Stringent vetting of stocks before investing oh Stringent vetting of stocks before investing

We have found that four eyes looking at a company prevents a single fund manager from falling in love with a stock - Gerald Ambrose
We have found that four eyes looking at a company prevents a single fund manager from falling in love with a stock - Gerald Ambrose
Below are excerpts of BizWealth’s interview with managing director Gerald Ambrose on Aberdeen Asset Management’s investment philosophy:

How stringent is the process of evaluating a stock to be invested by Aberdeen? 

Our company’s visit note consists of an extensive template, all of which needs to be filled out by a fund manager when he visits a company. This template is designed to leave no stone unturned. It not only covers the financials of the company, but also the management and the board of directors among other things.

We want to make sure management is honest. Things like that can be a bit subjective, I know, but when
we buy into a stock, it is like going into a partnership. We want to make sure what we are buying into, is what will continue to be, for a long time to come.

Every Friday, we have our internal KL office meeting where all the fund managers discuss their stock ideas and the outcome of their respective company visits. All fund managers’ views, irrespective of seniority, have an equal weight in these discussions. It is during this meeting that we sort the wheat from the chaff.

Then every Monday, we have our regional investment meeting where the key stock ideas are again discussed
with the extended team. Our regional counterparts get a say on our investment ideas as well. For a stock to be selected for addition to a portfolio, there will need to have been at least 2 meetings and visit notes from 2 different fund managers with the management of the company. We have found that four eyes looking at a company prevents a single fund manager from falling in love with a stock.

While you do have that extensive template, what are some of the significant things you look out for?

Ideally, we need to be confident that the company will be profitable for at least 8 to 10 years. This is of
course subjective, but we like companies with a clear competitive advantage. 

If a company consistently produces high margins, that is typically a sign that the company has that
advantage. For example, we think that Public Bank is one of the best banks in the world.

Secondly, the company’s cashflow needs to be strong enough to fund whatever growth the company is
planning moving forward. Having said that, we are not opposed to giving the company money for growth,
let’s say via a rights issue, if we see that expansion will be good for the company.

Thirdly, does the company have excess cashflow over and above what is needed for capital expenditure? If so, would management consider be giving it back to shareholders?

Your investing strategy during difficult times like these? 

Our investing strategy is a simple bottom-up approach whatever the economic environment is like. From
our extensive analysis, we feel that we can forecast a company’s outlook with quite a high level of confidence.
From the top down, however, looking at things from a macro perspective, we don’t get the same confidence. And honestly, who can actually forecast macro variables and index targets?

We are instinctively cynical about ‘disrupters’, the Apples and the Amazons, until we are confident in their long-term sustainability. We do not know how they may do in years to come. We are not naturally into the next big thing. Fads run really fast. We try to avoid stocks that have investor momentum but which are really running on hot air. 

This investing strategy has always been the same since you started in 2005?

When the KL office started in 2005, we had a fund size of some US$100mil and our portfolio consisted of about 14 stocks. Today, our portfolio consists of about 40 stocks, which is still very focused and concentrated.

We do like looking at small companies, but because we are getting bigger, there is starting to be a market
capitalisation limit we look at, which is about US$200mil. 

Our portfolio management strategy involves (a) top slicing: for example, if a stock we bought has done very well and reached (or exceeded) our estimate of its fair value, we start to trim some, and (b) topping-up - using that money to buy some of our other stocks which have underperformed.

This is sort of a balancing system on its own. We are always invested - about 98% invested.

What are some of the things that are big no-nos for Aberdeen?

Governance is an area which is very important for us. We have learnt over time that bad corporate governance leads to bad performance. herefore we ask at the beginning: are the directors really independent? We look at their past history, whether they attend all board meetings.

The other thing we look at closely is related party transactions. Some big companies inevitably do this and we need to be sure that these transactions are in the shareholders’  best interests. For example, we look very closely for fair play if the major shareholder injects assets in his private companies into his listed entities.

We try to avoid that wander far from from their core activity without consulting shareholders.

Are you positive on Malaysia now?

 I feel that Malaysia is being forced into getting more efficient. With the removal of subsidies, Malaysians are starting to adjust to real life. Hard times help to produce greater efficiencies.

Malaysia’s economy is actually looking quite good. Oil prices have collapsed since last June so we’re now smack in the middle of it, yet our trade and current accounts are still in surplus. Our latest Industrial
Production Index figures show that the manufacturing sector is doing pretty well.

Although we are running a budget deficit, it is narrowing.
Malaysia is in fact expanding and diversifying regionally. When we compare Malaysia’s external assets
compared to its external liabilities, it is very strong compared with our neighbours. Moving forward, I see
Malaysia deriving more of its income from more diversified sources.

Then why has the ringgit been so battered?

The near-term movement of all currencies appears to be in the hands of the traders. Like other emerging market central banks, Bank Negara has avoided wasting hard-earned reserves to combat this - our international reserves are in fact now starting to tick up. I feel the Ringgit is way undervalued.
Now would be a very good time to buy into the Ringgit. However, with the uncertainties at large in the global economy, we now seem to be in ‘No Man’s Land’ where nobody is willing to move in and buy.

What is your opinion of the global economy at this point?

For seven years or more, the world economy has been subjected to a massive experiment by central banks around the developed world.Nobody knows how the experiment will turn out. I personally do not foresee the Fed raising interest rates in December because I don’t think the US economy is strong enough to handle it.

In fact when the Fed does raise interest rates, it’s possible that markets could fall heavily, in my view.
Then perhaps, this would cause the fourth bout of quantitative easing (QE4) to take place.

However, all these rounds of QE never actually put any money into the pockets of Americans. People have always looked to central banks as the saviours of the economy.