Some time back I had the fortune of meeting with some interesting guys who are involved in Central Asia.
Like some of you, I have read the stories of stupendous, life-changing growth and opportunities. I’ve even met a good number of investors who have placed what amounted to a grubstake and walked away with more money than they could ever spend… in a few life times.
Our friend Clemente Cappello of Sturgeon Capital has been making Central Asia his core area of focus for the past 5 years. He’s one of the guys we turn to when we want on-the-ground intelligence regarding places like Kazakhstan.
Over the next few days we’ll get to know Clemente a bit better, and get an insider’s peak at an oft-misunderstood part of the world.
Chris: Clemente, can you illustrate the macroeconomic case for investing in central Asian countries?
Clemente: We often say that we’re not trying to be the smartest, most sophisticated guys in the market with our strategies. We like to make the “dumb” trade. By that we mean: Invest in fast growing, low debt, cheap markets, avoiding the usual Frontier Market pitfalls of counterparty risk, outright frauds, etc. It’s much easier to do well with the wind at your back. Simple (but not easy, as Warren Buffet would say).
So quite simply, the macroeconomic case for the Central Asian economies can be made by highlighting three key points:
- The region is awash with (relatively unexploited) natural resources. More importantly, and particularly in relation to oil and gas, production and exports are rising. Coupled with a low cost base for Central Asian natural resource companies and a relatively attractive fiscal policy, regional producers and exporters stand to benefit much more than, say, those in Russia, where government taxation means Russian producers have much less exposure to upside. Conversely, with rising production and a low cost base, Central Asian producers are also able not only to tolerate but to continue growing in a low commodity price environment. This capitalisation on the current commodity super-cycle have seen some Central Asian countries post impressive GDP growth and maintain and continue strong economic profiles e.g. very low Debt/GDP ratios with well managed Central Bank policy;
- So, we have a region capitalising on a wealth of untapped energy, metal, mineral and other natural resources, which is relatively well-placed to weather volatility in commodity prices, which has also witnessed some of the most rapid per country GDP growth in the world in recent years. Secondly, add to that the fact that these markets are literally in the middle of three of the 5 (including South Africa) BRICS countries i.e. Russia in the North, India in the South, China in the East. China, and more recently India, are spending billions of dollars investing in infrastructure and licenses to secure supply for their own booming economies. So if you like, investing in Central Asia is a bit of a leveraged play on the South East Asian growth story. If Asia is the supplier to the West, then we’re investing in Central Asia as “the supplier of the supplier”;
- The third key point to make is that these equity markets are cheap. Not only the local markets (although the Kazakhstan local index is down around 70% off of its 2007/8 highs, and is currently trading at a 50%+ discount to both the MSCI Frontier and Emerging Market Indices), but also companies that can be classified as mid-large cap companies, listed in London, Hong Kong, New York, Toronto, Sydney, etc. that have a substantial exposure to Central Asian economies. These businesses have suffered from (a) a chronic lack of mainstream analyst coverage which has led to (b) the categorization of poorly understood “Central Asian” stocks as the first to go as a “sell” in a portfolio in a general “risk off” environment. We’ve continued to see quality companies continue to increase value for shareholders by various value metric estimations (earnings per share, dividend per share, etc.) and institute markedly improved corporate governance, yet see their share price pushed to unjustifiable lows. Historically, fundamentally and relatively, these markets are cheap. It’s not something we’ll often say, but in this case, companies have delivered but investors have not.
Chris: Some of the largest known reserves of natural resources in the world are sitting in this region. Kazakhstan alone holds the 3rd largest known Uranium reserves, 4th largest natural gas reserves, and large gold, coal and oil reserves. Resource wealth doesn’t automatically translate into regional wealth… just look at the DRC. What makes this region different, and why now?
Clemente: You used the example of the Democratic Republic of Congo there, which is quite pertinent given that we often hear from certain investors to whom we speak regarding the region say, “but what about Africa, isn’t that the best part of the world for frontier market investments right now?” Whilst our expertise does not lie in African market investments, from what we do know, we would say that compared to Africa, Central Asia has a very different, and we would argue from an investors perspective, much stronger heritage in terms of its history and culture.
Most notably, as it has seen a 21st Century re-emergence, the region was once the way of the old Silk Route named after the lucrative trade in Chinese silk which began over 2000 years ago. This soon became the lifeblood route of trade between Europe, Africa and China, covering most of the civilized world. Various parts of Central Asia have been a large part of the Mongol, Alexandrian, Persian and Turkic empires.
More recently, for all of its failings, the Soviet Union maintained and built upon relatively high levels and broad education across the Central Asian countries. A relatively high level of education across the region still exists today.
What this means for us as investors is that we have a long-standing and deep-seated tradition of trading and merchant culture, with a high level of education in a relatively young population. This equates to an educated, able and competitive workforce for local companies. There are a lot of very smart young executives and entrepreneurs who, having moved abroad and had the advantage of experience in developed market companies and business and finance schools, are returning to the region to develop and head up many local businesses.
This further translates into a good understanding by local management of proper corporate governance, management and business development strategy and practices. Regional companies listed on developed market exchanges such as the London Stock Exchange are viewed by many as a matter of national pride and a sign of the significant progress and potential for Central Asian economies.
For us as investors, these qualitative influences are ultimately expressed as this translates into better corporate governance and genuine corporate concern for shareholder interests (versus some other Frontier Markets where the shareholder is last on the list of stakeholders in the equation for both co-owners and managers alike).
Chris: Well, as a guy who grew up and has travelled extensively throughout Africa I can certainly see your points…
Well pick it up again tomorrow with Clemente.
“Country selection is more important in frontier markets than in emerging markets.” – Cliff Quisenberry, Caravan Capital Management