Batterymarch: markets need to be respected and feared
Investment Outlook Series: Ray Prasad, a senior fund manager at Batterymarch Financial Management, says urban legends of investing have been turned upside down and there is a new appreciation for risk and volatility.
This is part of an AsianInvestor series on the 2009 investment outlook of fund managers with Asian portfolios.
Ray Prasad is a Boston-based senior global emerging markets portfolio manager at Batterymarch Financial Management. He joined Batterymarch in 1997 to perform emerging markets research and was promoted to portfolio manager in 2000. In 2005, he was named senior portfolio manager, with primary responsibility for Asian markets.
Prasad focuses primarily on the Asian markets within BatterymarchÆs emerging markets team, which manages around $3 billion in emerging Asian equities in both dedicated portfolios and broader mandates.
Batterymarch, which has a quantitative and fundamental approach to investing, manages more than $23 billion in equity assets worldwide.
What are the biggest opportunities that you see in the coming 12 months?
Prasad: Asia, along with the other emerging markets, still offers better expected earnings growth than the developed markets û despite falling estimate revisions û as well as better profitability. Furthermore, the global financial turmoil has brought stocks in these markets back to their historical valuation discount relative to developed market equities. For example, China currently trades at 8.2 times forward price-to-earnings compared to 9.8 times for the MSCI World Index. China also has substantially less leverage, with a debt-to-equity ratio of 16% versus 83% for MSCI World.
Valuations are similarly attractive in other Asian markets. In fact, these are the lowest valuation levels since the Asian crisis, from which the markets recovered nicely. This environment provides the opportunity to buy attractive stocks at bargain prices, which has typically worked well for investors with a longer-term horizon.
As for how to capitalise on these opportunities, weÆre focusing on bottom-up company fundamentals, as we would in any market environment. Our models continue to favour firms whose businesses are related to domestic demand and companies involved with infrastructure build-out, which is critical for AsiaÆs development. The focus is also on quality large-cap names with a strong market position that are trading at very attractive valuations.
How has the global financial crisis affected the way you manage your portfolios?
Even though emerging markets have strong fundamentals, the breadth of the global crisis has caused things to behave differently. We can identify companies with strong balance sheets and position the portfolio somewhat more defensively in this environment. But rising stock correlations, coupled with extreme volatility have made it difficult to realise alpha from the market. Also, analysts typically tend to lag the market during downtrends, so we have to be more vigilant in evaluating some of their earnings forecasts. Lastly, we have made a tactical shift toward larger, quality companies with strong managements.
What is the biggest lesson you have learned from the US credit crisis?
Everyone has learned that nothing is too big to fail. Investors have always felt that the US was too big to fail, but not anymore. It seemed as if companies like Goldman Sachs or Citigroup û the bluest of the blue chips û would be there forever and become bigger and bigger, and that a money market fund would never lose money. Some of these urban legends have been turned upside down. There is a new appreciation for risk and volatility. The market needs to be respected and feared.
Have you made any significant changes to your asset allocation in terms of markets or sectors in the past few months?
Changes in our portfolios are incremental, reflecting the changes in the market environment. In recent months, we have cut back on cyclicals and commodities while increasing our holdings in companies involved with infrastructure development in emerging countries as well as companies that are benefiting from domestic consumer demand. As a result, we are now holding fewer materials stocks and have more holdings in telecommunications and consumer-related companies. From a country perspective, we have been increasing our exposure to China, and we have higher-than-historical exposure to the larger cap names with quality management.
What are your favoured markets in Asia?
China is a big overweight for us given the fiscal and monetary flexibility of the government. The Chinese authorities are able to bring substantial resources to stimulate growth and prevent a hard economic landing. Recently they put together a $586 billion multi-year package, which is large for a $3.6 trillion economy. Loan-to-deposit ratios are amongst the lowest globally as is leverage for both consumers and corporates. The other Asian countries are facing domestic challenges, be it on the political front or from a rapidly slowing global economy. Some of the big Asian economies have large externally oriented sectors, and slowing exports will present a challenge for them. Apart from this, forward price-to-earnings for China has come down from 20 times a year ago to around 8 times today.
What markets are you bearish over?
WeÆre not avoiding any market in particular. Our approach is to look at companies on an individual basis, regardless of their location. Our goal is to avoid those companies that arenÆt well positioned to ride out the current turmoil. These might be companies that made too many capital expenditures at the top of the cycle and now have to deal with declining demand, or perhaps theyÆre leveraged and facing funding constraints.
What are your market weightings within an Asia ex-Japan equities portfolio?
China û Overweight
Hong Kong - Underweight
India - Underweight
Indonesia - Overweight
Korea - Overweight
Malaysia û Underweight
Pakistan û N/A
Philippines û N/A
Singapore - Underweight
Sri Lanka û N/A
Taiwan - Underweight
Thailand - Underweight
Vietnam û N/A
Which sectors do you expect to outperform in the coming year?
The market is driven to a large extent by new flows and is exhibiting high volatility. Company valuations do not seem to matter. This is reminiscent of the tech boom, when valuations also seemed to be ignored. Our models point toward large-cap firms with quality management, which are presenting some of the best values today. WeÆre finding these companies across a range of sectors and countries.
Which sectors do you expect to underperform?
The flip side to what IÆve just described is some of the names in sectors that are seeing a dramatic slowdown in demand or have built substantial capacity in recent years. Companies that leveraged themselves at the peak of the cycle can be expected to underperform as the economic environment gets tougher.
What are the main challenges that you expect to face in the coming 12 months?
Our models, which focus on the fundamental strength of individual companies, have proven effective over time. In the shorter term, our main challenge is one of investor rationality. Investors are no longer differentiating between stocks based on their actual value.
What are the main risks of investing in Asia at the moment? How are you managing those risks?
Asian countries are less insulated from the global economy than other emerging markets because of their trading partnerships, especially with the US. So a lengthy global economic slowdown is the greatest risk for the intermediate term. On the other hand, Asian markets are benefiting from the drop in commodity prices.
Regardless of the macroeconomic conditions, we are always focused on managing risk. Our process incorporates multiple risk controls, including broad diversification across markets and industries. We evaluate a stock from multiple perspectives û both global and local, within industry and country. Our focus is on maintaining a solid risk-to-reward perspective.
Ray Prasad is a Boston-based senior global emerging markets portfolio manager at Batterymarch Financial Management. He joined Batterymarch in 1997 to perform emerging markets research and was promoted to portfolio manager in 2000. In 2005, he was named senior portfolio manager, with primary responsibility for Asian markets.
Prasad focuses primarily on the Asian markets within BatterymarchÆs emerging markets team, which manages around $3 billion in emerging Asian equities in both dedicated portfolios and broader mandates.
Batterymarch, which has a quantitative and fundamental approach to investing, manages more than $23 billion in equity assets worldwide.
What are the biggest opportunities that you see in the coming 12 months?
Prasad: Asia, along with the other emerging markets, still offers better expected earnings growth than the developed markets û despite falling estimate revisions û as well as better profitability. Furthermore, the global financial turmoil has brought stocks in these markets back to their historical valuation discount relative to developed market equities. For example, China currently trades at 8.2 times forward price-to-earnings compared to 9.8 times for the MSCI World Index. China also has substantially less leverage, with a debt-to-equity ratio of 16% versus 83% for MSCI World.
Valuations are similarly attractive in other Asian markets. In fact, these are the lowest valuation levels since the Asian crisis, from which the markets recovered nicely. This environment provides the opportunity to buy attractive stocks at bargain prices, which has typically worked well for investors with a longer-term horizon.
As for how to capitalise on these opportunities, weÆre focusing on bottom-up company fundamentals, as we would in any market environment. Our models continue to favour firms whose businesses are related to domestic demand and companies involved with infrastructure build-out, which is critical for AsiaÆs development. The focus is also on quality large-cap names with a strong market position that are trading at very attractive valuations.
How has the global financial crisis affected the way you manage your portfolios?
Even though emerging markets have strong fundamentals, the breadth of the global crisis has caused things to behave differently. We can identify companies with strong balance sheets and position the portfolio somewhat more defensively in this environment. But rising stock correlations, coupled with extreme volatility have made it difficult to realise alpha from the market. Also, analysts typically tend to lag the market during downtrends, so we have to be more vigilant in evaluating some of their earnings forecasts. Lastly, we have made a tactical shift toward larger, quality companies with strong managements.
What is the biggest lesson you have learned from the US credit crisis?
Everyone has learned that nothing is too big to fail. Investors have always felt that the US was too big to fail, but not anymore. It seemed as if companies like Goldman Sachs or Citigroup û the bluest of the blue chips û would be there forever and become bigger and bigger, and that a money market fund would never lose money. Some of these urban legends have been turned upside down. There is a new appreciation for risk and volatility. The market needs to be respected and feared.
Have you made any significant changes to your asset allocation in terms of markets or sectors in the past few months?
Changes in our portfolios are incremental, reflecting the changes in the market environment. In recent months, we have cut back on cyclicals and commodities while increasing our holdings in companies involved with infrastructure development in emerging countries as well as companies that are benefiting from domestic consumer demand. As a result, we are now holding fewer materials stocks and have more holdings in telecommunications and consumer-related companies. From a country perspective, we have been increasing our exposure to China, and we have higher-than-historical exposure to the larger cap names with quality management.
What are your favoured markets in Asia?
China is a big overweight for us given the fiscal and monetary flexibility of the government. The Chinese authorities are able to bring substantial resources to stimulate growth and prevent a hard economic landing. Recently they put together a $586 billion multi-year package, which is large for a $3.6 trillion economy. Loan-to-deposit ratios are amongst the lowest globally as is leverage for both consumers and corporates. The other Asian countries are facing domestic challenges, be it on the political front or from a rapidly slowing global economy. Some of the big Asian economies have large externally oriented sectors, and slowing exports will present a challenge for them. Apart from this, forward price-to-earnings for China has come down from 20 times a year ago to around 8 times today.
What markets are you bearish over?
WeÆre not avoiding any market in particular. Our approach is to look at companies on an individual basis, regardless of their location. Our goal is to avoid those companies that arenÆt well positioned to ride out the current turmoil. These might be companies that made too many capital expenditures at the top of the cycle and now have to deal with declining demand, or perhaps theyÆre leveraged and facing funding constraints.
What are your market weightings within an Asia ex-Japan equities portfolio?
China û Overweight
Hong Kong - Underweight
India - Underweight
Indonesia - Overweight
Korea - Overweight
Malaysia û Underweight
Pakistan û N/A
Philippines û N/A
Singapore - Underweight
Sri Lanka û N/A
Taiwan - Underweight
Thailand - Underweight
Vietnam û N/A
Which sectors do you expect to outperform in the coming year?
The market is driven to a large extent by new flows and is exhibiting high volatility. Company valuations do not seem to matter. This is reminiscent of the tech boom, when valuations also seemed to be ignored. Our models point toward large-cap firms with quality management, which are presenting some of the best values today. WeÆre finding these companies across a range of sectors and countries.
Which sectors do you expect to underperform?
The flip side to what IÆve just described is some of the names in sectors that are seeing a dramatic slowdown in demand or have built substantial capacity in recent years. Companies that leveraged themselves at the peak of the cycle can be expected to underperform as the economic environment gets tougher.
What are the main challenges that you expect to face in the coming 12 months?
Our models, which focus on the fundamental strength of individual companies, have proven effective over time. In the shorter term, our main challenge is one of investor rationality. Investors are no longer differentiating between stocks based on their actual value.
What are the main risks of investing in Asia at the moment? How are you managing those risks?
Asian countries are less insulated from the global economy than other emerging markets because of their trading partnerships, especially with the US. So a lengthy global economic slowdown is the greatest risk for the intermediate term. On the other hand, Asian markets are benefiting from the drop in commodity prices.
Regardless of the macroeconomic conditions, we are always focused on managing risk. Our process incorporates multiple risk controls, including broad diversification across markets and industries. We evaluate a stock from multiple perspectives û both global and local, within industry and country. Our focus is on maintaining a solid risk-to-reward perspective.
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