This fund-management firm gained an edge with 202 on-site company meetings in one year
For investors, finding an edge can make all the difference between winning and losing stocks.
A way fund managers do that is by speaking with company executives. At LGM Investments, a subsidiary of the Bank of Montreal that oversees $5.5 billion, managers, analysts and researchers held 932 company meetings, including 202 on-site visits, over the past year.
LGM’s strategy is to select companies whose management teams “have their interests aligned with minority shareholders and that allocate capital very prudently,” said Irina Hunter, co-manager of the $204 million LGM Emerging Markets Equity Fund BAEMX, +0.31% which was established in December 2008. It has a five-star rating, the highest, from Morningstar.
Visiting companies and analyzing their operations in person can give a money manager a deeper understanding of unique opportunities and risks, said Hunter, who’s based in London.
“Our job is to find quality companies that are dominant with high moats,” she said in an interview July 24. “They generate a lot of cash and allocate capital in a way that allows them to generate high returns. We travel to where the companies are, because it is important for us to understand the opportunities and challenges in the market. It is also important for us to hear the challenges and opportunities from management itself, and get an understanding of the culture.”
We’ll show how well the fund has performed below, along with its top holdings. But first, here are comments from Hunter about how she and her colleagues select companies for investment.
Hunter said she is most interested in companies with low debt and high cash returns that operate in countries “where consumers are coming from a low economic base — countries such as India, Indonesia and Vietnam.” Companies with good free cash flow can “compound” cash flow in those markets because of growing populations and “the rise of the middle class,” she said.
She then emphasized how important it is for the interest of a company’s management and board of directors to be “aligned with minority shareholders,” while capital is allocated “very prudently.” Hunter said that some large companies that investors might expect to see in an emerging-market fund don’t fit the bill because of family control over voting shares.
The fund invests only in stocks that pay dividends. Buybacks can be a prudent way for management teams to deploy capital, Hunter said.
Hunter said Mr Price Group MRP, +3.16%MRPLY, +3.67% a fashion retailer in South Africa, had increased its sales significantly while doubling its profit margin and “almost quadrupling” its free cash flow over the past 10 years.
An American investor who hears that a retailer is increasing its sales rapidly might shy away from the stock if the company is following the typical growth pattern of building a lot of new stores. A debt-fueled over-expansion might lead to an eventual slowing of same-store sales growth, lower profits and poor stock performance.
But Hunter said Mr Price Group‘s growth came mainly from increased sales and better profit margins within its existing store base.
She met with Mr Price’s management team in February and came away “very impressed” with their “focus on execution and driving profitability out of the existing network — re-negotiating cheaper rents, focusing on having store extensions rather than new stores, using scale to negotiate even better deals with suppliers and working on consolidating distribution centers.”
All those activities underscore what Hunter called “relentless cost control,” leading to rising operating margins. She also said the company “hasn’t fallen into the trap of making expensive overseas acquisitions like their competitors.”
Another important aspect of LGM’s management style is investment timing. Meeting with a company’s management can help a fund manger determine if the events leading to a sharp decline in share price are part of a long-term pattern or merely a “bump in the road.”
Hunter said a 40% decline in Mr Price Group’s shares in late 2016 presented a buying opportunity. A temporary break in the company’s typical sales pattern happened because of poor fashion choices that were quickly corrected.
When discussing the interests of minority shareholders, Hunter said Mr Price Group tends to pay out 65% to 70% of its earnings as dividends.
Yum China Holdings YUMC, -2.08% was spun off from Yum Brands YUM, -0.89% in 2016 to operate KFC and Pizza Hut restaurants in China. The company runs over 7,600 restaurants, with menus designed to appeal to local tastes.
One reason Hunter found the stock attractive when the companies were separated was that the Chinese market provides so much room for expansion.
“If you look at the penetration of restaurants in China, it comes out to only five restaurants (KFC and Pizza Hut) per one million people. The goal is to get it to 15,” she said, adding that, in comparison, Yum Brands has 28 restaurants per one million people in the U.S.
Hunter said Yum China has “best-in-class management” that has been able to turn the ship around. After a period of negative same-store sales growth, the company has been able to “double” operating margins since 2014 while achieving a 5% same-store sales growth rate.
“We believe they can actually deliver mid-teens growth rates (12% to 15% or maybe higher) over coming years,” she said.
Hunter likes the stock’s valuation, which her team estimates to be about 22 times earnings and its free cash flow yield of about 4.5%, “which is not expensive at all,” she said.
The BMO LGM Emerging Markets Equity Fund’s class A shares have an initial sales charge of up to 5%; however, the sales charge is waived if investments are made through Charles Schwab, Fidelity and other distributors.
Here’s how the fund’s class A shares (excluding any sales charges and net of expenses) have performed against its Morningstar category and its benchmark, the MSCI Emerging Markets Index:
|Total return – 2018 through July 23||Total return – 2017||Average annual return – 3 years||Average return – 5 years|
|BMO LGM Emerging Markets Equity Fund||-4.2%||37.8%||8.0%||4.4%|
|Morningstar Emerging Markets category||-6.5%||34.2%||5.4%||5.0%|
|MSCI Emerging Markets Index (U.S. dollars)||-6.0%||37.8%||7.9%||8.4%|
|Sources: Morningstar, FactSet|
Here are the top 10 holdings (of 39) of the BMO LGM Emerging Markets Equity Fund as of May 31:
|Company||Ticker||Country||Industry||Share of fund||Total return – 2018 through July 23||Total return – 3 years||Total return – 5 years|
|PT Bank Mandiri (Persero) Tbk||BMRI, +1.95%||Indonesia||Regional Banks||5.3%||-18%||36%||60%|
|Yum China Holdings Inc.||YUMC, -2.08%||United States||Restaurants||5.1%||-14%||N/A||N/A|
|Sands China Ltd.||1928, +2.14%||China||Casinos/Gaming||5.1%||3%||42%||25%|
|Magnit PJSC GDR||MGNT, +0.76%||Russia||Food Retail||4.7%||-38%||-68%||-70%|
|Wal-Mart de Mexico SAB de CV||WALMEX, +1.89%||Mexico||Discount Stores||4.6%||17%||66%||92%|
|ITC Ltd.||500875, +0.42%||India||Tobacco||3.8%||10%||43%||25%|
|Yes Bank Ltd.||532648, -1.26%||India||Regional Banks||3.5%||24%||141%||364%|
|HDFC Bank Ltd.||500180, +0.36%||India||Regional Banks||3.2%||16%||99%||228%|
|Mr Price Group Ltd.||MRP, +3.16%||South Africa||Department Stores||3.2%||-7%||-1%||111%|
|AIA Group Ltd.||1299, -0.36%||China||Life/Health Insurance||3.1%||4%||39%||105%|
The local tickers for each company are listed in the table, except for Yum China, which is publicly traded in the U.S., and Magnit PJSC, which the fund invested in through its global depositary receipts on the London Stock Exchange. There are also American depositary receipts (ADRs) for several that are traded on U.S. exchanges:
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