Berg: Go Beyond Global Developed Markets

Looking globally, what’s the current picture?

We remain in a low- interest, low- growth world, and that reduces investor expectations. Still, global equities remain good value on a relative basis, and I think could achieve a return between 6% and 8% a year over the next three to five years. Some say valuations are extended but they’re not. It’s true that US stock valuations are at the highs prior to the financial crisis, but US companies now earn 25% above their pre-crisis levels.

Also if you look through a dividend lens, you can argue that companies are actually cheap. Global equities yielded about 2.5% at the end of September, while the 10-year German Bund yielded 1.0% and 10-year Treasuries yielded 2.5%. In 2007, global equities yielded near 2%, when you could get 3% from Bunds and almost 5% from Treasuries. So you can now own real, growing, profitable businesses with dividend yields above those of fixed income alternatives.

What’s your approach to managing a global strategy?

I’m trying to harness the best thoughts of T. Rowe Price analysts, sector, regional managers and fixed income managers, and put them into a high-conviction portfolio of large- and mid-cap companies that is truly global. I’m invested in about 30 countries, almost twice that of many global managers who tend to focus on developed markets. By contrast, I invest in 15 different emerging and frontier countries. Additionally, I have a clear preference for growth and quality. I’m not just looking for businesses that are exceptionally cheap but for ones that are more profitable, faster growing, gaining share, better run and that have higher returns, better balance sheets, and great management teams. Lastly, I want stock selection—not sector bets—to drive returns.

What about valuations?

Once you identify exceptional companies, the only way to win is to buy them for less than their intrinsic value. I want to acquire these companies at a discount so I can potentially make 40% to 60% over two to three years. I almost never buy stocks with anything less than a year time horizon because markets are relatively efficient over the short term. I also rarely buy companies for 10 years because the world changes more in a decade than most people can fathom. The nice thing about a two- to three-year holding period is that it means I care about the fundamentals on a three- to five-year basis.

I’m always looking at a mosaic of valuation methods, but my preferred method is based on free cash flow [operating cash flow minus capital expenditures]. Cash is what really drives businesses. Cash doesn’t lie.

Why is the strategy so focused on emerging markets?

One big reason I like emerging markets is because they are a less efficient part of the market, and I’m fortunate to have a lot of analytic resources at T. Rowe Price to generate returns from these inefficiencies. Second, just mathematically, for all the headlines about the US leading the global recovery, emerging markets are still driving approximately 70% of global growth. The final thing is the very broad way I’m able to access emerging markets. BRICs, with the exception of India, are relatively well known, but they are only half of the emerging market opportunity set. This is why we look deeper and ultimately seek to invest in stocks and markets that we believe will define the next ten years of the emerging world growth story.

Then who are the emerging market winners?

I like emerging markets that are domestically driven, that are starting from a low per capita GDP and that have low debt to GDP—economies like India, Indonesia, the Philippines, Peru, and Turkey. For all the talk of emerging market troubles, their underlying consumption and growth stories are unchanged. In frontier markets, there can be liquidity constraints so I focus on two of the biggest that could evolve into emerging markets, Vietnam and Nigeria.

Where are you particularly finding growth companies?

The internet is still a game changer for the way consumers interact and purchase products—not just search companies, but other internet business models like Priceline and Amazon. Priceline, in particular, is an online travel company with a very broad set of consumers globally, pretty high ticket purchases, and which has taken a lot of share from travel agents. There are also a lot of interesting software companies that are taking share.

Another really interesting area is financials. In the developed world, I own some well-run financials that could benefit when rates and volatility move higher, such as Morgan Stanley and State Street. I also like high quality, traditional banks in fast growing markets like India and Indonesia. They’re not valued differently to developed world banks even though their markets’ growth rates are much higher. Owning these is a broad play on their economies’ faster growth.

Last word?

2014-GL-959