This has been a tough year for emerging-markets investors.
Fueled by unrest in Brazil and a sluggish economy in China, the broad MSCI emerging-markets index is down 14% this year. The drop has been led by stock market sell-offs in Brazil (-26% in local currency), China (-11.5%), Russia (-9%) and South Korea (-8%). In U.S. dollars, returns are even worse.
It seems it would be a difficult time to manage an emerging-markets fund. Not so for Lewis Kaufman, manager of Thornburg's Developing World Fund. The Santa Fe, N.M., fund is up more than 3% this year, beating 96% of its peers.
Kaufman, 37, has managed the fund since its inception in 2009. He has avoided South Korea — he said he no longer considers that country a developing economy — and focused on companies that sell products to consumers in emerging economies. One of the fund's top holdings is French company Remy Cointreau, which sells much of its expensive liquors to consumers in developing economies, such as China.
"The fund has thrived while most stocks in the developing world have languished in 2013," Morningstar's William Samuel Rocco wrote in a May 28 report about the fund. "He has steered clear of the especially disappointing Korean market and invested relatively modest amounts in a few other big markets that have really struggled."
Morningstar gives the fund a rare five-star rating.
It would seem that an artist's haven in New Mexico would be an unusual place from which to manage a mutual fund targeting small economies across the globe. But Kaufman, who previously worked for Morgan Stanley and Citigroup, said he's thrilled to be at Thornburg, which he joined in 2005.
"It's really a stock picker's paradise, a place where you really have the flexibility to develop yourself and look at whatever stocks make sense," he said. "I like stocks and I like all different kinds of stocks. I love working at a place where I have the ability to look at different kinds of things. Santa Fe is a place where you get blue skies 300 days a year, good mountain living, direct proximity to skiing. It was a part of the country that appealed to us."
Q: How many companies do you own?
A: At this second, the number is 52. In the grand scheme of things 52 stocks is a relatively concentrated portfolio. Most managers are going to run their portfolios with 100, 200 stocks. This is a very volatile asset class and we want to have a good understanding of what we own in the portfolio.
Q: What is the fund's strategy?
A: We started the fund not long after 2008, which was a year when the emerging markets were pretty much cut in half. A lot of mutual fund managers did worse than that; they were down 55%, 60%, 65%, 70% even. I have a fundamental belief you cannot compound your way out of that sort of result. Our top goal from the start of our fund was to do a better job of managing the volatility for our shareholders.
Q: How do you do that, given volatility in the emerging markets?
A: We focus on financially sound, free cash flow generative companies with business models that are not predicated on financial leverage. Emerging markets are a pretty volatile place; the last thing you want to do is own companies that are going to have to go to the equity or debt markets and have to finance themselves.
Q: What are some companies you like in the emerging markets?
A: We have an investment in a company called Robinson in Thailand. It's a play on rural consumption. They're a department store chain. It's a business model that generates a lot of free cash flow. Another example is BIM, a retailer in Turkey. In oil and gas, the biggest company in the emerging markets is Petrobras in Brazil. The more oil and gas prices go down, the more they need to finance through equity and debt. Imagine trying to do a multibillion-dollar equity offering when oil prices are down, when people are bearish on Brazil, when everybody knows you have to sell stock. Instead of Petrobras, we invest in Gran Tierra on the Canadian market. It has assets in Colombia, Brazil, Peru, Argentina. It's a good mix of production and exploration. They're actually generating free cash flow. I don't really have to worry if oil prices go down, how it's going to finance itself. It's more return, less risk.
Q: Your fund has 12% of its assets in U.S. stocks and big investments in companies like Remy Cointreau, Prada and Colgate-Palmolive. How is that a play on the emerging markets?
A: We actually consider those to be emerging-markets stocks. We don't really care where they're based, we care who they sell to. We see opportunities in companies that are oriented or levered to domestic demand trends in the emerging markets. Prada is 65%, 70% in the emerging markets. People are going to brush their teeth. They're going to migrate to the global brands like Colgate-Palmolive. When's the last time you brushed your teeth with a private-label toothpaste? What they've got is a very dominant business in the emerging markets. Remy Cointreau, the French cognac company, they sell $2,000 bottles of cognac in China. They're a great way to play emerging markets in the near term.
Q: In which countries do you see the best opportunities in the emerging markets?
A: Southeast Asia is only 10% of the MSCI, but our fund is 21% in those countries. Indonesia, Philippines and Thailand are the three big ones. I think that is one of the few regions in the world with the potential to surprise from a GDP perspective in the next few years. It's a part of the world that was starved for capital for the better part of the last decade and only in the last five to seven years has the capital returned. I'm very optimistic about that part of the world.
Q: How do you address the volatility of emerging markets' currencies?
A: We want to avoid countries that have the potential to devalue their currencies — Venezuela, Argentina, Egypt. Turkey is a very dangerous currency outlook. In those countries we're going to employ a much higher hurdle. Contrast that with the Philippines or Thailand, where we have an optimistic view of the currency. If I have a choice of a bank in the Philippines or a bank in Turkey, I'm going to emphasize the one in the Philippines and de-emphasize the one in Turkey.
Q: This has been an abysmal year for the emerging markets. Why would anyone invest there now?
A: What are the drivers of consumption? It's job growth, real wage increases, low consumer credit penetration that can increase and high savings rates that can come down. All of those things favor the emerging markets. Credit is only going to become more and more affordable in the emerging markets.
Q: Your biggest holding is Tencent Holdings Ltd. of China, which is up more than 90% since the end of 2011. What does that company do?
A: It's the most important Internet company nobody's ever heard of. What they were was the AOL Instant Messenger in China. They had a lot of users but didn't make money. In 2003, they woke up and took it upon themselves to develop a game business that grew into massive, multiplayer online games. That's how they monetized the instant messenger. They took that core capability and became the dominant player in games. What really makes this investment exciting, not only are they well-positioned in games, they've also leveraged their IM brand to enter mobile chat. They have probably the most important mobile asset in China, Wechat. It lets you do text and video chat.
About the fund
Lead manager: Lewis Kaufman
The fund: Thornburg Developing World (THDAX)
Headquarters: Santa Fe, N.M.
Assets: $759 million
Top five holdings: Tencent Holdings Ltd. (China), Siam Commercial Bank (Thailand), Yandex (Russia), NagaCorp Ltd. (Cambodia), Southern Copper Corp. (United States)
Morningstar rating: Five stars
Performance: Down 5% in the second quarter of 2013