David Nadel


March 14, 2014
For our TV viewers, this weekend is the last of public television’s current pledge campaigns and WEALTHTRACK is revisiting our Fed Centennial special with James Grant and Richard Sylla.

When you think small cap investing India is probably not the first country that comes to mind. But the small cap pioneers at the Royce Funds feel differently. David Nadel, who is their Director of International Research and runs several Royce Funds explains the lure of India. Continue Reading »

Transcript: Nadel & Foster 10-26-12 #918

November 16, 2012


#918- 10/26/12


CONSUELO MACK:  This week on WEALTHTRACK, Royce Funds’ David Nadel and Seafarer’s Andrew Foster sail the world searching for hidden treasures. Why are these two portfolio managers finding more gems in international markets? Find out next on Consuelo Mack WEALTHTRACK.


Hello and welcome to this edition of WEALTHTRACK. I’m Consuelo Mack. One of the eternal truths of investing is that price matters. As recent Great Investor guest Bruce Berkowitz told us, the best investment advice he ever received was that “the price you pay for a security determines most of your success… maybe 75% of your success.” Pay too much for even the greatest company, you can lose money; pay nothing for a mediocre company, you can make a lot of money.


It turns out the same rules apply to stock markets. And with more investors putting money into market based exchange traded funds, or ETFs, price matters more than ever. According to the Financial Times, net new global inflows into ETFs have soared $182.6 billion so far in 2012, up 42% over the same period last year and already surpassing 2011’s full year total. So what kind of prices are investors paying for these funds? It depends on which markets they are buying. And according to a recent report, there is a huge gap among global markets right now. Some are historically quite expensive, others quite cheap.


According to a research report put out by California-based Cambria Investment Management and recommended to us by WEALTHTRACK guest David Nadel, the U.S. is one of the most expensive markets right now. Cambria used a valuation measure developed by Yale economist and frequent WEALTHTRACK guest Robert Shiller. It’s called CAPE, which stands for Cyclically Adjusted Price-to-Earnings ratio and it’s figured over trailing ten year periods, instead of the commonly used price to earnings ratios, or P/E’s figured on current or estimated earnings for a year. According to Cambria, going all the way back to the late 1800s,  the best ten year periods to invest in the U.S. were when the cyclically adjusted price to earnings ratio began the period at an average of under 11. With that low starting point, the market delivered average annualized 10 year returns of 16.1%. The worst ten year periods were when the market started at a CAPE of around 23. The average ten year market return after starting at that level was negative 3.3%.


What is the U.S. market’s CAPE level now? It’s above 20. As Cambria says “It very much matters what price one pays for an investment!” Future returns are lower when valuations are high, and future returns are higher when valuations are low. The same rules apply to overseas markets.


This week’s WEALTHTRACK guests pay close attention to valuations all over the globe. Andrew Foster is the founder and chief investment officer of Seafarer Capital Partners where he manages the newly launched Seafarer Overseas Growth and Income Fund, which focuses on foreign markets, especially in the developing world. Until going out on his own, Foster was a portfolio manager at Matthews International Capital Management where he managed several funds, including the Matthews Asian Growth and Income Fund. David Nadel is director of international research for Royce & Associates, the firm founded and still run by legendary small company stock pioneer Chuck Royce. Nadel is co-portfolio manager of Royce Global Value Fund, as well as involved in managing six other funds focusing on smaller company stocks around the world. I began the interview by asking Nadel about his current strategy in the Royce Global Value Fund, why he is de-emphasizing the U.S


DAVID NADEL: When we launched the fund back in the beginning of 2007, we were actually overweight the U.S. quite a bit. We were about 50% weighted in the U.S. We basically go where the value is. Through the global economic crisis of the fall of 2008, the beginning of 2009, the values really shifted, where the European stocks sold off very aggressively, emerging market stocks sold off even more aggressively. And so suddenly coming out of that period, we faced a very different profile in terms of relative value. And so now if you dialed the clock further up to today, we’re at a juncture which I think is almost a historic bifurcation between the U.S. markets and a lot of the foreign markets. We’ve just gone through a period which is apparently the second largest rally ever in an election year, in the 52-week period leading up to today.


CONSUELO MACK:  In the S&P 500.


DAVID NADEL: So the S&P has rallied about 30%. And I think there’s a great deal of complacency in the U.S. equity markets. We’re dealing with corporate earning margins that are at historic highs, and yet on a ten-year trailing earnings basis, the U.S. is trading at about a 50% premium to its normal P/E. And a ten-year number, I think, is interesting, because it takes you straight through the global economic crisis, the sort of Shiller P/E, if you will.




DAVID NADEL: And then you look by comparison, a CAPE, exactly. And then you look by comparison at many markets around the world and they’re trading at 30 to 80% discounts on this ten-year earnings number relative to their normal P/Es. Places like Germany, Austria, Japan, Brazil, et cetera, et cetera. So different geographies. So we basically go where the value is. We’re now at about a 15 or 20% U.S. weighting. That could change, again.


CONSUELO MACK:  Which is low, right, the U.S. benchmark.


DAVID NADEL: Which is very low, certainly versus a benchmark, yes. But that could change again. We could be back up at 50%, it just depends where the value is.


CONSUELO MACK:  And Andrew, congratulations, number one, on starting the Seafarer Fund.




CONSUELO MACK:  And you started your own fund, so you could have basically done any sort of a fund you wanted to. You chose to do an overseas fund, specifically, excluding the U.S. Why?



ANDREW FOSTER: Well, I’m mainly focused on the emerging markets within my fund, and I do have a background in those markets, so there’s some familiarity there. But beyond that, I have been a growth investor for my whole career. I tend to have a value bent to my growth investing, but I look for change and for progress in markets. And it’s not so much that I don’t see that in the U.S., but I see an evolution happening in the emerging world, where a great deal of progress is occurring, particularly new markets are forming, households are experiencing higher standards of living. And that transformation really gives rise to new economic opportunities. I trace all of that through financial statements in companies and the profits they derive, but it’s that change that is a really valuable intersection to invest in. And I look for that evolution, and I find it in the emerging markets in particular.


CONSUELO MACK:  And when you’re talking about growth, you’re sitting next to a value guy, so what does growth mean to you?


ANDREW FOSTER: Well, for me, growth is really about finding sustainable growth. Growth that can be compounded over time. I think one of the tricky things in investing in the emerging markets is folks get blinded by starry-eyed optimism over what growth might be achievable. They look at companies that could grow at 20 or 30 or 40%, and hurrah, isn’t this wonderful? What often happens is that the valuations associated with those companies are already very high, because it’s quite obvious those companies are growing quickly, and they tend to be valued steeply. But even more so, that growth tends to peter out, often, very quickly. And that sort of rate of growth is difficult to sustain. I think what I try and do is find companies that I can hold for very long periods of time. Be confident in their financials and confident they’re participating in that evolution I was talking about. And see that growth unfold steadily.


CONSUELO MACK:  So the growth rates, instead of being sometimes 20 or 30%, which you would steer away from, are what? I mean, what’s a good sustainable growth rate?


ANDREW FOSTER: I love to find growth rates between maybe 7 or 15%, somewhere in that range. It may sound like I’m undershooting a little bit, the growth potential of the emerging world, but actually it’s a very attractive place to invest in terms of finding sustainable growth. And I mentioned I had a bit of a value tilt. I find that in the emerging world, at least, companies that are growing that slowly, although I think that’s a plenty healthy growth rate, often are overlooked by investors as being a bit mature or past their prime, or maybe having a challenged business model. And consequently the valuations are not as steep as you would think. And so you get maybe a bit better of a valuation, and hopefully more sustainable growth.


CONSUELO MACK:  So growth with a value bent for Andrew. And, David, Royce is a value shop.




CONSUELO MACK:  And you’ve told me many times in the past that you won’t pay up for growth. So tell us what value means for you at Royce.


DAVID NADEL:  I find the distinction between value and growth almost a little bit artificial. What we are really, as it sounds like Andrew would find it a bit artificial as well, what we’re really focused on is value creation. And the way that we define value creation is through sustainably high returns on invested capital. If a business has a return on invested capital less than its cost of capital, it doesn’t matter how quickly it grows; it will eventually grow itself into bankruptcy, which is what we saw in the late ’90s with dotcom companies.


And so what we’re really much more interested in is businesses that have sustainably high returns on invested capital. If there’s growth on top of that, well then the value creation becomes exponential. And that’s all the better. The beauty of having a global fund and having a universe of really about 35,000 stocks to choose from is we can afford to cherry-pick. So we like to think that we can get all of those things at once. High returns on invested capital, strong track record of that, prospects for that to continue. Pretty good growth, and not pay a whole lot for it. It’s not always easy. But that’s the holy grail.


CONSUELO MACK:  A least for the Global Value Fund. I know you run a lot of other funds that are more diversified at Royce.




CONSUELO MACK:  But then you choose just 65 names, essentially.


DAVID NADEL:  That’s right.


CONSUELO MACK:  So what are the absolutely key characteristics to make it into the Global Value Fund?


DAVID NADEL:  The beginning process is the businesses have to have a minimum 15% return on invested capital on average, for the last five years. They have to have at least half of their balance sheet funded by shareholder’s equity. So these are very strong balance sheets. They have to have minimal liquidity requirements, because we’re hoping the fund will grow and liquidity will become more of a problem with time. But after those steps, the process becomes much more qualitative and there’s much more judgment applied. Some of the things that we look for: we like businesses that have dominant market-shares in what they do. And that’s often surprising for people to hear with small and mid-cap companies. But if you’re talking about a niche business, many of these companies have dominant market-shares.


You know, one company we’re invested in is a company called Spirax-Sarco. They’re the global number one in steam systems. So steam is used in all kinds of things. Pharmaceutical production, food, et cetera, et cetera. And just pumps out 35% returns on invested capital year after year. It’s sort of the definition of defensive growth. It’s compounded at eight and a year, sort of a profile that Andrew might like, 8% a year for the last 25 years. It’s increased its dividend for the last 44 years, consecutively. And we’re certainly big believers in past as prologue. So if a business has a track record that long, I bet you they’re going to increase their dividend for the 45th year. I’m going to take that bet. And dividends are not crucial to us. I mean, there’s a dividend component to our fund. But those are the sort of things we look for- businesses that have a moat. Sort of Warren Buffett small-cap stocks, if you will. And we’re buy and hold investors.


CONSUELO MACK:  So that the keys for you, when you look at a company, that would make it into the Seafarer portfolio, and I’m listening to that income is not critical, but it’s important to paying a dividend. And yours is a growth and income fund, so income is very important to you, right?


ANDREW FOSTER: Yes, indeed. So the sustainable growth is the primary characteristic I look for, but a very close adjunct to that is current income. And the reasons I use current income, I personally think the growth is the long-term investment opportunity that we’re trying to trace in the portfolio. But the current income does three things for us: we’re investing in a lot of diverse markets with different standards of transparency and accounting, and by using current income, by measuring it, we have a fairly common valuation metric in looking at these companies: their ability to generate current income and grow that current income. So that’s one thing. It helps us standardize our positions and evaluate them on, maybe not apples to apples basis, but something closer to that.


CONSUELO MACK:  So no matter what market you’re investing in, if they’re generating a dividend income, that that’s one metric that you can compare, yeah.


ANDREW FOSTER: The second thing is that, based on my prior experience as an investor, it’s a very important thing to find current income, to mitigate volatility. I’m mainly in the emerging markets right now, and they’re very inherently volatile markets. But my experience is that income acts like a bit of a sea anchor for your portfolio. If it generates a decent amount of current income, and that income is secure, you’ve done the homework to find companies that will pay dividends in good times and bad, like the company you just mentioned, then as markets begin to fall, if you have a portfolio of stocks paying those dividends, they tend to decline less rapidly. And then they actually tend to find a floor sooner than the markets as a whole, and don’t decline nearly to the same extent. That’s at least been the historical case. And so that income provides that stability of the portfolio.


The third thing it does is it helps me vet the quality of the company’s businesses. To cut to the chase about it, if a company produces a dollar of earnings, that’s something to be lauded. But if a company can translate a dollar of that earnings into cash, that it can pay out to you as a shareholder, that tends to mean a more tangible business model that is less likely resting on ephemeral qualities that may evaporate during a time of market distress.


CCONSUELO MACK:  Where are you finding the greatest values?


DAVID NADEL: Well, I guess the U.S. on a ten-year CAPE is trading at about 22 times earnings, so the normal number if closer to 14, so that’s pretty dramatic. There are some other markets around the world that are quite pricey as well. And so we will tend to avoid those- Indonesia, Malaysia, large swaths of Latin America are quite expensive.


CONSUELO MACK:  Andrew, would you agree with that?


ANDREW FOSTER: Yes, I agree with all of those markets as being expensive.




DAVID NADEL:  I mean, I think we’re finding a lot of value ironically in parts of Europe that are really in a position to benefit from a weak currency. Economies that are export powerhouses. Germany would be an obvious example. But two of our top four holdings in the portfolio happen to be Austrian companies. Austria, obviously, a relatively small country, but the businesses are run in a very cost-focused way, very disciplined. The market’s trading at seven times the average ten-year trailing earnings. I mean, it makes absolutely no sense. This is not a peripheral Europe country. Japan trading at a huge discount to normal ten-year trailing earnings. South Africa is not particularly expensive. Brazil has become much cheaper. China has become dramatically cheaper, because of various things, including fraud in some companies and worries about slowing growth. But there are still highly legitimate, high quality businesses to buy that are Hong Kong listed, et cetera. Some of which we own.


So with a global fund or an international fund, like Andrew’s, there is always a place to find value. I was just in Singapore, last month, also in Turkey. But if you want to find value in places, there’s almost always a proxy. Singapore is cheap, really, as a market. But the companies address the ASEAN region; many of them are Indonesia plays or they are Malaysia plays, or they’re even Burma plays; Myanmar, you know, a country that’s opening up after decades of being sort of a hermit nation. So there are always creative ways of finding value.


CONSUELO MACK:  So, Andrew, you have a concentration right now in the Seafarer portfolio of, what, 70% in East and Southeast Asia?


ANDREW FOSTER: That’s right. That’s right.


CONSUELO MACK:  How did that happen?


ANDREW FOSTER: Well, I have a background in those markets, and that’s part of it, because I’ve researched those markets intensely. But I would agree with the arguments that David’s made over some of the valuations, particularly in East Asia at present.


CONSUELO MACK:  And such as?


ANDREW FOSTER: China. I’m a bottom-up investor, so I have less fluency talking at the market level, but I would say that I find a lot of values in stocks around greater China at this moment. I think the tricky thing is that China’s growth is structurally slowing. It’s not just a cyclical thing that we’re going through. China’s economy’s matured a great deal. And I don’t anticipate that it will ever grow at the same sort of rates that it has done in the past.


CONSUELO MACK:  So it’s matured, the structural changes have matured from the export-driven economy to what, to consumer, or?


ANDREW FOSTER: Well, that is the question. To what? I think there’s been a lot of talk about it moving towards a more consumer-led economy, but frankly, that’s going to take two or three decades to accomplish.




ANDREW FOSTER: At best. I think people talk about it as if it’s a shift that could happen over five years or maybe even over a decade. I think it’ll be a lot slower in coming. But I think it is a time to be looking at a different facet of growth in China. What I would say, or at least I’m quite convinced of, is that the companies that drove China’s growth in the past will almost assuredly not be the same ones that drive it in the future.


CONSUELO MACK:  So such as?


ANDREW FOSTER: I think the services sector is where I’m particularly focused.  I’m looking at companies that are engaged in software, entertainment, media within China. I think these are parts of the economy that people really don’t associate with China having winners, global winners in any of these industries. And they’re not famous for protecting intellectual property; in fact, tromping on it. Or having freedom of speech. But China is changing very rapidly, and I think the services sector in particular is one to pay attention to.


CONSUELO MACK:  We had the BRICS and now we have what are called MIST, and that’s Mexico, Indonesia, South Korea and Turkey. So Jim O’Neill at Goldman Sachs who coined the BRICS, now has MIST as kind of the next tier, the next generation. And you just said earlier that you have just come back from Turkey recently.




CONSUELO MACK:  So what’s Royce doing in Turkey?


DAVID NADEL:  Well, it was our second trip to Turkey in two-and-a-half years. And I think we are certainly drawn to the macro picture in Turkey. It’s a very young, socially mobile population. I think the median age is about 26. It’s unlevered, not a lot of debt in the society. The banks were all cleaned up in the early 2000s. Not a single bank failed in the global economic crisis. And it is really an exciting market, because of also where it’s positioned, physically.


CONSUELO MACK:  Dangerous and exciting.


DAVID NADEL:  Well, dangerous these days, but I think over the long-term, from an economic perspective, will be quite exciting. And it used to be really a play on European export. But European exports are now roughly equivalent to MENA region exports- MENA meaning Middle East/Africa- for Turkey. So it’s become much less Europe-dependent. And the irony is, now Turkey is really maybe not even interested in joining the Euro, after all the struggles.


CONSUELO MACK:  Because they don’t need the Euro.


DAVID NADEL:  They don’t really, yes, right, exactly. Why go to that party? From a macro perspective, we’re really attracted to it. What we found from a bottoms-up stock selection perspective, and we are like Andrew, we’re bottoms-up stock pickers, ultimately, is that the corporate governance standards of a lot of companies were just not up to our standards. So we do have one investment directly in Turkey. We also have another one which is an Italian company, I mean this is the classic way that we invest, you know, going to the developed market, getting the access to the emerging markets. It’s a pharmaceutical company called Recordati. They are a play on Turkey, Russia, and Eastern Europe. But they have about an 80-year history of productive R&D and a whole pipeline of productive drugs.


CONSUELO MACK:  And they’re Italian.


DAVID NADEL:  They’re a Milan-based company. But Italy’s less than a quarter of their revenues at this point. Truly a global business, family controlled, four percent dividend yield, trades at about six times operating income. Very cheap. Because it’s Italian. I mean, who wants Italian equities, right? But they’re missing the point, because 75% of the revenues are out of Italy. And a big portion of that is Eastern Europe. So that’s kind of how we’re accessing Turkey for now.


CONSUELO MACK:  I mean, so what’s your view of Turkey?


ANDREW FOSTER:  I’m quite excited about that market for very similar reasons that David brought up. I think the region around Turkey is quite unstable right now, and that’s obviously creating some macroeconomic headwinds, both with Europe’s woes, as David mentioned.


CONSUELO MACK:  Syria, right.


ANDREW FOSTER:  And then the military conflict in Syria and also the instability in the Middle East. These are all challenges, but I honestly think when I look at what companies are doing there, bottom-up, I think Turkey can possibly play a role in unifying parts of the region. At least commercially, if not politically. I saw multiple cases of Turkish entrepreneurs spreading out into the region and creating viable intra-region enterprises, and playing a lead role in uniting some of the commercial enterprises in the region. It was irrespective of industry. So I found that a very fascinating trend. It’s, frankly, been around for millennia. The Turkish are not new to this, but the level of rigor that they’re bringing to some of these regional business models is new. And so I’m excited about that.


CONSUELO MACK:  One Investment for long-term diversified portfolio? David Nadel, is there one investment that we all should own some of?


DAVID NADEL:  Sure. I’m going to pick Ashmore Group. Ashmore Group is an emerging markets fixed-income specialist. They also are an emerging markets equity management, based in the U.K.  It’s about almost a four billion dollar company, pays about a four percent dividend. Not expensive, again, for us, six or seven times operating income.


CONSUELO MACK:  And why a wealth management company that specializes in fixed-income?


DAVID NADEL:  And they’re actually the largest company in the world to do this, as a pure play. But the allocations to emerging market fixed-income, and keep in mind this is one of the few reliable sources of yield today. The allocations are less than four percent in the U.S. and in Europe. Japan in the last decade has gone from a four percent allocation to a 24% allocation. Because of course, the Japanese are totally yield-starved.




DAVID NADEL:  And I think that if Americans aren’t yield-starved yet, I don’t know what they’re waiting for.  And the same thing with the Europeans. So my bet is that America and Europe will catch up with Japan, and Ashmore will be a big beneficiary of that.


CONSUELO MACK:  So, Andrew, one investment?


ANDREW FOSTER: Yes, my investment is the Vanguard Total Stock Market Fund. Its ticker is VTSMX.  And I know that’s a little bit off-base, given that we’re both active managers. I believe in active management.


CONSUELO MACK:  No, no, and you also are very focused managers, so this is a total stock market index fund?


ANDREW FOSTER: I’m very much an international investor as well, and I think there’s probably more value overseas than in the U.S., as David, I think, rightly pointed out.  The reason I’m choosing that is it’s aimed at the part of your audience that probably has little exposure to equity markets at all right now. I’ve been traveling around the country a lot lately, setting up my new business, and I just hear a constant refrain about just the amount of fear that’s out there. That there’s any growth left at all. China’s not growing, the U.S. is tepid, Europe is in a dark, dark place.


CONSUELO MACK:  Right, so this is what you’re hearing out there, right?


ANDREW FOSTER: And the exposure that people have to growth assets and equities in particular, I think is very low. And I’m not trying to dismiss the major concerns that are out there in markets at present. They are serious. But I think it is not really a satisfactory response, in my mind, to retreat from markets altogether. So I’m recommending a very basic fund with low expenses, and I believe mightily in low expenses, that gives people a broad exposure to markets. It’s a way to get back in. If you haven’t been in, I think you do need to be in markets. Maybe you don’t jump in, but you at least put more than a toe in; maybe a foot at this stage.


CONSUELO MACK:  Well, thank you both very much.  You are both really stepped into equities up to your necks, in your businesses, your portfolios as well. So thanks so much for joining us. David Nadel, it’s always a treat to have you from Royce, the Global Value Fund, among many others.


DAVID NADEL:  Good to be on your show again.


CONSUELO MACK:  And Andrew Foster, you know, congratulations on setting out on your own with Seafarer.




CONSUELO MACK:  And may you have happy sailing ahead of you.




CONSUELO MACK:  It’s great to have you both on WEALTHTRACK.




DAVID NADEL:  Thanks again.


CONSUELO MACK:  At the conclusion of every WEALTHTRACK, we give you one suggestion to help you build and protect your wealth over the long term. This week’s Action Point is one we have recommended before and is particularly relevant given our discussion. It is: consider a diversified approach to investing in emerging markets.


The simplest, cheapest, most straight-forward way to invest in growing developing markets is through an ETF. Vanguard’s Emerging Markets ETF is an inexpensive pure play recommended by Morningstar. If you prefer the skills of a portfolio management team for a broadly based emerging markets stock fund, Morningstar recommends American Funds New World Fund, which is more conservative than many of its peers and has low expenses. It does charge a front-end load however.


And that concludes this edition of WEALTHTRACK. Thank you for watching and make the week ahead a profitable and a productive one.


October 26, 2012

Morningstar recommends: For a more passive approach- Vanguard Emerging Markets ETF (VWO)
VWO Chart

VWO data by YCharts

For a more active approach- American Funds New World Fund (NEWFX)

Watch this episode here.


October 26, 2012

“Price matters!” Pay too much for the stock of even the greatest company and you can lose money. That’s what Great Investor Bruce Berkowitz, portfolio manager of The Fairholme Fund told WEALTHTRACK recently. This week’s guests couldn’t agree more. They are searching far and wide for the best bargains. They are finding them, not in the U.S. but overseas. Andrew Foster is the Founder and Chief Investment Officer of Seafarer Capital Partners which focuses on companies in emerging markets. David Nadel is the Director of International Research for Royce & Associates where he concentrates on smaller companies. Continue Reading »

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