same time, there’s also generational change. We’ve noticed that as the patriarch, the family patriarch of the family, hands the reins over to the next generation, a lot of that next generation are Western educated, are conversant in this language that we’ve just talked about and so they will make changes. That’s an exciting part. When you see a change in corporate governance driven by that generational change that suddenly maybe they’re not empire builders, that suddenly they do care about returns on invested capital and that certainly makes for a much better investment than one where they continue adding new divisions. I’ll give you an example. In Korea, a midsize industrial company had two very unrelated divisions. And I asked after many, many years of over investment in these two sectors now with the opportunity to generate a tremendous amount of free cash flow where you’re going to start returning that cash to shareholders or thinking about maybe splitting the businesses because they’re two very unrelated businesses? And the CFO gently reminded me that the controlling shareholder has three sons and that told me everything I needed to know. And sure enough, many, many months later, the controlling family bought a completely unrelated business for the third son to run. So you need to ask yourself different kinds of questions in emerging markets. And it isn’t always about where you are. I find that kind of silly and frustrating when people want to apply Scandinavian level types of corporate governance standards on emerging markets. We are emerging. I applaud companies when they make change. It’s about, so many times it’s about the trajectory of change rather than where you are. And so most of my boards are not independent. If you start acting like a world class company that cares about governance and it cares about minority shareholders providing transparency, cares about return on invested capital, you will get larger pools of capital chasing your shares. If you care about the share price, this is what you should be thinking about. If you don’t care about your share price and I can give you another example. The CFO of a Korean utility telling me, “I don’t see why anyone invests in our shares,” that tells me what I need to know. Why would you invest in those kind of companies when the controlling shareholder doesn’t care about the share price? How deep is the compensation in shares driven deeper into the organization? This is kind of new grounds for emerging markets. We didn’t require independent boards in the US until very recently. And by the way, at our similar stage of economic development, didn’t we pollute the environment at the dawn of the industrial revolution? Didn’t we employ child labor? And so yes, emerging markets are behind. We’re still developing. We should be supportive and encouraging of those companies that are taking baby steps in the right direction. And that’s what we’d like to do with these companies.

Seides: I’m curious to go from that individual assessment up to part of your process which is the types of information that you’re gathering in 30 countries around the world. Lots of different companies, a lot of different political regimes requires a breadth that many have struggled with in emerging market equities. And I’m curious, what does your team look like?

Graña: I am a firm believer that emerging markets are not an island to themselves. Not all the world’s crises originate from emerging markets, not all the world’s problems originate from emerging markets. We get hit from contagion from other asset classes. And so it’s very important to have a more integrated approach. We spend a fair amount of time talking to our emerging market debt team to get their perspective, to hear about what the global fixed income team is thinking. We spend a fair amount of time integrating with centralized research at Janus Henderson. Many of our emerging market success stories started off as carbon copies of successful business models in the US and then we evolve and change depending on local conditions. But nevertheless, it’s very helpful to hear the centralized research point of view in terms of what’s happening in other parts of the world. We integrate with the ESG team to talk about what the latest standards are. We have a dedicated team of analysts, but we rely on the larger part of the organization to complement what we do. It’s very hard to keep track of what’s happening in 30 countries plus what’s happening in the US markets, plus what’s happening with ECB, plus what’s happening on geopolitics. And so consequently, I think by being part of an organization that values partnership and values collaboration, it makes us all better investors. The emerging market debt team could disagree with me. Maybe they’re bullish on Brazil and I’m bearish. But having that debate, friendly debate, makes us better investors. Maybe it’s I’m bringing up points that they hadn’t thought of, maybe they’re bringing up points I hadn’t thought of. Having that different perspective, that cross asset allocation discussion makes us better investors.

Seides: How do you manage around the challenges of language and cultural barriers individually with you and your team compared to the countries you’re investing in?

Graña: So this is where there’s strength in diversity on a team. But the first point I would mention is that most emerging markets, you could get by with the international language of bad English. But you need to do more than that. Obviously, you will miss cultural nuances, things get lost in translation and so you do want to have members of your team that do speak different languages, I speak Spanish and understand Portuguese. There are members of the team that speak Chinese and that does matter. That is important. Yes, meeting with the CEO and CFO that many cases speak English or bad English as I said, we all speak bad English, I suppose, that certainly gives you one perspective. But imagine if you could speak with the line manager or the head of the factory or the head of the Union in the local language over drinks, over dinner, over lunch? And you get a much more unfiltered view of what’s happening. Maybe it prompts questions that you hadn’t thought of, maybe you get a better sense of how deep in the organization some of these changes the CEO is talking about really penetrating. Due diligence isn’t just about asking a treasurer or CFO or IR at a conference in New York. That’s not sufficient due diligence. You need to travel to these countries, kick the tires, meet with competitors, meet with the supply chain, meet with former employees, expert networks, meet with government officials, regulators. Many times they were, they came from these companies, to get a much more holistic view of what’s happening on the ground and what’s happening with these companies. So I would say that it is a very labor-intensive process. I struggled to see how a purely quantitative approach would work in emerging markets. I would struggle to see how a purely bottom-up just by the companies that have the highest or best improving returns on invested capital, how that would work because it ignores all these other factors, these soft intangibles, the relationship with the government like corporate governance, culture of the companies. Do they value their employees? These are all legitimate questions that I think perhaps play an outsized role in emerging markets.

Seides: After all the years that you’ve been in these markets before coming to Janus Henderson, I’m curious if you thought of striking out on your own?

Graña: I would say absolutely not. As I said, emerging markets is not an island unto themselves. We would need to build an organization that would touch upon different asset classes, the emerging market fixed income, emerging market currencies. We would need to have an understanding of the global fixed income markets, sovereign research. We would need to have plenty of capabilities to cover things as varied as China A-Shares as Vietnamese stocks, South African stocks, Brazilian stocks. To recreate that on your own would be given my process and my thought that this is a labor-intensive process, right, you can’t just screen for the best ideas in emerging markets. You actually have to go see them, meet with competitors. The short answer is no. I think it would be rather hard to recreate this as a sort of one-man shop or a small-man shop, a small-woman shop. It would be very hard to recreate.

Seides: So we’ve gone through this period of probably more than a decade now where the U.S. markets have just outperformed the rest of the world. And I’m curious as you’re talking to people about what you’ve done, does this question come up of you know…

Graña: Why bother?

Seides: Yes.

Graña: Why bother. Well number one, I would say if you were to strip out the 40 most successful U.S. stocks out of the S&P 500 and compare that to the, so the remaining S&P 460 I guess, the S&P 460’s performance is actually bang in line with emerging markets, bang in line with European markets. There’s an outsized outperformance by the likes of Google and Apple that have sort of skewed US equity returns. Historically, there were two reasons to invest in emerging markets, outsourcing and convergence. Outsourcing of course, is building cheaper, faster, better. Then there was convergence. So as income levels rose in emerging markets, you’d expect households to want to buy cars, homes. But we’re now beginning to see an emerging third reason to invest in emerging markets, which is innovation. And a lot of these are technology-enabled companies that are solving EM frictions in very new and interesting ways. We have to keep in mind that emerging markets are home to great economic inequities, very uneven access to healthcare, financial services and so forth. Some of the most exciting innovations that we’re seeing address those obstacles. Why do you need to build a branch network in rural India when you could reach those people through FinTech or through smartphones? That’s an example of an innovation that will change lives. The bankable population if you have to build branches is small in some countries. But if you’re able to use technology in new and creative ways, then the bankable population is 100% of the population practically. And so this is what gets us so excited that it is isn’t just about buying the best outsourcing stories, the best convergence stories. It’s increasingly about buying the best innovators. And there is a lot of homegrown EM innovation. I will fully acknowledge that innovation in emerging markets is not evenly spread throughout all the countries. Clearly, Asia generates a fair amount of innovative companies relative to Latin America and Eastern Europe, Middle East and Africa. But nevertheless, this emerging theme gets me very excited about the future of the asset class.

Seides: There’s always these times in emerging markets where some country is blowing up in a bad way and others are blowing up in a good way. I’m curious if you looked out on the horizon, what countries are you most excited about and which ones are you most concerned about?

Graña: I would say that Vietnam is one that I’m most excited about. It’s not a very well researched market. It’s a success story. If I were to turn the clock back on China 30, 40 years ago, that’s exactly where Vietnam is today. So think a government that is very much attracting foreign investment or an export-led model. They have a young demographic labor force willing to work, a great infrastructure and so they’ve created the right ecosystem. For example, the largest exporter out of Vietnam today is not shoes and T-shirts, it’s actually Samsung. Samsung doesn’t produce smartphones in China anymore. They do produce them in Korea, but the low and medium end phones are now produced out of Vietnam. The largest exporter of Vietnam is now Samsung. And so as a result, you have this positive feedback loop that wages can rise and as wages rise in Vietnam, you get a domestic consumption story that’s sustainable. And with good macroeconomic management, and Vietnam has gone through periods where they didn’t have good macroeconomic management, but they learned. And again, I am a proponent of crises. I know that they hurt a lot of people, but they clean up bad practices and they better position the country for, many times, for a better future. And that’s exactly what’s happened to Vietnam. Many people invest in Vietnam by buying staples and certainly earlier stage economic development countries, you focus on staples because people will move from buying milk from neighborhood market and buying shelf stable milk at a supermarket. But increasingly, we’re also beginning to get excited about opportunities that we see in the financial sector, in the real estate sector. And then as the market develops, as valuations move higher, we would expect to see a lot more IPOs. And so now is the time to do due diligence, now is the time to figure out which are the right management teams, which horses are the right ones to back because they are succeeding where a lot of emerging markets are not. We have seen peak globalization. The export-driven economic model that was used by, very successfully by Japan, then Korea, Taiwan and now China, that is not going to be as easy to replicate going forward, [with] rising protectionism pressures everywhere. We’ve probably seen the limit of deindustrialization. We’ve seen populist pressures in developed markets. But Vietnam is one that’s actually succeeding and so I’m most excited about Vietnam. In terms of countries that I’m concerned about, I do worry very much about Brazil. I think Brazil is losing its way. Obviously, they responded very poorly to COVID, echoes of how we responded in the US. But the difference is we could be irresponsible with our government balance sheet. We have the global reserve currency. We could run massive budget deficits for the foreseeable future without a significant change in the market’s perception of that risk. Emerging markets, you can’t for the most part. You can’t have Italy-style government debt-to-GDP with emerging market interest rates. Italy gets away with it because they import German interest rates. Brazil doesn’t have that benefit. And so because they responded very poorly to COVID, there’s a lot of populist pressures to loosen the purse strings further and continue to loosen the purse strings. So that fiscal anchor is now in doubt. And next year 2022 looks like the incumbent president based on all the latest polls, would likely lose to Lula, former president of Brazil. He came at the same, sort of a similar time as Chavez and Putin. They came into power making lots of promises, but they’ve benefited from a once in a hundred-year commodity boom, 2000 to 2008 environment. I don’t think anyone’s expecting that kind of once in a hundred-year commodity boom again. And so spending without that commodity boom will lead to an even worse situation. So for many, many reasons, I think they’ve governed themselves into a quagmire. And even though again, Brazil is home to a lot of great management teams, but at the same time, I’m very concerned about the trajectory that Brazil is heading. And they have not by the way, addressed the supply side reforms. A lot of product which is produced in the interior of Brazil, rots before it gets to the ports because there’s an insufficient amount of infrastructure. And so it’s not just about stabilizing the fiscal accounts which is I think, a necessary but insufficient condition. It has to also be about supply side reform. It has to be about reducing the cost of doing business in Brazil. Brazil’s tax regime is at a labyrinth and the infrastructure is poor and education levels need to rise. Those are the things that should have been tackled in addition to stabilizing the fiscal and they haven’t been.

Seides: So if we look through to your portfolio, what types of exposures does that lend itself to in both Vietnam and Brazil?

Graña: So Vietnam as I said, is not yet in the benchmark. And so any exposure there which we have about 3% of the portfolio, is totally out of benchmark. We would love to have more in Vietnam, but as it stands today, about three-quarters of the Vietnamese stock market, maybe a little less now, are state-owned enterprises which again, we struggle with from a governance perspective. And then of the remaining balance in Vietnam, many of those have hit their foreign ownership limits so it’s rather hard to buy those shares. But as more companies list and as those foreign ownership limits change and we would expect that to happen in the coming years, that we would be buyers of that situation.

Seides: How about Brazil?

Graña: In Brazil, we are asking ourselves a lot of questions about our positioning. We certainly weren’t very overweight Brazil. We actually were neutral towards Brazil. As we started to feel uncomfortable with the trajectory, we need to ask ourselves those kind of questions. When you ask me about how do you deal with currency, currency is intrinsically part of the country decision, in my view. There are three things that you could do on a country decision. You could change your country active, you can go more underweight or more overweight depending on how excited you are about the country, you could change what you own. So obviously, an exporter would benefit from a weaker currency and domestics would be hurt. Or third, you could hedge the currency. And sadly, the cost of hedging in emerging markets is rather expensive, generally. So basically, we only have two tools in our toolbox and those two tools would argue that we need to think long and hard about changing what we own in Brazil and potentially changing how much we own.

Seides: All right Daniel, well it’s time to ask you a couple of closing questions. What is your favorite hobby or activity outside of work and family?

Graña: I believe that life is about experience and that asset accumulation should either facilitate an experience or remind you of an experience. So I have a mask collection from Indonesia, Thailand, the Pacific Northwest and Africa I love to stare into as I’m pondering investments. Another is travel, culture, food, art and other ways to sort of challenge who you are and what you like because that’s effectively what travel does. It gets you out of your comfort zone. You’re going to have to try new food. Maybe it’s a little spicier than you like, maybe it’s a different protein than you like, but nevertheless it’s gently challenging you, causing you to evolve and change. And so to me, that is what life is about, accumulating masks, I suppose is one of them and travel is another.

Seides: What’s your most important daily habit?

Graña: Quiet time. I purposely try really hard to create some quiet time in my day to deconstruct, to synthesize and make connections. Maybe it’s about a book on Ulysses S. Grant making a connection to a situation I’m finding in emerging markets. Maybe it’s a book on the Boxer Rebellion in the 19th century in China and what that means for investing in China today. You need to have some quiet time to let your brain make those connections.

Seides: What’s your biggest personal pet peeve?

Graña: Willful ignorance. I certainly can forgive ignorance. No one can know everything, but the active choice to remain ignorant bothers me.

Seides: And how about on the investment side, which it could cross over, but your biggest investment pet peeve?

Graña: I would say arrogance and the callous disregard for risk.

Seides: Which two people have had the biggest impact on your professional life?

Graña: I would say it’s a tale of two investors who shall remain unnamed. One who experienced great success but then wouldn’t or couldn’t evolve and so the lesson I took from there is you have to stay humble and you have to continue adapting and changing. And the other one who didn’t have the right pedigree, but used her very different background to approach investing in a very different way and that’s okay. Being different allows you to approach problems in an unexpected way so this led me to think about how there is strength and diversity of experience and that’s what I look for in my team.

Seides: What’s been your biggest mistake and what have you learned from it?

Graña: You might find this a curious answer. When social media was first beginning make an impact, I frankly didn’t understand. I did not appreciate the business potential. I thought it was going to be limited because I couldn’t imagine sharing personal details and my own opinions for others to see. If you really are a true friend of mine, shouldn’t you just pick up the phone and shouldn’t we just catch up over a dinner? I did not understand. The lesson here is that sometimes you are not the target audience, number one. And number two, sometimes you become the target audience as you change. I underappreciated that when social media first showed up on the scene, I had to join Facebook to understand what is it that people are talking? What are they doing? I’ve gained now an appreciation that for many, it’s about making connections with similar minded people even if they’re not your friends. Maybe they’re your online friends, but they’re not your personal friends. It’s about finding communities and the different ways of monetizing that. And so just because I didn’t see the potential, doesn’t mean that there isn’t potential. And so again, who is the target audience? And you have to be humble enough to appreciate that maybe you will change and you will become the target audience.

Seides: How do you take that and put it into a different context to say that there’s something that you don’t see, but you might be wrong?

Graña: In emerging markets where we have very creative governments and companies and so creative and not in a good way. And so I have the scars to show from my investment mistakes. I’ve heard every lie, both from governments and from companies. There is a benefit to experience and the experience comes in not only being cynical, not believing everything you’re told, but also being mature enough where you are to understand that you don’t see the whole picture. You may not see the whole picture. And so therefore read about it, challenge your preconceptions, talk to those who are in the target audience. Maybe talk to the younger generation, 20, 30 years younger than you to see how they’re experiencing life. Simply because you went a certain path doesn’t mean necessarily that they need to follow the path. I’m trying to remember the exact saying, something along the lines of that, “Follow what your elders follow, but take your own path,” something along the lines of that. And that’s exactly right. Pursue love, pursue justice, pursue success, but don’t necessarily follow the same footsteps that the older generations have taken. With that knowledge, you do have to ask that everyone’s path will be different than yours. Certainly the younger generation’s will be and so therefore, you need to see how some of these new innovative business models are approaching problems differently. You have to be open minded.

Seides: What teaching from your parents has most stayed with you?

Graña: My Hispanic upbringing taught me not to offend, not to be mano lucado. That was very important in most Hispanic households. And what I’ve learned however, that there are times to be bold, brave, blunt and sometimes offensive. And so I completely agree, you have to respect. You have to understand that everyone’s on a different path, but there are also times when you have to speak up and there are times to be brave and bold. And so that’s what I would say would be the life lesson I learned. It’s important not to be disrespectful, but it’s also important sometimes to challenge.

Seides: All right Daniel, last one. What life lesson have you learned that you wish you knew a lot earlier in life?

Graña: Compassion is a big word. We were the family that lost everything in the revolution. We were the family that suffered most in the U.S. economic downturns because we weren’t well established. Good fortune isn’t always a function of hard work. And so over time, I’ve come to appreciate that compassion is a big word and there are many different ways of applying that, with your family, with your friends, with colleagues and so forth. And so over time, it was a lesson that I’ve always felt that if you worked hard and studied hard and made a difference, that life would reward you. And many times that’s true, but many times that’s not always true.

Seides: Daniel, thanks so much.

Graña: I appreciate it. Thank you.

Seides: I hope you enjoyed this conversation and maybe even piqued your interest to explore further. See you next time.