Rakesh Bordia, principal and portfolio manager at Pzena Investment Management, explains the core principles that guide the firm’s approach to value investing and why he believes that this approach is especially effective in emerging markets. He also discusses the stocks he’s picked out as winners from China’s stock market decline in recent years.
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Pzena Investment Management is an American firm with recognised expertise in deep value investing. Before joining Pzena in 2007, Rakesh served as a principal at Booz Allen Hamilton, where he focused on innovation and growth strategies.
Rakesh has a deep understanding of emerging markets, which he draws on to explain the opportunities and challenges of investing, the importance of a long-term horizon, and the crucial valuation metrics that Pzena takes into account.
He also provides strategic perspectives on Chinese stocks, particularly Alibaba [9988.HK], and why he thinks they appeal to value investors in 2023.
“A stock is only a good or a bad investment, depending on what you pay for it,” he tells OptoSessions, getting straight to the heart of the principles that drive Pzena’s approach.
Pzena’s philosophy centres on an unwavering commitment to classic research-driven value investing. The organisation has committed to this throughout the last decade, despite being outperformed by growth investors during that time, but it is now reaping the rewards. “That’s who we are,” says Rakesh. “It took true grit and discipline to stay the course.”
“A stock is only a good or a bad investment, depending on what you pay for it.”
Core characteristics
Pzena’s investments all share three core characteristics.
Firstly, they are businesses with a fundamental competitive edge over their peers, whether that is scale, distribution, technology, or something else.
Secondly, their stock is currently undervalued thanks to a temporary setback to its performance. This is where Pzena’s active management approach is crucial because Rakesh and his colleagues work hard to assess what steps the business’ management are taking to fix any given issue and ensure it is transitory.
And the third consideration is the downside protection of the stock, given that Pzena expects them to recover over a multi-year time horizon.
Rakesh gives the hypothetical example of investing in a stock in 2019 that faced some temporary but fixable challenges.
“Nobody saw Covid coming. And when Covid came, everything went for a toss.”
“You have to really understand the downside protection, which is [asking], what’s the balance sheet? What is the cash flow of the business? If the pain persists for very long, does the company have the ability to make it to the other side?”
Emerging Markets for the long haul
A long-term horizon is another key component of Pzena’s approach.
“We dabble in the deep value part of the universe,” explains Rakesh, “where most of our investments are in the cheapest 20% of the universe.”
This isn’t distressed investing, however; Rakesh emphasises that Pzena is actively looking for companies with a strong competitive edge. These companies only become cheap when issues arise for which there is no immediate fix in sight, usually meaning it will take years for them to fully capitalise on their competitive advantage.
“It could be a cyclical business, [there could be] supply/demand issues, or it could be that a company's cost structure needs to be fixed,” Rakesh explains. The key point is that resolving it and fixing profitability will take years, not weeks or months.
“Our average holding period for most stocks in our portfolio is around three to five years,” by which time companies tend to have fixed the issues, and markets once again give them credit for their fundamental earning power.
Rakesh – and Pzena – think that contrary to popular opinion, value investing works well in emerging markets.
“If you go back to why value works as an investing approach,” says Rakesh, “it works because we are all human. It works because we have a tendency towards risk aversion; we have a tendency to shun uncertainty.”
“As a result, when there is uncertainty, there’s fear in the market. Stock prices deviate from their long-term fundamentals because people don’t want to own those stocks. That is what creates an opportunity for value investors like us to capitalise on those price dislocations.”
This fear factor is elevated in emerging markets. Unstable political and economic environments lead to unpredictable events, such as the attempted coup in Turkey in 2016 or Russia’s invasion of Ukraine.
“These are significant geopolitical events which can dramatically change people's perspective about a country. That creates a much bigger price dislocation versus [markets in] the US.”
One of the challenges of investing in emerging markets, besides political and economic instability, is a relatively immature business environment. “There is less data availability,” says Rakesh, which makes a “critical research orientation, with the focus on fundamentals… particularly powerful in emerging markets.”
“As a result, when there is uncertainty, there’s fear in the market. Stock prices deviate from their long-term fundamentals because people don’t want to own those stocks. That is what creates an opportunity for value investors like us to capitalise on those price dislocations.”
Value in China
Of all the emerging markets, China has been most in the spotlight in recent years. The country’s challenges, as far as investors are concerned, have brought stocks like Alibaba to the forefront of Rakesh’s attention.
“We believe that [Alibaba] is one of the most amazing value stocks in the emerging markets universe right now,” says Rakesh. Its position as a leader in a still-growing industry means it has a market share as well as positive earnings growth while also being China’s largest cloud provider.
Moreover, as Rakesh underlines, “a lot of the things that could have gone wrong have already gone wrong for them. If you look at the skew of outcomes, it’s significantly towards the upside.”
China as a whole offers potential to value investors, given the performance slump the nation’s stocks suffered relative to other emerging markets during 2021.
“A lot of very attractively run businesses with strong fundamentals came into the deep value category for us,” Rakesh reflects, including real estate conglomerate China Overseas Land & Investment [0688.HK], hotel and casino operator Galaxy Entertainment [0027.HK] and brokerage firm GF Securities [1776.HK].
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