Beyond DCF: Investment lessons from a career spanning four decades

How have emerging markets (EMs) changed over the last 35 years? And, perhaps more importantly, where do you see them going from here?

Emerging markets have changed a lot. Major countries such as South Korea, Taiwan have graduated to advanced, high income status. And China is on the way to becoming a middle income country. Almost all EMs have developed orthodox economic structures, with standard features like central banks and regulated banking systems.

Emerging markets are dominant or major players in a number of industries and sectors like shipbuilding, energy and semiconductors. They are also home to some of world’s leading companies. TSMC, Samsung, Hynix, Tencent, DJI, Alibaba, Infosys, Vale. The list goes on.

There have been many different economic and political phases, too. From 1980 to 2008 we saw the adoption of “Washington Consensus” driven by the International Monetary Fund and the World Bank, which ushered in free markets, sound monetary policy and lighter touch government. Whereas post the global financial crisis there has been some rollback; regulation and geopolitics are now playing a bigger role in both emerging and developed markets.

After China, do you see any country or region becoming similarly important in economic and market terms over the next 10 years?

India is the obvious choice. Its scale and huge domestic market provides a fertile ground for big companies to grow. Vietnam and Indonesia are smaller in size but are also poised to play a more important role. The population there expect better governance and it seems that they are also getting it.

What are your favourite and most intriguing EM countries?

That is a really hard question. In terms of intriguing and most memorable, I would say North Korea and Iran—but not for investment reasons. Before sanctions kicked in, I travelled in these countries and I learned two main things. First, do not believe what you read in the newspapers and do not confuse hostile or bad government with the people of the country. Second, people everywhere have the same concerns: family and happiness.

Russia is equally beguiling. Its vast size spans from arctic to subtropical territory. If Russia focused on maximizing the land and its people instead of acquiring more land, it could be the most powerful country in the world. Then there are India and China. They have to be included because of the vast scale and variety in their cultures and populations.

What are the key ingredients of building and leading a successful team?

I have thought about this a lot over the years and have boiled it down to five things:

1. Hire good people and give them room to exercise their creativity.
2. Agree clear attainable objectives for the team and each individual.
3. Ensure you create a culture based on common goal and values. E.g., the clients’ risk adjusted return; high ethical standards; collegiality and candor—always be friendly and respectful but don’t be afraid to address problems.
4. Create a challenging but interesting and enjoyable place to work.
5. Share the rewards fairly, transparently.

Markets can humble the most seasoned investors. What lessons have you learnt?

No situation is ever the same. So experience is valuable, but there are always new ways to make mistakes. In investing and in life it is important to differentiate between what are long-term eternal truths to what is a passing fad. As an example of a truth: companies with high return on capital are generally better investments. Whereas an example of a fad is that value stocks outperform. This was true from 1950-1980, but not over the last few decades. So moats can fade. Just look at Coke versus water, or Li & Fung. It is important to learn to see the sea change.

Finally, people are always important. Invest wisely in them and the rest usually takes care of itself.

With geopolitics and macro increasingly driving markets, fundamental discounted cash flow (DCF) based analysis is becoming more tricky – how does an investment team evolve and adapt?

We are taking advantage of the progress on the technological front. AI and big data are valuable components of the toolkit. They are complementary to what we do. Context is important and humans can take into account context better than AI. But machines can crunch through data better than humans as they are more objective.

Also frequent self-examination of investment process and assumptions is crucial. The annual offsite meetings that we hold is a good example of where we take two days off from our daily tasks in order to do some introspection and ask ourself what we have learnt and what we can do better.

In your opinion, what makes a good investor?

There are many ways to be a good investor: quants, fundamental, trading, and so on. But there are some common traits.

First is an inclination to think differently; to be automatically thinking, “what is wrong with consensus, what has the market got wrong?” Most humans want to be agreeable. Investing is one area where being agreeable does not help. Second, put more weight on facts rather than opinion, whether your own, from brokers, or even experts. Russia is a great example; look relentlessly for relevant factual evidence. And lastly, try to look at stock from as many angles as possible. Doing so should minimize the nasty surprises as you are looking far beyond just the main drivers of a stock.

How do you maintain your interest in your work, particularly in tough periods like the one we are in now?

To me, investing is always interesting. There is always something new happening; new technologies, consumer trends, politics and so on.

In tough periods, I try to treat the challenge as a technical one and minimize emotions. By asking questions like, why is there underperformance? Will it pass by itself or is there an improvement we need to make? You can treat it more like a mathematical problem. Focusing the team in this way also minimizes blame and motivates them to be constructive.

Inevitably there is some element of emotional response. Dealing with stress at 4 a.m. requires a pleasant mental distraction. Hobbies are effective and riding and tweaking my bike have tended to work for me.

You graduated with a degree in technology from MIT and initially worked in artificial intelligence (AI). AI has had many false starts over the past few decades. Is this time different?

I worked in AI just as the AI winter came in the 1980s. I had the chance to work with some top MIT professors and Nobel Prize winners. Back then, researchers were attempting to understand human thinking using hardware that was over a hundred times less powerful than today’s computers. Whereas now our computers are vastly more powerful and all we are trying to do is make the computer drive a car. So the hardware has improved dramatically and yet our ambition has shrank. So I think it is different this time in that we can deliver more humble but realistic and useful applications.

If you had 100K to invest today with your home as the only other asset alongside – where would you invest it?

There are very few free lunches available in investing. But diversification is one of them. I would invest in portfolio that is diversified across different countries and asset classes. That is how any long-term portfolio should be disposed.

In terms of specifics, Vietnam, India, and Indonesia over the long run – although India and Indonesia have done well over the last two years.

What would you say to a young person about a career in finance. Is it just about the money, or is there a deeper purpose and meaning?

Society’s view of finance has evolved significantly since I entered the industry in the 1980s. In those days, the Berlin wall had just come down, China had started to open up its economy, and markets were going to lift billions of people out of poverty. We felt very good about entering the industry. Especially in emerging markets where we were channeling capital into emerging countries; directly lifting up the living standards of the world’s lower income population.

The narrative has changed since the global financial crisis. Markets are now blamed for inequality and other problems. However, let’s look at it objectively: there is no rich country that is not a market economy. If you compare the non-market economies – i.e., North Korea and Cuba – they have well educated people and yet are still impoverished.

On the other hand, even the poorest countries that adopted market economics have progressed rapidly. I vividly remember my early company visits in India and China in the early 1990s. There were dirt roads and brown water flowed out of the taps. People walking on the street missing a leg or arm because of inadequate medical care. Things have changed drastically and markets have made this possible. So one should feel good about contributing to this progress in some way.

Now that DCF analysis, research trips, client meetings will be a thing of the past for you, what are you looking forward to in the next phase of your life?

I will always be an investor. The stimulation of thinking about what is happening in the world and expressing that view through investing and then having the market judge whether you are right or wrong is invigorating and keeps you engaged with the world. When I wake up in the morning, something Putin or Powell said may have a direct impact on my portfolio.

But I will do other things. I would like to be involved with companies or organizations that are bringing some significant benefit to the world; whether that be through a better environment, healthcare, or innovative technology.

What do you read and do you have any book recommendations?

I read all sorts of things: science, economics, history, novels and much more besides. It is usually what most people find too serious; I don’t have much patience for fluffy novels. Here is a list of some of my favourites over the years:

This time is different – Reinhardt and Rogoff
The art of war – Sun Tzu
The black swan – Nassim Nicholas Taleb
Market Wizards – Jack D. Schwager
The price of inequality – Joseph Stiglitz
When genius failed – Roger Lowenstein
The alchemy of finance – George Soros
One up on Wall Street – Peter Lynch
The unbearable lightness of being – Milan Kundera
Siddartha – Herman Hesse
A history of western philosophy – Bertrand Russell
On human nature – E O Wilson
The heritage of Chinese civilization – Albert M. Craig
Pioneering portfolio management – David Swenson
Behave – Robert Sapolsky
Beyond religion – Dalai Lama
The lessons of history – Ariel and Will Durant
The checklist manifesto – Atul Gawande
Thinking fast and slow – Daniel Kahneman
Factfulness – Hans Rosling

In terms of the books and people that have most impacted my thinking on investments, I would have to say: Lynch – One up on Wall Street; Swenson – Pioneering portfolio management; and Ray Dalio’s “Changing World Order” video.

What will you miss most in retirement? And do you have any words of encouragement for the team?

Debating markets with the team and industry peers. Having the flow of information that is available to us as institutional investors. The collegiality in our team and the firm. These are all things I will miss.

There is an old Persian saying: “This too shall pass”, and it refers to anything bad or good. The market has cycles and when you are in the bad phase, it feels like it is lasting a long time. But, remember, it will pass.